Part I. Rulings — Internal Revenue Bulletin 2002-21

Section 61.—Gross Income Defined

26 CFR 1.61–1: Gross income.

Under the CCR method of accounting, the amount of a CCR payment is not includible in the taxpayer’s gross income and may not be included in the taxpayer’s basis in the purchased vehicle. See Rev. Proc. 2002–36, page 993.

Section 446.—General Rule for Methods of Accounting

26 CFR 1.446–1: General rule for methods of accounting.

26 CFR 1.446–3: Notional Principal Contracts.

Notional Principal Contract . This ruling provides that where a nonperiodic payment made pursuant to a notional principal contract is comprised of noncontingent and contingent components, the parties must recognize the noncontingent component of the nonperiodic payment over the term of the notional principal contract.

Rev. Rul. 2002–30

ISSUE

What is the appropriate method for the inclusion into income or deduction of a nonperiodic payment made pursuant to a notional principal contract where the payment is comprised of noncontingent and contingent components?

FACTS

T enters into a notional principal contract (“NPC”) with CP on October 1, 2002, for a term of 18 months. Pursuant to the terms of the NPC, T agrees to make quarterly payments to CP based on threemonth LIBOR multiplied by a notional principal amount of $100,000,000. In exchange, CP agrees that upon expiration

of the NPC on March 31, 2004, CP will pay T 6 percent per year multiplied by a notional principal amount of $92,000,000 (the fixed payment amount). In addition, CP or T will make a payment upon expiration equal to the percentage change in the value of the S&P 500 stock index multiplied by a notional principal amount of $8,000,000. If the change is positive (an appreciation amount), CP will make a payment to T ; if the change is negative (a depreciation amount), T will make a payment to CP . Any depreciation amount payable by T will be netted against the fixed payment amount payable by CP .

LAW

Section 1.446–3 of the Income Tax Regulations provides rules on the timing of inclusion of income and deductions for amounts paid or received pursuant to NPCs.

Section 1.446–3(c)(1)(i) defines a NPC as a financial instrument that provides for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal amount, in exchange for specified consideration or a promise to pay similar amounts. Payments made pursuant to NPCs are divided into three categories (periodic, nonperiodic, and termination payments), and the regulations provide separate timing regimes for each.

Section 1.446–3(e)(1) defines periodic payments as payments made or received pursuant to a NPC that are payable at intervals of one year or less during the entire term of the contract, that are based on a specified index, and that are based on a notional principal amount. Section 1.446–3(e)(2) provides that all taxpayers, regardless of their methods of accounting, must recognize the ratable daily portion of a periodic payment for the taxable year to which that portion relates.

Section 1.446–3(h)(1) defines a termination payment as a payment made or received to extinguish or assign all or a proportionate part of the remaining rights and obligations of any party under a NPC.

Section 1.446–3(f)(1) provides that a nonperiodic payment is any payment

made or received with respect to a NPC that is not a periodic payment or a termination payment. The recognition rules for nonperiodic payments are set forth in § 1.446–3(f)(2). Section 1.446–3(f)(2)(i) provides that all taxpayers, regardless of their methods of accounting, must recognize the ratable daily portion of a nonperiodic payment for the taxable year to which that portion relates. Generally, a nonperiodic payment must be recognized over the term of a NPC in a manner that reflects the economic substance of the contract.

Section 1.446–3(f)(2)(ii) provides generally that a nonperiodic payment must be recognized over the term of the contract by allocating it in accordance with the forward rates of a series of cash-settled forward contracts that reflect the specified index and the notional principal amount.

Section 1.446–3(f)(2)(iii)(A) provides that an upfront payment may be amortized by assuming that the nonperiodic payment represents the present value of a series of equal payments made throughout the term of the swap contract (the level payment method).

Section 1.446–3(f)(2)(iii)(B) provides that nonperiodic payments other than an upfront payment may be amortized by treating the contract as if it provided for a single upfront payment (equal to the present value of the nonperiodic payments) and a loan between the parties. The single upfront payment is then amortized under the level payment method described in § 1.446–3(f)(2)(iii)(A). The time value component of the loan is not treated as interest, but together with the amortized amount of the deemed upfront payment, is recognized as a periodic payment. See § 1.446–3(f)(4), Example 6, for an illustration of these rules.

Section 1.446–3(g)(4) provides that a swap with significant nonperiodic payments is treated as two separate transactions consisting of an on-market, level payment swap and a loan. The loan must be accounted for by the parties to the contract independently of the swap. The time value component associated with the loan is not included in the net income or net deduction from the swap under § 1.446– 3(d) of this section, but is recognized as

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Section 481.—Adjustments Required for Changes in Method of Accounting

26 CFR 1.481–1: Adjustments in general. 26 CFR 1.481–4: Adjustments taken into account with consent.

A purchaser of a motor vehicle that is subject to a lease in connection with which a lessee has made a CCR payment to the dealer from which the lessee originally leased the vehicle may obtain automatic consent to change to the CCR method of accounting. See Rev. Proc. 2002–36, page 993.

Section 513.—Unrelated Trade or Business

26 CFR 1.513–4: Certain sponsorship not unrelated trade or business.

T.D. 8991

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Taxation of Tax-Exempt Organizations’ Income From Corporate Sponsorship

AGENCY: Internal Revenue Service (IRS), Treasury Department.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the tax treatment of corporate sponsorship payments received by tax-exempt organizations. The final regulations affect exempt organizations that receive sponsorship payments.

DATES: Effective Date : These regulations are effective April 25, 2002.

Applicability Date : These regulations are applicable for payments solicited or received after December 31, 1997.

FOR FURTHER INFORMATION CONTACT: Stephanie Lucas Caden or Barbara E. Beckman of Office of Associate Chief Counsel (TE/GE), (202) 622–6080 (not a toll-free number).

interest for all purposes of the Internal Revenue Code.

Section 1.446–3(d) provides that for all purposes of the Code, the net income or net deduction from a NPC for a taxable year is included in, or deducted from, gross income for that taxable year. The net income or net deduction from a NPC for a taxable year equals the total of all of the periodic payments that are recognized from that contract for the taxable year under § 1.446–3(e), and all of the nonperiodic payments that are recognized from that contract for the taxable year under § 1.446–3(f). Each party to the NPC determines its payments and receipts attributable to the taxable year and takes into account, as net income or net deduction, the result of those payments and receipts. See § 1.446–3(e)(3), Example 1; and § 1.446–3(g)(6), Example 3.

ANALYSIS

The agreement between T and CP is a NPC as defined in § 1.446–3(c)(1)(i). Pursuant to the terms of the contract, T will pay to CP amounts based on LIBOR quarterly, in exchange for CP ’s promise to pay specified consideration at expiration.

The amounts that T pays to CP are periodic payments as defined in § 1.446– 3(e)(1). These LIBOR-based payments are payable at intervals of less than one year and are calculated by reference to a specified index upon a notional principal amount of $100,000,000. Pursuant to § 1.446–3(e)(2), T and CP must recognize the ratable daily portion of each periodic payment for the taxable year to which that portion relates.

The amount payable on March 31, 2004, is a nonperiodic payment, which T and CP are required to recognize over the term of the NPC in a manner that reflects the economic substance of the NPC. In substance, the nonperiodic payment that CP must pay T on expiration equals the sum of two independent components, one noncontingent and the other contingent. The noncontingent component (the fixed payment amount) equals $8,280,000, that is the product of 6 percent per year, or 9 percent for 18 months, and the notional principal amount of $92,000,000. The contingent component (the appreciation

or depreciation amount) equals the product of the percentage appreciation or depreciation in the value of the S&P 500 stock index and the notional principal amount of $8,000,000. In order to reflect the economic substance of the NPC, each component must be treated separately for purposes of applying the NPC rules in § 1.446–3. As a result, pursuant to § 1.446–3(f)(2)(i), the fixed payment amount due on March 31, 2004, must be recognized over the term of the NPC in a manner consistent with § 1.446–3(f)(2)(ii) or (iii). This treatment of the fixed payment amount payable by CP is not affected by the possibility that T may be required to pay a depreciation amount to CP that, under the terms of the NPC, will be netted against CP ’s obligation to pay the fixed payment amount. Pursuant to § 1.446–3(g)(4), T must accrue interest income and CP may accrue interest deductions.

HOLDING

T and CP must recognize the noncontingent component of the nonperiodic payment over the term of the NPC, and must also account for interest, in a manner consistent with §§ 1.446–3(f)(2)(ii) or (iii), and 1.446–3(g)(4).

DRAFTING INFORMATION

The principal author of this revenue ruling is Elizabeth Handler of the Office of Associate Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling, contact Ms. Handler at (202) 622–3930 (not a toll-free call).

Section 451.—General Rule for Taxable Year of Inclusion

26 CFR 1.451–1: General rule for taxable year of inclusion.

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scheduled and printed material published by or on behalf of an exempt organization that is not related to and primarily distributed in connection with a specific event conducted by the exempt organization.

To reflect the differences between the 1993 proposed regulations and section 513(i), and in response to comments submitted on the 1993 proposed regulations, new proposed regulations (REG–209601– 92, 2000–1 C.B. 829) (2000 proposed regulations) were issued on March 1, 2000 (65 F.R. 11012). The 2000 proposed regulations amend the regulations under section 513, and provide that qualified sponsorship payments within the meaning of section 513(i) are not UBTI. The 2000 proposed regulations define the phrase “substantial return benefit” to mean any benefit other than (1) a use or acknowledgment of the payor’s name or logo in connection with the exempt organization’s activities, or (2) certain goods or services that have an insubstantial value under existing IRS guidelines. Generally, according to the 2000 proposed regulations, benefits such as complimentary tickets, pro-am playing spots, and receptions for donors have an insubstantial value only if they have a fair market value of not more than 2% of the payment, or $74 (adjusted for inflation for tax years beginning after calendar year 2000 pursuant to section 1(f)(3)), whichever is less. See § 1.170A– 13(f)(8)(i)(A); Rev. Proc. 90–12 (1990–1 C.B. 471), as adjusted for inflation (for calendar year 2002, the amount is $79, see Rev. Proc. 2001–59 (2001–52 I.R.B. 623) (December 26, 2001)). The 2000 proposed regulations clarify that for an exempt organization to avail itself of the section 513(i) safe harbor, it must establish that some portion of the payment exceeds the fair market value of any substantial return benefit received by a payor in return for making the payment. In a sponsorship arrangement, the fair market value of the substantial return benefit may equal the entire amount of the sponsorship payment. The burden of establishing the fair market value of any substantial return benefit falls on the exempt organization. The 2000 proposed regulations state that the exempt organization’s determination of the fair market value of a substantial return benefit provided to the payor will not be set aside

SUPPLEMENTARY INFORMATION:

Background

Exempt organizations generally must pay tax on unrelated business taxable income, as defined in section 512. Section 512(a)(1) defines unrelated business tax- able income (UBTI) as the gross income derived by an organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions that are directly connected with the carrying on of the trade or business, both computed with the modifications provided in section 512(b).

