Part III. Administrative, Procedural, and Miscellaneous

spect to the date by which they must adopt amendments to comply with changes in the law, including a remedial amendment period for amendments to reflect changes to the qualification requirements made by SBJPA.

C. Definitions

If a term that is used in this notice is defined in the regulations under § 401(k) or § 401(m), then the definition under these regulations applies for purposes of this notice. For example, “plan” as used in this notice means plan as defined in § 1.401(k)–1(g)(11) of the Income Tax Regulations.

In addition, for purposes of this notice, the “testing year” is the plan year for which the ADP or ACP for HCEs is being tested; the “prior year” is the plan year immediately preceding the testing year. If the plan uses data from the testing year in determining the ADP or ACP for NHCEs, it is using the “current year testing method;” if the plan uses data from the prior year in determining the ADP or ACP for NHCEs, it is using the “prior year testing method.”

Sections V and VI of this notice provide additional definitions used in applying the first plan year rule and definitions used in the rules relating to changes in the group of eligible employees when a plan uses the prior year testing method.

Because of the amendments made to § 401(k) and § 401(m), certain portions of § 1.401(k)–1 and §§ 1.401(m)–1 and 1.401(m)–2 no longer reflect current law. This notice provides guidance on a limited number of issues relating to the use of the prior year testing method and relating to a change in testing method. The regulations shall continue in force to the extent that they are not inconsistent with the Code, as amended, and subsequent guidance, including Notice 97–2 and this notice.

III. USE OF CURRENT YEAR

TESTING METHOD

As provided under § 401(k)(3)(A) and § 401(m)(2)(A), an employer may elect to

Cash or Deferred Arrangements; Nondiscrimination

Notice 98–1

I. PURPOSE

This notice provides guidance and transition relief relating to recent statutory amendments to the nondiscrimination rules under § 401(k) and § 401(m) of the Internal Revenue Code. The rules applicable to qualified cash or deferred arrangements under § 401(k) and matching and employee contributions under § 401(m) were amended by the Small Business Job Protection Act of 1996 (SBJPA), Pub. L. 104–188. Specifically, this notice provides guidance on

• The election to use the current year testing method.

• The use of qualified nonelective contributions (QNCs) and qualified matching contributions (QMACs) under the prior year testing method.

• The application of the first plan year rule under the prior year testing method.

• The impact of certain plan population changes under the prior year testing method.

• A change from the current year testing method to the prior year testing method, including related transition relief.

• Plan amendments needed to reflect the testing method of a plan, including the application of the remedial amendment period under § 401(b).

II. BACKGROUND

A. SBJPAAmendments to § 401(k)

and § 401(m)

Under § 401(k) and § 401(m), the actual deferral percentage (ADP) and the actual contribution percentage (ACP) of highly compensated employees (HCEs) are compared with those of nonhighly compensated employees (NHCEs). Section 1433(c) of SBJPA amended § 401(k)(3)(A) and § 401(m)(2)(A), effective for plan years beginning after De

cember 31, 1996, to provide for the use of prior year data in determining the ADP and ACP for NHCEs, while continuing to provide for the use of current year data for HCEs. Alternatively, an employer may elect to use current year data for determining the ADP and ACP for both HCEs and NHCEs, but the statute provides that this election may be changed only as provided by the Secretary. Section 1433(d) of SBJPA amended § 401(k)(3) and § 401(m)(3) to provide a special rule for determining the ADP and ACP for NHCEs for the first plan year of a plan (other than a successor plan) where the prior year testing method is used.

B. Guidance on the SBJPA

Amendments

Notice 97–2, 1997–2 I.R.B. 22, provides guidance on determining the individuals who are taken into account in computing the ADP or ACP for NHCEs for the prior year under the prior year testing method. The guidance provides transition relief to allow plans using the current year testing method for the 1997 testing year to change to the prior year testing method for the 1998 testing year without obtaining approval from the Internal Revenue Service. The notice also provides rules for distributions of excess contributions and excess aggregate contributions.

Notice 97–2 states that Treasury and the Service will issue guidance regarding the conditions under which employers that elect to use current year data for the 1998 or a later plan year may change that election and use prior year testing for subsequent plan years. Notice 97–2 also requested comments concerning (i) the use of QNCs and QMACs in computing the prior year’s ADP for NHCEs, including methods of preventing inappropriate double counting; and (ii) the appropriate determination of the prior year’s ADP for NHCEs when the group of employees tested is significantly different in the current year than in the prior year. After consideration of the comments received, this notice provides guidance on these issues.

Rev. Proc. 97–41, 1997–33 I.R.B. 51, provides guidance to sponsors of plans that are qualified under § 401(a) with re

D. Effect of Statutory Changes on

Regulations

January 20, 1998 42 1998–3 I.R.B.

they are allocated, while QNCs allocated to the accounts of NHCEs will not be taken into account in determining the permitted ADP or ACP for HCEs until the following plan year.

V. FIRST PLAN YEAR RULE

UNDER PRIOR YEAR TESTING METHOD

Section 401(k)(3)(E) provides that, for the first plan year of any plan (other than a successor plan) that uses the prior year testing method, the ADP for NHCEs for the prior year is 3%, or, if the employer elects, is the ADP for NHCEs for that first plan year. For this purpose, the “first plan year” of any plan is the first year in which the plan, within the meaning of § 414(l), is or includes a section 401(k) plan (i.e., the first year a plan provides for elective contributions described in § 1.401(k)–1(g)(3)). However, a plan does not have a first plan year if for such plan year the plan is aggregated under § 1.401(k)–1(g)11) with any other plan that was or that included a section 401(k) plan in the prior year.

Section 401(m)(3) provides that rules similar to the rules of § 401(k)(3)(E) shall apply for purposes of the ACP test. For purposes of the ACP test, the “first plan year” of any plan is the first year in which a plan, within the meaning of § 414(l), is or includes a section 401(m) plan (i.e., the first year a plan provides for employee contributions described in § 1.401(m)– 1(f)(6) or matching contributions described in § 1.401(m)–1(f)(12), or both). However, a plan does not have a first plan year if for such plan year the plan is aggregated for purposes of § 1.401(m)– 1(g)(14) with any other plan that was or that included a section 401(m) plan in the prior year.

For purposes of this notice, a plan is a “successor plan” if 50% or more of the eligible employees for the first plan year were eligible employees under another section 401(k) plan (or section 401(m) plan, as applicable) maintained by the employer in the prior year. For example, in 1998, Employer H sponsors Plan T, a section 401(k) plan. In 1999, Employer H establishes Plan U, also a section 401(k) plan, which had 200 eligible employees, including 100 employees who were eligible employees under Plan T in 1998. Plan U is a successor plan.

use the current year testing method for a plan in lieu of the prior year testing method. A plan using the prior year testing method may adopt the current year testing method for any subsequent testing year. Notification to or filing with the Service of an election to use the current year testing method is not required in order for the election to be valid. However, as provided in section IX of this notice, the plan document governing the plan must reflect whether the plan uses the current year testing method or the prior year testing method for a testing year.

A plan that uses the current year testing method for a testing year may not be permissively aggregated under § 1.410(b)– 7(d) with a plan that uses the prior year testing method for that testing year.

IV. USE OF QNCs AND QMACs

UNDER PRIOR YEAR TESTING METHOD

Section 401(k)(3)(D) and § 401(m)(3) provide that an employer may take into account QNCs and QMACs in calculating the ADP, and QNCs in calculating the ACP, as provided by the Secretary. A plan may continue to take QNCs and QMACs into account under the prior year testing method, subject to the limitations set forth in section VII.B. of this notice.

A. Timing of Contribution of QNCs

and QMACs

In order to be taken into account in the calculation of the ADP or ACP for a year under the prior year testing method, a QNC or QMAC must be allocated as of a date within the year and must actually be paid to the trust no later than the end of the 12-month period following the end of the year to which the contribution relates. See §§ 1.401(k)–1(b)(4)(i)(A) and (b)(5)(v) and §§ 1.401(m)–1(b)(4)(ii) and (b)(5)(iv). Consequently, under the prior year testing method, in order to be taken into account in calculating the ADP or ACP for NHCEs for the prior year, a QNC or QMAC must be contributed by the end of the testing year. Thus, for example, if the prior year testing method is used for the 1998 testing year, QNCs that are allocated to the accounts of NHCEs for the 1997 plan year (i.e., the prior year) must be contributed to the plan by the end of

the 1998 plan year in order to be treated as elective contributions for purposes of the ADP test for the 1998 testing year. By contrast, in order to be taken into account in calculating the ADP or ACP for HCEs for the 1998 testing year, a QNC or QMAC must be contributed by the end of the 1999 plan year.

It should be noted that § 1.415–6(b)(7)(ii) provides that, for purposes of satisfying § 415, employer contributions shall not be deemed credited to a participant’s account for a particular limitation year unless the contributions are actually made to the plan no later than 30 days after the end of the period described in § 404(a)(6) applicable to the taxable year with or within which the particular limitation year ends. Thus, contributions made after the date described in § 1.415–6(b)(7)(ii) are treated as annual additions for the next § 415 limitation year. Accordingly, under either the prior year testing method or the current year testing method, a violation of § 415(c) might occur if QNCs or QMACs are contributed after the date described in § 1.415–6(b)(7)(ii).

B. Nondiscrimination Testing of

QNCs under the Prior Year Testing Method

Section 1.401(k)-1(b)(5) provides that (i) the amount of nonelective contributions, including those QNCs treated as elective contributions for purposes of the ADP test, and (ii) the amount of nonelective contributions, excluding those QNCs treated as elective contributions for purposes of the ADP test, must each satisfy the requirements of § 401(a)(4). Under § 1.401(m)-1(b)(5), a similar rule applies to QNCs treated as matching contributions for purposes of the ACP test.

