Part I. Rulings — Internal Revenue Bulletin 2003-14

Section 42.—Low-Income Housing Credit

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 102.—Gifts and Inheritances

26 CFR 1.102–1: Gifts and inheritances.

Why are grant payments made to businesses under the World Trade Center grant program not excluded from a grant recipient’s gross income as a gift under section 102(a)? See Notice 2003–18, page 699.

Section 118.—Contributions to the Capital of a Corpo- ration

26 CFR 1.118–1: Contributions to the capital of a corporation.

Are grant payments made to businesses under the World Trade Center grant programs excluded from gross income as contributions to capital under section 118? See Notice 2003–18, page 699.

Section 139.—Disaster Relief Payments

Why are grant payments made to businesses under the World Trade Center grant programs not excluded from a recipient’s gross income as qualified disaster relief payments under section 139? See Notice 2003–18, page 699.

Section 165.—Losses

26 CFR 1.165–1: Losses.

Must recipients of grant payments made under the World Trade Center grant programs reduce the amount of an allowable casualty loss deduction under section 165 or include in gross income all or part of a casualty loss claimed in a prior year? See Notice 2003–18, page 699.

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 337.—Nonrecognition for Property Distributed to Parent in Complete Liquidation of Subsidiary

26 CFR 1.337(d)–6: New transitional rules imposing tax on property owned by a C corporation that becomes property of a RIC or REIT.

T.D. 9047

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

Certain Transfers of Property to Regulated Investment Companies [RICs] and Real Estate Investment Trusts

[REITs]

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

SUMMARY: This document contains final regulations that apply to certain transactions or events that result in a Regulated Investment Company [RIC] or a Real Estate Investment Trust [REIT] owning property that has a basis determined by reference to a C corporation’s basis in the property. These regulations affect RICs, REITs, and C corporations and clarify the tax treatment of transfers of C corporation property to a RIC or REIT.

DATES: Effective Date: These regulations are effective March 18, 2003.

Applicability Dates: For dates of applicability, see §§1.337(d)–5(d), 1.337(d)– 6(e) and 1.337(d)–7(f).

FOR FURTHER INFORMATION CONTACT: Jennifer D. Sledge, (202) 622–7750 (not a toll-free number).

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 1545–1672. This information is required to obtain a benefit, i.e., to elect to recognize gain as if the C corporation had sold the property at fair market value or to elect section 1374 treatment.

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

The estimated annual burden per respondent is 30 minutes.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the In- ternal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Of- fice 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 might 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 26 CFR part 1. On February 7, 2000, temporary regulations (T.D. 8872, 2000–1 C.B. 639 [65 FR 5775]) (the 2000 temporary regulations) relating to certain transactions or events that result in a RIC or REIT owning property that has a basis determined by reference to a C corporation’s basis in the property were published in the Federal Register . A notice of proposed rulemaking (REG–209135–88, 2000–1 C.B.

2003–14 I.R.B. 676 April 7, 2003

unless the C corporation that qualifies as a RIC or REIT or transfers property to a RIC or REIT elects deemed sale treatment. In most other respects, the regulations under §1.337(d)–7T follow the regulations under §1.337(d)–6T.

No public hearing was requested or held on the 2002 temporary regulations. Written or electronic comments responding to the notice of proposed rulemaking were received. After consideration of all the comments, the proposed regulations are adopted as amended (the final regulations) by this Treasury decision, and the corresponding temporary regulations are removed. The revisions are discussed below.

Explanation and Summary of Comments

This preamble first discusses a change in the time for making the section 1374 election under §1.337(d)–6. This preamble then discusses the clarification of the rules concerning the use of loss carryforwards, credits and credit carryforwards found in the regulations under both §1.337(d)–6 and §1.337(d)–7. Finally, this preamble discusses the clarification of certain issues related to the special rule for partnerships found in §1.337(d)–7.

Time for Making Section 1374 Election under §1.337(d)–6

As explained above, the regulations under §1.337(d)–6T provide that, if property of a C corporation that is not a RIC or REIT becomes the property of a RIC or REIT in a conversion transaction, then the C corporation is subject to deemed sale treatment, unless the RIC or REIT elects to be subject to section 1374 treatment. Under §1.337(d)–6T(c)(4)(ii), the section 1374 election may be filed by the RIC or REIT with any federal income tax return filed by the RIC or REIT on or before March 15, 2003, provided that the RIC or REIT has reported consistently with such election for all periods. Commentators expressed concern that, in the case of a conversion transaction occurring on January 1, 2002 (the last date of applicability of §1.337(d)–6T), the time limit for making a section 1374 election could preclude a RIC or REIT from extending the due date of its federal income tax return beyond March 15, 2003. In response to this comment, the final regula

681 [65 FR 5805]) cross-referencing the temporary regulations was published in the Federal Register for the same day. The 2000 temporary regulations were intended to carry out the purposes of the repeal of the General Utilities doctrine as enacted in the Tax Reform Act of 1986 (the 1986 Act) (Public Law 99–514, 100 Stat. 2085), as amended by the Technical and Miscellaneous Revenue Act of 1988 (Public Law 100–647, 102 Stat. 3342). The 1986 Act amended sections 336 and 337 to require corporations to recognize gain or loss on the distribution of property in connection with complete liquidations other than certain subsidiary liquidations. Section 337(d) directs the Secretary to prescribe regulations as may be necessary to carry out the purposes of the General Utilities repeal, including rules to “ensure that such purposes may not be circumvented . . . through the use of a regulated investment company, a real estate investment trust, or tax-exempt entity . . . .”

The 2000 temporary regulations also reflected the principles set forth in Notice 88– 19, 1988–1 C.B. 486, in which the IRS announced its intention to promulgate regulations under the authority of section 337(d) with respect to transactions or events that result in a RIC or REIT owning property that has a basis determined by reference to a C corporation’s basis (a carryover basis). Notice 88–19 provided that the regulations would apply with respect to the net built-in gain of C corporation assets that become assets of a RIC or REIT by the qualification of a C corporation as a RIC or REIT or by the transfer of assets of a C corporation to a RIC or REIT (a conversion transaction). The notice further provided that, where the regulations apply, the C corporation would be treated, for all purposes, as if it had sold all of its assets at their respective fair market values and immediately liquidated. The notice provided, however, that the regulations would not allow the recognition of a net loss and that immediate gain recognition could be avoided if the C corporation that qualified as a RIC or REIT or the transferee RIC or REIT, as the case may have been, elected to be subject to tax under section 1374 with respect to the C corporation property. Notice 88–19 also indicated that the regulations would apply retroactively to June 10, 1987.

A public hearing on the cross-referenced notice of proposed rulemaking was held on May 10, 2000. Written or electronic comments responding to the notice of proposed rulemaking were received. After consideration of these comments, Treasury and the IRS decided to issue two new sets of temporary regulations. On January 2, 2002, temporary regulations (T.D. 8975, 2002–1 C.B. 379 [67 FR 8]) (the 2002 temporary regulations) were published in the Federal Register . The regulations under §1.337(d)–6T apply to conversion transactions occurring on or after June 10, 1987, and before January 2, 2002, and the regulations under §1.337(d)–7T apply to conversion transactions occurring on or after January 2, 2002. A notice of proposed rulemaking (REG–142299–01 and REG– 209135–88, 2002–1 C.B. 418 [67 FR 48]) cross-referencing the temporary regulations was published in the Federal Reg- ister for the same day.

