Part IV. Items — Internal Revenue Bulletin 1998-41

established by the RRB quarterly, and is calculated to generate sufficient tax revenue to fund the RRB’s current supplemental annuity obligations.

Under section 3221(d), the tax imposed by section 3221(c) does not apply to an employer with respect to employees who are covered by a supplemental pension plan established pursuant to an agreement reached through collective bargaining between the employer and employees. However, if an employee for whom the employer is relieved of any tax under the section 3221(d) exception becomes entitled to a supplemental annuity from the RRB, the employer is subject to an excise tax equal to the amount of the supplemental annuity paid to the employee (plus a percentage determined by the RRB to be sufficient to cover administrative costs attributable to those supplemental annuity payments).

Section 3221(d) was enacted by Public Law 91–215, 84 Stat. 70, which amended the Railroad Retirement Act of 1937 and the Railroad Retirement Tax Act. The legislative history to Public Law 91–215 indicates that the exception under section 3221(d) from the tax imposed under section 3221(c) was “directed primarily at the situation existing on certain short-line railroads which are owned by the steel companies. The employees of these lines are, for the most part, covered by other supplemental pension plans established pursuant to collective bargaining agreements between the steel companies and the unions representing the majority of their employees. . . . [T]hese railroads will no longer be required to pay a tax to finance the supplemental annuity fund, but will be required to reimburse the Railroad Retirement Board for any supplemental annuities that their employees may be paid upon retirement.” S. Rep. 91–650, 91st Cong., 2d Sess. 6 (February 3, 1970).

Summary of Regulations

These proposed regulations provide rules for determining whether a plan is a supplemental pension plan established pursuant to an agreement reached through collective bargaining. Under these proposed regulations, a plan is a supplemental pension plan only if the plan is a pen

Notice of Rulemaking and Notice of Public Hearing

Exception From Supplemental Annuity Tax on Railroad Employers

REG–209769–95

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed regulations that provide guidance to employers covered by the Railroad Retirement Tax Act. The Railroad Retirement Tax Act imposes a supplemental tax on those employers, at a rate determined by the Railroad Retirement Board, to fund the Railroad Retirement Board’s supplemental annuity benefit. These proposed regulations provide rules for applying the exception from the supplemental tax with respect to employees covered by a supplemental pension plan established pursuant to a collective bargaining agreement and for applying a related excise tax with respect to employees for whom the exception applies. This document also provides notice of a public hearing on these proposed regulations.

DATES: Comments must be received by December 22, 1998. Requests to speak and outlines of topics to be discussed at the public hearing scheduled for January 20, 1999, must be received by December 30, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–209769–95), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG–209769–95), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the “Tax Regs” option on the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs.

ustreas.gov/prod/tax_regs/comments.html. The public hearing will be held in Room 2615, Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Linda S. F. Marshall, (202) 622-6030; concerning submissions and the hearing, Michael Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to the Employment Tax Regulations (26 CFR Part 31) under section 3221(d). These proposed regulations provide guidance regarding the section 3221(d) exception from the tax imposed under section 3221(c) with respect to employees covered by a supplemental pension plan of the employer established pursuant to an agreement reached through collective bargaining.

Under the Railroad Retirement Act of 1974, as amended (RRA), an employee of a railroad employer generally is entitled to receive a supplemental annuity paid by the Railroad Retirement Board (RRB) at retirement. An employee is entitled to receive a supplemental annuity only if the employee has performed at least 25 years of service with the railroad industry, including service with the railroad industry before October 1, 1981. The monthly amount of the supplemental annuity ranges from $23 to $43, based on the employee’s number of years of service. See 45 U.S.C. 231b(e). Under section 2(h)(2) of the RRA, an employee’s supplemental annuity is reduced by the amount of payments received by the employee from any plan determined by the RRB to be a supplemental pension plan of the employer, to the extent those payments are derived from employer contributions.