These nondiscrimination requirements continue to apply to plans that use the prior year testing method. This is true even though the QNCs allocated to the HCEs and NHCEs in a single plan year are taken into account for ADP and ACP testing in different testing years. Accordingly, QNCs allocated to the accounts of NHCEs and HCEs for the same plan year will be subject to the requirements of § 401(a)(4) for that plan year; however, QNCs allocated to the accounts of HCEs will be taken into account for ADP or ACP testing in the plan year for which

1998–3 I.R.B 43 January 20, 1998

If a plan (other than a successor plan) uses the prior year testing method and for its first plan year the plan determines the ADP or ACP for NHCEs for the prior plan year using the ADP or ACP for NHCEs for that first plan year (in lieu of 3%), then the use of the prior year testing method in the next testing year is not treated as a change in testing method. Such a plan would not be subject to the limitations on double counting described in section VII.B. for that next testing year. If a successor plan uses the prior year testing method for its first plan year, the ADP and ACP for NHCEs for the prior year are determined under the rules in section V of this notice.

VI. CHANGES IN THE GROUP OF

ELIGIBLE NHCEs WHERE PLAN USES PRIOR YEAR TESTING METHOD

A. General Rule: Disregard Changes

in the Group of NHCEs

Except as provided in section VI.B. and C., below, under the prior year testing method, the ADP or ACP for NHCEs for the prior year under a plan is determined without regard to changes in the group of NHCEs who are eligible employees under the plan in the testing year. Thus, under the prior year testing method, the prior year ADP or ACP for NHCEs is used even though some NHCEs may have first become eligible employees under the plan in the testing year because they meet existing plan eligibility requirements, and even though individuals who were eligible employees under the plan and NHCEs in the prior year are no longer employed by the employer or have become HCEs in the testing year.

B. Exception for Plan Coverage

Changes

If a plan results from, or is otherwise affected by, a plan coverage change that becomes effective during the testing year, then the ADP and ACP for NHCEs for the prior year under the plan is the weighted average of the ADPs for the prior year subgroups and the weighted average of the ACPs for the prior year subgroups, respectively.

C. Optional Rule for Minor Plan

Coverage Changes

If a plan results from, or is otherwise affected by, a plan coverage change, and 90% or more of the total number of NHCEs from all prior year subgroups are from a single prior year subgroup, then in determining the ADP or ACP for NHCEs for the prior year under the plan, an employer may elect to use the ADP and ACP for NHCEs for the prior year of the plan under which that single prior year subgroup was eligible, in lieu of using the weighted averages described in section VI.B., above.

D. Definitions

For purposes of this notice:

1. “Plan coverage change” means a change in the group or groups of eligible employees under a plan on account of (a) the establishment or amendment of a plan, (b) a plan merger, consolidation, or spinoff under § 414(l), (c) a change in the way plans within the meaning of § 414(l) are combined or separated for purposes of § 1.401(k)–1(g)(11) (e.g., permissively aggregating plans not previously aggregated under § 1.410(b)–7(d), or ceasing to permissively aggregate plans under § 1.410(b)–7(d)), or (d) a combination of any of the foregoing.

2. “Prior year subgroup” means all NHCEs for the prior year who, in the prior year, were eligible employees under a specific section 401(k) plan (or, in the case of the ACP test, a specific section 401(m) plan) maintained by the employer and who would have been eligible employees in the prior year under the plan being tested if the plan coverage change had first been effective as of the first day of the prior year instead of first being effective during the testing year.

3. “Weighted average of the ADPs for the prior year subgroups” and “weighted average of the ACPs for the prior year subgroups” mean the sum, for all prior year subgroups, of the adjusted ADPs and adjusted ACPs, respectively.

4. “Adjusted ADP” and “adjusted ACP” with respect to a prior year subgroup mean the respective ADP and ACP for NHCEs for the prior year of the spe

cific plan under which the members of the prior year subgroup were eligible employees, multiplied by a fraction, the numerator of which is the number of NHCEs in the prior year subgroup and the denominator of which is the total number of NHCEs in all prior year subgroups.

E. Examples

The requirements of this section VI are illustrated by the following examples:

Example 1:

(i) Employer B maintains two plans, Plan N and Plan P, each of which includes a section 401(k) plan. The plans were not permissively aggregated under § 1.410(b)–7(d) for the 1998 testing year. Both plans use the prior year testing method. Plan N had 300 eligible employees who were NHCEs for 1998, and their ADP for that year was 6%. Plan P had 100 eligible employees who were NHCEs for 1998, and the ADP for those NHCEs for that plan was 4%. Plan N and Plan P are permissively aggregated under § 1.410(b)–7(d) for the 1999 plan year.

(ii) The permissive aggregation of Plan N and Plan P for the 1999 testing year under § 1.410(b)–7(d) is a plan coverage change that results in treating the plans as one plan (Plan NP) for purposes of § 1.401(k)–1(g)(11). Therefore, the prior year ADP for NHCEs under Plan NP for the 1999 testing year is the weighted average of the ADPs for the prior year subgroups.

(iii) The first step in determining the weighted average of the ADPs for the prior year subgroups is to identify the prior year subgroups. With respect to the 1999 testing year, an employee is a member of a prior year subgroup if the employee (A) was an NHCE of Employer B for the 1998 plan year, (B) was an eligible employee for the 1998 plan year under any section 401(k) plan maintained by Employer B, and (C) would have been an eligible employee in the 1998 plan year under Plan NP if Plan N and Plan P had been permissively aggregated under § 1.410(b)–7(d) for that plan year. The NHCEs who were eligible employees under separate section 401(k) plans for the 1998 plan year comprise separate

January 20, 1998 44 1998–3 I.R.B.

NHCEs who would have been eligible employees under Plan R for the 1998 plan year if the plan were established as of the first day of that plan year were eligible employees under Plan Q). Therefore, for purposes of the 1999 testing year under Plan R, the ADP for NHCEs for the prior year is the weighted average of the ADPs for the prior year subgroups, or 5%, the same as that of Plan Q.

Example 4:

(i) The facts are the same as in Example 3, except that the provisions of Plan R extend eligibility to 50 hourly employees who previously were not eligible employees under any section 401(k) plan maintained by Employer C.

(ii) Plan R is a successor plan, within the meaning of section V of this notice (because 100 of Plan R’s 150 eligible employees were eligible employees under another section 401(k) plan maintained by Employer C in the prior year), and, therefore, the first plan year rule of that section does not apply.

(iii) The establishment of Plan R is a plan coverage change that affects Plan R. Because the 50 hourly employees were not eligible employees under any section 401(k) plan of Employer C for the prior year, they do not comprise a prior year subgroup. Accordingly, Plan R still has only one prior year subgroup. Therefore, for purposes of the 1999 testing year under Plan R, the ADP for NHCEs for the prior year is the weighted average of the ADPs for the prior year subgroups, or 5%, the same as that of Plan Q.

VII. CHANGE FROM CURRENT

YEAR TO PRIOR YEAR TESTING METHOD

A. General Rule

Section 401(k)(3)(A) provides that if an employer elects to use the current year testing method for purposes of the ADP test, that method may not be changed except as provided by the Secretary. A similar rule applies under § 401(m)(2)(A) in the case of the ACP test. Thus, the statute indicates that once an employer elects to use the current year testing method, the ability to change that election will be limited.

In general, it is expected that plans will select a testing method and retain it.

prior year subgroups. Thus, there are two prior year subgroups under Plan NP for the 1999 testing year: the 300 NHCEs who were eligible employees under Plan N for the 1998 plan year and the 100 NHCEs who were eligible employees under Plan P for the 1998 plan year.

(iv) The weighted average of the ADPs for the prior year subgroups is the sum of: (A) the adjusted ADP with respect to the prior year subgroup that consists of the NHCEs who were eligible employees under Plan N, and (B) the adjusted ADP with respect to the prior year subgroup that consists of the NHCEs who were eligible employees under Plan P. The adjusted ADP for the prior year subgroup that consists of the NHCEs who were eligible employees under Plan N is 4.5%, calculated as follows: 6% (the ADP for the NHCEs under Plan N for the prior year) x 300/400 (the number of NHCEs in that prior year subgroup divided by the total number of NHCEs in all prior year subgroups), which equals 4.5%. The adjusted ADP for the prior year subgroup that consists of the NHCEs who were eligible employees under Plan P is 1%, calculated as follows: 4% (the ADP for the NHCEs under Plan P for the prior year) � 100/400 (the number of NHCEs in that prior year subgroup divided by the total number of NHCEs in all prior year subgroups), which equals 1%. Thus, the prior year ADP for NHCEs under Plan NP for the 1999 testing year is 5.5% (the sum of adjusted ADPs for the prior year subgroups, 4.5% plus 1%).

Example 2:

(i) Employer C maintains a plan, Plan Q, which includes a section 401(k) plan and which uses the prior year testing method. Plan Q covers employees of Division A and Division B. In 1998, Plan Q had 500 eligible employees who were NHCEs, and the ADP for those NHCEs for 1998 was 5%. Effective January 1, 1999, Employer C spins off a portion of Plan Q under § 414(l), creating a new Plan R which includes a section 401(k) plan in which the 100 employees of Division B are eligible employees.