The regulations under §1.337(d)–6T provide that, if property of a C corporation that is not a RIC or REIT becomes the property of a RIC or REIT in a conversion transaction, then the C corporation is subject to deemed sale treatment, unless the RIC or REIT elects to be subject to section 1374 treatment. Thus, the C corporation generally recognizes gain and loss as if it sold the property converted to RIC or REIT property or transferred to the RIC or REIT (the converted property) to an unrelated party at fair market value immediately before the conversion transaction. If the C corporation recognizes net gain on the deemed sale, then the basis of the converted property in the hands of the RIC or REIT is adjusted to its fair market value immediately before the conversion transaction. The regulations under §1.337(d)–6T do not permit a C corporation to recognize a net loss on the deemed sale. Where there is a net loss, the C corporation recognizes no gain or loss on the deemed sale, and the C corporation’s basis in the converted property carries over to the RIC or REIT.

The regulations under §1.337(d)–7T provide that, if property of a C corporation that is not a RIC or REIT becomes the property of a RIC or REIT in a conversion transaction, then the RIC or REIT will be subject to tax on the net built-in gain in the converted property under the rules of section 1374 and the regulations thereunder,

April 7, 2003 677 2003–14 I.R.B.

tain the rule under section 703(b) that the deemed sale election is made at the partnership level.

Contribution of Loss Assets by Partnership

Under the partnership rule, if a partnership were to elect deemed sale treatment under §1.337(d)–7T, any gain recognized by the partnership on the deemed sale is allocated to the C corporation partner. A commentator expressed concern that if the contribution by the partnership to a RIC or REIT includes multiple assets, the deemed sale may generate losses on certain assets and gain on others even though there is an overall net built-in gain. The commentator suggested that losses recognized by the partnership must also be allocated to the C corporation partner.

Under §1.337(d)–7T, when a partnership elects deemed sale treatment, only net gains are recognized. If a net gain is recognized, the C corporation partner will receive the benefit of offsetting losses (as a result of the reduction in net gain). The final regulations under §1.337(d)–7 have been modified to clarify that the gain allocated to the C corporation partner on a deemed sale transaction is the C corporation partner’s distributive share of the net gain in the assets transferred to the RIC or REIT by the partnership.

Allocation of Gain or Loss on Subsequent Sale of RIC or REIT Stock

Under section 358, a partnership that elects deemed sale treatment under §1.337(d)–7T(c) with respect to a conversion transaction increases its basis in the RIC or REIT stock by the net gain recognized on such transaction. A commentator suggested that the C corporation partner should be allowed to use this basis increase to offset any gain or loss recognized by the partnership on the eventual sale of the RIC or REIT stock.

Treasury and the IRS agree with this comment. Accordingly, the final regulations under §1.337(d)–7 provide that any adjustment to the basis of the RIC or REIT stock held by the partnership as a result of electing deemed sale treatment will constitute an adjustment to the basis of that stock with respect to the C corporation partner only.

tions under §1.337(d)–6 extend the time for making the section 1374 election to September 15, 2003.

Use of Loss Carryforwards, Credits and Credit Carryforwards

Under the 2002 temporary regulations, recognized built-in gains and recognized built-in losses that have been taxed in accordance with these regulations are treated like other gains and losses of RICs and REITs that are not subject to tax under these regulations. Thus, they are included in computing investment company taxable income for purposes of section 852(b)(2), real estate investment trust taxable income for purposes of section 857(b)(2), net capital gain for purposes of sections 852(b)(3) and 857(b)(3), gross income derived from sources within any foreign country or possession of the United States for purposes of section 853, and the dividends paid deduction for purposes of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and 857(b)(3)(A).

In addition, consistent with section 1374, the 2002 temporary regulations generally allow RICs and REITs to use loss carryforwards and credits and credit carryforwards arising in taxable years for which the corporation that generated the attribute was a C corporation (and not a RIC or REIT) to reduce net recognized built-in gain and the tax thereon, subject to the limitations imposed by sections 1374(b)(2) and (b)(3) and §§1.1374–5 and 1.1374–6. The 2002 temporary regulations also provide an ordering rule for applying loss carryforwards, credits, and credit carryforwards to reduce net recognized built-in gain (and the tax thereon) and RIC or REIT taxable income (and the tax thereon). Under this ordering rule, loss carryforwards of a RIC or REIT must be used to reduce net recognized built-in gain for a taxable year to the greatest extent possible before such losses can be used to reduce investment company taxable income for purposes of section 852(b) or real estate investment trust taxable income for purposes of section 857(b). A similar rule applies to the use of credits and credit carryforwards.

A commentator asked whether the use of loss carryforwards, credits and credit carryforwards for purposes of section 1374 affected the use of loss carryforwards, credits and credit carryforwards for purposes of subchapter M. In response to this com

ment, the final regulations under §§1.337(d)–6 and 1.337(d)–7 clarify that the use of loss carryforwards, credits and credit carryforwards for purposes of the section 1374 tax does not change the extent to which such loss carryforwards, credits and credit carryforwards can be used for purposes of subchapter M.

Special Rule for Partnerships under §1.337(d)–7

Section §1.337(d)–7T applies to property transferred by a partnership to a RIC or REIT to the extent of any C corporation partner’s proportionate share of the transferred property (the partnership rule). The regulations state that, if the partnership elects deemed sale treatment with respect to such transfer, then any gain recognized by the partnership on the deemed sale must be specially allocated to the C corporation partner.

In response to comments, the regulations have been revised to clarify that the principles of section 704(b) and (c) apply in determining the C corporation partner’s share of the transferred property. As revised, the regulations provide that the principles of these regulations apply to property transferred by a partnership to a RIC or REIT to the extent of any C corporation partner’s distributive share of the gain or loss in the transferred property. The following sections highlight other specific comments received with respect to this rule.

Partnerships with Multiple Corporate Partners

A commentator expressed concern that the partnership rule does not specify whether the C corporation partner or the partnership is considered the transferor for purposes of making the deemed sale election. Further, the commentator asserted that in the case of a partnership with multiple corporate partners, each corporate partner should be allowed to make (or not make) a deemed sale election.

Treasury and the IRS believe that requiring each corporate partner to make a deemed sale election would be inconsistent with section 703(b) (which generally requires that elections be made at the partnership level) and would create unnecessary administrative complexity. Therefore, the final regulations under §1.337(d)–7 re

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Partnerships with Tax-Exempt Partners

A commentator expressed concern that the partnership rule in §1.337(d)–7T may have an unintended punitive effect when the C corporation partner is a tax-exempt entity. Tax-exempt entities that are partners in a partnership that holds debt financed property are subject to tax under the unrelated business income tax (UBIT) rules unless certain criteria are satisfied. One of these criteria (the fractions rule) requires that: (1) the tax-exempt partner’s share of overall partnership income for any tax year is no greater than its smallest share of partnership loss in any tax year; and (2) each allocation with respect to the partnership has substantial economic effect within the meaning of section 704(b)(2). The commentator expressed concern that the special allocation of gain to the tax-exempt partner that is required by §1.337(d)–7T when the partnership makes a deemed sale election may violate the fractions rule, tainting all income from the partnership for UBIT purposes.

In response to this comment, Treasury and the IRS have amended the regulations under section 514 to provide that allocations that are mandated by statute or regulation (other than subchapter K of chapter 1 of the Internal Revenue Code and the regulations thereunder) are not considered for purposes of determining qualification under the fractions rule. This rule applies to partnership allocations made in taxable years beginning on or after January 1, 2002.

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 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 regulations do 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 final regulations will be 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 Jennifer D. Sledge of the Office of Associate Chief Counsel (Corporate). Other personnel from Treasury Department and the IRS participated in their development.