Section 3221(c) imposes a tax on each railroad employer to fund the supplemental annuity benefits payable by the Railroad Retirement Board. The tax imposed under section 3221(c) is based on workhours for which compensation is paid. The rate of tax under section 3221(c) is

October 13, 1998 8 1998–41 I.R.B.

sion plan within the meaning of §1.401– 1(b)(1)(i). Under this definition, a plan is a pension plan only if the plan is established and maintained primarily to provide systematically for the payment of definitely determinable benefits to employees over a period of years, usually for life, after retirement. Thus, for example, a plan generally is not a supplemental pension plan if distributions from the plan that are attributable to employer contributions may be made prior to a participant’s death, disability, or termination of employment. See Rev. Rul. 74–254 (1974–1 C.B. 90); Rev. Rul. 56–693 (1956–2 C.B. 282).

These proposed regulations also require that the RRB determine that a plan is a private pension under its regulations in order for the plan to be a supplemental pension plan under section 3221(d) and these proposed regulations. This requirement is included because the section 3221(d) exception to the section 3221(c) tax is based on the assumption that any participant for whom the exception applies will receive a reduced supplemental annuity because of the supplemental pension plan on account of which the section 3221(c) tax is eliminated. The IRS requests comments regarding other appropriate requirements for a supplemental pension plan within the meaning of section 3221(d).

These proposed regulations also provide rules for determining whether a plan is established by collective bargaining agreement with respect to an employer. These rules generally follow the rules applicable to qualified plans for this purpose.

Section 3221(d) imposes an excise tax equal to the amount of the supplemental annuity paid to any employee with respect to whom the employer has been excepted from the section 3221(c) tax under the section 3221(d) exception. These proposed regulations include rules applying this excise tax under section 3221(d).

Proposed Effective Date

These proposed regulations are proposed to be effective October 1, 1998.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assess

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

Comments and Public Hearing

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

A public hearing has been scheduled for January 20, 1999, at 10 a.m. in Room 2615, Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC. Because of access restrictions, visitors will not be admitted beyond the Internal Revenue Building lobby more than 15 minutes before the hearing starts.

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

Persons that wish to present oral comments at the hearing must submit comments and an outline of topics to be discussed and the time to be devoted to each topic (in the manner described under the ADDRESSES caption of this preamble) by December 30, 1998.

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

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

Drafting Information

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

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 31 is proposed to be amended as follows:

PART 31—EMPLOYMENT TAXES AND COLLECTION OF INCOME AT SOURCE

Paragraph 1. The authority citation for part 31 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 31.3221–4 is added under the undesignated center heading “Tax on Employers” to read as follows:

§31.3221–4 Exception from supplemental tax.

(a) General rule. Section 3221(d) provides an exception from the excise tax imposed by section 3221(c). Under this exception, the excise tax imposed by section 3221(c) does not apply to an employer with respect to employees who are covered by a supplemental pension plan, as defined in paragraph (b) of this section, that is established pursuant to an agreement reached through collective bargaining between the employer and employees, within the meaning of paragraph (c) of this section.

(b) Definition of supplemental pension plan —(1) In general. A plan is a supplemental pension plan covered by the section 3221(d) exception described in paragraph (a) of this section only if it meets the requirements of paragraphs (b)(2) through (4) of this section.

(2) Pension benefit requirement. A plan is a supplemental pension plan within the meaning of this paragraph (b) only if the plan is a pension plan within the meaning of §1.401–1(b)(1)(i) of this chapter. Thus, a plan is a supplemental pension plan only if the plan provides for the payment of definitely determinable benefits to employees over a period of years, usually for life, after retirement. A plan need not be funded through a qualified trust that meets the requirements of section 401(a) or an annuity contract that meets the requirements of section 403(a) in order to meet the requirements of this paragraph (b)(2). A plan that is a profitsharing plan within the meaning of §1.401–1(b)(1)(ii) of this chapter or a stock bonus plan within the meaning of

1998–41 I.R.B. 9 October 13, 1998

§1.401–1(b)(1)(iii) of this chapter is not a supplemental pension plan within the meaning of this paragraph (b).

(3) Railroad Retirement Board determi- nation with respect to the plan. A plan is a supplemental pension plan within the meaning of this paragraph (b) with respect to an employee only during any period for which the Railroad Retirement Board has made a determination under 20 CFR 216.42(d) that the plan is a private pension, the payments from which will result in a reduction in the employee’s supplemental annuity payable under 45 U.S.C. 231a(b). A plan is not a supplemental pension plan for any time period before the Railroad Retirement Board has made such a determination, or after that determination is no longer in force.