(ii) The spin-off of Plan R is a plan coverage change that affects Plan Q. Accordingly, for purposes of the 1999 testing year under Plan Q, the prior year ADP

for NHCEs under Plan Q is the weighted average of the ADPs for the prior year subgroups. Plan Q has only one prior year subgroup (because the only NHCEs who would have been eligible employees under Plan Q for the 1998 plan year if the spin-off had occurred as of the first day of that plan year were eligible employees under Plan Q). Therefore, for purposes of the 1999 testing year under Plan Q, the ADP for NHCEs for the prior year is the weighted average of the ADPs for the prior year subgroups, or 5%, the same as if the plan spin-off had not occurred.

Example 3:

(i) The facts are the same as in Example 2, except that instead of spinning off Plan R from Plan Q, Employer C amends the eligibility provisions under Plan Q to exclude employees of Division B effective January 1, 1999. In addition, effective on that same date, Employer C establishes a new plan, Plan R, which includes a section 401(k) plan that uses the prior year testing method. The only eligible employees under Plan R are the 100 employees of Division B who were eligible employees under Plan Q.

(ii) Plan R is a successor plan, within the meaning of section V of this notice (because all of the employees were eligible employees under Plan Q in the prior year), and, therefore, the first plan year rule of that section does not apply.

(iii) The amendment to the eligibility provisions of Plan Q and the establishment of Plan R are plan coverage changes that affect Plan Q and result in Plan R. Accordingly, the prior year ADP for NHCEs under Plan Q is the weighted average of the ADPs for the prior year subgroups. Plan Q has only one prior year subgroup (because the only NHCEs who would have been eligible employees under Plan Q for the 1998 plan year if the amendment to the Plan Q eligibility provisions had occurred as of the first day of that plan year were eligible employees under Plan Q). Therefore, for purposes of the 1999 testing year under Plan Q, the ADP for NHCEs for the prior year is the weighted average of the ADPs for the prior year subgroups, or 5%, the same as if the plan amendment had not occurred.

(iv) Similarly, Plan R has only one prior year subgroup (because the only

1998–3 I.R.B 45 January 20, 1998

that changes from the current year to the prior year testing method for the first time for either the 1997 or 1998 testing year, the ADP and ACP for NHCEs used for that testing year are the same as the ADP and ACP, respectively, for NHCEs used for the prior testing year.

3. Examples

The limitations on double counting are illustrated by the following examples:

Example 1:

(i) Employer A established Plan M, a calendar year section 401(k) plan, in 1993 and, through the 2000 testing year, has always used the current year testing method under Plan M. The ADP for the HCEs under Plan M is 7% for the 2000 testing year. Based solely on elective contributions by NHCEs under Plan M for the 2000 testing year, the ADP for NHCEs for the 2000 testing year is 4%. In order to satisfy the ADP test, Employer A provides a QNC to each NHCE for the 2000 testing year equal to 1% of compensation. No other contributions under Plan M are taken into account in determining the ADP for NHCEs. Thus, the ADP for NHCEs for the 2000 testing year is 5%. Plan M is amended to use the prior year testing method instead of the current year testing method for purposes of the ADP test for the 2001 testing year.

(ii) In determining the ADP for NHCEs under Plan M for the 2001 testing year in accordance with the prior year testing method, the elective contributions made by NHCEs under Plan M for the 2000 plan year are taken into account. However, the QNCs equal to 1% of compensation made under Plan M on behalf of NHCEs for the 2000 plan year are disregarded because they were used to satisfy the ADP test for the 2000 testing year. Thus, for purposes of the 2001 testing year, the ADP for NHCEs for the prior year is 4% (unless additional QNCs for NHCEs are timely contributed and allocated for the 2000 plan year).

Example 2:

(i) The facts are the same as in Example 1, except that the testing years are 1997 and 1998, instead of 2000 and 2001. (ii) For purposes of the 1998 testing year, the ADP for NHCEs for the prior

Treasury and the Service recognize, however, that there may be legitimate reasons for occasionally reevaluating and changing the testing method under a plan. In addition, certain business transactions may result in a diversity of testing methods among plans of an employer, and the employer may wish to use consistent testing methods. Finally, Treasury and the Service believe that employers with existing plans should be given a period of time to decide whether to change from the current year testing method (which was the required testing method prior to the SBJPA changes) to the prior year testing method.

Accordingly, a plan is permitted to change from the current year testing method to the prior year testing method in any of the following situations:

1. The plan is not the result of the aggregation of two or more plans, and the current year testing method was used under the plan for each of the 5 plan years preceding the plan year of the change (or if lesser, the number of plan years the plan has been in existence, including years in which the plan was a portion of another plan).

2. The plan is the result of the aggregation of two or more plans, and for each of the plans that are being aggregated (the aggregating plans), the current year testing method was used for each of the 5 plan years preceding the plan year of the change (or if lesser, the number of plan years since that aggregating plan has been in existence, including years in which the aggregating plan was a portion of another plan).

3. A transaction occurs that is described in § 410(b)(6)(C)(i) and § 1.410(b)–2(f); as a result of the transaction, the employer maintains both a plan using the prior year testing method and a plan using the current year testing method; and the change from the current year testing method to the prior year testing year method occurs within the transition period described in § 410(b)(6)(C)(ii).

4. The change occurs during the plan’s remedial amendment period for the SBJPA changes (see Rev. Proc. 97–41). Notification to or filing with the Service of a change from the current year to the prior year testing method is not required in order for the change to be valid. However, as provided in section IX of this no

tice, the plan document governing the plan must reflect such a change.

B. Limitations on Double Counting of Certain Contributions

If a plan changes from the current year testing method to the prior year testing method, then, for purposes of the first testing year for which the change is effective, the ADP and ACP for NHCEs for the prior year is determined in the following manner:

1. The ADP for NHCEs for the prior year is determined taking into account only (a) elective contributions for those NHCEs that were taken into account for purposes of the ADP test (and not the ACP test) under the current year testing method for the prior year and (b) QNCs that were allocated to the accounts of those NHCEs for the prior year but that were not used to satisfy the ADP test or the ACP test under the current year testing method for the prior year.

2. The ACP for NHCEs for the prior year is determined taking into account only (a) employee contributions for those NHCEs for the prior year, (b) matching contributions for those NHCEs that were taken into account for purposes of the ACP test (and not the ADP test) under the current year testing method for the prior year, and (c) QNCs that were allocated to the accounts of those NHCEs for the prior year but that were not used to satisfy the ACP test or the ADP test under the current year testing method for the prior year. Thus, in determining the ADP for NHCEs for the prior year, the following contributions made for the prior testing year are disregarded: QNCs used to satisfy either the ADP or ACP test under the current year testing method for the prior testing year, elective contributions taken into account for purposes of the ACP test, and all QMACs. Similarly, in determining the ACP for NHCEs for the prior year, the following contributions made for the prior testing year are disregarded: QNCs used to satisfy either the ADP or ACP test under the current year testing method for the prior testing year, QMACs taken into account for purposes of the ADP test, and all elective contributions.

The limitations on double counting under this section VII.B. do not apply for testing years beginning before January 1, 1999. Accordingly, in the case of a plan

January 20, 1998 46 1998–3 I.R.B.

year is 5%. The QNCs equal to 1% of compensation made under Plan M on behalf of NHCEs that were used to satisfy the ADP test for the 1997 testing year are not disregarded because the limitation on double counting applies only for testing years beginning on or after January 1, 1999.

VIII. ANTI-ABUSE PROVISION

This guidance is designed to provide simple, practical rules that accommodate legitimate plan changes. At the same time, the rules are intended to be applied by employers in a manner that does not make use of changes in plan testing procedures or other plan provisions to inflate inappropriately the prior year ADP and ACP for NHCEs (which are used as benchmarks for testing the ADP and ACP for HCEs). Further, the ADP and ACP tests are part of the overall requirement that benefits or contributions not discriminate in favor of HCEs. Therefore, a plan will not be treated as satisfying the ADP or ACP test if there are repeated changes in plan testing procedures or plan provisions that have the effect of distorting the ADP or ACP test so as to increase significantly the permitted ADP or ACP for HCEs and if a principal purpose of the changes was to achieve such a result.

IX. PLAN PROVISIONS

REGARDING TESTING METHOD

Sections 1.401(k)–1(b)(2)(iii) and 1.401(m)–1(b)(2) require that a plan to which § 401(k) or § 401(m) applies must provide that the ADP or ACP test will be met. Because a plan may now use either the current year testing method or the prior year testing method, a plan must specify which of these two testing methods it is using. If the employer changes the testing method under a plan, the plan must be amended to reflect the change. Further, if the first plan year rule described in § 401(k)(3)(E) and § 401(m)(3) and section V of this notice applies, a plan that incorporates these provisions by reference must specify whether the ADP and ACP for NHCEs for the prior plan year is 3% or the current year’s ADP and ACP for the NHCEs.

The regulations under § 401(k) and § 401(m) permit a plan to incorporate by reference § 401(k)(3) and § 401(m)(2)

(and, if applicable, § 401(m)(9)) and the specific underlying regulations. A plan that incorporates these provisions by reference must continue to refer to the applicable Code sections and the specific underlying regulations, must specify which of the two testing methods (prior year or current year) it is using, and must now provide that it is incorporating by reference subsequent Internal Revenue Service guidance issued under the applicable Code provisions. Further, for purposes of the first plan year rule described in § 401(k)(3)(E) and § 401(m)(3) and section V of this notice, a plan that incorporates these provisions by reference must specify whether the ADP and ACP for NHCEs for the prior plan year is 3% or the current year’s ADP and ACP for the NHCEs.