* * * * *

Adoption of Amendments to the Regu- lations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by removing the entries for “Section 1.337(d)–5T”, “Section 1.337(d)–6T”, and “Section 1.337(d)–7T” and adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.337(d)–5 also issued under 26 U.S.C. 337.

Section 1.337(d)–6 also issued under 26 U.S.C. 337.

Section 1.337(d)–7 also issued under 26 U.S.C. 337. * * *

§1.337(d)–5T [Redesignated as §1.337(d)–5]

Par. 2. Section 1.337(d)–5T is redesignated as §1.337(d)–5 and the language “(temporary)” is removed from the end of the section heading.

Par. 3. Newly designated §1.337(d)–5 is amended as follows:

In paragraph (b)(3), first sentence, the reference to “§1.337(d)–5T(b)” is removed and “paragraph (b) of this section” is added in its place.
In paragraph (d), third sentence, the references to “§1.337(d)–5T(b)(1)” and “§1.337(d)–6T” are removed and “paragraph (b)(1) of this section” and “§1.337(d)–6” are added in their places, respectively.
In paragraph (d), fourth sentence, the reference to “§1.337(d)–6T” is removed and “§1.337(d)–6” is added in its place.
In paragraph (d), last sentence, the reference to “§1.337(d)–7T” is removed and “§1.337(d)–7” is added in its place.

Par. 4. Section 1.337(d)–6 is added to read as follows:

§1.337(d)–6 New transitional rules imposing tax on property owned by a C corporation that becomes property of a RIC or REIT.

(a) General rule —(1) Property owned by a C corporation that becomes property of a RIC or REIT. If property owned by a C corporation (as defined in paragraph (a)(2)(i) of this section) becomes the property of a RIC or REIT (the converted property) in a conversion transaction (as defined in paragraph (a)(2)(ii) of this section), then deemed sale treatment will apply as described in paragraph (b) of this section, unless the RIC or REIT elects section 1374 treatment with respect to the conversion transaction as provided in paragraph (c) of this section. See paragraph (d) of this section for exceptions to this paragraph (a).

(2) Definitions —(i) C corporation. For purposes of this section, the term C cor- poration has the meaning provided in section 1361(a)(2) except that the term does not include a RIC or REIT.

(ii) Conversion transaction. For purposes of this section, the term conversion transaction means the qualification of a C corporation as a RIC or REIT or the transfer of property owned by a C corporation to a RIC or REIT.

(b) Deemed sale treatment —(1) In gen- eral. If property owned by a C corporation becomes the property of a RIC or REIT in a conversion transaction, then the C corporation recognizes gain and loss as if it sold the converted property to an unrelated party at fair market value on the deemed sale date (as defined in paragraph (b)(3) of this section). This paragraph (b) does not apply if its application would result in the recognition of a net loss. For this purpose, net loss is the excess of aggregate losses over aggregate gains (including items of income), without regard to character.

(2) Basis adjustment. If a corporation recognizes a net gain under paragraph (b)(1) of this section, then the converted property has a basis in the hands of the RIC or REIT equal to the fair market value of such property on the deemed sale date.

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tion 857(b)(5)(B), the amount of a REIT’s recognized built-in gain that is subject to tax under section 857(b)(5) is the tax imposed by section 857(b)(5) multiplied by a fraction the numerator of which is the amount of recognized built-in gain (without regard to recognized built-in loss and recognized built-in gain from prohibited transactions) that is not derived from sources referred to in section 856(c)(3) and the denominator of which is the gross income (without regard to gross income from prohibited transactions) of the REIT that is not derived from sources referred to in section 856(c)(3).

(B) Taxable income limitation. The taxable income limitation determined as provided in §1.1374–2(a)(2) is reduced by an amount equal to the tax imposed under sections 857(b)(5), (6), and (7).

(ii) Loss carryforwards, credits and credit carryforwards —(A) Loss carryforwards. Consistent with paragraph (c)(1)(i) of this section, net operating loss carryforwards and capital loss carryforwards arising in taxable years for which the corporation that generated the loss was not subject to subchapter M of chapter 1 of the Internal Revenue Code are allowed as a deduction against net recognized built-in gain to the extent allowed under section 1374 and the regulations thereunder. Such loss carryforwards must be used as a deduction against net recognized built-in gain for a taxable year to the greatest extent possible before such losses can be used to reduce other investment company taxable income for purposes of section 852(b) or other real estate investment trust taxable income for purposes of section 857(b) for that taxable year.

(B) Credits and credit carryforwards. Consistent with paragraph (c)(1)(i) of this section, minimum tax credits and business credit carryforwards arising in taxable years for which the corporation that generated the credit was not subject to subchapter M of chapter 1 of the Internal Revenue Code are allowed to reduce the tax imposed on net recognized built-in gain under this paragraph (c) to the extent allowed under section 1374 and the regulations thereunder. Such credits and credit carryforwards must be used to reduce the tax imposed under this paragraph (c) on net recognized built-in gain for a taxable year to the greatest extent possible before such credits and credit carryforwards can be used to reduce the tax, if any, on other invest

ration’s last taxable year before the first taxable year in which it qualifies to be taxed as a RIC or REIT.

(ii) Other conversion transactions. If the conversion transaction is a transfer of property owned by a C corporation to a RIC or REIT, then the deemed sale date is the end of the day before the day of the transfer.

(4) Example. The rules of this paragraph (b) are illustrated by the following example:

Example. Deemed sale treatment on merger into RIC. (i) X, a calendar-year taxpayer, has qualified as a RIC since January 1, 1991. On May 31, 1994, Y, a C corporation and calendar-year taxpayer, transfers all of its property to X in a transaction that qualifies as a reorganization under section 368(a)(1)(C). X does not elect section 1374 treatment under paragraph (c) of this section and chooses not to rely on §1.337(d)–5. As a result of the transfer, Y is subject to deemed sale treatment under this paragraph (b) on its tax return for the short taxable year ending May 31, 1994. On May 31, 1994, Y’s only assets are Capital Asset, which has a fair market value of $100,000 and a basis of $40,000 as of the end of May 30, 1994, and $50,000 cash. Y also has an unrestricted net operating loss carryforward of $12,000 and accumulated earnings and profits of $50,000. Y has no taxable income for the short taxable year ending May 31, 1994, other than gain recognized under this paragraph (b). In 1997, X sells Capital Asset for $110,000. Assume the applicable corporate tax rate is 35%.

(ii) Under this paragraph (b), Y is treated as if it sold the converted property (Capital Asset and $50,000 cash) at fair market value on May 30, 1994, recognizing $60,000 of gain ($150,000 amount realized $90,000 basis). Y must report the gain on its tax return for the short taxable year ending May 31, 1994. Y may offset this gain with its $12,000 net operating loss carryforward and will pay tax of $16,800 (35% of $48,000).

(iii) Under section 381, X succeeds to Y’s accumulated earnings and profits. Y’s accumulated earnings and profits of $50,000 increase by $60,000 and decrease by $16,800 as a result of the deemed sale. Thus, the aggregate amount of subchapter C earnings and profits that must be distributed to satisfy section 852(a)(2)(B) is $93,200 ($50,000 + $60,000 $16,800). X’s basis in Capital Asset is $100,000. On X’s sale of Capital Asset in 1997, X recognizes $10,000 of gain, which is taken into account in computing X’s net capital gain for purposes of section 852(b)(3). (c) Election of section 1374 treatment (1) In general —(i) Property owned by a C corporation that becomes property of a RIC or REIT. Paragraph (b) of this section does not apply if the RIC or REIT that was formerly a C corporation or that acquired property from a C corporation makes the election described in paragraph (c)(4) of this section. A RIC or REIT that makes such an election will be subject to tax on the net built-in gain in the converted property under the rules of section 1374 and the regu

lations thereunder, as modified by this paragraph (c), as if the RIC or REIT were an S corporation.