Section 513(a) defines unrelated trade or business as any trade or business the conduct of which is not substantially related (aside from the need of an organization for income or funds or the use it makes of the profits derived) to the exercise or performance by the organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501. Section 513(c), captioned “Advertising, etc., activities,” provides that the term trade or business includes any activity carried on for the production of income from the sale of goods or the performance of services, and that an activity does not lose identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may, or may not, be related to the exempt purposes of the organization. See § 1. 513–1(b). The IRS first published a notice of proposed rulemaking (EE–74–92, 1993–1 C.B. 708) (1993 proposed regulations) on January 22, 1993 (58 F.R. 5687), proposing that the regulations under section 513 be amended to provide guidance on the proper tax treatment of sponsorship payments received by an exempt organization. The 1993 proposed regulations focused on the nature of the services provided by the exempt organization rather than the benefit received by the sponsor, and distinguished advertising, which is an unrelated trade or business activity, from acknowledgments, which are the mere recognition of a sponsor’s payment and therefore do not result in UBTI. In a so-called “tainting rule,” the 1993 proposed regulations provided that if any activities, messages or programming

material constituted advertising with respect to a sponsorship payment, then all related activities, messages, or programming material that might otherwise be acknowledgments would be considered advertising. The 1993 proposed regulations also proposed to amend the regulations under section 512(a) by adding examples of the allocation rule governing exploitation of exempt activities in cases involving sponsorship income.

The Taxpayer Relief Act of 1997, Public Law 105–34, section 965 (111 Stat. 788, 893–94), amended the Internal Revenue Code (Code) by adding section 513(i). Section 513(i) governs the treatment of certain sponsorship payments by providing that qualified sponsorship payments are not subject to the unrelated business income tax (UBIT). Section 513(i) defines qualified sponsorship pay- ments as payments made by a person engaged in a trade or business with respect to which there is no arrangement or expectation that such person will receive any substantial return benefit other than the use or acknowledgment of the name or logo (or product lines) of the person’s trade or business in connection with the exempt organization’s activities. Section 513(i) further provides that use or acknowledgment does not include advertising (including messages containing qualitative or comparative language, price information or other indications of savings or value, or an endorsement or other inducement to purchase, sell, or use a sponsor’s products or services).

Section 513(i) specifically provides that, to the extent a portion of a payment would (if made as a separate payment) be a qualified sponsorship payment, that portion of such payment and the other portion of such payment are treated as separate payments. Whether a separate transaction that falls outside of the section 513(i) safe harbor is subject to the UBIT depends on the application of existing rules under sections 512, 513, and 514.

Section 513(i) applies to payments solicited or received after December 31, 1997. Section 513(i) does not apply to qualified convention and trade show activities (described in section 513(d)(3)(B)) or to the sale of an acknowledgment or advertising in exempt organization periodicals. For this purpose, the term periodicals means regularly

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for purposes of applying the section 513(i) safe harbor so long as the organization makes a reasonable and good faith valuation of the substantial return benefit received by the payor.

The 2000 proposed regulations provide that the right to be the only sponsor of an activity, or the only sponsor representing a particular trade, business, or industry is generally not a substantial return benefit. Any portion of the payment attributable to the exclusive sponsorship arrangement, therefore, may be a qualified sponsorship payment. However, if in return for a payment, the exempt organization agrees that products or services that compete with the payor’s products or services will not be sold or provided in connection with one or more activities of the exempt organization, the payor has received a substantial return benefit and the portion of the payment attributable to the exclusive provider arrangement is not a qualified sponsorship payment. Consistent with the allocation rule described above, when a payor receives both exclusive sponsorship and exclusive provider rights in exchange for making a payment, the fair market value of the exclusive provider arrangement and any other substantial return benefit is determined first ( i.e., without regard to the existence of the exclusive sponsorship arrangement).

The 2000 proposed regulations clarify that qualified sponsorship payments in the form of money or property (but not services) are treated as contributions received by the exempt organization for purposes of determining public support to the organization under section 170(b)(1)(A)(vi) or section 509(a)(2). The exclusion of contributed services for purposes of determining public support is consistent with the general rule regarding donated services. See §§ 1.509(a)–3(f), 1.170A–9(e)(7)(i) and 1.170A–1(g). A public hearing was held on June 21, 2000. After consideration of all the comments, the proposed regulations under section 513(i) are revised as follows. The major areas of the comments and revisions are discussed below.

Explanation of Provisions and Discussion of Comments

Like the 2000 proposed regulations, the final regulations define the phrase

substantial return benefit to mean any benefit other than (1) a use or acknowledgment of the payor’s name or logo in connection with the exempt organization’s activities, or (2) certain goods or services that have an insubstantial value. If a payor receives a substantial return benefit in exchange for a payment, the section 513(i) safe harbor does not apply to the payment (or portion thereof) attributable to the substantial return benefit. In that case, whether the payment (or portion thereof) is subject to UBIT must be determined under existing principles and rules. Thus, the payment may not be subject to UBIT because the exempt organization’s activity is not an unrelated trade or business within the meaning of section 513(a) (for example, because substantially all of the work in carrying on the trade or business is performed by volunteers) or is not regularly carried on within the meaning of section 512(a)(1), or because one of the section 512(b) modifications applies. See also Rev. Rul. 77–367 (1977–2 C.B. 193) (inurement) and Rev. Rul. 66–358 (1966–2 C.B. 218) (private benefit).

Many comments were received regarding the disregarded benefits standard contained in the 2000 proposed regulations. Commentators generally believe that valuing insubstantial benefits places an undue administrative burden on exempt organizations. Commentators also believe that the disregarded benefits standard in the proposed regulation is too low and significantly diminishes an exempt organization’s ability to appropriately thank its sponsors. While the $79 ceiling (as adjusted for 2002) is an appropriate amount for exempt organizations to thank individual donors, the Treasury Department and IRS agree with the commentators that the $79 ceiling is too low with respect to corporations or persons engaged in a trade or business. In response to these concerns, the final regulations eliminate the $79 ceiling placed on the fair market value of benefits that may be disregarded for purposes of section 513(i).

Several commentators suggest that in addition to eliminating the $79 ceiling, the final regulations should increase the level of disregarded benefits to 10% or 15% of the amount of the payment. The Treasury Department and IRS believe 2%

is an appropriate level for several reasons. The 2% threshold is used in other areas of the Code and regulations to describe insubstantial amounts. The 2000 proposed regulations allow the full amount of qualified sponsorship payments (except for payments in the form of services) to be treated as contributions for purposes of the public support test under sections 170(b)(1)(A)(vi) and 509(a)(2), without reduction for the amount of disregarded benefits. The 2% ceiling keeps the level of disregarded benefits low enough so that the entire amount of a qualified sponsorship payment may be treated as a contribution for public support purposes. Accordingly, the final regulations disregard benefits having a fair market value of not more than 2% of the payment.

Many commentators to the 2000 proposed regulations object to a requirement that exempt organizations must value benefits provided to payors where the payment does not affect the organization’s tax liability, e.g., where the payment attributable to the benefit constitutes income from a trade or business that is substantially related to the organization’s exempt purposes. The Treasury Department and IRS note that organizations described in section 170(c) (other than section 170(c)(1)) are required to account for benefits provided to donors under section 6115. See Publication 1771, “ Chari- table Contributions - Substantiation and Disclosure Requirements. ” Pursuant to section 6115, a section 170(c) organization that receives a quid pro quo contribution in excess of $75 is required to inform the donor that the amount of the contribution that is deductible for federal income tax purposes is limited to the amount by which the payment exceeds the value of goods or services (except as provided in § 1.170A–13(f)(8)(i)) furnished by the charity, and is required to provide a good faith estimate of the value of those goods or services. Therefore, for exempt organizations eligible to receive tax deductible contributions, there is no additional tax administrative burden imposed by the disregarded benefits provision of either the 2000 proposed regulations or the final regulations.

The final regulations provide that in determining whether the 2% threshold has been exceeded in any year, all return

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benefits (other than use or acknowledgment) must be considered. For example, if in exchange for a payment the exempt organization provides both a license and advertising the combined fair market value of which does not exceed 2% of the total payment, the entire payment (even the portion attributable to the advertising) may be treated as a qualified sponsorship payment, and the entire amount (except any payment in the form of services) constitutes public support under section 509. Alternatively, if the combined fair market value exceeds 2% of the total payment, the value of both the license and advertising is not disregarded and constitutes a substantial return benefit. In that case, the portions of the payment attributable to the license and advertising each must be analyzed separately under sections 512, 513, and 514. Only the portion of the payment, if any, that exceeds the fair market value of the substantial return benefit constitutes a qualified sponsorship payment.

Consistent with the 2000 proposed regulations, the final regulations provide that the right to be the only sponsor of an activity, or the only sponsor representing a particular trade, business or industry is generally not a substantial return benefit. The portion of any payment attributable to the exclusive sponsorship arrangement, therefore, may be a qualified sponsorship payment. However, if in return for a payment, the exempt organization agrees that products or services that compete with the payor’s products or services will not be sold or provided in connection with one or more activities of the exempt organization, the payor has received a substantial return benefit and the portion of the payment attributable to the exclusive provider arrangement is not a qualified sponsorship payment.

Some commentators express concern that the definition of exclusive provider arrangements contained in the 2000 proposed regulations may include vendor contracts negotiated as part of a competitive bidding process required by state law. Both the 2000 proposed regulations and the final regulations provide that unless the exempt organization agrees to limit distribution of competing products in connection with the payment, the exempt organization has not entered into an exclusive provider arrangement. For example, when the nature of the goods or

services to be provided necessitates the use of only one provider because of limited space or because the competitive bidding process requires only the lowest bid be accepted, the exempt organization has not entered into an exclusive provider arrangement unless it agrees to limit distribution of competing products.