(4) Other requirements. [Reserved] (c) Collective bargaining agreement. A plan is established pursuant to a collective bargaining agreement with respect to an employee only if, in accordance with the rules of §1.410(b)–6(d)(2) of this chapter, the employee is included in a unit of employees covered by an agreement that the Secretary of Labor finds to be a collective bargaining agreement between employee representatives and one or more employers, provided that there is evidence that retirement benefits were the subject of good faith bargaining between employee representatives and the employer or employers.

(d) Substitute section 3221(d) excise tax. Section 3221(d) imposes an excise tax on any employer who has been excepted from the excise tax imposed under section 3221(c) by the application of section 3221(d) and paragraph (a) of this section with respect to an employee. The excise tax is equal to the amount of the supplemental annuity paid to that employee under section 2(b) of the Railroad Retirement Act of 1974 (88 Stat. 1305), plus a percentage thereof determined by the Railroad Retirement Board to be sufficient to cover the administrative costs attributable to such payments under section 2(b) of that Act. (e) Effective date. This section is effective October 1, 1998.

Michael P. Dolan, Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on September 22, 1998, 8:45 a.m., and published in the issue of the Federal Register for September 23, 1998, 63 F.R. 50819)

Notice of Rulemaking and Notice of Public Hearing

Guidance Under Section 1032 Relating to the Treatment of a Disposition by One Corporation of the Stock of Another Corporation in a Taxable Transaction

REG–106221–98

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed regulations relating to the treatment of a disposition by a corporation (the acquiring corporation) of the stock of another corporation (the issuing corporation) in a taxable transaction. The proposed regulations interpret section 1032 of the Internal Revenue Code. The proposed regulations affect corporations and their subsidiaries.

DATES: Written comments must be received by December 22, 1998. Requests to speak and outlines of topics to be discussed at the public hearing scheduled for Thursday, January 7, 1999 must be received by Thursday, December 17, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–106221–98), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG–106221–98), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the “Tax Regs” option on the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs. ustreas.gov/prod/tax_regs/comments.html. The public hearing will be held in room 2615, Internal Revenue Building, 1111

Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Lee A. Dean, (202) 622-7550; concerning submissions and the hearing, LaNita VanDyke, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 1032(a) provides that no gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for stock (including treasury stock) of such corporation. No gain or loss shall be recognized by a corporation with respect to any lapse or acquisition of an option to buy or sell its stock (including treasury stock).

Before the enactment of section 1032 in 1954, Treasury regulations provided that “where a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another.” (Treas. Reg. 111, §29.22(a)–15 (1934)).

As applied, this regulation resulted in the recognition of gain or loss on the disposition by a corporation of its treasury stock, even though the corporation would not have recognized gain or loss on the disposition of newly issued shares. See, e.g., Firestone Tire & Rubber Co. v. Com- missioner, 2 T.C. 827 (1943). This disparity of treatment gave rise to tax avoidance possibilities. A corporation expecting a gain upon disposition of treasury shares might avoid such gain by canceling its treasury shares and issuing new stock, whereas a corporation might produce a fictitious loss by purchasing its own shares and reselling them at a lower price.

Congress enacted section 1032(a) in 1954 to eliminate this potential disparity between the tax treatment of a disposition by a corporation of its treasury stock and a disposition of newly issued stock. H.R. No. 1337, 83d Cong., 2d Sess. 268 (1954).

Rev. Rul. 74–503 (1974–2 C.B. 117) considers the tax consequences of a parent corporation’s transfer to its subsidiary of its own treasury stock in a transaction

October 13, 1998 10 1998–41 I.R.B.

to which section 351 applies. The ruling states that “[t]he transfer of [parent] stock was not for the purpose of enabling [the subsidiary corporation] to acquire property by the use of such stock.” Rev. Rul. 74–503 holds that, since the basis of previously unissued parent stock in the hands of the parent corporation is zero, the basis of the parent corporation’s treasury stock in the hands of the parent corporation is also zero. Accordingly, under the transferred basis rule of section 362(a), the subsidiary corporation’s basis of the treasury stock of the parent corporation is also zero (the zero basis result).