Rev. Proc. 97–41 provides that qualified retirement plans have a remedial amendment period under § 401(b) so that certain plan amendments for SBJPA generally are not required to be adopted before the last day of the first plan year beginning on or after January 1, 1999. Pursuant to Rev. Proc. 97–41, a plan provision reflecting the ADP or ACP testing method is a disqualifying provision, and thus any plan amendments to reflect a choice in testing method are not required to be adopted until the end of this remedial amendment period. However, plans must be operated in accordance with the SBJPA changes to § 401(k)(3)(A) and § 401(m)(2)(A) as of the statutory effective date. In addition, under Rev. Proc. 97–41, any retroactive amendments must reflect the choices made in the operation of the plan for each testing year, including the choice of testing method (and any changes to that election), and must reflect the date on which the plan began to operate in accordance with those choices (and any such changes).

X. PAPERWORK REDUCTION ACT

The collection of information contained in this notice has been reviewed and approved by the Office of Management and Budget (OMB) in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–1579. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the col

lection of information displays a valid OMB control number.

The collection of information in this notice is in section IX. This requirement to amend plan documents is necessary to reflect the new nondiscrimination test under § 401(k)(3) and § 401(m)(2) as amended by SBJPA. The pre-SBJPA method of nondiscrimination testing is still available under these Code sections and a plan amendment may not be required to reflect the choice of the preSBJPA testing method. The information will be used to determine whether the ADP and ACP of HCEs exceeds the ADP and ACP of NHCEs by more than the statutory limits. The collection of information is required to obtain a benefit. The likely respondents are businesses or other for-profit institutions, and nonprofit institutions.

The estimated total annual recordkeeping burden is 49,000 hours. The estimated annual burden per recordkeeper is 20 minutes. The estimate number of recordkeepers is 147,000.

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

XI. COMMENTS

Treasury and the Service invite comments regarding the matters discussed in this notice. Comments may be submitted to the Service at CC:DOM:CORP:R (Notice 98–1), Room 5226, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Alternatively, taxpayers may hand-deliver comments between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (Notice 97– XX), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or may submit comments electronically via the Service’s Internet site at http://www.irs.ustreas. gov/prod/tax_regs/comments.html.

Drafting Information

The principal authors of this notice are Susan Lennon of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations) and Roger Kuehnle of the Employee Plans Division.

1998–3 I.R.B 47 January 20, 1998

For further information regarding this notice, contact the Employee Plans Division’s telephone assistance service between 1:30 and 4:00 p.m., Eastern Time, Monday through Thursday at (202) 6226074/75. (These telephone numbers are not toll-free.)

Publicly Traded Partnerships

Notice 98–3

This notice provides the method for grandfathered publicly traded partnerships to elect to remain exempt from § 7704 of the Internal Revenue Code pursuant to § 7704(g). This notice also provides the procedures for revoking the election. In addition, this notice informs grandfathered publicly traded partnerships that do not elect the application of § 7704(g) that the rules contained in proposed regulation § 1.743–2 regarding special § 743(b) basis accounts may be followed for purposes of a conversion from a partnership to a corporation. The references in this notice to § 7704(g) reflect the amendments made by the Taxpayer Relief Act of 1997 (1997 TRA), Pub. L. No. 105–34, 111 Stat. 788 (1997).

BACKGROUND

Section 7704(a) provides that a publicly traded partnership is treated as a corporation.

Section 7704(b) defines a partnership as a “publicly traded partnership” if interests in the partnership are traded on an established securities market or are readily tradable on a secondary market (or the substantial equivalent thereof).

Section 7704(c) provides that a publicly traded partnership will not be treated as a corporation if, for the current taxable year and each preceding taxable year beginning after December 31, 1987 during which the partnership (or any predecessor) was in existence, (1) at least 90 percent of the gross income of the partnership consisted of certain “qualifying income” (as defined in § 7704(d)), and (2) the partnership would not be described in § 851(a) if the partnership were a domestic corporation.

Section 7704 applies to taxable years beginning after December 31, 1987. However, for any existing partnership (as

defined in § 10211(c)(2) of the Revenue Reconciliation Act of 1987 (1987 Act), 1987-3 C.B. 125), § 7704 applies to taxable years beginning after December 31, 1997. The term “existing partnership” means any partnership that was a publicly traded partnership on December 17, 1987. If a substantial new line of business is added with respect to an existing partnership anytime after December 17, 1987, the grandfather status of the partnership terminates.

Section 7704(g) was enacted as part of the 1997 TRA. Under § 7704(g), an existing 1987 partnership may elect to remain exempt from § 7704(a) by agreeing to pay each taxable year a 3.5 percent tax on gross income from the active conduct of all trades and businesses of the partnership. A publicly traded partnership may make the election under § 7704(g) if: (1) the partnership is an existing partnership (as defined in § 10211(c)(2) of the 1987 Act), (2) § 7704(a) has not applied (and without regard to § 7704(c)(1) would not have applied) to the partnership for all taxable years beginning after December 31, 1987, and before January 1, 1998, and (3) the partnership elects the application of § 7704(g) for its first taxable year beginning after December 31, 1997, and consents to the application of the 3.5 percent tax imposed for each taxable year on gross income from the active conduct of all trades or businesses of the partnership.

PROCEDURAL REQUIREMENTS

To make an election under § 7704(g), a partnership must file with the Memphis Service Center a statement that provides the following: (1) a notification at the top of the statement that an election is being made (that is, “ELECTION UNDER SECTION 7704(g) FILED PURSUANT TO NOTICE 98-3”); (2) the name of the partnership; (3) the federal tax identification number of the partnership; (4) the mailing address of the partnership; (5) the taxable year of the partnership; and (6) a declaration that, pursuant to § 7704(g), the partnership consents to the imposition of a 3.5 percent tax on gross income from the active conduct of all trades and businesses by the partnership.

The statement must be signed by the tax matters partner of the partnership (as defined under § 6231(a)(7)) and must be filed at any time on or before the 75th day

of the first taxable year of the partnership beginning after December 31, 1997. The mailing address for the Memphis Service Center is Internal Revenue Service, Stop 1, 5333 Getwell Road, Memphis, TN 38118.

TAX ON GROSS INCOME

An electing partnership must pay each taxable year a tax of 3.5 percent of the gross income from all active trades and businesses conducted by the partnership. The tax is not deductible by the partnership. Pursuant to § 705(a)(2)(B), a partner of an electing partnership must reduce the adjusted basis of the partner’s partnership interest by a proportionate share of the 3.5 percent tax paid by the partnership.

TERMINATION OF ELECTION

If a partnership that elects special treatment under § 7704(g) adds a substantial new line of business after December 31, 1997, the election under § 7704(g) will terminate. The rules concerning a new line of business and the timing of a resulting termination that are set forth in § 1.7704–2 of the regulations will be applied to electing partnerships.

In addition, a partnership may voluntarily terminate its election at any time by filing a notice of revocation. The revocation will be effective as of the date designated in the notice, but not earlier than the date that the notice is filed with the Internal Revenue Service. Once a partnership revokes or otherwise terminates its election under § 7704(g), the election may not be reinstated. If the partnership remains a publicly traded partnership on the date of the termination and does not meet the exception for partnerships with passive-type income contained in § 7704(c), then absent an actual transaction that eliminates the partnership, the conversion from a partnership to a corporation will be determined under § 7704(f).

PROCEDURAL REQUIREMENTS FOR REVOCATION

To make a revocation under § 7704(g), a partnership must file with the Memphis Service Center a statement that provides the following: (1) a notification at the top of the statement that a revocation is being made (that is, “REVOCATION UNDER

January 20, 1998 48 1998–3 I.R.B.

SECTION 7704(g) FILED PURSUANT TO NOTICE 98–3”; (2) the name of the partnership; (3) the federal tax identification number of the partnership; (4) the mailing address of the partnership; (5) the taxable year of the partnership; (6) a declaration that, pursuant to § 7704(g), the partnership revokes its election to pay a 3.5 percent tax on gross income from the active conduct of all trades and businesses by the partnership; and (7) the effective date of the revocation. The statement must be signed by the tax matters partner of the partnership (as defined under § 6231(a)(7)).

PARTNERSHIPS THAT DO NOT ELECT

If an existing partnership does not elect the special treatment of § 7704(g), then the partnership will become taxable as a corporation if it (1) remains a publicly traded partnership on the first day of its first taxable year beginning after December 31, 1997, and (2) does not meet the exception for partnerships with passivetype income contained in § 7704(c). Absent an actual transaction that eliminates the partnership, the conversion from a partnership to a corporation will be treated under § 7704(f) as an asset transfer from the partnership to the corporation followed by a liquidation of the partnership.

On October 28, 1997, proposed regulations under § 743 were issued that provide that upon the contribution of assets by a partnership to a corporation, the special § 743 basis accounts are reflected in the basis of the assets in the hands of the corporation. 62 Fed. Reg. 55768, 1997–48 I.R.B. 13. Although these rules are in proposed form, the Service will not challenge a taxpayer’s § 7704(f) conversion, or any actual transaction applying the conversion method of § 7704(f) that follows the rules in proposed regulation § 1.743–2, so long as the conversion or transaction occurs prior to the issuance of further guidance on this issue.

DRAFTING INFORMATION

The principal author of this notice is Christopher Kelley of the Office of the Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact

Christopher Kelley at (202) 622-3080 (not a toll-free number).

Foreign Tax Credit Abuse

Notice 98–5

Treasury and the Internal Revenue Service understand that certain U.S. taxpayers (primarily multinational corporations) have entered into or may be considering a variety of abusive tax-motivated transactions with a purpose of acquiring or generating foreign tax credits that can be used to shelter low-taxed foreign-source income from residual U.S. tax. These transactions generally are structured to yield little or no economic profit relative to the expected U.S. tax benefits, and typically involve either: (1) the acquisition of an asset that generates an income stream subject to foreign withholding tax, or (2) effective duplication of tax benefits through the use of certain structures designed to exploit inconsistencies between U.S. and foreign tax laws. This notice announces that Treasury and the Service will address these transactions through the issuance of regulations as well as by application of other principles of existing law, and requests public comment with respect to these and related foreign tax credit issues.