In particular, these commentators express concern about the tax-treatment of discounts and rebates negotiated with vendors as part of the competitive bidding process. Generally, discounts (and rebates) are considered an adjustment to the purchase price and do not constitute gross income to the purchaser. See Rev. Rul. 84–41 (1984–1 C.B. 130); Rev. Rul. 76–96 (1976–1 C.B. 23). For example, when a university negotiates discounted rates for the soft drinks it purchases for its cafeterias, snack bars, and concessions, the amount of the discount is not includible in UBTI.

Many commentators suggest that the exclusive provider provisions in the 2000 proposed regulations create an implication that exclusive provider arrangements are automatically subject to UBIT because they fall outside the scope of section 513(i). This assumption is incorrect; although the income from some exclusive provider arrangements may be includible in UBTI, not all contracts will meet the criteria for inclusion in UBTI pursuant to sections 511, 512, and 513. For example, a university that enters into a multi-year contract with a soft drink company to be the exclusive provider of soft drinks on campus in return for an annual payment is not necessarily subject to UBIT on that payment. If the company agrees to provide, stock, and maintain on-campus vending machines as needed, leaving little or no obligation on the university’s part to perform any services or conduct activities in connection with the enterprise, then based on this contract alone the university may not have the requisite level of activity to constitute a trade or business under section 513(a). This example assumes no agency relationship exists between the company and the university. In determining the level of activity, however, any promotional or marketing efforts by the university pursuant to the contract should be considered. If the contract grants the company a license to market its products using the university’s

name and logo, the portion of the total payment attributable to the value of the license may be excludable as a royalty under section 512(b)(2). In some cases, payments in connection with the grant of an exclusive concession, such as for the operation of a campus bookstore or cafeteria, may be treated as rental income under section 512(b)(3).

When an exempt organization agrees to perform substantial services in connection with the exclusive provider arrangement, income received by the organization may be includible in UBTI. For example, assume that a university enters into a multi-year contract with a sports drink company under which the company will be the exclusive provider of sports drinks for the university’s athletic department and concessions. As part of the contract, if the university agrees to perform various services for the company, such as guaranteeing that coaches make promotional appearances on behalf of the company ( e.g., attending photo shoots, filmed commercials, and retail store appearances), assisting the company in developing marketing plans, and participating in joint promotional opportunities, then the university’s activities are likely to constitute a regularly carried on trade or business. These activities are unlikely to be substantially related to the university’s exempt purposes. Furthermore, the income received by the university for those services is not excludable as a royalty under section 512(b)(2). See Rev. Rul. 81–178 (1981–2 C.B. 135), situation 2. The 2000 proposed regulations solicited comments on the application of the rules governing periodicals and trade shows to an exempt organization’s Internet sites, and whether providing a link to a sponsor’s Internet site is advertising within the meaning of section 513(i). The comments received generally suggest that a link to a corporate sponsor’s Internet site as part of a sponsorship arrangement is not a message, but a convenient feature of the Internet that can only be activated by the viewer, and thus constitutes a permissible form of acknowledgment. With regard to periodicals, most commentators expressed the view that the term “periodical”, for purposes of the section 513(i) exclusion, includes material published

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electronically. Some commentators suggest that an exempt organization’s Internet site should not be treated as a periodical simply because it has text that changes from time to time. Other commentators suggest criteria for analyzing whether an Internet site is a periodical.

Only a few comments were received on the application of the trade show exclusion in section 513(i) to an exempt organization’s Internet site. These comments generally suggest that trade shows conducted over the Internet be treated the same as trade shows conducted in person. That is, payments made in connection with Internet-based trade shows would not be exempt from UBIT as qualified sponsorship payments, but would be exempt from UBIT as income generated by qualified convention and trade show activity.

Many options for addressing the Internet in the final regulations were considered. The final regulations take the approach that, where possible, answers are provided. However, the Treasury Department and IRS note that the analysis of particular Internet issues, such as the use of hyperlinks, may be different for purposes of section 513(i) than other sections of the Code. The Treasury Department and IRS also conclude that some Internet issues addressed in comments are beyond the scope of section 513(i).

For purposes of section 513(i), the issue of whether a hyperlink constitutes an acknowledgment or advertising is addressed in the final regulations with two new examples. In the first new example, the exempt organization posts a list of its sponsors on its website, including the sponsor’s Internet address, which appears as a hyperlink from the exempt organization’s website to the sponsor’s website. The example concludes that posting the sponsor’s website address constitutes an acknowledgment, even though it appears as a hyperlink. In the second new example, a charity maintains a website that contains a hyperlink to a sponsor’s website where an endorsement by the charity for the sponsor’s product appears. The charity approved the endorsement before it was posted on the sponsor’s website. The example concludes that the endorsement is advertising. These two examples address hyperlinks for purposes of section 513(i) only,

and do not suggest how hyperlinks are treated under other sections of the Code.

With respect to periodicals, section 513(i) mentions periodicals only in the sense that the safe harbor does not apply to any payment which entitles the payor to the use or acknowledgment of the name or logo (or product lines) of the payor’s trade or business in exempt organization periodicals. Such payments are analyzed instead under the existing UBIT rules. Section § 1.512(a)–1(f) provides special rules for determining the amount of UBTI attributable to the sale of advertising in exempt organization periodicals. After considering the comments, the Treasury Department and IRS conclude that the regulations under section 512 are the more appropriate place for an analysis of issues relating to electronic periodicals. Nevertheless, the Treasury Department and IRS clarify that periodicals may include some forms of electronic publication. The final regulations state that the term periodical means regularly scheduled and printed material published by or on behalf of the exempt organization that is not related to and primarily distributed in connection with a specific event conducted by the exempt organization, and for this purpose, printed material includes material that is published electronically.

As noted above, relatively few comments were received on the trade show exclusion. Because of the small sampling of comments received, and because trade show rules impact many different industries and typically involve large sums of money, the final regulations do not change the rules on what constitutes a qualified convention and trade show activity. Existing guidance on trade shows is found in section 513(d) and § 1.513–3, and any reference to trade shows in the final regulations under section 513(i) is intended to be consistent with these rules.

Many commentators wrote regarding the valuation of substantial return benefits, and suggest that the 2000 proposed regulations do not offer enough guidance on how to make a reasonable and good faith valuation of a substantial return benefit. Commentators also assert that the valuation provisions do not further administrative convenience and simplicity. The fair market value of any substantial return benefit provided as part of a sponsorship arrangement is the price at

which the benefit would be provided between a willing recipient and a willing provider of the benefit, neither being under any compulsion to enter into the arrangement and both having reasonable knowledge of relevant facts, and without regard to any other aspect of the sponsorship arrangement. While the Treasury Department and IRS appreciate the difficulty an exempt organization has in valuing substantial return benefits, the final regulations retain the valuation standard contained in the 2000 proposed regulations. Several commentators suggest incorporating safe harbors into the final regulations to determine the value of a substantial return benefit. For example, one commentator suggests that a safe harbor be added to provide that an exempt organization’s valuation would not be challenged if it were determined based on the face amount of the tickets, cost of the dinner, or any reasonably comparable measure. Another commentator suggests that the fair market value be based on data provided by the payor, or as agreed by the parties. Another commentator favors predicting values of yearly benefits based on actual benefits provided over a three-year period. After considering these comments, the Treasury Department and IRS conclude that the safe harbors suggested by the commentators either are inconsistent with the general rule, do not provide any additional guidance, or are prone to abuse. For this reason, no safe harbors were added to the final regulations with respect to valuation.

Clarification is provided, however, with respect to the valuation date. The 2000 proposed regulations provide that in allocating a sponsorship payment, the fair market value of the substantial return benefit is to be determined on the date the parties enter into the sponsorship arrangement. The final regulations take the same approach for binding, written sponsorship contracts. This rule, which is illustrated by two new examples, provides exempt organizations the advantage of only having to value substantial return benefits once, even if the value of the substantial return benefit increases over the term of the contract. If the parties make a material change to a sponsorship contract, it is treated as a new contract as of the date the material change is effective. A material change is defined as an extension or

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(as defined in § 1.513–4) in the form of money or property (but not services).

(3) Examples . The provisions of this paragraph (f) may be illustrated by the following examples:

Example 1 . - - Example 2 . Q, a performing arts center, enters into a contract with a large company to be the exclusive sponsor of the center’s theatrical events. The company makes a payment of cash and products in the amount of $100,000 to Q, and in return, Q agrees to make a broadcast announcement thanking the company before each show and to provide $2,000 of advertising in the show’s program (2% of $100,000 is $2,000). The announcement constitutes use or acknowledgment pursuant to section 513(i)(2). Because the value of the advertising does not exceed 2% of the total payment, the entire $100,000 is a qualified sponsorship payment under section 513(i), and $100,000 is treated as a contribution for purposes of section 509(a)(2)(A)(i).

Example 3 . R, a charity, enters into a contract with a law firm to be the exclusive sponsor of the charity’s outreach program. Instead of making a cash payment, the law firm agrees to perform $100,000 of legal services for the charity. In return, R agrees to acknowledge the law firm in all its informational materials. The total fair market value of the legal services, or $100,000, is a qualified sponsorship payment under section 513(i), but no amount is treated as a contribution under section 509(a)(2)(A)(i) because the contribution is of services.

Par. 4. Section 1.512(a)–1 is amended by:

Revising the paragraph heading and introductory text for paragraph (e).
Redesignating the current Example in paragraph (e) as Example 1 and revising the heading.
Adding Example 2 to paragraph (e). The revisions and additions read as follows:

§ 1.512(a)–1 Definition .

(e) Examples . This section is illustrated by the following examples:

Example 1 . - - Example 2 . (i) P, a manufacturer of photographic equipment, underwrites a photography exhibition organized by M, an art museum described in section 501(c)(3). In return for a payment of $100,000, M agrees that the exhibition catalog sold by M in connection with the exhibit will advertise P’s product. The exhibition catalog will also include educational material, such as copies of photographs included in the exhibition, interviews with photographers, and

renewal of the contract, or a more than incidental change to any amount payable (or other consideration) under the contract. If there is no binding, written contract, the fair market value of the substantial return benefit is determined when the benefit is provided. The reason for distinguishing between written and oral agreements in the final regulations is to allow smaller exempt organizations to arrange sponsorship informally on a year-to-year basis and value those benefits each year as they occur.