Section 1.1032–2(b), applicable to certain triangular reorganizations occurring on or after December 23, 1994, eliminates gain recognition in certain cases when an acquiring corporation (S) acquires property or stock of another corporation (T) in exchange for stock of the corporation (P) in control of S. Section 1.1032–2(b) provides that, “For purposes of §1.1032– 1(a), in the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization (as described in §1.358–6(b)), P stock provided by P to S, or directly to T or T’s shareholders on behalf of S, pursuant to the plan of reorganization is treated as a disposition by P of its own stock for T’s assets or stock, as applicable.” Section 1.1032–2(c) provides that S must recognize gain or loss on its exchange of P stock if S did not receive the P stock pursuant to the plan of reorganization.

Section 1.1502–13(f)(6)(ii), initially published as temporary regulations applicable to transactions occurring on or after July 12, 1995 (T.D. 8598, 1995–2 C.B. 188), eliminates gain recognition under certain conditions on a member’s disposition of the stock of its common parent. If the requirements of that section are satisfied, §1.1502–13(f)(6)(ii) provides that “If a member, M, would otherwise recognize gain on a qualified disposition of P stock, then immediately before the qualified disposition, M is treated as purchasing the P stock from P for fair market value with cash contributed to M by P (or, if necessary, through any intermediate members).” Among other requirements, the member must, pursuant to a plan, transfer the stock “immediately to a nonmember that is not related.” See §1.1502–13(f)(6)(ii)(B). The preamble to

the temporary regulations explains that the gain relief provisions “prevent taxpayers from being subject to inappropriate taxation on gains in certain transactions.” (T.D. 8598, 1995–2 C.B. 188, 189.)

Section 83 provides rules for property, including parent’s stock, transferred in connection with the performance of services. Section 83(h) provides, in part, that “there shall be allowed as a deduction under section 162, to the person for whom were performed the services in connection with which such property was transferred, an amount equal to the amount included . . . in the gross income of the person who performed such services.” Section 1.83–6(b) provides that “[e]xcept as provided in section 1032, at the time of the transfer of property in connection with the performance of services the transferor recognizes gain to the extent that the transferor receives an amount that exceeds the transferor’s basis in the property.” Section 1.83–6(d) provides that, “[i]f a shareholder of a corporation transfers property to an employee of such corporation . . . in consideration of services performed for the corporation, the transaction shall be considered to be a contribution of such property to the capital of such corporation by the shareholder, and immediately thereafter a transfer of such property by the corporation to the employee . . . .”

Rev. Rul. 80–76 (1980–1 C.B. 15) addresses the use of a parent corporation’s stock as compensation to an employee of a subsidiary corporation. Under the facts, A, a shareholder of P, transfers P stock directly to B, an employee of S. The ruling holds in part that, “because section 83 applies to the transfer of P stock to B, S does not recognize gain or loss on the transfer of the P stock.”

Explanation of Provisions

Some of the concerns that ultimately led to the enactment of section 1032 are present where a subsidiary corporation holds the stock of a parent corporation. For example, a parent corporation could place treasury stock in a subsidiary corporation in order to attempt to recognize losses if the price of the parent corporation stock goes down, or could sell shares directly if the price rises. See Rev. Rul. 74–503 (1974–2 C.B. 117). The zero basis result limits such planning opportunities.

These tax avoidance possibilities are not present, however, in transactions where one corporation transfers its own stock to another corporation pursuant to a plan by which the second corporation immediately transfers the stock of the first corporation to acquire money or other property. The risk of selective loss recognition does not arise where the stock of the parent corporation is used immediately by the subsidiary corporation to acquire money or other property and therefore does not have sufficient time to depreciate in value. This concept is reflected in Rev. Rul. 74–503, which provides a factual carve-out for transfers of parent corporation stock made for the purpose of enabling a subsidiary corporation to acquire property. Also, the IRS and the Treasury have not applied the zero basis result in such integrated transactions, regardless of whether such a disposition of stock is part of a tax-free reorganization or is part of a taxable acquisition. See §§1.1502–13(f)(6)(ii) and 1.1032–2(b). These proposed regulations provide that no gain or loss is recognized in certain taxable transactions where one corporation immediately disposes of the stock of another corporation pursuant to a plan to acquire money or other property. The IRS and Treasury believe that, in such transactions, the nonapplicability of the zero basis result avoids inappropriate gain recognition and is consistent with the purposes of section 1032. No inference is intended regarding the applicability of the zero basis result to transactions outside of the scope of these proposed regulations.