I. BACKGROUND

United States persons are subject to U.S. income tax on foreign-source as well as U.S.-source income. Subject to applicable limitations, U.S. persons with foreign-source income may credit income taxes imposed by foreign jurisdictions against their U.S. income tax liability on foreign-source income.

Worldwide taxation of U.S. persons coupled with the allowance of a foreign tax credit establishes general tax neutrality between foreign and domestic investment by U.S. taxpayers. A tax system that simply exempts foreign-source income from taxation creates an incentive for citizens and residents to invest overseas in low-taxed jurisdictions. On the other hand, worldwide taxation without a foreign tax credit creates double taxation that distorts investment decisions by inhibiting foreign investment or business activities. The foreign tax credit provisions of

the Code, principally sections 901 through 907 and 960, effectuate Congress’s intent to provide relief from double taxation and alleviate these distortions. American Chicle Co. v. United States, 316 U.S. 450 (1942); Burnet v. Chicago Portrait Co., 285 U.S. 1 (1932).

In contrast to certain tax credits that are intended to create an incentive for taxpayers to invest in certain activities, such as the research credit under section 41 or the low-income housing credit under section 42, the foreign tax credit is designed to reduce the disincentive for taxpayers to invest abroad that would be caused by double taxation. In other words, the foreign tax credit is intended to preserve neutrality between U.S. and foreign investment and to minimize the effect of tax consequences on taxpayers’ decisions about where to invest and conduct business.

Relief from double taxation generally is not calculated separately with respect to each dollar of foreign-source income and tax. The foreign tax credit limitation or “basket” regime of section 904(d) permits, to a limited extent, a credit for foreign tax imposed with respect to income taxed at a rate in excess of the applicable U.S. rate to shelter from U.S. tax income from other, similar investments and activities that are subject to a relatively low rate of tax (the “cross-crediting regime”). Accordingly, the foreign tax credit provisions do not limit credits on an item-by-item basis. Rather, subject to certain restrictions, the provisions permit cross-crediting of foreign taxes imposed with respect to specified groups or types of income as consistent with the interrelated quality of multinational operations of U.S. persons.

Multinational corporations that are subject to relatively low rates of tax on their foreign-source income may be in an excess limitation position. Generally, such taxpayers may properly use credits for foreign taxes imposed on high-taxed foreign income to offset residual U.S. tax on their low-taxed foreign income. Treasury and the Service are concerned, however, that such taxpayers may enter into foreign tax credit-generating schemes designed to abuse the cross-crediting regime and effectively transform the U.S. worldwide system of taxation into a system exempting foreign-source income from residual U.S. tax.

1998–3 I.R.B 49 January 20, 1998

This result is clearly incompatible with the existence of the detailed foreign tax credit provisions and cross-crediting limitations enacted by Congress. No statutory purpose is served by permitting credits for taxes generated in abusive transactions designed to reduce residual U.S. tax on low-taxed foreign-source income. The foreign tax credit benefits derived from such transactions represent subsidies from the U.S. Treasury to taxpayers that operate and earn income in low-tax or zero-tax jurisdictions. The effect is economically equivalent to the tax sparing benefits for U.S. taxpayers that Congress and the Treasury have consistently opposed in the tax treaty context because such benefits are inconsistent with U.S. tax principles and sound tax policy.

II. ABUSIVE ARRANGEMENTS

Treasury and the Service have identified two classes of transactions that create potential for foreign tax credit abuse. The first class consists of transactions involving transfers of tax liability through the acquisition of an asset that generates an income stream subject to foreign gross basis taxes such as withholding taxes. Transactions described in this class may include acquisitions of income streams through securities loans and similar arrangements and acquisitions in combination with total return swaps. In abusive arrangements involving such transactions, foreign tax credits are effectively purchased by a U.S. taxpayer in an arrangement where the expected economic profit from the arrangement is insubstantial compared to the foreign tax credits generated.

The second class of transactions consists of cross-border tax arbitrage transactions that permit effective duplication of tax benefits. Duplicate benefits result when the U.S. grants benefits and, in addition, a foreign country grants benefits (including benefits from a full or partial imputation or exemption system, or a preferential rate for certain income) to separate persons with respect to the same taxes or income. These duplicate benefits generally can result where the U.S. and a foreign country treat all or part of a transaction or amount differently under their respective tax systems. In abusive arrangements involving such transactions, the U.S. taxpayer exploits these inconsistencies where the expected economic

profit is insubstantial compared to the foreign tax credits generated.

The following are examples of abusive arrangements within the scope of this notice.

Example 1

On June 29, 1998, US, a domestic corporation, purchases all rights to a copyright for $75.00. The copyright will expire shortly and the only income expected to be received with respect to the copyright is a royalty payable June 30, 1998. The gross amount of the royalty is expected to be $100.00. The royalty payment is subject to a 30-percent Country X withholding tax. On June 30, 1998, US receives the $100.00 royalty payment, less the $30.00 withholding tax. US reasonably expects to incur a $5.00 economic loss (having paid $75.00 for the right to receive a $70.00 net royalty payment), but expects to acquire a $30.00 foreign tax liability. In this example, US has effectively purchased foreign tax credits in a transaction that was reasonably expected to result in an economic loss.

Example 2

On June 29, 1998, US, a domestic corporation, purchases a foreign bond for $1096.00 (including accrued interest). The foreign bond provides for annual interest payments of $100.00 payable June 30 of each year. The interest payments are subject to a 4.9-percent Country X withholding tax. On June 30, 1998, US receives a $95.10 interest payment on the bond (net of a $4.90 Country X withholding tax). On July 4, 1998, US sells the bond for $1001.05. Because the value of the bond is not reasonably expected to appreciate due to market factors, US reasonably can expect only a $0.15 economic profit (the $1001.05 sales price and the $95.10 net interest coupon, less the $1096.00 purchase price) and expects to acquire a $4.90 foreign tax liability. In this example, US has effectively purchased foreign tax credits in a transaction with respect to which the reasonably expected economic profit is insubstantial in relation to expected U.S. foreign tax credits. No implication is intended as to whether the interest described in this example will constitute high withholding tax interest under section 904(d)(2)(B).

Example 3

F, an entity that does not receive a tax benefit from foreign tax credits, wishes to acquire a foreign bond with a value of $1000.00 that provides for annual interest payments of $100.00. The interest payments are subject to a 4.9-percent Country X withholding tax. Instead of purchasing the bond, F invests its $1000.00 elsewhere and enters into a three-year notional principal contract (NPC) with US, an unrelated domestic corporation. Under the terms of the NPC, US agrees to make an annual payment to F equal to $96.00 and F agrees to make an annual payment to US equal to the product of $1000.00 and a rate calculated based on LIBOR. In addition, the parties agree that, upon termination of the NPC, US will make a payment to F based on the appreciation, if any, in the value of the foreign bond, and F will make a payment to US based on the depreciation, if any, in the value of the foreign bond.

In order to hedge its obligations under the NPC, US purchases the bond for $1000.00. Assume that, in connection with the purchase of the foreign bond, US incurs or maintains an additional $1000.00 of borrowing at an interest rate equal to the LIBORbased rate provided for in the NPC.

At the time US enters into this arrangement, US reasonably expects to incur an annual $0.90 economic loss each year under the arrangement (the $95.10 net interest payment on the bond plus the LIBOR-based amount received from F under the NPC, less the sum of the $96.00 payment to F under the NPC and the LIBOR-based amount associated with the $1000.00 borrowing incurred or maintained in order to acquire the foreign bond). In this example, US has effectively purchased foreign tax credits in a transaction that was reasonably expected to result in an economic loss.

Example 4

US, a domestic corporation, forms N, a Country X corporation, by contributing $10.00 to the capital of N in exchange for the only share of N common stock. N borrows $90.00 from F, a Country X individual unrelated to US, at an annual interest rate of 7.5 percent, and N purchases preferred stock of an unrelated party with a par value of $100.00 or a bond with a face amount of $100.00. US reasonably expects the preferred stock or bond to pay dividends or interest at an annual rate of 10 percent. Alternatively, rather than purchasing preferred stock or the bond, N lends $100.00 to US at an annual interest rate of 10 percent.

Country X treats the F loan as an equity investment and does not allow a deduction for N ’s interest expense. Country X imposes an individual income tax and a corporate income tax of 30 percent. Country X thus is expected to impose a $3.00 corporate income tax each year on N . Country X has an imputation system, under which dividends from Country X corporations are excluded from the gross income of Country X individuals. (A similar result could be achieved if the dividends are wholly or partially exempt from Country X tax due to a consolidated return or group relief regime, a dividend-received deduction, or an imputation credit.)

At the time US enters into this arrangement, US reasonably expects that N will have annual earnings and profits of $0.25 ($10.00 dividend or interest income from the preferred stock or bond (or $10.00 interest income from the loan to US ), less $6.75 interest expense and $3.00 foreign tax liability). US expects that each year N will pay a $0.25 dividend to US and US will claim a $3.00 foreign tax credit for taxes deemed paid under section 902. In this example, US has entered into an arrangement to exploit the inconsistency between U.S. and Country X tax laws in order to generate foreign tax credits in a transaction with respect to which the reasonably expected economic profit is insubstantial in relation to expected U.S. foreign tax credits.