Few comments were received on the § 1.512(a)–1(e) example relating to expense allocation. Of the comments received, most state that the 1993 proposed regulations did not interpret the exploitation exception too broadly, and request that the prior examples be reinstated. The commentators also suggest that the new example is factually unrealistic. Despite these comments, the final regulations do not change the § 1.512(a)– 1(e) example. The comments received generally do not contain substantive suggestions for change, and the Treasury Department and IRS believe that the current example in the final regulations correctly amplifies the technical provisions of the regulation, which is very limited in scope.

Special Analyses

It has been determined that this decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the final rule does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Code, these regulations were previously submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Stephanie Lucas Caden, Office of

Division Counsel/Associate Chief Counsel (Tax Exempt/Government Entities), Internal Revenue Service. However, personnel from other offices of the Service and the Treasury Department participated in their development.

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is 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. In § 1.170A–9, a sentence is added to the end of paragraph (e)(6)(i) to read as follows:

§ 1.170A–9 Definition of section 170(b)(1)(A) organization .

(e) - - (6) - - - (i) - - - For purposes of this paragraph (e), the term contributions includes qualified sponsorship payments (as defined in § 1.513–4) in the form of money or property (but not services).

Par. 3. Section 1.509(a)–3 is amended by:

Adding a sentence to the end of paragraph (f)(1).
Revising the paragraph heading and introductory text for paragraph (f)(3).
Redesignating the current Example in paragraph (f)(3) as Example 1 and revising the heading.
Adding Example 2 and Example 3 to paragraph (f)(3).

The revisions and additions read as follows;

§ 1.509(a)–3 Broadly, publicly supported organizations .

(f) * * * (1) * * * For purposes of section 509(a)(2), the term contributions includes qualified sponsorship payments

2002–21 I.R.B. 977 May 28, 2002

an essay by the curator of M’s department of photography. For purposes of this example, assume that none of the $100,000 is a qualified sponsorship payment within the meaning of section 513(i) and § 1.513–4, that M’s advertising activity is regularly carried on, and that the entire amount of the pay

ment is unrelated business taxable income to M. Expenses directly connected with generating the unrelated business taxable income ( i.e., direct advertising costs) total $25,000. Expenses directly connected with the preparation and publication of the exhibition catalog (other than direct advertising

costs) total $110,000. M receives $60,000 of gross revenue from sales of the exhibition catalog. Expenses directly connected with the conduct of the exhibition total $500,000.

(ii) The computation of unrelated business taxable income is as follows:

(A) Unrelated trade or business (sale of advertising):

Income $100,000

Directly-connected expenses (25,000)

Subtotal 75,000 $75,000

(B) Exempt function (publication of exhibition catalog):

Income (from catalog sales) 60,000

Directly-connected expenses (110,000)

Net exempt function income (loss) (50,000) (50,000)

Unrelated business taxable income 25,000

section, or disregarded benefits described in paragraph (c)(2)(ii) of this section.

(ii) Certain benefits disregarded . For purposes of paragraph (c)(2)(i) of this section, benefits are disregarded if the aggregate fair market value of all the benefits provided to the payor or persons designated by the payor in connection with the payment during the organization’s taxable year is not more than 2% of the amount of the payment. If the aggregate fair market value of the benefits exceeds 2% of the amount of the payment, then (except as provided in paragraph (c)(2)(iv) of this section) the entire fair market value of such benefits, not merely the excess amount, is a substantial return benefit. Fair market value is determined as provided in paragraph (d)(1) of this section.

(iii) Benefits defined . For purposes of this section, benefits provided to the payor or persons designated by the payor may include:

(A) Advertising as defined in paragraph (c)(2)(v) of this section.

(B) Exclusive provider arrangements as defined in paragraph (c)(2)(vi)(B) of this section.

(D) Exclusive or nonexclusive rights to use an intangible asset ( e.g., trademark, patent, logo, or designation) of the exempt organization.

(iv) Use or acknowledgment . For purposes of this section, a substantial return

(iii) Expenses related to publication of the exhibition catalog exceed revenues by $50,000. Because the unrelated business activity (the sale of advertising) exploits an exempt activity (the publication of the exhibition catalog), and because the publication of editorial material is an activity normally conducted by taxable entities that sell advertising, the net loss from the exempt publication activity is allowed as a deduction from unrelated business income under paragraph (d)(2) of this section. In contrast, the presentation of an exhibition is not an activity normally conducted by taxable entities engaged in advertising and publication activity for purposes of paragraph (d)(2) of this section. Consequently, the $500,000 cost of presenting the exhibition is not directly connected with the conduct of the unrelated advertising activity and does not have a proximate and primary relationship to that activity. Accordingly, M has unrelated business taxable income of $25,000.

Par. 5. Section 1.513–4 is added to read as follows:

§ 1.513–4 Certain sponsorship not un- related trade or business .

(a) In general . Under section 513(i), the receipt of qualified sponsorship payments by an exempt organization which is subject to the tax imposed by section 511 does not constitute receipt of income from an unrelated trade or business.

(b) Exception . The provisions of this section do not apply with respect to payments made in connection with qualified convention and trade show activities. For rules governing qualified convention and trade show activity, see § 1.513–3. The

provisions of this section also do not apply to income derived from the sale of advertising or acknowledgments in exempt organization periodicals. For this purpose, the term periodical means regularly scheduled and printed material published by or on behalf of the exempt organization that is not related to and primarily distributed in connection with a specific event conducted by the exempt organization. For this purpose, printed material includes material that is published electronically. For rules governing the sale of advertising in exempt organization periodicals, see § 1.512(a)–1(f).

(c) Qualified sponsorship payment (1) Definition . The term qualified spon- sorship payment means any payment by any person engaged in a trade or business with respect to which there is no arrangement or expectation that the person will receive any substantial return benefit. In determining whether a payment is a qualified sponsorship payment, it is irrelevant whether the sponsored activity is related or unrelated to the recipient organization’s exempt purpose. It is also irrelevant whether the sponsored activity is temporary or permanent. For purposes of this section, payment means the payment of money, transfer of property, or performance of services.

(2) Substantial return benefit —(i) In general . For purposes of this section, a substantial return benefit means any benefit other than a use or acknowledgment described in paragraph (c)(2)(iv) of this

May 28, 2002 978 2002–21 I.R.B.

benefit does not include the use or acknowledgment of the name or logo (or product lines) of the payor’s trade or business in connection with the activities of the exempt organization. Use or acknowledgment does not include advertising as described in paragraph (c)(2)(v) of this section, but may include the following: exclusive sponsorship arrangements; logos and slogans that do not contain qualitative or comparative descriptions of the payor’s products, services, facilities or company; a list of the payor’s locations, telephone numbers, or Internet address; value-neutral descriptions, including displays or visual depictions, of the payor’s product-line or services; and the payor’s brand or trade names and product or service listings. Logos or slogans that are an established part of a payor’s identity are not considered to contain qualitative or comparative descriptions. Mere display or distribution, whether for free or remuneration, of a payor’s product by the payor or the exempt organization to the general public at the sponsored activity is not considered an inducement to purchase, sell or use the payor’s product for purposes of this section and, thus, will not affect the determination of whether a payment is a qualified sponsorship payment.

(v) Advertising . For purposes of this section, the term advertising means any message or other programming material which is broadcast or otherwise transmitted, published, displayed or distributed, and which promotes or markets any trade or business, or any service, facility or product. Advertising includes messages containing qualitative or comparative language, price information or other indications of savings or value, an endorsement, or an inducement to purchase, sell, or use any company, service, facility or product. A single message that contains both advertising and an acknowledgment is advertising. This section does not apply to activities conducted by a payor on its own. For example, if a payor purchases broadcast time from a television station to advertise its product during commercial breaks in a sponsored program, the exempt organization’s activities are not thereby converted to advertising.

(vi) Exclusivity arrangements —(A) Exclusive sponsor . An arrangement that acknowledges the payor as the exclusive

sponsor of an exempt organization’s activity, or the exclusive sponsor representing a particular trade, business or industry, generally does not, by itself, result in a substantial return benefit. For example, if in exchange for a payment, an organization announces that its event is sponsored exclusively by the payor (and does not provide any advertising or other substantial return benefit to the payor), the payor has not received a substantial return benefit.

(B) Exclusive provider . An arrangement that limits the sale, distribution, availability, or use of competing products, services, or facilities in connection with an exempt organization’s activity generally results in a substantial return benefit. For example, if in exchange for a payment, the exempt organization agrees to allow only the payor’s products to be sold in connection with an activity, the payor has received a substantial return benefit.

(d) Allocation of payment —(1) In gen- eral . If there is an arrangement or expectation that the payor will receive a substantial return benefit with respect to any payment, then only the portion, if any, of the payment that exceeds the fair market value of the substantial return benefit is a qualified sponsorship payment. However, if the exempt organization does not establish that the payment exceeds the fair market value of any substantial return benefit, then no portion of the payment constitutes a qualified sponsorship payment.

(i) Treatment of payments other than qualified sponsorship payments . The unrelated business income tax (UBIT) treatment of any payment (or portion thereof) that is not a qualified sponsorship payment is determined by application of sections 512, 513, and 514. For example, payments related to an exempt organization’s providing facilities, services, or other privileges to the payor or persons designated by the payor, advertising, exclusive provider arrangements described in paragraph (c)(2)(vi)(B) of this section, a license to use intangible assets of the exempt organization, or other substantial return benefits, are evaluated separately in determining whether the exempt organization realizes unrelated business taxable income.

(ii) Fair market value . The fair market value of any substantial return benefit

provided as part of a sponsorship arrangement is the price at which the benefit would be provided between a willing recipient and a willing provider of the benefit, neither being under any compulsion to enter into the arrangement and both having reasonable knowledge of relevant facts, and without regard to any other aspect of the sponsorship arrangement.

(iii) Valuation date . In general, the fair market value of the substantial return benefit is determined when the benefit is provided. However, if the parties enter into a binding, written sponsorship contract, the fair market value of any substantial return benefit provided pursuant to that contract is determined on the date the parties enter into the sponsorship contract. If the parties make a material change to a sponsorship contract, it is treated as a new sponsorship contract as of the date the material change is effective. A material change includes an extension or renewal of the contract, or a more than incidental change to any amount payable (or other consideration) pursuant to the contract.