If the conditions of these proposed regulations are satisfied, no gain or loss is recognized on the disposition of the stock of one corporation (the issuing corporation) by another corporation (the acquiring corporation). The proposed regulations apply if, pursuant to a plan to acquire money or other property, (1) the acquiring corporation acquires stock of the issuing corporation directly or indirectly from the issuing corporation in a transaction in which, but for this section, the basis of the stock of the issuing corporation in the hands of the acquiring corporation would be determined with respect to the issuing corporation’s basis in the issuing corporation’s stock under section 362(a); (2) the acquiring corporation immediately transfers the stock of the issu

1998–41 I.R.B. 11 October 13, 1998

ing corporation to acquire money or other property; and (3) no party receiving stock of the issuing corporation from the acquiring corporation receives a substituted basis in the stock of the issuing corporation within the meaning of section 7701(a)(42). For purposes of this section, “property” includes services. See §1.1032–1.

Mechanics of Proposed Regulations

These proposed regulations adopt the cash purchase model used in §1.1502– 13(f)(6)(ii) to provide relief from gain. In transactions to which the proposed regulations apply, immediately before the disposition of the issuing corporation’s stock, the acquiring corporation is treated as purchasing the issuing corporation’s stock from the issuing corporation for fair market value with cash contributed to the acquiring corporation by the issuing corporation (or, if necessary, through intermediate corporations).

As a result of this deemed cash purchase of stock, the acquiring corporation will have a fair market value basis in the issuing corporation’s stock pursuant to section 1012, and the issuing corporation will increase its basis in the stock of the acquiring corporation (and, if necessary, the stock basis of intermediate corporations) by that amount. See, e.g., section 358.

No inference is intended regarding whether circular cash flows would be respected apart from this regulation. Similarly, no inference is intended with respect to other methods of avoiding gain on the acquiring corporation’s use of the issuing corporation’s stock.

A cross-reference in §1.83–6(d) to the proposed regulations clarifies that the mechanics of the proposed regulations— rather than the mechanics of §1.83– 6(d)—apply to a corporate shareholder’s transfer of its own stock to any person in consideration of services performed for another corporation where the conditions of these proposed regulations are satisfied.

The cash purchase model of these proposed regulations preserves the acquiring corporation’s deduction under section 162 for the use of the issuing corporation’s stock to compensate the acquiring corporation’s employees. In addition, as in Rev. Rul. 80–76, the cash purchase model of these proposed regulations provides that the acquiring corporation will not

recognize gain or loss on the transfer of the stock of the issuing corporation. The proposed regulations provide that the cash purchase model is applicable only when the acquiring corporation immediately transfers the stock of the issuing corporation to acquire money or other property. The IRS and the Treasury believe that these proposed regulations address the same issues as in Rev. Rul. 80–76 and, when issued in final form, will render Rev. Rul. 80–76 obsolete.

Stock Options

Section 1032(a), in conjunction with the rules governing the taxation of options, also operates to prevent selective loss recognition in the case where a corporation issues options to buy or sell its own stock. See Deficit Reduction Act of 1984, H.R. Rep. No. 432, 98th Cong., 2d. Sess. pt. 2 1196 (1984) (expanding section 1032(a) to provide that a corporation does not recognize gain or loss with respect to any lapse or acquisition of an option to buy or sell its stock, including treasury stock). As in the case of a subsidiary corporation’s dealings in parent corporation stock, however, section 1032 may not always prevent selective loss recognition where a subsidiary corporation deals in options on parent corporation stock. Again, the zero basis result serves to limit such planning opportunities.

The Treasury and the IRS have determined that the concerns underlying section 1032 are not present where the issuing corporation transfers options on its own stock to the acquiring corporation pursuant to a plan by which the acquiring corporation immediately transfers those options to acquire money or other property. Accordingly, these proposed regulations apply to an option issued by an issuing corporation to buy or sell its own stock in the same manner as they apply to stock of an issuing corporation.