(ii) Property subject to the rules of sec- tion 1374 owned by a RIC, REIT, or S cor- poration that becomes property of a RIC or REIT. If property subject to the rules of section 1374 owned by a RIC, a REIT, or an S corporation (the predecessor) becomes the property of a RIC or REIT (the successor) in a continuation transaction, the rules of section 1374 apply to the successor to the same extent that the predecessor was subject to the rules of section 1374 with respect to such property, and the 10-year recognition period of the successor with respect to such property is reduced by the portion of the 10-year recognition period of the predecessor that expired before the date of the continuation transaction. For this purpose, a continuation transaction means the qualification of the predecessor as a RIC or REIT or the transfer of property from the predecessor to the successor in a transaction in which the successor’s basis in the transferred property is determined, in whole or in part, by reference to the predecessor’s basis in that property.

(2) Modification of section 1374 treatment —(i) Net recognized built-in gain for REITs —(A) Prelimitation amount. The prelimitation amount determined as provided in §1.1374–2(a)(1) is reduced by the portion of such amount, if any, that is subject to tax under section 857(b)(4), (5), (6), or (7). For this purpose, the amount of a REIT’s recognized built-in gain that is subject to tax under section 857(b)(5) is computed as follows:

( 1 ) Where the tax under section 857(b)(5) is computed by reference to section 857(b)(5)(A), the amount of a REIT’s recognized built-in gain that is subject to tax under section 857(b)(5) is the tax imposed by section 857(b)(5) multiplied by a fraction the numerator of which is the amount of recognized built-in gain (without regard to recognized built-in loss and recognized built-in gain from prohibited transactions) that is not derived from sources referred to in section 856(c)(2) and the denominator of which is the gross income (without regard to gross income from prohibited transactions) of the REIT that is not derived from sources referred to in section 856(c)(2).

( 2 ) Where the tax under section 857(b)(5) is computed by reference to sec

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$80,000 basis). Because X’s $30,000 of net income for the 1997 taxable year exceeds the net recognized built-in gain of $20,000, the taxable income limitation does not apply. X, therefore, has $20,000 net recognized built-in gain for the year. Assuming that X has not used its $3,000 of capital loss carryforwards in a prior taxable year and that their use is allowed under section 1374(b)(2) and §1.1374–5, X is allowed a $3,000 deduction against the $20,000 net recognized built-in gain. X would owe tax of $5,950 (35% of $17,000) on its net recognized built-in gain, except that X may use its $2,000 of business credit carryforwards to reduce this tax, assuming that X has not used the credit carryforwards in a prior taxable year and that their use is allowed under section 1374(b)(3) and §1.1374–6. Thus, X owes tax of $3,950 under this paragraph (c).

(iv) For purposes of subchapter M of chapter 1 of the Internal Revenue Code, X’s earnings and profits for the year increase by $26,050 ($30,000 capital gain on the sale of Real Property - $3,950 tax under this paragraph (c)). For purposes of section 857(b)(2) and (b)(3), X’s net capital gain for the year is $23,050 ($30,000 capital gain reduced by $3,000 capital loss carryforward and further reduced by $3,950 tax).

(d) Exceptions —(1) Gain otherwise rec- ognized. Paragraph (a) of this section does not apply to any conversion transaction to the extent that gain or loss otherwise is recognized on such conversion transaction. See, for example, sections 336, 351(b), 351(e), 356, 357(c), 367, 368(a)(2)(F), and 1001. (2) Re-election of RIC or REIT status (i) Generally. Except as provided in paragraphs (d)(2)(ii) and (iii) of this section, paragraph (a)(1) of this section does not apply to any corporation that—

(A) Immediately prior to qualifying to be taxed as a RIC or REIT was subject to tax as a C corporation for a period not exceeding two taxable years; and

(B) Immediately prior to being subject to tax as a C corporation was subject to tax as a RIC or REIT for a period of at least one taxable year.

(ii) Property acquired from another cor- poration while a C corporation. The exception described in paragraph (d)(2)(i) of this section does not apply to property acquired by the corporation while it was subject to tax as a C corporation from any person in a transaction that results in the acquirer’s basis in the property being determined by reference to a C corporation’s basis in the property.

(iii) RICs and REITs previously sub- ject to section 1374 treatment. If the RIC or REIT had property subject to paragraph (c) of this section before the RIC or REIT became subject to tax as a C corporation as described in paragraph (d)(2)(i) of this section, then paragraph (c) of this section applies to the RIC or REIT upon its requali

ment company taxable income for purposes of section 852(b) or on other real estate investment trust taxable income for purposes of section 857(b) for that taxable year.

(iii) 10-year recognition period. In the case of a conversion transaction that is a qualification of a C corporation as a RIC or REIT, the 10-year recognition period described in section 1374(d)(7) begins on the first day of the RIC’s or REIT’s first taxable year. In the case of other conversion transactions, the 10-year recognition period begins on the day the property is acquired by the RIC or REIT.

(3) Coordination with subchapter M rules —(i) Recognized built-in gains and losses subject to subchapter M . Recognized built-in gains and losses of a RIC or REIT are included in computing investment company taxable income for purposes of section 852(b)(2), real estate investment trust taxable income for purposes of section 857(b)(2), capital gains for purposes of sections 852(b)(3) and 857(b)(3), gross income derived from sources within any foreign country or possession of the United States for purposes of section 853, and the dividends paid deduction for purposes of sections 852(b)(2)(D), 852(b)(3)(A), 857(b)(2)(B), and 857(b)(3)(A). In computing such income and deduction items, capital loss carryforwards and net operating loss carryforwards that are used by the RIC or REIT to reduce recognized built-in gains are allowed as a deduction, but only to the extent that they are otherwise allowable as a deduction against such income under the Internal Revenue Code (including section 852(b)(2)(B)). (ii) Treatment of tax imposed. The amount of tax imposed under this paragraph (c) on net recognized built-in gain for a taxable year is treated as a loss sustained by the RIC or the REIT during such taxable year. The character of the loss is determined by allocating the tax proportionately (based on recognized built-in gain) among the items of recognized built-in gain included in net recognized built-in gain. With respect to RICs, the tax imposed under this paragraph (c) on net recognized built-in gain is treated as attributable to the portion of the RIC’s taxable year occurring after October 31.

(4) Making the section 1374 election (i) In general. A RIC or REIT makes a sec

tion 1374 election with the following statement: “[Insert name and employer identification number of electing RIC or REIT] elects under §1.337–6(c) to be subject to the rules of section 1374 and the regulations thereunder with respect to its property that formerly was held by a C corporation, [insert name and employer identification number of the C corporation, if different from name and employer identification number of the RIC or REIT].” However, a RIC or REIT need not file an election under this paragraph (c), but will be deemed to have made such an election if it can demonstrate that it informed the Internal Revenue Service prior to January 2, 2002, of its intent to make a section 1374 election. An election under this paragraph (c) is irrevocable.

(ii) Time for making the election. An election under this paragraph (c) may be filed by the RIC or REIT with any federal income tax return filed by the RIC or REIT on or before September 15, 2003, provided that the RIC or REIT has reported consistently with such election for all periods.