(iv) Examples . The following examples illustrate the provisions of this section:

Example 1 . On June 30, 2001, a national corporation and Z, a charitable organization, enter into a five-year binding, written contract effective for years 2002 through 2007. The contract provides that the corporation will make an annual payment of $5,000 to Z, and in return the corporation will receive no benefit other than advertising. On June 30, 2001, the fair market value of the advertising to be provided to the corporation in each year of the agreement is $75, which is less than the disregarded benefit amount provided for in paragraph (c)(2)(ii) of this section (2% of $5,000 is $100). In 2002, pursuant to the sponsorship contract, the corporation makes a payment to Z of $5,000, and receives the specified benefit (advertising). As of January 1, 2002, the fair market value of the advertising to be provided by Z each year has increased to $110. However, for purposes of this section, the fair market value of the advertising benefit is determined on June 30, 2001, the date the parties entered into the sponsorship contract. Therefore, the entire $5,000 payment received in 2002 is a qualified sponsorship payment.

Example 2 . The facts are the same as Example 1, except that the contract provides for an initial payment by the corporation to Z of $5,000 in 2002, followed by annual payments of $1,000 during each of years 2003–2007. In 2003, pursuant to the sponsorship contract, the corporation makes a payment to Z of $1,000, and receives the specified advertising benefit. In 2003, the fair market value of the benefit provided ($75, as determined on June 30, 2001) exceeds 2% of the total payment received (2% of

2002–21 I.R.B. 979 May 28, 2002

exclusive sponsor of the bowl game. The detailed contract between P and the corporation provides that in exchange for a $1,000,000 payment, the name of the bowl game will include the name of the corporation. In addition, the contract provides that the corporation’s name and established logo will appear on player’s helmets and uniforms, on the scoreboard and stadium signs, on the playing field, on cups used to serve drinks at the game, and on all related printed material distributed in connection with the game. P also agrees to give the corporation a block of game passes for its employees and to provide advertising in the bowl game program book. The fair market value of the passes is $6,000, and the fair market value of the program advertising is $10,000. The agreement is contingent upon the game being broadcast on television and radio, but the amount of the payment is not contingent upon the number of people attending the game or the television ratings. The contract provides that television cameras will focus on the corporation’s name and logo on the field at certain intervals during the game. P’s use of the corporation’s name and logo in connection with the bowl game constitutes acknowledgment of the sponsorship. The exclusive sponsorship arrangement is not a substantial return benefit. Because the fair market value of the game passes and program advertising ($16,000) does not exceed 2% of the total payment (2% of $1,000,000 is $20,000), these benefits are disregarded and the entire payment is a qualified sponsorship payment, which is not income from an unrelated trade or business.

Example 5 . Q organizes an amateur sports team. A major pizza chain gives uniforms to players on Q’s team, and also pays some of the team’s operational expenses. The uniforms bear the name and established logo of the pizza chain. During the final tournament series, Q distributes free of charge souvenir flags bearing Q’s name to employees of the pizza chain who come out to support the team. The flags are valued at less than 2% of the combined fair market value of the uniforms and operational expenses paid. Q’s use of the name and logo of the pizza chain in connection with the tournament constitutes acknowledgment of the sponsorship. Because the fair market value of the flags does not exceed 2% of the total payment, the entire amount of the funding and supplied uniforms are a qualified sponsorship payment, which is not income from an unrelated trade or business.

Example 6 . R is a liberal arts college. A soft drink manufacturer enters into a binding, written contract with R that provides for a large payment to be made to the college’s English department in exchange for R agreeing to name a writing competition after the soft drink manufacturer. The contract also provides that R will allow the soft drink manufacturer to be the exclusive provider of all soft drink sales on campus. The fair market value of the exclusive provider component of the contract exceeds 2% of the total payment. R’s use of the manufacturer’s name in the writing competition constitutes acknowledgment of the sponsorship. However, the exclusive provider arrangement is a substantial return benefit. Only that portion of the payment, if any, that R can demonstrate exceeds the fair market value of the exclusive provider arrangement is a qualified sponsorship payment.

$1,000 is $20). Therefore, only $925 of the $1,000 payment received in 2003 is a qualified sponsorship payment.

(2) Anti-abuse provision . To the extent necessary to prevent avoidance of the rule stated in paragraphs (d)(1) and (c)(2) of this section, where the exempt organization fails to make a reasonable and good faith valuation of any substantial return benefit, the Commissioner (or the Commissioner’s delegate) may determine the portion of a payment allocable to such substantial return benefit and may treat two or more related payments as a single payment.

(e) Special rules —(1) Written agree- ments . The existence of a written sponsorship agreement does not, in itself, cause a payment to fail to be a qualified sponsorship payment. The terms of the agreement, not its existence or degree of detail, are relevant to the determination of whether a payment is a qualified sponsorship payment. Similarly, the terms of the agreement and not the title or responsibilities of the individuals negotiating the agreement determine whether a payment (or any portion thereof) made pursuant to the agreement is a qualified sponsorship payment.

(2) Contingent payments . The term qualified sponsorship payment does not include any payment the amount of which is contingent, by contract or otherwise, upon the level of attendance at one or more events, broadcast ratings, or other factors indicating the degree of public exposure to the sponsored activity. The fact that a payment is contingent upon sponsored events or activities actually being conducted does not, by itself, cause the payment to fail to be a qualified sponsorship payment.

(3) Determining public support . Qualified sponsorship payments in the form of money or property (but not services) are treated as contributions received by the exempt organization for purposes of determining public support to the organization under section 170(b)(1)(A)(vi) or 509(a)(2). See §§ 1.509(a)–3(f)(1) and 1.170A–9(e)(6)(i). The fact that a payment is a qualified sponsorship payment that is treated as a contribution to the payee organization does not determine whether the payment is deductible by the payor under section 162 or 170.

(f) Examples . The provisions of this section are illustrated by the following

examples. The tax treatment of any payment (or portion of a payment) that does not constitute a qualified sponsorship payment is governed by general UBIT principles. In these examples, the recipients of the payments at issue are section 501(c) organizations. The expectations or arrangements of the parties are those specifically indicated in the example. The examples are as follows:

Example 1 . M, a local charity, organizes a marathon and walkathon at which it serves to participants drinks and other refreshments provided free of charge by a national corporation. The corporation also gives M prizes to be awarded to winners of the event. M recognizes the assistance of the corporation by listing the corporation’s name in promotional fliers, in newspaper advertisements of the event and on T-shirts worn by participants. M changes the name of its event to include the name of the corporation. M’s activities constitute acknowledgment of the sponsorship. The drinks, refreshments and prizes provided by the corporation are a qualified sponsorship payment, which is not income from an unrelated trade or business.

Example 2 . N, an art museum, organizes an exhibition and receives a large payment from a corporation to help fund the exhibition. N recognizes the corporation’s support by using the corporate name and established logo in materials publicizing the exhibition, which include banners, posters, brochures and public service announcements. N also hosts a dinner for the corporation’s executives. The fair market value of the dinner exceeds 2% of the total payment. N’s use of the corporate name and logo in connection with the exhibition constitutes acknowledgment of the sponsorship. However, because the fair market value of the dinner exceeds 2% of the total payment, the dinner is a substantial return benefit. Only that portion of the payment, if any, that N can demonstrate exceeds the fair market value of the dinner is a qualified sponsorship payment.

Example 3 . O coordinates sports tournaments for local charities. An auto manufacturer agrees to underwrite the expenses of the tournaments. O recognizes the auto manufacturer by including the manufacturer’s name and established logo in the title of each tournament as well as on signs, scoreboards and other printed material. The auto manufacturer receives complimentary admission passes and pro-am playing spots for each tournament that have a combined fair market value in excess of 2% of the total payment. Additionally, O displays the latest models of the manufacturer’s premier luxury cars at each tournament. O’s use of the manufacturer’s name and logo and display of cars in the tournament area constitute acknowledgment of the sponsorship. However, the admission passes and pro-am playing spots are a substantial return benefit. Only that portion of the payment, if any, that O can demonstrate exceeds the fair market value of the admission passes and pro-am playing spots is a qualified sponsorship payment.

Example 4 . P conducts an annual college football bowl game. P sells to commercial broadcasters the right to broadcast the bowl game on television and radio. A major corporation agrees to be the

May 28, 2002 980 2002–21 I.R.B.

Example 7 . S is a noncommercial broadcast station that airs a program funded by a local music store. In exchange for the funding, S broadcasts the following message: “This program has been brought to you by the Music Shop, located at 123 Main Street. For your music needs, give them a call today at 555–1234. This station is proud to have the Music Shop as a sponsor.” Because this single broadcast message contains both advertising and an acknowledgment, the entire message is advertising. The fair market value of the advertising exceeds 2% of the total payment. Thus, the advertising is a substantial return benefit. Unless S establishes that the amount of the payment exceeds the fair market value of the advertising, none of the payment is a qualified sponsorship payment.

Example 8 . T, a symphony orchestra, performs a series of concerts. A program guide that contains notes on guest conductors and other information concerning the evening’s program is distributed by T at each concert. The Music Shop makes a $1,000 payment to T in support of the concert series. As a supporter of the event, the Music Shop receives complimentary concert tickets with a fair market value of $85, and is recognized in the program guide and on a poster in the lobby of the concert hall. The lobby poster states that, “The T concert is sponsored by the Music Shop, located at 123 Main Street, telephone number 555–1234.” The program guide contains the same information and also states, “Visit the Music Shop today for the finest selection of music CDs and cassette tapes.” The fair market value of the advertisement in the program guide is $15. T’s use of the Music Shop’s name, address, and telephone number in the lobby poster constitutes acknowledgment of the sponsorship. However, the combined fair market value of the advertisement in the program guide and complimentary tickets is $100 ($15 + $85), which exceeds 2% of the total payment (2% of $1,000 is $20). The fair market value of the advertising and complimentary tickets, therefore, constitutes a substantial return benefit and only that portion of the payment, or $900, that exceeds the fair market value of the substantial return benefit is a qualified sponsorship payment.

Example 9 . U, a national charity dedicated to promoting health, organizes a campaign to inform the public about potential cures to fight a serious disease. As part of the campaign, U sends representatives to community health fairs around the country to answer questions about the disease and inform the public about recent developments in the search for a cure. A pharmaceutical company makes a payment to U to fund U’s booth at a health fair. U places a sign in the booth displaying the pharmaceutical company’s name and slogan, “Better Research, Better Health,” which is an established part of the company’s identity. In addition, U grants the pharmaceutical company a license to use U’s logo in marketing its products to health care providers around the country. The fair market value of the license exceeds 2% of the total payment received from the company. U’s display of the pharmaceutical company’s name and slogan constitutes acknowledgment of the sponsorship. However, the license granted to the pharmaceutical company to use U’s logo is a substantial return benefit. Only that portion of the payment, if any, that U can demonstrate exceeds the fair market value of the license granted to the pharmaceutical company is a qualified sponsorship payment.