Amendment to §1.1032–2

The preamble to the final regulations under §1.1032–2 states that the tax treatment of a disposition by the acquiring corporation (S) of stock options of the corporation (P) in control of S was beyond the scope of the project. (Preamble to Final Regulations under sections 358, 1032 and 1502 [T.D. 8648, 1996–1 C.B. 37, 39].) The IRS and the Treasury be

lieve that the tax treatment of stock options of the issuing corporation in these triangular reorganizations also should be addressed under section 1032. Accordingly, these proposed regulations amend §1.1032–2 to provide that §1.1032–2 shall apply to an option to buy or sell P stock issued by P in the same manner as that section applies to the stock of P.

Proposed Effective Date

The regulations are proposed to be effective on the date that final regulations are published in the Federal Register.

Special Analyses

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

Comments and Public Hearing

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

A public hearing has been scheduled for Thursday, January 7, 1999 beginning at 10 a.m., in room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Because of access restrictions, visitors will not be admitted beyond the Internal Revenue Building lobby more than 15 minutes before the hearing starts.

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

Persons who wish to present oral comments at the hearing must request to speak, and submit an outline of topics to

October 13, 1998 12 1998–41 I.R.B.

be discussed and the time to be devoted to each topic by Thursday, December 17, 1998. A period of ten minutes will be allocated to each person for making comments.

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

Drafting Information

The principal author of these proposed regulations is Lee A. Dean of the Office of the Assistant Chief Counsel (Corporate), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regulations

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

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.83–6 is amended by adding two sentences to the end of paragraph (d)(1) to read as follows:

§1.83–6 Deduction by employer.

(d)(1) * * * For special rules that may apply to a corporate shareholder’s transfer of its own stock to any person in consideration of services performed for another corporation, see §1.1032–3. The preceding sentence applies to transfers of stock occurring on or after the date these regulations are published as final regulations in the Federal Register.

Par. 3. Section 1.1032–2 is amended by:

Revising paragraph (e);
Adding paragraph (f). The addition and revision read as follows:

§1.1032–2 Disposition by a corporation of stock of a controlling corporation in certain triangular reorganizations.

(e) Stock options. The rules of this section shall apply to an option to buy or sell P stock issued by P in the same manner as the rules of this section apply to P stock.

(f) Effective dates. This section applies to triangular reorganizations occurring on or after December 23, 1994. Paragraph (e) applies to transfers of stock options occurring on or after the date these regulations are published as final regulations in the Federal Register.

Par. 4. Section 1.1032–3 is added to read as follows:

§1.1032–3 Disposition of stock or stock options in certain transactions not qualifying under any other nonrecognition provision.

(a) Scope. This section provides rules for certain transactions in which one corporation (the acquiring corporation) acquires money or other property (as defined in §1.1032–1) in exchange, in whole or in part, for stock of another corporation (the issuing corporation).

(b) General rule. In a transaction to which this section applies, no gain or loss is recognized on the disposition of the issuing corporation’s stock by the acquiring corporation. The transaction is treated as if, immediately before the acquiring corporation disposes of the stock of the issuing corporation, the acquiring corporation purchased the issuing corporation’s stock from the issuing corporation for fair market value with cash contributed to the acquiring corporation by the issuing corporation (or, if necessary, through intermediate corporations).

(1) The acquiring corporation acquires stock of the issuing corporation directly or indirectly from the issuing corporation in a transaction in which, but for this section, the basis of the stock of the issuing corporation in the hands of the acquiring corporation would be determined with respect to the issuing corporation’s basis in the issuing corporation’s stock under section 362(a);

(2) The acquiring corporation immediately transfers the stock of the issuing corporation to acquire money or other property; and

(3) No party receiving stock of the issuing corporation from the acquiring cor

poration receives a substituted basis in the stock of the issuing corporation within the meaning of section 7701(a)(42).

(d) Stock options. The rules of this section shall apply to an option issued by a corporation to buy or sell its own stock in the same manner as the rules of this section apply to the stock of an issuing corporation.

(e) Examples. The following examples illustrate the application of this section:

Example 1. (i) X, a corporation, owns all of the stock of Y corporation. Y reaches an agreement with A, an individual, to acquire a truck from A in exchange for 10 shares of X stock with a fair market value of $100. To effectuate Y ’s agreement with A, X transfers to Y the X stock in a transaction in which, but for this section, the basis of the X stock in the hands of Y would be determined with respect to X ’s basis in the X stock under section 362(a). Y immediately transfers the X stock to A to acquire the truck.