(5) Example. The rules of this paragraph (c) are illustrated by the following example:

Example. Section 1374 treatment on REIT elec- tion. (i) X, a C corporation that is a calendar-year taxpayer, elects to be taxed as a REIT on its 1994 tax return, which it files on March 15, 1995. As a result, X is a REIT for its 1994 taxable year and would be subject to deemed sale treatment under paragraph (b) of this section but for X’s timely election of section 1374 treatment under this paragraph (c). X chooses not to rely on §1.337(d)–5. As of the beginning of the 1994 taxable year, X’s property consisted of Real Property, which is not section 1221(a)(1) property and which had a fair market value of $100,000 and an adjusted basis of $80,000, and $25,000 cash. X also had accumulated earnings and profits of $25,000, unrestricted capital loss carryforwards of $3,000, and unrestricted business credit carryforwards of $2,000. On July 1, 1997, X sells Real Property for $110,000. For its 1997 taxable year, X has no other income or deduction items. Assume the highest corporate tax rate is 35%.

(ii) Upon its election to be taxed as a REIT, X retains its $80,000 basis in Real Property and its $25,000 accumulated earnings and profits. X retains its $3,000 of capital loss carryforwards and its $2,000 of business credit carryforwards. To satisfy section 857(a)(2)(B), X must distribute $25,000, an amount equal to its earnings and profits accumulated in nonREIT years, to its shareholders by the end of its 1994 taxable year.

(iii) Upon X’s sale of Real Property in 1997, X recognizes gain of $30,000 ($110,000–$80,000). X’s recognized built-in gain for purposes of applying section 1374 is $20,000 ($100,000 fair market value as of the beginning of X’s first taxable year as a REIT

April 7, 2003 681 2003–14 I.R.B.

( 2 ) Where the tax under section 857(b)(5) is computed by reference to section 857(b)(5)(B), the amount of a REIT’s recognized built-in gain that is subject to tax under section 857(b)(5) is the tax imposed by section 857(b)(5) multiplied by a fraction the numerator of which is the amount of recognized built-in gain (without regard to recognized built-in loss and recognized built-in gain from prohibited transactions) that is not derived from sources referred to in section 856(c)(3) and the denominator of which is the gross income (without regard to gross income from prohibited transactions) of the REIT that is not derived from sources referred to in section 856(c)(3).

(B) Taxable income limitation. The taxable income limitation determined as provided in §1.1374–2(a)(2) is reduced by an amount equal to the tax imposed under section 857(b)(5), (6), and (7).

(ii) Loss carryforwards, credits and credit carryforwards —(A) Loss carryforwards . Consistent with paragraph (b)(1)(i) of this section, net operating loss carryforwards and capital loss carryforwards arising in taxable years for which the corporation that generated the loss was not subject to subchapter M of chapter 1 of the Internal Revenue Code are allowed as a deduction against net recognized built-in gain to the extent allowed under section 1374 and the regulations thereunder. Such loss carryforwards must be used as a deduction against net recognized built-in gain for a taxable year to the greatest extent possible before such losses can be used to reduce other investment company taxable income for purposes of section 852(b) or other real estate

fication as a RIC or REIT, except that the 10-year recognition period with respect to such property is reduced by the portion of the 10-year recognition period that expired before the RIC or REIT became subject to tax as a C corporation and by the period of time that the corporation was subject to tax as a C corporation.

(e) Effective date. This section applies to conversion transactions that occur on or after June 10, 1987, and before January 2, 2002. In lieu of applying this section, taxpayers generally may apply §1.337(d)–5 to determine the tax consequences (for all taxable years) of any conversion transaction that occurs on or after June 10, 1987, and before January 2, 2002, except that RICs and REITs that are subject to section 1374 treatment with respect to a conversion transaction may not rely on §1.337(d)–5(b)(1), but must apply paragraphs (c)(1)(i), (c)(2)(i), (c)(2)(ii), and (c)(3) of this section, with respect to built-in gains and losses recognized in taxable years beginning on or after January 2, 2002. Taxpayers are not prevented from relying on §1.337(d)–5 merely because they elect section 1374 treatment in the manner described in paragraph (c)(4) of this section instead of in the manner described in §1.337(d)–5(b)(3) and (c). For conversion transactions that occur on or after January 2, 2002, see §1.337(d)–7.

§1.337(d)–6T [Removed]

Par. 5. Section 1.337(d)–6T is removed. Par. 6. Section 1.337(d)–7 is added to read as follows:

§1.337(d)–7 Tax on property owned by a C corporation that becomes property of a RIC or REIT.

(a) General rule —(1) Property owned by a C corporation that becomes property of a RIC or REIT. If property owned by a C corporation (as defined in paragraph (a)(2)(i) of this section) becomes the property of a RIC or REIT (the converted property) in a conversion transaction (as defined in paragraph (a)(2)(ii) of this section), then section 1374 treatment will apply as described in paragraph (b) of this section, unless the C corporation elects deemed sale treatment with respect to the conversion transaction as provided in paragraph (c) of this section. See paragraph (d) of this section for exceptions to this paragraph (a).

(2) Definitions —(i) C corporation. For purposes of this section, the term C cor-

poration has the meaning provided in section 1361(a)(2) except that the term does not include a RIC or REIT.

(b) Section 1374 treatment —(1) In general —(i) Property owned by a C cor- poration that becomes property of a RIC or REIT. If property owned by a C corporation becomes the property of a RIC or REIT in a conversion transaction, then the RIC or REIT will be subject to tax on the net built-in gain in the converted property under the rules of section 1374 and the regulations thereunder, as modified by this paragraph (b), as if the RIC or REIT were an S corporation.

2003–14 I.R.B. 682 April 7, 2003

carryforwards to reduce the tax, assuming that X has not used the credit carryforwards in a prior taxable year and that their use is allowed under section 1374(b)(3) and §1.1374–6. Thus, X owes tax of $3,950 under this paragraph (b).

(iv) For purposes of subchapter M of chapter 1 of the Internal Revenue Code, X’s earnings and profits for the year increase by $26,050 ($30,000 capital gain on the sale of Real Property - $3,950 tax under this paragraph (b)). For purposes of section 857(b)(2) and (b)(3), X’s net capital gain for the year is $23,050 ($30,000 capital gain reduced by $3,000 capital loss carryforward and further reduced by $3,950 tax).

(c) Election of deemed sale treatment (1) In general. Paragraph (b) of this section does not apply if the C corporation that qualifies as a RIC or REIT or transfers property to a RIC or REIT makes the election described in paragraph (c)(5) of this section. A C corporation that makes such an election recognizes gain and loss as if it sold the converted property to an unrelated party at fair market value on the deemed sale date (as defined in paragraph (c)(3) of this section). See paragraph (c)(4) of this section concerning limitations on the use of loss in computing gain. This paragraph (c) does not apply if its application would result in the recognition of a net loss. For this purpose, net loss is the excess of aggregate losses over aggregate gains (including items of income), without regard to character.

(2) Basis adjustment. If a corporation recognizes a net gain under paragraph (c)(1) of this section, then the converted property has a basis in the hands of the RIC or REIT equal to the fair market value of such property on the deemed sale date.

(3) Deemed sale date —(i) RIC or REIT qualifications. If the conversion transaction is a qualification of a C corporation as a RIC or REIT, then the deemed sale date is the end of the last day of the C corporation’s last taxable year before the first taxable year in which it qualifies to be taxed as a RIC or REIT.

(4) Anti-stuffing rule. A C corporation must disregard converted property in computing gain or loss recognized on the conversion transaction under this paragraph (c), if—

(i) The converted property was acquired by the C corporation in a transaction to which section 351 applied or as a contribution to capital;

investment trust taxable income for purposes of section 857(b) for that taxable year.

