Part I. Rulings — Internal Revenue Bulletin 2002-49

claim, N “reimburses” the medical expense and simultaneously offsets the “loan” by retaining the amount of the “reimbursement.” The “reimbursments” and “loan” offsets are made through bookkeeping entries. Thus, to the extent the employee submits claims for uninsured medical expenses during the year, N excludes that amount of the “loans” from the employee’s gross income under § 105(b) and from the employment taxes. To the extent an employee does not have uninsured medical expenses equal to the “loans,” N forgives the “loans.”

LAW AND ANALYSIS

In general, § 106(a) provides that gross income of an employee does not include employer-provided coverage under an accident or health plan. Under § 106(a), an employee may exclude premiums for accident or health insurance coverage that are paid by an employer. Also, under § 105(b), an employee may exclude amounts received through employer-provided accident or health insurance if those amounts are paid to reimburse expenses incurred by the employee for medical care (of the employee, the employee’s spouse, or the employee’s dependents) for personal injuries or sickness.

Section 105(e) provides that amounts received under an accident or health plan for employees are treated as amounts received through accident or health insurance for purposes of § 105(b). Section 1.105–5(a) of the Income Tax Regulations defines an accident or health plan as an arrangement for the payment of amounts to employees in the event of personal injuries or sickness.

Section 1.105–2 provides that only amounts that are paid specifically to reimburse the taxpayer for expenses incurred by the taxpayer for the prescribed medical care are excludable from gross income under § 105(b). Accordingly, § 105(b) does not apply to amounts that the taxpayer would be entitled to receive irrespective of whether or not the taxpayer incurs expenses for medical care.

Amounts excluded from gross income under § 105(b) are also excluded from income tax withholding under § 3401(a). In addition, amounts paid under a plan established by an employer on account of expenses incurred by the employee for medical care (of the employee, the em

Section 42.—Low-Income Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 105.—Amounts Received Under Accident and Health Plans

(Also Sections 125 and 106.)

Section 105 advance reimbursement of medical expenses. This ruling amplifies Rev. Rul. 2002–3, 2002–3 I.R.B. 316, to clarify that amounts paid to an employee as “advance reimbursements” or “loans” without regard to whether the employee has suffered a personal injury or sickness or incurred medical expenses are not excludable from the employee’s gross income under section 105(d), whether or not that employee incurs medical expenses during the year.

Rev. Rul. 2002–80

ISSUE

Whether, under the facts described, amounts an employer pays to an employee as “advance reimbursements” or “loans” are excluded from gross income under § 105(b) and from employment taxes under §§ 3401(a), 3121(a), and 3306(b) of the Internal Revenue Code.

FACTS

Situation (1). Employer M provides health coverage for its employees through a group health insurance policy. The coverage constitutes accident or health coverage for purposes of the exclusion for employer-provided accident or health coverage under § 106(a).

M has a payroll arrangement under which an employee’s salary is reduced and M applies the salary reduction amounts to the payment of the premiums for the group health insurance policy for the employee during the year. The salary reduction used to pay for the premiums is mandatory for M’s highly compensated employees. All other employees elect whether to purchase

the group health insurance policy through salary reduction. Thus, under M’s plan, all employees have a lower salary in exchange for employer-provided group health insurance coverage.

In addition to the group health insurance policy, M has a plan under which M reimburses the uninsured medical expenses of employees. To ameliorate the salary reduction for the group health insurance policy, M makes payments to an employee in amounts that cause the employee’s aftertax pay from M to be the same or approximately the same as what it would have been if there were no salary reduction to pay premiums for the group health insurance policy. M characterizes these payments as “advance reimbursements” of the uninsured medical expenses.