Example 5

US, a domestic corporation, forms N, a Country X entity. US contributes $100.00 to the capital of N in exchange for a 100-percent ownership interest. N borrows $900.00 from F, an unrelated Country X corporation, at an annual interest rate of 8 percent, and N purchases preferred stock of an unrelated

January 20, 1998 50 1998–3 I.R.B.

nomic profit, foreign taxes will be treated as an expense. In addition, interest expense (and similar amounts, including borrowing fees, “in lieu of” payments, forward contract payments, and notional principal contract payments) generally will be taken into account in determining expected economic profit only to the extent that the indebtedness or contract giving rise to the expense is part of the arrangement.

In addition, the regulations will provide special rules that will operate to deny credits for foreign taxes generated in abusive arrangements involving asset swaps or other hedging devices (including rules that allocate interest expense to an arrangement in certain cases other than pursuant to a tracing approach). For example, an arrangement involving a purchase of a foreign security coupled with an asset swap that is designed to hedge substantially all of the taxpayer’s risk of loss with respect to the security for the duration of the arrangement generally will constitute an abusive foreign tax credit arrangement even if the taxpayer has not incurred indebtedness for the specific purpose of acquiring the asset. However, the regulations will not treat arrangements involving debt instruments as abusive solely because the taxpayer diminishes its risk of interest rate or currency fluctuations, unless the taxpayer also diminishes its risk of loss with respect to other risks (e.g., creditor risk) for a significant portion of the taxpayer’s holding period. See Part VI of this notice for additional rules for portfolio hedging strategies and partial hedges.

Under the foregoing principles, the regulations will not disallow foreign tax credits merely because income from the arrangement is subject to a high foreign tax rate. Treasury and the Service anticipate that credits for taxes paid to a hightax jurisdiction will not be subject to disallowance under the regulations absent other indicia of abuse.

The regulations generally will not disallow a credit for withholding taxes on dividends if the holding period requirement of section 901(k) is satisfied. However, the regulations will operate to determine whether foreign tax credits with respect to cross-border tax arbitrage arrangements (as described in Part II, above) will be disallowed, even if such

party with a par value of $1000.00 that US reasonably expects to pay dividends at an annual rate of 10 percent. The dividends are subject to a Country Y 25-percent withholding tax. Country X treats the F loan as an equity investment in N and treats N as a partnership. Consequently, F claims a foreign tax credit in Country X for 90 percent of the withholding tax paid by N . Under U.S. law, the F loan is respected as debt, and N is disregarded as a separate entity (a partnership with only one partner). See Reg. § 301.7701-3(a) and § 301.7701-3(b)(2)(C). Thus, US claims a U.S. foreign tax credit for the taxes paid by N and the tax benefit of the foreign taxes paid by N are effectively duplicated.

At the time US enters into this arrangement, US reasonably expects an annual profit of $3.00 ($100.00 dividend income, less $72.00 interest expense and $25.00 foreign tax liability) and an annual foreign tax credit of $25. In this example, US has entered into an arrangement to exploit the inconsistency between U.S. and Country X tax laws in order to generate foreign tax credits in a transaction with respect to which the reasonably expected economic profit is insubstantial in relation to expected U.S. foreign tax credits.

III. REGULATIONS TO BE ISSUED

PURSUANT TO THIS NOTICE

Regulations will be issued to disallow foreign tax credits for taxes generated in abusive arrangements such as those described in Part II above. These regulations will be issued under the authority of some or all of the following sections of the Internal Revenue Code of 1986: section 901, section 901(k)(4), section 904, section 864(e)(7), section 7701(l), and section 7805(a).

In general, these regulations will disallow foreign tax credits in an arrangement such as those described in Part II above from which the reasonably expected economic profit is insubstantial compared to the value of the foreign tax credits expected to be obtained as a result of the arrangement. The regulations will emphasize an objective approach to calculating expected economic profit and credits, and will require that the determination of expected economic profit reflect the likelihood of realizing both potential gain and potential loss (including loss in excess of the taxpayer’s investment). Thus, under the regulations, expected economic profit will be determined without regard to executory financial contracts ( e.g., a notional principal contract, forward contract, or similar instrument) that do not represent a real economic investment or potential for profit or that are not properly treated as part of the arrangement. Fur

ther, the regulations will require that expected economic profit be determined over the term of the arrangement, properly discounted to present value.

It is expected that the regulations in general and any test relying on a comparison of economic profit and credits in particular would be applied to discrete arrangements. The utility of a test comparing profits and credits depends upon the proper delineation of the arrangement to be tested. If necessary to effectuate the purposes of the regulations, a series of related transactions or investments may be treated as a single arrangement or portions of a single transaction or investment may be treated as separate arrangements. The proper grouping of transactions and investments into arrangements will depend on all relevant facts and circumstances.

For example, a series of transactions involving a purchase and resale might be treated as a single arrangement. Similarly, an investment together with related hedging and financing transactions, e.g., a borrowing, an investment, and an asset swap designed to limit the taxpayer’s economic exposure with respect to the investment, might be treated as a single arrangement. In addition, if a controlled foreign corporation, as part of its business, enters into a buy-sell transaction involving a debt instrument, that buy-sell transaction could be treated as a separate arrangement.

In general, reasonably expected economic profit will be determined by taking into account foreign tax consequences (but not U.S. tax consequences). However, it is inappropriate in the context of the U.S. foreign tax credit system to allow foreign tax credits with respect to abusive arrangements simply because the arrangements generate substantial foreign tax savings. Accordingly, the regulations will provide that the calculation of expected economic profit will not include expected foreign tax savings attributable to a tax credit or similar benefit allowed by a foreign country with respect to a tax paid to another foreign country.

In general, expected economic profit will be determined by taking into account expenses associated with an arrangement, without regard to whether such expenses are deductible in determining taxable income. For example, in determining eco

1998–3 I.R.B 51 January 20, 1998

VII. COMMENTS

Comments are requested on the matters discussed in this notice. Written comments may be submitted to the Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Attention: CC:DOM:CORP:R (Notice 98–5), Room 5226, Washington DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (Notice 98–5), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington DC. Alternatively, taxpayers may submit comments directly to the IRS Internet site at http://www.irs.ustreas.gov/prod/tax_ regs/comments.html. Comments will be available for public inspection and copying.

For further information regarding this notice, contact Seth Goldstein or Rebecca Rosenberg of the Office of Associate Chief Counsel (International) at 202-6223850 (not a toll-free call).

Qualified Funeral Trusts

Notice 98–6

PURPOSE

Section 1309 of the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, 111 Stat. 788 (the Act) added § 685 of the Internal Revenue Code to permit certain trusts to elect Qualified Funeral Trust (QFT) status. This notice provides guidance on QFT eligibility requirements, election procedures, and simplified reporting requirements.

BACKGROUND

A pre-need funeral trust arises from an arrangement where funeral merchandise or services are purchased from a seller to benefit a specified beneficiary before the beneficiary’s death. A pre-need cemetery merchandise trust arises from an arrangement where cemetery merchandise or services are purchased from a seller to benefit a specified beneficiary before the beneficiary’s death. The purchaser enters into a contract with the seller of the funeral or cemetery merchandise or services whereby the purchaser selects the merchandise and services to be provided upon the death of the beneficiary, and agrees to

credits arise with respect to withholding taxes on dividends and the section 901(k) holding period is satisfied. In addition, the regulations generally will apply to determine whether credits should be disallowed with respect to qualified taxes (as defined in section 901(k)(4)(B)) that are not subject to the general section 901(k) holding period rule. For example, the regulations may disallow credits with respect to gross basis taxes paid or accrued with respect to certain arrangements involving equity swaps and equity buy-sell transactions entered into by securities dealers even if such credits would not have been disallowed under section 901(k) pursuant to section 901(k)(4). See section 901(k)(4)(C).

IV. EFFECTIVE DATE OF

REGULATIONS ISSUED PURSUANT TO THIS NOTICE

The regulations to be issued with respect to arrangements of the kind described in Part II above generally will be effective with respect to taxes paid or accrued on or after December 23, 1997, the date this notice was issued to the public. The effective date of the regulations issued pursuant to this notice, however, will not limit the application of other principles of existing law to determine the proper tax consequences of the structures or transactions addressed in the regulations.

V. IRS COORDINATION

PROCEDURES

The Service intends to carefully examine foreign tax credits claimed in arrangements of the type described in Part II to determine whether such credits should be disallowed under existing law even without application of the regulations to be issued pursuant to this notice. The Service plans to establish early coordination procedures utilizing foreign tax credit experts in the National Office and the International Field Assistance Specialization Program to assist examining agents in analyzing these transactions. These coordination procedures will continue in effect following issuance of the regulations to ensure uniform and appropriate application of the regulations by examining agents.

VI. OTHER FOREIGN TAX CREDIT

GUIDANCE

Treasury and the Service are considering issuing other guidance to ensure that foreign tax credits are allowed to U.S. taxpayers in a manner consistent with the overall structure of the Code and the intent of Congress in enacting the credit. For example, Treasury and the Service are considering issuing additional regulations under section 904(d)(2)(B)(iii) to address abusive transactions involving high withholding taxes. Treasury and the Service are also considering whether additional approaches may be necessary to identify abuses in the case of foreign gross basis taxes generally.

In addition, Treasury and the Service are considering various approaches to address structures (including hybrid entity structures) and transactions intended to create a significant mismatch between the time foreign taxes are paid or accrued and the time the foreign-source income giving rise to the relevant foreign tax liability is recognized for U.S. tax purposes. For such structures and transactions, Treasury and the Service are considering either deferring the tax credits until the taxpayer recognizes the income, or accelerating the income recognition to the time at which the credits are allowed ( e.g., by allocating the credits or the income under section 482).