(B) Credits and credit carryforwards. Consistent with paragraph (b)(1)(i) of this section, minimum tax credits and business credit carryforwards arising in taxable years for which the corporation that generated the credit was not subject to subchapter M of chapter 1 of the Internal Revenue Code are allowed to reduce the tax imposed on net recognized built-in gain under this paragraph (b) to the extent allowed under section 1374 and the regulations thereunder. Such credits and credit carryforwards must be used to reduce the tax imposed under this paragraph (b) on net recognized built-in gain for a taxable year to the greatest extent possible before such credits and credit carryforwards can be used to reduce the tax, if any, on other investment company taxable income for purposes of section 852(b) or on other real estate investment trust taxable income for purposes of section 857(b) for that taxable year.

deduction against such income under the Internal Revenue Code (including section 852(b)(2)(B)). (ii) Treatment of tax imposed. The amount of tax imposed under this paragraph (b) on net recognized built-in gain for a taxable year is treated as a loss sustained by the RIC or the REIT during such taxable year. The character of the loss is determined by allocating the tax proportionately (based on recognized built-in gain) among the items of recognized built-in gain included in net recognized built-in gain. With respect to RICs, the tax imposed under this paragraph (b) on net recognized built-in gain is treated as attributable to the portion of the RIC’s taxable year occurring after October 31.

(4) Example. The rules of this paragraph (b) are illustrated by the following example:

Example. Section 1374 treatment on REIT elec- tion. (i) X, a C corporation that is a calendar-year taxpayer, elects to be taxed as a REIT on its 2004 tax return, which it files on March 15, 2005. As a result, X is a REIT for its 2004 taxable year and is subject to section 1374 treatment under this paragraph (b). X does not elect deemed sale treatment under paragraph (c) of this section. As of the beginning of the 2004 taxable year, X’s property consisted of Real Property, which is not section 1221(a)(1) property and which had a fair market value of $100,000 and an adjusted basis of $80,000, and $25,000 cash. X also had accumulated earnings and profits of $25,000, unrestricted capital loss carryforwards of $3,000, and unrestricted business credit carryforwards of $2,000. On July 1, 2007, X sells Real Property for $110,000. For its 2007 taxable year, X has no other income or deduction items. Assume the highest corporate tax rate is 35%.

(iii) Upon X’s sale of Real Property in 2007, X recognizes gain of $30,000 ($110,000 - $80,000). X’s recognized built-in gain for purposes of applying section 1374 is $20,000 ($100,000 fair market value as of the beginning of X’s first taxable year as a REIT

$80,000 basis). Because X’s $30,000 of net income for the 2007 taxable year exceeds the net recognized built-in gain of $20,000, the taxable income limitation does not apply. X, therefore, has $20,000 net recognized built-in gain for the year. Assuming that X has not used its $3,000 of capital loss carryforwards in a prior taxable year and that their use is allowed under section 1374(b)(2) and §1.1374–5, X is allowed a $3,000 deduction against the $20,000 net recognized built-in gain. X would owe tax of $5,950 (35% of $17,000) on its net recognized built-in gain, except that X may use its $2,000 of business credit

April 7, 2003 683 2003–14 I.R.B.

(ii) Such converted property had an adjusted basis immediately after its acquisition by the C corporation in excess of its fair market value on the date of acquisition; and

(iii) The acquisition of such converted property by the C corporation was part of a plan a principal purpose of which was to reduce gain recognized by the C corporation in connection with the conversion transaction. For purposes of this paragraph (c)(4), the principles of section 336(d)(2) apply.

(5) Making the deemed sale election . A C corporation (or a partnership to which the principles of this section apply under paragraph (e) of this section) makes the deemed sale election with the following statement: “[Insert name and employer identification number of electing corporation or partnership] elects deemed sale treatment under §1.337(d)–7(c) with respect to its property that was converted to property of, or transferred to, a RIC or REIT, [insert name and employer identification number of the RIC or REIT, if different from the name and employer identification number of the C corporation or partnership].” This statement must be attached to the federal income tax return of the C corporation or partnership for the taxable year in which the deemed sale occurs. An election under this paragraph (c) is irrevocable.

(6) Examples. The rules of this paragraph (c) are illustrated by the following examples:

Example 1. Deemed sale treatment on merger into RIC. (i) X, a calendar-year taxpayer, has qualified as a RIC since January 1, 2001. On May 31, 2004, Y, a C corporation and calendar-year taxpayer, transfers all of its property to X in a transaction that qualifies as a reorganization under section 368(a)(1)(C). As a result of the transfer, Y would be subject to section 1374 treatment under paragraph (b) of this section but for its timely election of deemed sale treatment under this paragraph (c). As a result of such election, Y is subject to deemed sale treatment on its tax return for the short taxable year ending May 31, 2004. On May 31, 2004, Y’s only assets are Capital Asset, which has a fair market value of $100,000 and a basis of $40,000 as of the end of May 30, 2004, and $50,000 cash. Y also has an unrestricted net operating loss carryforward of $12,000 and accumulated earnings and profits of $50,000. Y has no taxable income for the short taxable year ending May 31, 2004, other than gain recognized under this paragraph (c). In 2007, X sells Capital Asset for $110,000. Assume the applicable corporate tax rate is 35%.

(ii) Under this paragraph (c), Y is treated as if it sold the converted property (Capital Asset and $50,000 cash) at fair market value on May 30, 2004, recognizing $60,000 of gain ($150,000 amount realized $90,000 basis). Y must report the gain on its tax return for the short taxable year ending May 31, 2004.

Y may offset this gain with its $12,000 net operating loss carryforward and will pay tax of $16,800 (35% of $48,000).

(iii) Under section 381, X succeeds to Y’s accumulated earnings and profits. Y’s accumulated earnings and profits of $50,000 increase by $60,000 and decrease by $16,800 as a result of the deemed sale. Thus, the aggregate amount of subchapter C earnings and profits that must be distributed to satisfy section 852(a)(2)(B) is $93,200 ($50,000 + $60,000 $16,800). X’s basis in Capital Asset is $100,000. On X’s sale of Capital Asset in 2007, X recognizes $10,000 of gain which is taken into account in computing X’s net capital gain for purposes of section 852(b)(3). Example 2. Loss limitation. (i) Assume the facts are the same as those described in Example 1, but that, prior to the reorganization, a shareholder of Y contributed to Y a capital asset, Capital Asset 2, which has a fair market value of $10,000 and a basis of $20,000, in a section 351 transaction.

(ii) Assuming that Y’s acquisition of Capital Asset 2 was made pursuant to a plan a principal purpose of which was to reduce the amount of gain that Y would recognize in connection with the conversion transaction, Capital Asset 2 would be disregarded in computing the amount of Y’s net gain on the conversion transaction.

(A) Immediately prior to qualifying to be taxed as a RIC or REIT was subject to tax as a C corporation for a period not exceeding two taxable years; and

(B) Immediately prior to being subject to tax as a C corporation was subject to tax as a RIC or REIT for a period of at least one taxable year.

(iii) RICs and REITs previously sub- ject to section 1374 treatment. If the RIC or REIT had property subject to paragraph (b) of this section before the RIC or REIT became subject to tax as a C corporation

as described in paragraph (d)(2)(i) of this section, then paragraph (b) of this section applies to the RIC or REIT upon its requalification as a RIC or REIT, except that the 10-year recognition period with respect to such property is reduced by the portion of the 10-year recognition period that expired before the RIC or REIT became subject to tax as a C corporation and by the period of time that the corporation was subject to tax as a C corporation.