During the year, the employee submits to M claims for uninsured medical expenses incurred by the employee, the employee’s spouse, or the employee’s dependents. To the extent the employee submits claims for uninsured medical expenses during the year, M excludes that amount of the “advance reimbursement” payments from the employee’s gross income under § 105(b) and does not withhold income tax or treat the amount as wages for Federal Insurance Contribution Act (FICA) or Federal Unemployment Tax Act (FUTA) purposes. To the extent an employee does not have uninsured medical expenses equal to the “advance reimbursements” made to the employee by the end of the year or upon the employee’s termination of employment, M will often treat excess “advance reimbursements” above uninsured medical expenses as forgiven and as additional compensation includible in the employee’s gross income.

Situation (2). The facts are the same as in Situation (1), except that the Employer, N, reimburses an employee’s health insurance premiums through purported “loans” rather than “advance reimbursements.” N implements the plan by making “loans” to the employee sufficient to cause the employee’s after-tax pay to remain essentially unchanged. The “loans,” which may or may not bear market rates of interest, only become due and payable at the time and to the extent that the employee submits to N claims for uninsured medical expenses. Upon receipt of a medical expense

2002–49 I.R.B. 925 December 9, 2002

ployee as “advance reimbursements” or “loans,” whether or not the employee incurs uninsured medical expenses during the year. Moreover, in Situation (2), the amounts paid to the employee do not constitute loans. Accordingly, all of the “advance reimbursements” or “loans” are included in the employee’s gross income under § 61 and are subject to employment taxes under §§ 3401(a), 3121(a), and 3306(b).

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 2002–3 is amplified.

DRAFTING INFORMATION

The principal author of this Revenue Ruling is Felix Zech of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this Revenue Ruling, contact him at (202) 622– 6080 (not a toll-free call).

Section 106.—Contributions by Employer to Accident and Health Plans

Advance reimbursements of medical expenses made irrespective of whether the employee has incurred medical expenses are not excludable from the employee’s gross income under section 105(b) of the Code even if the employee incurs expenses for medical care. See Rev. Rul. 2002–80, page 925.

Section 125.—Cafeteria Plans

Section 280G.—Golden Para- chute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

ployee’s spouse, or the employee’s dependents) are excluded from FICA and FUTA taxes under §§ 3121(a) and 3306(b).

Under § 125, an employer may establish a cafeteria plan that permits an employee to choose among two or more benefits, consisting of cash (generally, salary) and qualified benefits, including accident or health coverage. Pursuant to § 125, the amount of an employee’s salary reduction applied to purchase such coverage is not included in gross income, even though it is available to the employee and the employee could have chosen to receive cash instead. If an employee elects salary reduction pursuant to § 125, the accident and health coverage is excludable from gross income under § 106 as employer-provided accident or health coverage.

In Rev. Rul. 2002–3, 2002–3 I.R.B. 316, an employer applies salary reduction amounts to the payment of health insurance premiums for employees and then “reimburses” amounts to employees so that employees’ after-tax pay remains unchanged. The ruling concludes that although the salary reduction amounts used to pay the premiums are excludable from the employees’ gross income under § 106 because employer-paid, there are no employeepaid premiums for the employer to “reimburse.” Thus, the reimbursements that the employer makes to employees are not excludable from gross income under § 105(b) because they do not reimburse employees for expenses incurred by the employees. In addition, the reimbursements are not excluded from income tax withholding, FICA taxes, or FUTA taxes. The ruling also states that the same conclusion results when the salary reduction used to pay for the health insurance premiums is done without employee elections.

In Situation (1), although M purports to treat the “advance reimbursements” as payments for uninsured medical expenses, those amounts are paid to the employee regardless of whether the employee incurs expenses for medical care or suffers a personal injury or sickness during the year. Under § 1.105–5(a), M’s “advance reimbursement” plan is therefore not an accident or health plan because it is not an arrangement for the payment of amounts to employees in the event of personal injuries or sickness. In addition, under § 1.105–2, the

exclusion from gross income under § 105(b) applies only to amounts paid specifically to reimburse medical care expenses and does not apply to amounts that the employee would be entitled to receive irrespective of whether the employee incurs expenses for medical care. Because an M employee is not paid specifically to reimburse medical care expenses but is entitled to receive the “advance reimbursements” irrespective of whether any medical expenses have been incurred, none of those payments are excludable from gross income under § 105(b) or from income tax withholding under § 3401(a) whether or not the employee has actually incurred uninsured medical expenses during the year. Finally, because “advance reimbursements” under M’s plan are not made on account of expenses incurred by the employee for medical care, the payments are subject to FICA taxes under § 3121(a) and FUTA taxes under § 3306(b).