(ii) In this Example 1, no gain or loss is recognized on the disposition of the X stock by Y . Immediately before Y ’s disposition of the X stock, Y is treated as purchasing the X stock from X for $100 of cash contributed to Y by X .

Example 2. (i) Assume the same facts as Exam- ple 1, except that, rather than X stock, X transfers an option with a fair market value of $100 to buy X stock.

(ii) In this Example 2, no gain or loss is recognized on the disposition of the X stock option by Y . Immediately before Y ’s disposition of the X stock option, Y is treated as purchasing the X stock option from X for $100 of cash contributed to Y by X .

Example 3. (i) X, a corporation, owns all of the outstanding stock of Y corporation. A, an individual, is an employee of Y . Pursuant to an agreement between X and Y to compensate A for services provided to Y, X transfers to A 10 shares of X stock with a fair market value of $100. Under §1.83–6(d), but for this section, the transfer of X stock by X to A would be treated as a contribution of the X stock by X to the capital of Y, and immediately thereafter, a transfer of the X stock by Y to A . But for this section, the basis of the X stock in the hands of Y would be determined with respect to X ’s basis in the X stock under section 362(a).

(ii) In this Example 3, no gain or loss is recognized on the deemed disposition of the X stock by Y . Immediately before Y ’s deemed disposition of the X stock, Y is treated as purchasing the X stock from X for $100 of cash contributed to Y by X .

Example 4. (i) X, a corporation, issues 10 shares of X stock subject to a substantial risk of forfeiture to compensate Y ’s employee, A, for services. A does not have an election under section 83(b) in effect with respect to the X stock. X retains a reversionary interest in the X stock in the event that A forfeits the right to the stock. At the time the stock vests, the 10 shares of X stock have a fair market value of $100. Under §1.83–6(d), but for this section, the transfer of the X stock by X to A would be treated, at the time the stock vests, as a contribution of the X stock by X to the capital of Y, and immediately thereafter, a disposition of the X stock by Y to A . The basis of the X stock in the hands of Y, but for this section, would be

1998–41 I.R.B. 13 October 13, 1998

filed by April 15, 1998. Of this total, 13,311 taxpayers were reported as being previously uninsured. It has been estimated that an additional 5,781 tax returns reporting MSA contributions for the 1997 taxable year have been or will be filed after April 15, 1998, including 2,197 taxpayers who were previously uninsured. Accordingly, it has been determined that there were 41,668 (35,887 plus 5,781) MSA returns for 1997. Of this total, 15,508 (13,311 plus 2,197) were for taxpayers reported as being previously uninsured. As a result, 26,160 (41,668 minus 15,508) MSA returns count toward the applicable statutory limitation for 1997 MSA returns of 600,000.

Based on the Forms 8851 filed on or before August 1, 1998 by MSA trustees and custodians, it has been determined that 13,034 taxpayers who did not have MSA contributions for 1997 established MSAs for 1998 during the portion of 1998 preceding July 1. Of this total, 2,180 taxpayers were reported by trustees and custodians as previously uninsured, and therefore are not taken into account in determining whether 1998 is a “cut-off” year. In addition, 166 taxpayers were reported by trustees and custodians as excludable from the count because their spouse also established an MSA, and 37 taxpayers had more than one account. Accordingly, the applicable number of MSAs established from January 1, 1998 through June 30, 1998, is 10,651 (13,034 minus (2,180 plus 166 plus 37)). The alternative limitation for 1998 (90 percent of the applicable number of MSA returns for 1997 plus the product of 2.5 and the number of applicable MSAs established from January 1, 1998 through June 30, 1998) is 50,172 (90 percent of 26,160 plus 2.5 times 10,651), which is less than the statutory limit of 750,000. Thus, 1998 is not a cut-off year for the MSA pilot project by reason of either the 1997 MSA returns test of section 220(j)(2)(A) or the alternative test of section 220(j)(2)(B) of the Code.