(e) Special rule for partnerships. The principles of this section apply to property transferred by a partnership to a RIC or REIT to the extent of any C corporation partner’s distributive share of the gain or loss in the transferred property. If the partnership were to elect deemed sale treatment under paragraph (c) of this section in lieu of section 1374 treatment under paragraph (b) of this section with respect to such transfer, then any net gain recognized by the partnership on the deemed sale must be allocated to the C corporation partner, but does not increase the capital account of any partner. Any adjustment to the partnership’s basis in the RIC or REIT stock as a result of deemed sale treatment under paragraph (c) of this section shall constitute an adjustment to the basis of that stock with respect to the C corporation partner only. The principles of section 743 apply to such basis adjustment.

(f) Effective date. This section applies to conversion transactions that occur on or after January 2, 2002. For conversion transactions that occurred on or after June 10, 1987, and before January 2, 2002, see §§1.337(d)–5 and 1.337(d)–6.

§1.337(d)–7T [Removed]

Par. 7. Section 1.337(d)–7T is removed. Par. 8. In §1.514(c)–2, paragraph (e)(1)(v) is added to read as follows:

§1.514(c)–2 Permitted allocations under section 514(c)(9)(E).

* * * * * (e) * * * (1) * * * (v) Allocations made in taxable years beginning on or after January 1, 2002, that are mandated by statute or regulation other than subchapter K of chapter 1 of the Internal Revenue Code and the regulations thereunder.

* * * * *

2003–14 I.R.B. 684 April 7, 2003

§602.101 OMB Control numbers.

* * * * * (b) * * *

Current OMB control No.

Par. 9. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

CFR Part or section where identified or described

*****

Par. 10. In §602.101, paragraph (b) is amended by removing the entries for “1.337(d)–5T”, “1.337(d)–6T”, and “1.337– 7T” and adding entries in numerical order to the table to read as follows:

1.337(d)–5............................................................................................................................................................. 1545–1672

1.337(d)–6............................................................................................................................................................. 1545–1672

1.337(d)–7............................................................................................................................................................. 1545–1672

*****

David A. Mader, Assistant Deputy Commissioner

of Internal Revenue.

Approved March 7, 2003.

Pamela F. Olson, Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on March 13, 2003, 1:16 p.m., and published in the issue of the Federal Register for March 18, 2003, 68 F.R. 12817)

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

The adjusted applicable federal long-term rate is set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 467.—Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

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

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

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 April 2003. See Rev. Rul. 2003–35, page 687.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 705.—Determination of Basis of Partner’s Interest

26 CFR 1.705–1: Determination of basis of partner’s interest.

T.D. 9049

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Amendments to Rules for Determination of Basis of Partner’s Interest; Special Rules

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to special rules on determination of basis of a partner’s interest under section 705. The final regulations are necessary to coordinate sections 705 and 1032.

DATES: Effective Date: These regulations are effective March 18, 2003.

Applicability Date: For dates of applicability, see §1.705–2(e).

FOR FURTHER INFORMATION CONTACT: Barbara (MacMillan) Campbell or Rebekah A. Myers (202) 622–3050 (not a toll-free number).

April 7, 2003 685 2003–14 I.R.B.

proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Drafting Information

The principal author of these proposed regulations is Barbara (MacMillan) Campbell of the Office of the Associate Chief Counsel (Passthroughs and Special Industries). However, personnel from other offices of the IRS and the Treasury Department participated in their development.

* * * * *

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. Section 1.705–1 is amended by revising paragraph (a)(7) to read as follows:

§1.705–1 Determination of basis of partner’s interest.

(a) * * * (7) For basis adjustments necessary to coordinate sections 705 and 1032 in certain situations in which a partnership disposes of stock or any position in stock to which section 1032 applies of a corporation that holds a direct or indirect interest in the partnership, see §1.705–2.

* * * * *

Par. 3. Section 1.705–2 is amended as follows:

Paragraph (a) is amended by adding a new sentence after the third sentence.
Paragraph (b)(2) is added.
Paragraph (c)(1) is amended by adding a sentence at the end of the paragraph.
Paragraph (d) is added.
Paragraph (e) is revised. The additions and revision read as follows:

§1.705–2 Basis adjustments coordinating sections 705 and 1032.

(a) * * * Similarly, in situations where a section 754 election was not in effect for the year in which a partnership distrib

SUPPLEMENTARY INFORMATION:

Background

On March 29, 2002, the Treasury Department and the IRS published final regulations (T.D. 8986, 2002–1 C.B. 780 [67 FR 15112]) under section 705 of the Internal Revenue Code (Code) in the Federal Reg- ister . Those final regulations provide guidance on the coordination of sections 705 and 1032 in situations where a corporation acquires an interest in a partnership that holds stock in that corporation, a section 754 election is not in effect with respect to the partnership for the taxable year in which the corporation acquires the interest, and the partnership later sells or exchanges the stock. During the development of those final regulations, the Treasury Department and the IRS considered other issues related to the coordination of sections 705 and 1032. Accordingly, also on March 29, 2002, the Treasury Department and the IRS published proposed regulations (REG–167648– 01, 2002–1 C.B. 790 [67 FR 15132]) to revise the final regulations contained in §1.705–2 of 26 CFR part 1 in the Fed- eral Register . No written comments were received in response to the notice of proposed rulemaking, and no public hearing was requested or held. The proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

1. Overview of Proposed Regulations

The proposed regulations apply to situations where a corporation owns a direct or indirect interest in a partnership that owns stock in that corporation, the partnership distributes money or other property to another partner and that partner recognizes gain on the distribution during a year in which the partnership does not have an election under section 754 in effect, and the partnership subsequently sells or exchanges the stock. As stated in the preamble to the proposed regulations, in these situations it may be inconsistent with the intent of sections 705 and 1032 to increase the basis of the corporation’s partnership interest by the full amount of any gain resulting from the partnership’s sale or exchange of the stock which is not recognized by the corporation under section 1032.

Accordingly, the proposed regulations revise the purpose statement of §1.705–2(a)

to take into account situations involving such partnership distributions. The proposed regulations provide a specific rule implementing the revised purpose in single partnership cases. The proposed regulations also revise §1.705–2(c) to clarify that the tiered partnerships rule applies to situations involving such partnership distributions.

In addition, the proposed regulations clarify that references in the regulations to stock of a corporate partner include any position in stock of a corporate partner to which section 1032 applies.

2. Revisions in Final Regulations

These final regulations follow the proposed regulations but extend the rules of the proposed regulations to situations where a corporation owns a direct or indirect interest in a partnership that owns stock in that corporation, the partnership distributes money or other property to another partner and that partner recognizes loss on the distribution or the basis of the property distributed to that partner is adjusted during a year in which the partnership does not have an election under section 754 in effect, and the partnership subsequently sells or exchanges the stock. The revisions provide a more consistent approach, and better conform these final regulations to the final regulations issued on March 29, 2002, under section 705 (T.D. 8986, 2002–1 C.B. 780).

3. Effective Date

The final regulations apply with respect to sales or exchanges of stock occurring on or after March 18, 2003, except that paragraph (d) applies with respect to sales or exchanges of stock occurring on or after March 29, 2002.

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 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 regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of

2003–14 I.R.B. 686 April 7, 2003

utes money or other property to another partner and that partner recognizes gain or loss on the distribution or the basis of the property distributed to that partner is adjusted, the remaining partners’ inside basis and outside basis may not be equal.