In Situation (2), although N characterizes the payments to the employee as “loans,” it is understood that the employee will never become obligated to repay any of the purported “loans” to N. Under N’s plan, when the employee submits uninsured medical claims, N treats the reimbursements as an offset against that amount of the “loans.” However, if the employee does not submit claims, the outstanding amounts of the “loans” never become due and payable to N. (In addition, N may not notify or obtain the employee’s consent for the purported loan arrangement, in which event, the “loans” may be unenforceable under applicable law.)

Accordingly, under the specific facts described in Situation (2), the arrangement does not constitute a loan and is, in substance, the same as Situation (1). Like the transaction in Situation (1), the arrangement in Situation (2) is neither an accident or health plan under § 1.105–5(a) nor excludable from gross income under § 105(b) by reason of § 105–2 (either when paid to the employee or when offset against claims for uninsured medical expenses).

HOLDING

Under the facts described in Situations (1) and (2), the exclusion from gross income under § 105(b) does not apply to amounts that an employer pays to an em

December 9, 2002 926 2002–49 I.R.B.

Section 382.—Limitation on Net Operating Loss Carryfor- wards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 401.—Qualified Pen- sion, Profit-Sharing and Stock Bonus Plans

26 CFR 1.401(b)–1: Certain retroactive changes in plan.

A revenue procedure extends the time for amending pre-approved plans to comply with GUST to September 30, 2003, and also extends the time for making certain other plan amendments. See Rev. Proc. 2002– 73, page 932.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 467.—Certain Pay- ments for the Use of Property or Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 468.—Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 482.—Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 807.—Rules for Cer- tain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 1031.—Exchange of Property Held for Productive Use or Investment

26 CFR 1.1031(k)–1: Treatment of deferred ex-

changes.

Related party like-kind exchanges. Under the facts described, a taxpayer who transfers relinquished property to a qualified intermediary in exchange for replacement property formerly owned by a related party is not entitled to nonrecognition treatment under section 1031(a) of the Code if, as part of the transaction, the related party receives cash or other non-like-kind property for the replacement property.

Rev. Rul. 2002–83

ISSUE

Under the facts described below, is a taxpayer who transfers relinquished property to a qualified intermediary in exchange for replacement property formerly owned by a related party entitled to nonrecognition treatment under § 1031(a) of the Internal Rev

enue Code if, as part of the transaction, the related party receives cash or other nonlike-kind property for the replacement property?

FACTS

Individual A owns real property (Property 1) with a fair market value of $150x and an adjusted basis of $50x. Individual B owns real property (Property 2) with a fair market value of $150x and an adjusted basis of $150x. Both Property 1 and Property 2 are held for investment within the meaning of § 1031(a). A and B are related persons within the meaning of § 267(b).

C, an individual unrelated to A and B, wishes to acquire Property 1 from A. A enters into an agreement for the transfers of Property 1 and Property 2 with B, C, and a qualified intermediary (QI). QI is unrelated to A and B.

Pursuant to their agreement, on January 6, 2003, A transfers Property 1 to QI and QI transfers Property 1 to C for $150x. On January 13, 2003, QI acquires Property 2 from B, pays B the $150x sale proceeds from QI’s sale of Property 1, and transfers Property 2 to A.

LAW AND ANALYSIS

Section 1031(a)(1) provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind that is to be held either for productive use in a trade or business or for investment. Under § 1031(d), the basis of property acquired in a § 1031 exchange is the same as the basis of the property exchanged, decreased by any money the taxpayer receives and increased by any gain the taxpayer recognizes.