Questions regarding this announcement may be directed to Felix Zech in the Office of Associate Chief Counsel (Employee Benefits and Exempt Organizations) at (202) 622-4606 (not a toll free number).

determined with respect to X ’s basis in the X stock under section 362(a).

(ii) In this Example 4, no gain or loss is recognized on the deemed disposition of X stock by Y when the stock vests. Immediately before Y ’s deemed disposition of the X stock, Y is treated as purchasing X ’s stock from X for $100 of cash contributed to Y by X .

Example 5. (i) Assume the same facts as in Ex- ample 4, except that Y (rather than X ) retains a reversionary interest in the X stock in the event that A forfeits the right to the stock. Several years after X ’s transfer of the X shares, the stock vests.

(ii) This section does not apply to Y ’s deemed disposition of the X shares. For the tax consequences to Y on the deemed disposition of the X stock, see §1.83–6(b).

(f) Effective date. This section applies to transfers of stock or stock options of the issuing corporation occurring on or after the date these regulations are published as final regulations in the Federal Register.

Michael P. Dolan, Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on September 22, 1998, 8:45 a.m., and published in the issue of the Federal Register for September 23, 1998, 63 F.R. 50816)

Medical Savings Accounts

Announcement 98–88

PURPOSE

Sections 220(i) and (j) of the Internal Revenue Code provide that if the number of medical savings account (MSA) returns filed for 1997 exceeds 600,000, then October 1, 1998, is a “cut-off” date for the MSA pilot project. If a statutorily specified projection of the number of MSA returns that will be filed for 1998 exceeds 750,000, then October 1, 1998, will also be a “cut-off” date for the MSA pilot project. The Internal Revenue Service (I.R.S.) has determined that the applicable number of MSA returns filed for 1997 is 26,160, and that the applicable number of MSA returns projected to be filed for 1998 is 50,172 (after reduction in each case for statutorily specified exclusions, such as the exclusion for previously uninsured taxpayers). Consequently, October 1, 1998 is not a “cut-off” date and 1998 is not a “cut-off” year for the MSA pilot project.

BACKGROUND

The Health Insurance Portability and Accountability Act of 1996 added section 220 to the Code to permit eligible individuals to establish MSAs under a pilot project effective January 1, 1997. The pilot project has a scheduled “cut-off” year of 2000, but may have an earlier “cut-off” year if the number of individuals who have established MSAs exceeds certain numerical limitations. See sections 220(i) and (j).

If a year is a “cut-off” year, section 220(i)(1) generally provides that no individual will be eligible for a deduction or exclusion for MSA contributions for any taxable year beginning after the “cut-off” year unless the individual (A) was an active MSA participant for any taxable year ending on or before the close of the “cutoff” year, or (B) first became an active MSA participant for a taxable year ending after the “cut-off” year by reason of coverage under a high deductible health plan of an MSA-participating employer.

Section 220(j)(2)(A) provides that the numerical limitation for 1998 is exceeded if the number of MSA returns filed on or before April 15, 1998 for taxable years ending with or within the 1997 calendar year, plus the Secretary’s estimate of the number of MSA returns for those taxable years which will be filed after April 15, 1998, exceeds 600,000. Section 220(j)(2)(B) provides, as an alternative test, that the numerical limitation for 1998 is also exceeded if the sum of 90 percent of the sum determined under section 220(j)(2)(A) for 1998 plus the product of 2.5 and the number of MSAs for taxable years beginning in 1998 that are established during the portion of 1998 preceding July 1 (based on reports by MSA trustees and custodians), exceeds 750,000.

Under section 220(j)(3), in determining whether any calendar year is a “cut-off” year, the MSA of any previously uninsured individual is not taken into account. In addition, section 220(j)(4)(D) specifies that, to the extent practical, all MSAs established by an individual are aggregated and two married individuals opening separate MSAs are to be treated as having a single MSA for purposes of determining the number of MSAs.

A total of 35,887 tax returns reporting MSAs for the 1997 taxable year were

October 13, 1998 14 1998–41 I.R.B.

Correction of July 1998 Instructions for Form 706

Announcement 98–92

The July 1998 revision of the Instructions for Form 706 contain an error. On page 6, in column 1, in the first paragraph under Interest computation, the figure $320,618 is incorrect. The correct figure is $410,000.

1998–41 I.R.B. 15 October 13, 1998