Finally, Treasury and the Service are concerned about credits claimed in transactions described in Part II above, with respect to assets or income streams that are hedged pursuant to portfolio hedging strategies and with respect to hedges entered into with respect to assets or income streams that the taxpayer holds without diminished risk of loss for a significant period of time.

In general, regulations addressing these other foreign tax credit issues will be effective no earlier than the date on which proposed regulations (or other guidance such as a notice) describing the tax consequences of the arrangements are issued to the public. The effective date of any such regulations will not, however, affect the application of other principles of existing law to determine the proper tax consequences of the structures or transactions addressed in the regulations.

January 20, 1998 52 1998–3 I.R.B.

pay for them before the beneficiary’s death. Under state law, such amounts (or a portion thereof) are required to be held in trust during the beneficiary’s lifetime and are paid to the seller upon the beneficiary’s death.

Rev. Rul. 87–127, 1987–2 C.B. 156, addresses the taxation of pre-need funeral trusts. The ruling provides four situations under which funeral trusts are formed and concludes that in all four situations the trust is a grantor trust and the purchaser is treated for federal tax purposes as the owner of the trust. Any amount that a seller receives from the trust (as payment for services or merchandise) is includible in the gross income of the seller.

Section 685 permits the trustees of certain pre-need trusts to elect QFT status on behalf of the trusts. If the election is made, a trust is not treated as a grantor trust and the purchaser would not be subject to tax on trust income. The trustee is liable for the tax on the taxable income of the trust as determined in accordance with the income tax rate schedule generally applicable to estates and trusts. However, the personal exemption deduction under § 642(b) is unavailable.

QFT ELIGIBILITY REQUIREMENTS

Section 685(b) defines a QFT as any trust (other than a foreign trust) if—(1) the trust arises as a result of a contract with a person engaged in the trade or business of providing funeral or burial services or property necessary to provide such services, (2) the sole purpose of the trust is to hold, invest and reinvest funds in the trust and to use the funds solely to make payments for those services or property for the benefit of the beneficiaries of the trust, (3) the only beneficiaries of the trust are individuals with respect to whom those services or property are to be provided at their death under contracts described in item (1), (4) the only contributions to the trust are contributions by or for the benefit of those beneficiaries, (5) the trustee elects the application of this subsection, and (6) the trust would, but for this election, be treated as owned under subpart E (the grantor trust provisions) by the purchasers of the contracts.

Pre-need cemetery merchandise trusts are substantially similar to pre-need funeral trusts and therefore the analysis in

Rev. Rul. 87–127 applies to them. Preneed funeral trusts and pre-need cemetery merchandise trusts that meet one of the situations under Rev. Rul. 87–127 are grantor trusts and the purchasers of the contracts giving rise to the trusts are the owners of the trusts. Accordingly, these trusts may elect to be treated as QFTs if they meet the other QFT requirements under § 685.

A QFT cannot accept aggregate contributions by or for the benefit of an individual in excess of $7,000 (contribution limit). Section 685(c)(1). Section 685(c)(2) provides that for purposes of § 685(c)(1), all trusts having trustees that are related persons shall be treated as 1 trust. Persons are related if (A) the relationship between the persons is described in §§ 267 or 707(b), (B) the persons are treated as a single employer under subsection (a) or (b) of § 52, or (C) the Secretary determines that treating the persons as related is necessary to prevent avoidance of the purposes of this section. The $7,000 contribution limit is adjusted annually for inflation for any contracts entered into after calendar year 1998. Section 685(c)(3).

A trust is deemed to exceed the contribution limit under § 685(c) if the trust is determined, over the anticipated life of the trust, to receive projected contributions (based upon existing contributions, the applicable state law trust contribution requirements, and any expected contributions in excess of the state law requirements) that exceed the contribution limit. The determination is made at the inception of the trust and is made again when the amount of the projected contributions used in the previous determination changes. For example, a trust that is determined at its inception to exceed the contribution limit during the life of the trust will be deemed to exceed the contribution limit at inception. However, a trust that is determined at its inception not to exceed the contribution limit but exceeds the contribution limit in a future year, due to a change in projected contributions, will be deemed to exceed the contribution limit at the time of the change in projected contributions. A trust loses its QFT status at the time that it is deemed to exceed the contribution limit.

If a QFT has multiple beneficiaries, the contribution limit will apply separately to each beneficiary. A QFT that has multiple

beneficiaries will be taxed as if each beneficiary’s interest in the QFT is a separate trust. Each beneficiary’s share of the total contributions to a trust and share of the trust’s income is determined in accordance with the beneficiary’s interest in the trust; a beneficiary’s interest in a trust may be determined under any reasonable method.

QFT ELECTION PROCEDURES

A trustee may elect QFT status for trusts that meet the requirements of QFTs under § 685 for taxable years ending after August 5, 1997. Therefore, trusts existing prior to August 5, 1997, and trusts created after August 4, 1997, may elect QFT status. The filing of Form 1041–QFT is treated as the election. The election must be filed no later than the due date, with extensions, for filing the trust income tax return for the year of election. The election applies to each trust reported in the QFT return.

A trustee need not elect QFT status for the trust’s first eligible year; even if no election is made for the first eligible year, a QFT election may be made for subsequent tax years. A QFT election, once made, cannot be revoked without the consent of the Commissioner.

Under both § 685 and Rev. Rul. 87– 127, amounts received by the seller from a trust are treated as payments for services and merchandise and are includible in the gross income of the seller in the taxable year received or properly accrued under the seller’s method of accounting. In the case where a seller was not reporting income in accordance with Rev. Rul. 87– 127, for example, where a seller improperly reported investment income in the taxable year it was earned by the trust rather than the purchaser reporting such income, a duplication of income may result from an election under § 685. The Service is continuing to study this issue.

SIMPLIFIED QFT REPORTING REQUIREMENTS

A trustee of a QFT is required to file a trust return on behalf of the QFT. The proper form to file is Form 1041–QFT. A trustee may file one aggregate Form 1041–QFT for all of its QFTs and should follow the instructions associated with that form.

1998–3 I.R.B 53 January 20, 1998

tuition, fees, room, board, books, equipment, and other necessary expenses, such as transportation). However, for purposes of the student loan interest deduction, costs of attendance are reduced by educational assistance that the student receives and excludes from gross income under § 127, 135, 530, or as a scholarship.

The student loan interest deduction is available only for interest payments made during the first 60 months, whether or not consecutive, in which interest payments are required on the loan. Notice 97-60, 1997-46 I.R.B. 8, provides additional information about the student loan interest deduction.

Section 6050S(a) requires information reporting by any person engaged in a trade or business who, in the course of that trade or business, receives from any individual interest aggregating $600 or more for any calendar year on 1 or more qualified education loans.

Section 6050S(b) provides that the return of information must be in the form prescribed by the Secretary and contain:

(1) the name, address, and taxpayer identification number (TIN) of the individual with respect to whom interest was received,

(2) the name, address, and TIN of any individual certified by the individual named in the first item as the taxpayer who will claim that individual as a dependent for purposes of the deduction under § 151 for any taxable year ending with or within the year for which the information return is filed,

(3) the aggregate amount of interest received for the calendar year with respect to the individual named in the first item, and

(4) such other information as the Secretary may prescribe.

Section 6050S(c) states that information reporting is required by governmental units or any agency or instrumentality thereof. The return required by the governmental entity must be made by the officer or employee appropriately designated for the purpose of making the return.

Section 6050S(d) provides that every person required to make an information return under § 6050S(a) must also furnish to each individual whose name is required

REQUESTS FOR COMMENTS

The Treasury and the Service invite comments from the public on issues that may arise in implementing § 685. Send written comments to the following address:

Internal Revenue Service CC:DOM:CORP (NT 98-6;

CC:DOM:P&SI:1) P.O. Box 7604, Ben Franklin Station Washington, DC 20044 Alternatively, send written comments electronically via the Internet to the IRS Internet site at http://www.irs.ustreas.gov/ prod/tax_regs/comments.htm1. Please identify the comments as relating to this Notice.

DRAFTING INFORMATION

The principal author of this notice is Daniel J. Coburn of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice contact Mr. Coburn at (202) 622-3050 (not a toll-free call).

Returns Relating to Interest on Education Loans

Notice 98–7

PURPOSE

This notice describes the information reporting requirements for 1998 under § 6050S of the Internal Revenue Code (as enacted by the Taxpayer Relief Act of 1997, Pub. L. No. 105–34, § 202(c), 111 Stat. 804 (the Act)) that apply to certain persons who receive payments of interest that may be deductible as qualified education loan (“student loan”) interest. The Treasury Department intends to issue regulations on the information reporting required under § 6050S. Pending the issuance of those regulations, this notice describes who must report information with respect to payments of student loan interest, and the nature of the information that will be required under § 6050S for 1998. For 1998, payees are required to report interest received only with respect to student loans that have a “covered period” (described below) ending during or after 1998. Comments are requested regarding

the student loan interest reporting requirements that should apply for future years. The Internal Revenue Service will issue additional guidance on the student loan interest that a taxpayer may deduct, including further guidance for determining whether a taxpayer has made a payment of interest on a student loan during the first 60 months in which interest payments are required.

BACKGROUND

A. The Student Loan Interest

Deduction.

Section 202(a) of the Act added § 221 to the Code. Section 221 allows certain taxpayers who pay interest on qualified education loans to claim a federal income tax deduction for their interest payments, regardless of whether they itemize other deductions.