Section 1031 and the regulations thereunder allow for deferred exchanges of property. Under § 1031(a)(3) and § 1.1031(k)– 1(b) of the Income Tax Regulations, however, the property to be received by a taxpayer in the exchange (replacement property) must be: (i) identified within 45 days of the transfer of the property relinquished in the exchange (relinquished property) and (ii) received by the earlier of 180 days after the transfer of the relinquished property or the due date (including extensions)

2002–49 I.R.B. 927 December 9, 2002

transaction, the related party receives cash or other non-like-kind property for the replacement property.

DRAFTING INFORMATION

The principal author of this revenue ruling is Martin Scully, Jr., of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Scully at (202) 622–4960 (not a tollfree call).

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

(Also Sections 42, 280G, 382, 412, 467, 468, 482,

483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes of sections 382, 1274, 1288, and other sections of the Code, tables set forth the rates for December 2002.

Rev. Rul. 2002–81

This revenue ruling provides various prescribed rates for federal income tax purposes for December 2002 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the longterm tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Table 5 contains the federal rate for determining the present value of annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520. Finally, Table 6 contains the 2003 interest rate for sections 846 and 807.

of the transferor’s tax return for the taxable year in which the relinquished property is transferred.

Section 1.1031(k)–1(g)(4) allows taxpayers to use a qualified intermediary to facilitate a like-kind exchange. In the case of a transfer of relinquished property involving a qualified intermediary, the taxpayer’s transfer of relinquished property to a qualified intermediary and subsequent receipt of like-kind replacement property from the qualified intermediary is treated as an exchange with the qualified intermediary.

Section 1031(f) provides special rules for property exchanges between related parties. Under § 1031(f)(1), a taxpayer exchanging like-kind property with a related person cannot use the nonrecognition provisions of § 1031 if, within 2 years of the date of the last transfer, either the related person disposes of the relinquished property or the taxpayer disposes of the replacement property. The taxpayer takes any gain or loss into account in the taxable year in which the disposition occurs. For purposes of § 1031(f), the term “related person” means any person bearing a relationship to the taxpayer described in § 267(b) or 707(b)(1).

Section 1031(f) is intended to deny nonrecognition treatment for transactions in which related parties make like-kind exchanges of high basis property for low basis property in anticipation of the sale of the low basis property. The legislative history underlying § 1031(f) states that “if a related party exchange is followed shortly thereafter by a disposition of the property, the related parties have, in effect, ‘cashed out’ of the investment, and the original exchange should not be accorded nonrecognition treatment.” H.R. Rep. No. 247, 101 ^st Cong. 1 ^st Sess. 1340 (1989). To prevent related parties from circumventing the rules of § 1031(f)(1), § 1031(f)(4) provides that the nonrecognition provisions of § 1031 do not apply to any exchange that is part of a transaction (or a series of transactions) structured to avoid the purposes of § 1031(f)(1). The legislative history underlying § 1031(f)(4) provides:

If a taxpayer, pursuant to a pre-arranged plan, transfers property to an unrelated party who then exchanges the property with a party related to the taxpayer within 2 years of the previous transfer in a transaction otherwise qualifying un

der section 1031, the related party will not be entitled to nonrecognition treatment under section 1031. Id. at 1341. Accordingly, under § 1031(f)(4), if an unrelated third party is used to circumvent the purposes of the related party rule in § 1031(f), the nonrecognition provisions of § 1031 do not apply to the transaction.

In the present case, A is using QI to circumvent the purposes of § 1031(f) in the same way that the unrelated party was used to circumvent the purposes of § 1031(f) in the legislative history example. Absent § 1031(f)(1), A could have engaged in a like-kind exchange of Property 1 for Property 2 with B, and B could have sold Property 1 to C. Under § 1031(f)(1), however, the non-recognition provisions of § 1031(a) do not apply to that exchange because A and B are related parties and B sells the replacement property within 2 years of the exchange.