Example 10 . V, a trade association, publishes a monthly scientific magazine for its members containing information about current issues and developments in the field. A textbook publisher makes a large payment to V to have its name displayed on the inside cover of the magazine each month. Because the monthly magazine is a periodical within the meaning of paragraph (b) of this section, the section 513(i) safe harbor does not apply. See § 1.512(a)–1(f).

Example 11 . W, a symphony orchestra, maintains a website containing pertinent information and its performance schedule. The Music Shop makes a payment to W to fund a concert series, and W posts a list of its sponsors on its website, including the Music Shop’s name and Internet address. W’s website does not promote the Music Shop or advertise its merchandise. The Music Shop’s Internet address appears as a hyperlink from W’s website to the Music Shop’s website. W’s posting of the Music Shop’s name and Internet address on its website constitutes acknowledgment of the sponsorship. The entire payment is a qualified sponsorship payment, which is not income from an unrelated trade or business.

Example 12 . X, a health-based charity, sponsors a year-long initiative to educate the public about a particular medical condition. A large pharmaceutical company manufactures a drug that is used in treating the medical condition, and provides funding for the initiative that helps X produce educational materials for distribution and post information on X’s website. X’s website contains a hyperlink to the pharmaceutical company’s website. On the pharmaceutical company’s website, the statement appears, “X endorses the use of our drug, and suggests that you ask your doctor for a prescription if you have this medical condition.” X reviewed the endorsement before it was posted on the pharmaceutical company’s website and gave permission for the endorsement to appear. The endorsement is advertising. The fair market value of the advertising exceeds 2% of the total payment received from the pharmaceutical company. Therefore, only the portion of the payment, if any, that X can demonstrate exceeds the fair market value of the advertising on the pharmaceutical company’s website is a qualified sponsorship payment.

Robert E. Wenzel, Deputy Commissioner of

Internal Revenue .

Section 1012.—Basis of Property—Cost

26 CFR 1.1012–1: Basis of property.

Section 6050S.— Returns Relating to Higher Education Tuition and Related Expenses

26 CFR 1.6050S–2T: Electronic furnishing of infor- mation statements for qualified tuition and related expenses (temporary).

T.D. 8992

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 301, and 602

Information Reporting for Payments of Interest on Qualified Education Loans; Magnetic Media Filing Requirements for Information Returns

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains regulations relating to the information reporting requirements under section 6050S for payments of interest on qualified education loans, including the filing of information returns on magnetic media. The final regulations reflect changes to the law made by the Taxpayer Relief Act of 1997. The regulations provide guidance to payees receiving interest payments on qualified education loans.

DATES: Effective date : These regulations are effective April 29, 2002.

Applicability date : For date of applicability, see § 1.6050S–3(g).

Approved April 12, 2002.

Mark Weinberger, Assistant Secretary of the Treasury .

(Filed by the Office of the Federal Register on April 24, 2002, 8:45 a.m., and published in the issue of the Federal Register for April 25, 2002, 67 F.R. 20433)

2002–21 I.R.B. 981 May 28, 2002

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Donna Welch, (202) 622–4910; and concerning the magnetic media filing specifications, waivers for filing on magnetic media, and extensions of time, contact the Internal Revenue Service, Martinsburg Computing Center, (304) 263–8700 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545–1678. Responses to this collection of information are mandatory.

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

The estimated burden for the reporting in these regulations is reflected in the burden for Form 1098–E.

Estimated total annual reporting burden for 2000 for Form 1098–E: 483,098 hours.

Estimated number of responses for 2000 for Form 1098–E: 9,661,965. Estimated average annual burden hours per response for Form 1098–E: 3 minutes.

Comments concerning the accuracy of this burden and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

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

Background

This document contains amendments to the Income Tax Regulations (26 CFR part 1) relating to information reporting requirements under section 6050S. The Taxpayer Relief Act of 1997 (Public Law 105–34 (111 Stat. 788) (TRA ’97)) added section 221 of the Internal Revenue Code (Code) to allow certain taxpayers who pay interest on qualified education loans to claim a Federal income tax deduction for their interest payments. In general, as enacted by TRA ’97, a deduction is allowed for interest payments made during the first 60 months in which interest payments are required on a qualified education loan. However, no interest deduction is allowed for any interest paid before January 1, 1998. On January 21, 1999, the IRS issued proposed regulations (REG–116826–97, 1999–1 C.B. 701) under section 221. See 64 FR 3257 (1999). Section 221 was amended by the Economic Growth and Tax Relief Reconciliation Act of 2001 (Public Law 107–16 (115 Stat. 38)) to eliminate the limitation on the number of months during which interest paid on a qualified education loan is deductible, effective for interest paid after December 31, 2001, and to allow a deduction for voluntary payments of interest.

TRA ’97 also added section 25A of the Code to provide the Hope Scholarship Credit and the Lifetime Learning Credit (education tax credit). In general, the education tax credit allows certain taxpayers who pay qualified tuition and related expenses to an eligible educational institution to claim a nonrefundable credit against their Federal income tax liability. On January 6, 1999, the IRS issued proposed regulations (REG–106388–98, 1999–1 C.B. 756) under section 25A. See 64 FR 794 (1999). In addition, TRA ’97 added section 6050S of the Code. Section 6050S was amended by the Internal Revenue Service Restructuring and Reform Act of 1998 (Public Law 105–206 (112 Stat. 685) (RRA ’98)) and Public Law 107–131 (115 Stat. 2410). In general, section 6050S requires certain payees who receive payments of interest on one or more qualified education loans to file information returns and to furnish written information statements to assist taxpayers

and the IRS in determining any interest deduction allowable under section 221. In addition, section 6050S requires eligible educational institutions to file information returns and to furnish written information statements to assist taxpayers and the IRS in determining any education tax credit allowable under section 25A (as well as other tax benefits for higher education expenses). See H.R. Conf. Rept. No. 599, 105th Cong., 2d Sess., pp. 319–320 (1998). Similarly, section 6050S requires any person engaged in a trade or business of making payments to any individual under an insurance agreement as reimbursements or refunds of qualified tuition and related expenses to file information returns and to furnish written information statements.

Section 6050S(b) provides that the information return filed by payees who receive payments of interest on qualified education loans must contain: (1) the name, address, and taxpayer identification number (TIN) of the individual with respect to whom payments of interest on qualified education loans were received; (2) the aggregate amount of interest received for the calendar year from such individual; and (3) such other information as the Secretary may prescribe.

The IRS has published several notices describing the information reporting requirements for payees who receive interest on qualified education loans during the years 1998, 1999, 2000, and 2001. See Notice 98–7 (1998–1 C.B. 339), Notice 98–54 (1998–2 C.B. 641), Notice 99–37 (1999–2 C.B. 124), and Notice 2000–62 (2000–2 C.B. 587). A notice of proposed rulemaking under section 6050S (REG–105316–98, 2000–2 C.B. 98) was published in the Federal Register (65 FR 37728) on June 16, 2000, addressing the information reporting requirements for eligible educational institutions and insurers and payees who receive interest on qualified education loans. A public hearing was held on the proposed regulations on February 13, 2001. The IRS received written and electronic comments responding to the notice of proposed rulemaking.

The IRS and the Treasury Department have determined that the proposed regulations in § 1.6050S–1 addressing the information reporting requirements for eligible educational institutions and insurers

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reporting requirements. Based on section 6050S(f), the proposed regulations provide that if a payee contracts with another person to receive or collect interest payments on a qualified education loan on its behalf, the other person must comply with the information reporting requirements. Commentators requested clarification of how this rule would apply if a payee contracts with multiple parties, such as a billing service and a collection agent. Other commentators requested clarification of the rule for noncontractual arrangements and how the rule would apply if the person receiving the payments does not ordinarily possess the payor information required to file information returns ( e.g., a lock-box agent, a bankruptcy trustee, or a collection agency). The commentators suggested that the regulations provide that if a person collects or receives payments on a qualified loan on behalf of another person (whether or not a formal contract exists), the person collecting or receiving the payments must satisfy the reporting requirements, unless the other person does not possess the information needed to comply with the reporting requirements. This recommendation is consistent with the provisions of section 6050H and the regulations thereunder; therefore, the final regulations adopt this recommendation.

C. Forms 1098–E filed by third-party

Several commentators requested that the final regulations permit a payee to contract with a third party to file Forms 1098–E, Student Loan Interest Statement, and to furnish the information statements. The general instructions to Form 1099 and Form 1098 allow a filing agent if certain requirements are met. Therefore, the final regulations do not need to adopt this recommendation.

D. Information statement

Several commentators requested that the final regulations eliminate the requirement that a payee furnish certain instructions to a payor with the information statement. The commentators explained that the instructional language implies that the payee is able to provide tax assistance. The instructions that a payee is required to furnish with the information statement alert the payor to the limitations

should be withdrawn and that new proposed regulations should be issued. The IRS will issue proposed regulations in § 1.6050S–1 in a separate document. The proposed regulations in § 1.6050S–2 addressing the information reporting requirements for payees who receive payments of interest on qualified education loans are adopted as amended by this Treasury decision and redesignated as § 1.6050S–3. The comments received in connection with these regulations and the revisions are discussed in the “Explanation of Provisions and Summary of Comments” of this preamble.

Temporary regulations (66 FR 10191) and a notice of proposed rulemaking by cross reference (REG–107186–00, 2001–1 C.B. 973) (66 FR 10247) under section 6050S were published in the Fed- eral Register on February 14, 2001. Those regulations allow eligible educational institutions and payees who receive interest on qualified education loans to furnish information statements electronically to students and borrowers, respectively, if certain requirements are met. The temporary regulations for eligible educational institutions were designated as § 1.6050S–1T, and the temporary regulations for payees were designated as § 1.6050S–2T. The IRS and the Treasury Department have determined that those regulations should be finalized in a separate document. However, this Treasury decision redesignates § 1.6050S–1T and § 1.6050S–2T as § 1.6050S–2T and § 1.6050S–4T, respectively.