A qualified education loan is a loan used to pay the costs of attendance at an eligible educational institution for a student enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. The student must be the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent at the time the loan was taken. A loan made by an individual who is related to the borrower, within the meaning of § 267(b) or § 707(b)(1), is not a qualified education loan.

An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution that is described in § 481 of the Higher Education Act of 1965 (20 U.S.C. 1088) and, therefore, is eligible to participate in the student aid programs administered by the Department of Education. This category includes virtually all accredited public, nonprofit, and proprietary postsecondary institutions. For purposes of the student loan interest deduction, eligible educational institutions also include institutions that conduct an internship or residency program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care facility that offers postgraduate training.

Costs of attendance are generally the same as those described in § 472 of the Higher Education Act for purposes of calculating a student’s financial need ( e.g.,

B. Information Reporting Relating to

Student Loan Interest.

January 20, 1998 54 1998–3 I.R.B.

to be included in the return a written statement showing the name, address, and phone number of the reporting person’s information contact, and the aggregate amounts required to be included in the return.

Section 6050S(f) provides that, in the case of any amount received on behalf of another person, only the person first receiving the amount is required to make the return under § 6050S. Thus, where more than one person has a connection with a qualified education loan, the person first receiving the payment of interest, such as a loan servicer or collection agent receiving payments on behalf of the lender, is required to file an information return regarding the interest received on the loan.

DISCUSSION

A. Definitions.

The following definitions apply to these terms for purposes of this notice:

(1) Payee . A payee is the person first receiving one or more interest payments on a student loan.

(2) Payor. A payor is the individual with respect to whom interest payments are received on a particular student loan.

(3) Consolidated Loan. A consolidated loan is a single loan refinancing more than one student loan.

(4) Collapsed Loan. A collapsed loan is a set of loans of a single payor treated as a single loan for loan servicing purposes.

(5) Defaulted Loan. A defaulted loan is a loan with respect to which required payments of interest and principal have not been made when due over a period of time such that the holder has declared the loan in default based on its terms and conditions, and, if applicable, sought recourse against the ultimate guarantor of the loan.

(6) Covered Period. For loans other than consolidated loans, collapsed loans, and defaulted loans, the covered period begins on:

(a) the date on which the loan went into repayment status if the payee knows or has reason to know that date; or

(b) January 1, 1998, if the payee does not know and does not have reason to know that date.

For consolidated loans and collapsed loans, the covered period begins on:

(a) the most recent date on which any of the loans subject to consolidation or collapse went into repayment status, if the payee knows or has reason to know that date; or

(b) January 1, 1998, if the payee does not know and does not have reason to know that date.

For defaulted loans, the covered period begins on:

(a) the date the loan went into repayment status if the payee knows or has reason to know that date;

(b) the date the loan went into default, if the payee knows or has reason to know that date and does not know or have reason to know the date the loan went into repayment status; or

(c) January 1, 1998, if the payee does not know and does not have reason to know the dates the loan went into repayment status or default. The covered period ends on the date that is 60 months after the date on which the period starts or, if later, the last day of the month in which that 60-month date occurs. However, if the payee knows or has reason to know of any periods of grace, deferment, or forbearance during the covered period, the covered period is extended by the number of months the loan was subject to grace, deferment, or forbearance.

(7) Covered Student Loan. A covered student loan is a loan with a covered period ending during or after 1998 that is either:

(a) subsidized, guaranteed, financed, or otherwise treated as a student loan under a program of the federal, state, or local government or an institution of postsecondary education, or

(b) certified by the payor as a student loan.

B. Who Must File for 1998.

Payees who receive interest aggregating $600 or more during 1998 with respect to a single payor on one or more covered student loans must file an information return with respect to that interest.

C. Information Required for 1998.

Payees required under this notice to file information returns for 1998 must properly complete Form 1098–E, Student Loan Interest Statement, for all student loan accounts that contain one or more

covered student loans (“student loan account”). A payee may file a separate Form 1098-E for each student loan account of the payor, or a single Form 1098E for all student loan accounts of the payor.

For 1998, a properly completed Form 1098-E filed with the Service must include:

(1) the name, address, and TIN of the payee;

(2) the name, address, and TIN of the payor; and

(3) the aggregate amount of interest received during 1998 with respect to the student loans in the account or accounts included on the return.

Payments of interest made on or after January 1, 1998, on mixed use loans or revolving accounts, such as credit card accounts, are treated as interest paid with respect to a student loan (and must be reported as such) only if the mixed use loan or revolving account is certified to be, in part, a student loan, and the payee has a reasonable method for allocating the interest payments to the part of loan that is certified to be a student loan.

E. Coordination with Reporting on

Payments of Mortgage Interest.

If, for a year before 1998, a payee treated a loan as a mortgage within the definition of § 6050H(e) for purposes of the information reporting required under § 6050H, the payee must continue to treat the loan as a mortgage for information reporting purposes, even if all or part of the loan is used to pay costs of attendance.

For loans made on or after January 1, 1998, the payee must treat loans secured by real property and not made exclusively to acquire or improve real property as either mortgages or student loans in accordance with the certification provided by the payor. Thus, if a payor certifies all of a loan secured by real property and made on or after January 1, 1998, as a student loan, the payee must treat the entire loan as a student loan and not as a mortgage for purposes of information reporting. If the payor certifies part of a loan as a student loan, only the certified portion of the loan may be treated as a student loan for purposes of information reporting. For

D. Mixed Use Loans and Revolving

Accounts.

1998–3 I.R.B 55 January 20, 1998

loans made on or after January 1, 1998, the payee must treat a loan secured by real property and made exclusively to acquire or improve real property as a mortgage and provide information returns as required by § 6050H. The regulations under § 6050H will be amended to be consistent with this rule.

F. When To File.

The information returns required under § 6050S for 1998 must be sent to the Service by March 1, 1999.

G. Manner of Filing.

The regulations under § 6011 will be amended to require any person required to file 250 or more Forms 1098–E for 1998 to file those returns by magnetic media or electronically. Additional guidance will be provided on how to file by magnetic media or electronically.

H. Statements To Be Provided to

Payors .

The payee must provide each payor a statement containing the same information that is provided to the Service on the information return required by § 6050S. In addition, the statement provided to the payor must contain a phone number for the individual serving as information contact of the payee. The statement must also notify the payor that the amount of interest reported as paid may differ from the amount of interest that the payor may be able to claim as a deduction. The statement must be provided to the payor by February 1, 1999. The statement may be a copy of Form 1098–E (or an acceptable substitute statement).

I. Collecting Information.

The Service is developing an optional Form W-9S for use in collecting information for the purpose of complying with § 6050S. The payee will be able to use the form to collect the information necessary to meet the information reporting requirements of § 6050S. The information can be collected on paper or on an electronic version of Form W–9S (or an acceptable substitute). The payee also may collect the necessary information by using its own forms and procedures.

J. Waiver of Penalties.

The Treasury Department intends to issue regulations under § 6050S, and modify the regulations under § 6050H, to provide guidance on how payees are to comply with the requirements of the statute. Until the regulations are adopted, no penalties will be imposed under §§ 6721 and 6722 for failure to file correct information returns with the Service or to furnish correct statements to the payors with respect to whom information reporting is required under § 6050S (or § 6050H for those loans secured by real property the proceeds from which are used to pay the costs of postsecondary education). Furthermore, even after the regulations are adopted, no penalties will be imposed under §§ 6721 and 6722 for failure to file correct information returns or furnish correct statements for 1998 as required by § 6050S or § 6050H if the payee made a good faith effort to file information returns and furnish statements in accordance with this notice.

K. Request for Comments.

The Conference Report accompanying the Act states the following, “The conferees expect that the Secretary of Treasury will issue regulations setting forth reporting procedures that will facilitate the administration of this provision. Specifically, such regulations should require lenders separately to report to borrowers the amount of interest that constitutes deductible student loan interest ( i.e., interest on a student loan during the first 60 months in which interest payments are required). In this regard, the regulations should include a method for borrower certification to a lender that the loan proceeds are being used to pay for qualified higher education expenses.” H.R. Conf. Rep. No. 220, 105 Cong., 1st Sess. at 368 (1997). Treasury and the Service invite taxpayers to submit comments on how regulations could be drafted in accordance with the legislative history. In particular, comments are requested on how parties receiving interest are to determine whether a payment of interest on a student loan has been made during the first 60 months in which interest payments are required and on how much of a payment should be treated as interest, especially

where interest has been capitalized. Comments are requested by April 30, 1998. An original and eight copies of written comments should be sent to:

Internal Revenue Service Attn: CC:DOM:CORP:R Room 5228 (IT&A:Br1) P.O. Box 7604 Ben Franklin Station Washington, DC 20044, or hand delivered between the hours of 8:00 a.m. and 5:00 p.m. to: Courier’s Desk Internal Revenue Service Attn: CC:DOM:CORP:R Room 5228 (IT&A:Br1) 1111 Constitution Ave., NW Washington, DC Alternatively, taxpayers may submit comments electronically via the Internet by selecting the “Tax Regs” option on the IRS Home Page, or by submitting comments directly to http://www.irs.ustreas. gov/prod/tax_regs/comments.html (the IRS Internet site). All comments will be available for public inspection and copying in their entirety.

DRAFTING INFORMATION

The principal author of this notice is John McGreevy of the Office of the Assistant Chief Counsel (Income Tax and Accounting). For further information regarding information reporting, contact Mr. McGreevy on (202) 622-4910 (not a toll-free call) or, regarding the deduction, call John Moriarty on (202) 622-4950 (not a toll-free call).

26 CFR 601.601: Rules and regulations. (Also Part I, § 1397E)

Rev. Proc. 98–9