Accordingly, to avoid the application of § 1031(f)(1), A transfers low-basis Property 1 to QI who sells it to C for cash. QI acquires the high-basis replacement property from B and pays B the cash received from C. Thus, A engages in a like-kind exchange with QI, an unrelated third party, instead of B. However, the end result of the transaction is the same as if A had exchanged property with B followed by a sale from B to C. This series of transactions allows A to effectively cash out of the investment in Property 1 without the recognition of gain.

A’s exchange of property with QI, therefore, is part of a transaction structured to avoid the purposes of § 1031(f) and, under § 1031(f)(4), the non-recognition provisions of § 1031 do not apply to the exchange between A and QI. A’s exchange of Property 1 for Property 2 is treated as a taxable transaction. Under § 1001(a), A has gain of $100x, the difference between A’s amount realized on the exchange ($150x, the fair market value of Property 2) and A’s adjusted basis in the property exchanged ($50x).

HOLDING

Under the facts described above, a taxpayer who transfers relinquished property to a qualified intermediary in exchange for replacement property formerly owned by a related party is not entitled to nonrecognition treatment under § 1031(a) of the Internal Revenue Code if, as part of the

December 9, 2002 928 2002–49 I.R.B.

REV. RUL. 2002–81 TABLE 1

Applicable Federal Rates (AFR) for December 2002

Period for Compounding

Annual Semiannual Quarterly Monthly Short-Term

AFR 1.84% 1.83% 1.83% 1.82% 110% AFR 2.02% 2.01% 2.00% 2.00% 120% AFR 2.21% 2.20% 2.19% 2.19% 130% AFR 2.39% 2.38% 2.37% 2.37%

Mid-Term

AFR 3.31% 3.28% 3.27% 3.26% 110% AFR 3.64% 3.61% 3.59% 3.58% 120% AFR 3.98% 3.94% 3.92% 3.91% 130% AFR 4.31% 4.26% 4.24% 4.22% 150% AFR 4.98% 4.92% 4.89% 4.87% 175% AFR 5.82% 5.74% 5.70% 5.67%

Long-Term

AFR 4.92% 4.86% 4.83% 4.81% 110% AFR 5.42% 5.35% 5.31% 5.29% 120% AFR 5.91% 5.83% 5.79% 5.76% 130% AFR 6.42% 6.32% 6.27% 6.24%

REV. RUL. 2002–81 TABLE 2

Adjusted AFR for December 2002

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted AFR

Mid-term adjusted AFR

Long-term adjusted AFR

1.92% 1.91% 1.91% 1.90%

3.16% 3.14% 3.13% 3.12%

4.65% 4.60% 4.57% 4.56%

REV. RUL. 2002–81 TABLE 3

Rates Under Section 382 for November 2002

Adjusted federal long-term rate for the current month 4.65%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 4.65%

2002–49 I.R.B. 929 December 9, 2002

REV. RUL. 2002–81 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for December 2002

Appropriate percentage for the 70% present value low-income housing credit 7.95%

Appropriate percentage for the 30% present value low-income housing credit 3.41%

REV. RUL. 2002–81 TABLE 5

Rate Under Section 7520 for December 2002

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 4.0%

REV. RUL. 2002–81 TABLE 6

Applicable rate of interest for 2003 for purposes of section 846 and 807 5.27%

Section 1288.—Treatment of Original Issue Discounts on Tax-Exempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 1397E.—Credit to Holders of Qualified Zone Academy Bonds

What is the allocation for each State, the District of Columbia, and each possession of the United States of the national limitation for Qualified Zone Academy Bonds for calendar year 2003? See Rev. Proc. 2002–72, page 931.

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

Section 7872.—Treatment of Loans With Below-Market In- terest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2002. See Rev. Rul. 2002–81, page 928.

December 9, 2002 930 2002–49 I.R.B.