Explanation of Provisions and Summary of Comments

1. Information Reporting for Payments of Interest on Qualified Education Loans

The proposed regulations require any person engaged in a trade or business that receives from any payor interest of $600 or more for any calendar year on one or more qualified education loans (as defined in section 221(e)(1) and the regulations thereunder) (a payee) to file a Form 1098–E, Student Loan Interest Statement, with the IRS. Under the proposed regulations, a payee must report the name, address, and taxpayer identification number (TIN) of the payee; the name, address, and TIN of the payor; and the aggregate amount of interest received

during the calendar year from the payor. The final regulations retain these rules. As explained in the preamble to the proposed regulations, a payee may be the lender, the holder of the loan, or the loan servicer.

Consistent with TRA ’97, the proposed regulations provide that a payee is required to report interest payments received on a qualified education loan during only the first 60 months in which interest payments are required on the loan. The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the limitation on the number of months during which interest paid on a qualified education loan is deductible, effective for interest paid after December 31, 2001. Therefore, the final regulations eliminate the 60-month reporting period, so that payees must continue to report annually interest payments on qualified education loans.

A. Section 221 comments

The proposed regulations provide that, in determining the aggregate amount of interest payments to be reported by a payee, the term interest includes stated interest, loan origination fees (other than any fees for services), and capitalized interest as described in the regulations under section 221. Several commentators requested that other fees, such as insurance, be treated as deductible interest for purposes of section 221. In addition, several commentators requested clarification of, or changes to, the manner in which payments are allocated to interest, the definition of qualified education loans, and the ability to estimate capitalized interest. These comments were not considered in these regulations, which address only the information reporting requirements for interest payments on qualified education loans under section 221, but the comments will be considered in finalizing the regulations under section 221.

B. Reporting of interest received or collected by one or more persons

Section 6050S(f) requires that, in the case of any person who receives any amount on behalf of another person, only the first person receiving the amount is required to comply with the information

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determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. A final regulatory flexibility analysis has been prepared for the collection of information in this Treasury decision. This analysis is set forth in this preamble under the heading “Final Regulatory Flexibility Analysis.” Pursuant to section 7805(f), the proposed regulations preceding these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Final Regulatory Flexibility Analysis

The collection of information contained in § 1.6050S–3 is needed to assist the IRS and taxpayers in determining the amount of any interest deduction allowable under section 221. The objectives of these regulations are to provide uniform, practicable, and administrable rules under section 6050S. The types of small entities to which the regulations may apply are certain payees ( e.g., a lender, a holder of the loan, or a loan servicer) who receive interest payments of $600 or more on qualified education loans.

There are no known Federal rules that duplicate, overlap, or conflict with these regulations. The regulations are considered to have the least economic impact on small entities of all alternatives considered.

Moreover, the regulations requiring filing Forms 1098–E on magnetic media impose no additional reporting or recordkeeping and only prescribe the method of filing information returns that are already required to be filed. Further, these regulations are consistent with the statutory requirement that a payee is not required to file Forms 1098–E on magnetic media unless required to file at least 250 or more returns during the year. Finally, the economic impact caused by requiring Forms 1098–E on magnetic media should be minimal because most payee’s operations are computerized. Even if their operations are not computerized, the incremental cost of magnetic media reporting should be minimal in most cases because of the availability of computer service bureaus. In addition, the existing regulations under section 6011(e) provide that the IRS may waive the magnetic media filing requirements on a

on the deductibility of reported interest. In addition, the instructions clearly state that the payor should refer to the IRS forms and publications for information regarding the deductibility of reported interest. Therefore, the final regulations do not eliminate the required instructions; however, the regulations clarify that the payor should refer to the IRS forms and publications, and not the payee, for tax information.

The proposed regulations provide that the information statement must include the name, address, and phone number of the individual who is the information contact for the payee that filed the Form 1098–E. It is often not feasible for payees to identify a specific individual as the information contact. Therefore, the final regulations provide that the information statement must include the name, address, and phone number of an office or department of the payee as the information contact.

E. Payment adjustments after returns filed

Other commentators requested that the final regulations provide specific rules for reporting interest payment adjustments made after information returns have been filed with the IRS. The commentators stated that requiring reporting of adjustments to interest previously reported would be overly burdensome. The final regulations do not need to include specific rules because additional interest payments received in a subsequent year that relate to interest payments reported in a prior year are reportable in the year of receipt. Further, a payee is not required to report reimbursements or refunds of interest payments previously reported. However, a payee should file corrected information returns to report interest payments that were incorrectly reported in a prior year.

F. Effective date of regulations and continuation of Notice 98–7 for the calendar year 2002

The proposed regulations provide that the regulations will apply to information returns required to be filed, and information statements required to be furnished, after December 31, 2001. Several comments were received on the proposed

effective date. Several commentators recommended that the final regulations apply to new loans made on or after January 1 of the year that is 24 months after publication of the final regulations and that loans made before that date remain subject to the requirements in Notice 98–7, as modified. Other comments requested a period of at least 12 months after publication of final regulations to make programming changes to implement required reporting with respect to loan origination fees and capitalized interest.

Further comments requested that the reporting requirements in Notice 98–7, as modified, continue for information returns required to be filed, and information statements required to be furnished, for interest payments received during calendar year 2002 (for which the returns and statements are required to be filed and furnished in 2003). In general, the final regulations do not impose any significant reporting requirement beyond the reporting currently required by Notice 98–7, as modified, and Form 1098–E. However, in response to comments, the IRS and the Treasury Department extend Notice 98–7, as modified, for the calendar year 2002. Therefore, the final regulations apply to information returns required to be filed, and information statements required to be furnished, after December 31, 2003 (for interest payments received during calendar year 2003). In addition, in order to provide additional time for payees to implement reporting of loan origination fees and capitalized interest, the final regulations provide that a payee is not required to report payments of such amounts as interest for qualified education loans made before January 1, 2004.

Requirement to File Information Returns on Magnetic Media

The final regulations amend the regulations under section 6011(e) to require payees who are required to file 250 or more Forms 1098–E to file on magnetic media.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been

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showing of hardship. The waiver authority will be exercised so as not to unduly burden payees lacking both the necessary data processing facilities and access at a reasonable cost to computer service bureaus.

Drafting Information

The principal author of the regulations is Donna Welch, Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. However, other personnel from the IRS and the Treasury Department participated in the development of the regulations.

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1, 301, and 602 are amended as follows:

PART 1—INCOME TAX

Paragraph 1. The authority citation for part 1 is amended by removing the entry for “Section 1.6050S–1T” and by adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 - - Section 1.6050S–3 also issued under 26 U.S.C. 6050S(g). Section 1.6050S–4T also issued under 26 U.S.C. 6050S(g). - - Par. 2. Sections 1.6050–1T and 1.6050S–2T are redesignated as §§ 1.6050S–2T and 1.6050S–4T, respectively, and amended by revising the section headings to read as follows:

§ 1.6050S–2T Electronic furnishing of information statements for qualified tuition and related expenses (temporary).

§ 1.6050S–4T Electronic furnishing of information statements for payments of interest on qualified education loans (temporary).

Par. 3. Sections 1.6050S–0 and 1.6050S–3 are added to read as follows:

§ 1.6050S–0 Table of contents

This section lists captions contained in section 6050S.

§ 1.6050S–2T Electronic furnishing of information statements for qualified tuition and related expenses .

(a) Electronic furnishing of statements. (1) In general. (2) Consent. (i) In general. (ii) Change in hardware or software requirements. (iii) Example. (3) Required disclosures. (i) In general. (ii) Paper statement. (iii) Scope and duration of consent. (iv) Post-consent request for a paper statement. (v) Withdrawal of consent. (vi) Notice of termination. (vii) Updating information. (viii) Hardware and software requirements. (4) Format. (5) Posting. (6) Notice. (i) In general. (ii) Undeliverable electronic address. (iii) Corrected statements. (7) Retention. (b) Effective date.

§ 1.6050S–3 Information reporting for payments of interest on qualified education loans .

(a) Information reporting requirement in general. (b) Definitions. (1) Interest. (2) Payor. (c) Requirement to file return. (1) Form of return. (2) Information included on return. (3) Time and place for filing return. (i) In general. (ii) Extensions of time. (4) Use of magnetic media. (d) Requirement to furnish statement. (1) In general. (2) Time and manner for furnishing statement. (i) In general. (ii) Extensions of time. (3) Copy of Form 1098–E.

(e) Special rules. (1) Transitional rule for reporting of loan origination fees and capitalized interest. (2) Qualified education loan certification. (3) Payments of interest received or collected by one or more persons. (i) In general. (ii) Exception. (4) Reporting by foreign persons. (5) Governmental units. (f) Penalty provisions. (1) Failure to file correct returns. (2) Failure to furnish correct information statements. (3) Waiver of penalties for failures to include a correct TIN. (i) In general. (ii) Acting in a responsible manner. (iii) Manner of soliciting TIN. (4) Failure to furnish TIN. (g) Effective date.

§ 1.6050S–4T Electronic furnishing of information statements for payments of interest on qualified education loans .

§ 1.6050S–3 Information reporting for payments of interest on qualified education loans .

(a) Information reporting requirement in general . Except as otherwise provided

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in this section, any person engaged in a trade or business that, in the course of that trade or business, receives from any payor (as defined in paragraph (b)(2) of this section) interest payments that aggregate $600 or more for any calendar year on one or more qualified education loans (as defined in section 221(e)(1) and the regulations thereunder)(a payee) must—

(1) File an information return, as described in paragraph (c) of this section, with the Internal Revenue Service with respect to the payor; and

(2) Furnish a statement, as described in paragraph (d) of this section, to the payor.

(b) Definitions . The following definitions apply for purposes of this section:

(1) Interest . Interest includes stated interest, loan origination fees (other than fees for services), and capitalized interest as described in the regulations under section 221. See paragraph (e)(1) of this section for a special transitional rule relating to reporting of loan origination fees and capitalized interest.

(2) Payor . Payor means the individual who is carried on the books and records of the payee as the borrower on a qualified education loan. If there are multiple borrowers, the principal borrower on the payee’s books and records is treated as the payor for purposes of section 6050S and this section.

(c) Requirement to file return —(1) Form of return . A payee must file an information return for the payor on Form 1098–E, Student Loan Interest Statement . A payee may use a substitute for Form 1098–E if the substitute form complies with the applicable revenue procedures relating to substitute forms.

(2) Information included on return . A payee must include on Form 1098–E—

(i) The name, address, and taxpayer identification number (TIN)(as defined in section 7701(a)(41)) of the payee;

(ii) The name, address, and TIN of the payor;

(iii) The aggregate amount of interest payments received during the calendar year from the payor; and

(iv) Any other information required by Form 1098–E and its instructions.

(3) Time and place for filing return (i) In general . Except as provided in paragraph (c)(3)(ii) of this section, the Form 1098–E must be filed on or before February 28 (March 31 if filed electronically)

of the year following the calendar year in which interest payments were received. A payee must file Form 1098–E with the Internal Revenue Service according to the instructions to Form 1098–E.

(ii) Extensions of time . The Internal Revenue Service may grant a payee an extension of time to file returns required in this section upon a showing of good cause. See the instructions to Form 1098–E and applicable revenue procedures for rules relating to extensions of time to file.

(4) Use of magnetic media . See section 6011(e) and § 301.6011–2 of this chapter for rules relating to the requirement to file Forms 1098–E on magnetic media.

(d) Requirement to furnish statement (1) In general . A payee must furnish a statement to each payor for whom it is required to file a Form 1098–E. The statement must include—

(i) The information required under paragraph (c)(2) of this section;

(ii) A legend that identifies the statement as important tax information that is being furnished to the Internal Revenue Service;

(iii) Instructions that— (A) State that, under section 221 and the regulations thereunder, the payor may not be able to deduct the full amount of interest reported on the statement;

(B) In the case of qualified education loans made before January 1, 2004, for which the payee does not report payments of interest other than stated interest, state that the payor may be able to deduct additional amounts (such as certain loan origination fees and capitalized interest) not reported on the statement;

(C) State that the payor should refer to relevant Internal Revenue Service forms and publications, and should not refer to the payee, for explanations relating to the eligibility requirements for, and calculation of, any allowable deduction for interest paid on a qualified education loan; and

(D) Include the name, address, and phone number of the office or department of the payee that is the information contact for the payee that filed the Form 1098–E. (2) Time and manner for furnishing statement —(i) In general . Except as provided in paragraph (d)(2)(ii) of this section, a payee must furnish the statement

described in paragraph (d)(1) of this section to the payor on or before January 31 of the year following the calendar year in which payments of interest on a qualified education loan were received. If mailed, the statement must be sent to the payor’s last known address. If furnished electronically, the statement must be furnished in accordance with the applicable regulations.

(ii) Extensions of time . The Internal Revenue Service may grant a payee an extension of time to furnish statements required in this section upon a showing of good cause. See the instructions to Form 1098–E and applicable revenue procedures for rules relating to extensions of time to furnish statements.

(3) Copy of Form 1098–E . A payee may satisfy the requirement of this paragraph (d) by furnishing either a copy of Form 1098–E and its instructions or another document that contains all the information filed with the Internal Revenue Service and the information required by paragraph (d)(1) of this section if the document complies with applicable revenue procedures relating to substitute statements.

(e) Special rules —(1) Transitional rule for reporting of loan origination fees and capitalized interest . For qualified education loans made before January 1, 2004, a payee is not required to report payments of loan origination fees and capitalized interest as interest under section 6050S and this section.

(2) Qualified education loan certifica- tion . If a loan is not subsidized, guaranteed, financed, or is not otherwise treated as a student loan under a program of the Federal, state, or local government or an eligible educational institution, a payee must request a certification from the payor that the loan will be used solely to pay for qualified higher education expenses. A payee may use Form W–9S, Request for Student’s or Borrower’s Social Security Number and Certification, to obtain the certification. A payee may establish an electronic system for payors to submit Forms W–9S electronically as described in applicable forms and instructions. A payee may also develop a separate form to obtain the payor certification or may incorporate the certification into other forms customarily used by the payee, such as loan applications, provided

May 28, 2002 986 2002–21 I.R.B.

the certification is clearly set forth. If the certification is not received, the loan is not a qualified education loan for purposes of section 6050S and this section.

(3) Payments of interest received or collected by one or more persons —(i) In general . Except as otherwise provided in paragraph (e)(3)(ii) of this section, if a person collects or receives payments of interest on a qualified education loan on behalf of another person ( e.g., a lender), the person collecting or receiving the interest must satisfy the information reporting requirements of this section. In this case, the reporting requirements do not apply to the transfer of interest to the other person.

(ii) Exception . If the person collecting or receiving payments of interest on a qualified education loan on behalf of another person ( e.g., a lender) does not possess the information needed to comply with the information reporting requirements of this section, the other person must satisfy the information reporting requirements of this section.

(4) Reporting by foreign persons . A payee that is not a United States person (as defined in section 7701(a)(30)) must report payments of interest it receives on a qualified education loan only if it receives the payment—

(i) At a location in the United States; or

(ii) At a location outside the United States if the payee is—

(A) A controlled foreign corporation (within the meaning of section 957(a)); or

(B) A person 50 percent or more of the gross income of which, from all sources for the three-year period ending with the close of the taxable year preceding the taxable year in which interest payments were received (or for such part of the period as the person was in existence), was effectively connected with the conduct of a trade or business within the United States.

(5) Governmental units . A governmental unit, or an agency or instrumentality of a governmental unit, that receives from any payor interest payments that aggregate $600 or more for any calendar year on one or more qualified education loans is a payee, without regard to the requirement of paragraph (a) of this section that the interest be received in the course of a trade or business.

(f) Penalty provisions —(1) Failure to file correct returns . The section 6721 penalty may apply to a payee that fails to file information returns required by section 6050S and this section on or before the required filing date; that fails to include all of the required information on the return; or that includes incorrect information on the return. See section 6721, and the regulations thereunder, for rules relating to penalties for failure to file correct returns. See section 6724, and the regulations thereunder, for rules relating to waivers of penalties for certain failures due to reasonable cause.

(2) Failure to furnish correct informa- tion statements . The section 6722 penalty may apply to a payee that fails to furnish statements required by section 6050S and this section on or before the prescribed date; that fails to include all the required information on the statement; or that includes incorrect information on the statement. See section 6722, and the regulations thereunder, for rules relating to penalties for failure to furnish correct statements. See section 6724, and the regulations thereunder, for rules relating to waivers of penalties for certain failures due to reasonable cause.

(3) Waiver of penalties for failures to include a correct TIN —(i) In general . In the case of a failure to include a correct TIN on Form 1098–E or a related information statement, penalties may be waived if the failure is due to reasonable cause. Reasonable cause may be established if the failure arose from events beyond the payee’s control, such as a failure of the payor to furnish a correct TIN. However, the payee must establish that it acted in a responsible manner both before and after the failure.

(ii) Acting in a responsible manner . A payee must request the TIN of each payor if it does not already have a record of the payor’s correct TIN. If the payee does not have a record of the payor’s correct TIN, then it must solicit the TIN in the manner described in paragraph (f)(3)(iii) of this section on or before December 31 of each year during which it receives payments of interest. If a payor refuses to provide his or her TIN upon request, the payee must file the return and furnish the statement required by this section without the payor’s TIN, but with all other required information. The specific solicitation

requirements of paragraph (f)(3)(iii) of this section apply in lieu of the solicitation requirements of § 301.6724–1(e) and (f) of this chapter for the purpose of determining whether a payee acted in a responsible manner in attempting to obtain a correct TIN. A payee that complies with the requirements of this paragraph (f)(3) will be considered to have acted in a responsible manner within the meaning of § 301.6724–1(d) of this chapter with respect to any failure to include the correct TIN of a payor on a return or statement required by section 6050S and this section.

(iii) Manner of soliciting TIN . A payee must request the payor’s TIN in writing and must clearly notify the payor that the law requires the payor to furnish a TIN so that it may be included on an information return filed by the payee. A request for a TIN made on Form W–9S, Request for Student’s or Borrower’s Social Security Number and Certification, satisfies the requirements of this paragraph (f)(3)(iii). A payee may establish a system for payors to submit Forms W–9S electronically as described in applicable forms and instructions. A payee may also develop a separate form to request the payor’s TIN or incorporate the request into other forms customarily used by the payee, such as loan applications.

(4) Failure to furnish TIN . The section 6723 penalty may apply to any payor who is required (but fails) to furnish his or her TIN to a payee. See section 6723, and the regulations thereunder, for rules relating to the penalty for failure to furnish a TIN.

(g) Effective date . The rules in this section apply to information returns required to be filed, and information statements required to be furnished, after December 31, 2003.

PART 301—PROCEDURE AND ADMINISTRATION

Par. 4. The authority citation for part 301 continues to read in part as follows: Authority: 26 U.S.C. 7805 - - Par. 5. Section 301.6011–2 is amended by:

Revising the first sentence of paragraph (b)(1).
Revising paragraph (g)(1).
Adding paragraph (g)(3). The revisions and additions read as follows:

2002–21 I.R.B. 987 May 28, 2002

Authority: 26 U.S.C. 7805. Par. 7. In § 602.101, paragraph (b) is amended by removing the entry for “1.6050S–1T”, and adding two new entries in numerical order to the table to read as follows:

§ 602.101 OMB Control numbers.

(b) - -

Current OMB

control No.

§ 301.6011–2 Required use of magnetic media .

(b) Returns required on magnetic media . (1) If the use of Forms 1042–S, 1098, 1098–E, 1099 series, 5498, 8027, W–2G, or other form treated as a form specified in this paragraph (b)(1) is required by the applicable regulations or revenue procedures for the purpose of making an information return, the information required by the form must be submitted on magnetic media, except as otherwise provided in paragraph (c) of this section. - -

CFR part or section where identified and described

(g) Effective dates . (1) Except as otherwise provided in paragraph (g)(2) or (3) of this section, this section applies to returns required to be filed after December 31, 1986.

(3) This section applies to returns on Form 1098–E required to be filed after December 31, 2003.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 6. The authority citation for part 602 continues to read as follows:

1.6050S–3................................................................................................................................................................. 1545–1678

1.6050S–4T .............................................................................................................................................................. 1545–1729

Robert E. Wenzel, Deputy Commissioner of

Internal Revenue .

Approved April 8, 2002.

Mark Weinberger, Assistant Secretary of the Treasury .

(Filed by the Office of the Federal Register on April 26, 2002, 8:45 a.m., and published in the issue of the Federal Register for April 29, 2002, 67 F.R. 20901)

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