* * *

* * * * * (b) * * * (2) Required adjustments relating to dis- tributions. (i) This paragraph (b)(2) applies in situations where a corporation owns a direct or indirect interest in a partnership that owns stock in that corporation, the partnership distributes money or other property to another partner and that partner recognizes gain or loss on the distribution or the basis of the property distributed to that partner is adjusted during a year in which the partnership does not have an election under section 754 in effect, and the partnership subsequently sells or exchanges the stock. In these situations, the increase (or decrease) in the corporation’s adjusted basis in its partnership interest resulting from the sale or exchange of the stock equals the amount of gain (or loss) that the corporate partner would have recognized (absent the application of section 1032) if, for the year in which the partnership made the distribution, a section 754 election had been in effect.

(ii) The provisions of this paragraph (b)(2) are illustrated by the following example:

Example. (i) A, B, and corporation C form partnership PRS. A and B each contribute $10,000 and C contributes $20,000 in exchange for a partnership interest. PRS has no liabilities. PRS purchases stock in corporation C for $10,000, which appreciates in value to $70,000. PRS distributes $25,000 to A in complete liquidation of A’s interest in PRS in a year for which an election under section 754 is not in effect. PRS later sells the C stock for $70,000. PRS realizes a gain of $60,000 on the sale of the C stock. C’s share of the gain is $40,000. Under section 1032, C does not recognize its share of the gain.

(ii) Normally, C would be entitled to a $40,000 increase in the basis of its PRS interest for its allocable share of PRS’s gain from the sale of the C stock, but a special rule applies in this situation. If a section 754 election had been in effect for the year in which PRS made the distribution to A, PRS would have been entitled to adjust the basis of partnership property under section 734(b)(1)(A) by $15,000 (the amount of gain recognized by A with respect to the distribution to A under section 731(a)(1)). See §1.734– 1(b). Under §1.755–1(c)(1)(ii), the basis adjustment under section 734(b) would have been allocated to the C stock, increasing its basis to $25,000 (where there is a distribution resulting in an adjustment under sec

tion 734(b)(1)(A) to the basis of undistributed partnership property, the adjustment is allocated only to capital gain property).

(iii) If a section 754 election had been in effect for the year in which PRS made the distribution to A, the amount of gain that PRS would have recognized upon PRS’s disposition of C stock would be $45,000 ($70,000 minus $25,000 basis in the C stock), and the amount of gain C would have recognized upon PRS’s disposition of the C stock (absent the application of section 1032) would be $30,000 (C’s share of PRS’s gain of $45,000 from the stock sale). Accordingly, upon PRS’s sale of the C stock, the increase in the basis of C’s interest in PRS is $30,000.

(c) * * * (1) * * * Similarly, if a corporation owns an indirect interest in its own stock through a chain of two or more partnerships, and a partnership in the chain distributes money or other property to another partner and that partner recognizes gain or loss on the distribution or the basis of the property distributed to that partner is adjusted during a year in which the partnership does not have an election under section 754 in effect, then upon any subsequent sale or exchange of the stock, the bases of the interests in the partnerships included in the chain shall be adjusted in a manner that is consistent with the purpose of this section.

* * * * *

(d) Positions in Stock. For purposes of this section, stock includes any position in stock to which section 1032 applies.

(e) Effective date. This section applies to gain or loss allocated with respect to sales or exchanges of stock occurring after December 6, 1999, except that paragraph (d) of this section is applicable with respect to sales or exchanges of stock occurring on or after March 29, 2002, and the fourth sentence of paragraph (a), paragraph (b)(2), and the third sentence of paragraph (c)(1) of this section are applicable with respect to sales or exchanges of stock occurring on or after March 18, 2003.

David A. Mader, Assistant Deputy Commissioner

of Internal Revenue.

Approved March 6, 2003.

Pamela F. Olson, Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on March 17, 2003, 8:45 a.m., and published in the issue of the Federal Register for March 18, 2003, 68 F.R. 12815)

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, on this page.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, on this page.

Section 1033.—Involuntary Conversions

26 CFR 1.1033(a)–1: Involuntary conversions; nonrecognition of gain.

May a business defer, under section 1033, recognition of gain realized on receipt of a grant payment made under the World Trade Center grant program? See Notice 2003–18, page 699.

Section 1274.— Determin- ation 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 April 2003.

Rev. Rul. 2003–35

This revenue ruling provides various prescribed rates for federal income tax purposes for April 2003 (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 shortterm, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section

April 7, 2003 687 2003–14 I.R.B.

a term of years, or a remainder or a reversionary interest for purposes of section 7520.

1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term taxexempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income hous

ing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of annuity, an interest for life or for

REV. RUL. 2003–35 TABLE 1

Applicable Federal Rates (AFR) for April 2003

Period for Compounding

Annual Semiannual Quarterly Monthly Short-Term

AFR 1.46% 1.45% 1.45% 1.45% 110% AFR 1.61% 1.60% 1.60% 1.59% 120% AFR 1.75% 1.74% 1.74% 1.73% 130% AFR 1.90% 1.89% 1.89% 1.88%

Mid-Term

AFR 2.96% 2.94% 2.93% 2.92% 110% AFR 3.26% 3.23% 3.22% 3.21% 120% AFR 3.56% 3.53% 3.51% 3.50% 130% AFR 3.86% 3.82% 3.80% 3.79% 150% AFR 4.46% 4.41% 4.39% 4.37% 175% AFR 5.22% 5.15% 5.12% 5.10%

Long-Term

AFR 4.58% 4.53% 4.50% 4.49% 110% AFR 5.04% 4.98% 4.95% 4.93% 120% AFR 5.51% 5.44% 5.40% 5.38% 130% AFR 5.98% 5.89% 5.85% 5.82%

REV. RUL. 2003–35 TABLE 2

Adjusted AFR for April 2003

Period for Compounding

Annual Semiannual Quarterly Monthly Short-term adjusted AFR 1.26% 1.26% 1.26% 1.26%

Mid-term adjusted AFR 2.57% 2.55% 2.54% 2.54%

Long-term adjusted AFR 4.41% 4.36% 4.34% 4.32%

2003–14 I.R.B. 688 April 7, 2003

REV. RUL. 2003–35 TABLE 3

Rates Under Section 382 for April 2003

Adjusted federal long-term rate for the current month 4.41%

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.) 4.58%

REV. RUL. 2003–35 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for April 2003

Appropriate percentage for the 70% present value low-income housing credit 7.87%

Appropriate percentage for the 30% present value low-income housing credit 3.37%

REV. RUL. 2003–35 TABLE 5

Rate Under Section 7520 for April 2003

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 3.6%

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

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

Section 4945.—Taxes on Taxable Expenditures

26 CFR 53.4945–4: Grants to individuals. (Also §117; §1.117–1.)

Scholarship grants, employer- related private foundations. This ruling states that for purposes of sections 117 and 4945 of the Code, scholarships and educational grants awarded by a private foundation under an employer-related program to employees and their children, when the employee is a victim killed or seriously injured in a qualified disaster, may be awarded without regard to the percentage guidelines in Rev. Proc.

76–47, 1976–2 C.B. 670. Thus, grants awarded under such a program will be described in section 4945(g)(1) and will not be taxable expenditures under section 4945(d)(3).

Rev. Rul. 2003–32

ISSUE

If a private foundation awards educational grants to employees or children of employees of a particular employer who are victims of a qualified disaster as defined in § 139 of the Internal Revenue Code, and the educational grants do not satisfy the percentage test of Rev. Proc. 76–47, 1976–2 C.B. 670, are these educational grants treated as scholarships subject to the provisions of § 117 and not treated as taxable expenditures under § 4945(d)(3)?

FACTS

The foundation is exempt from federal income tax under § 501(c)(3) and is a private foundation under § 509(a). The foundation has applied under § 4945(g) for

approval of its proposed scholarship program. The foundation intends to provide scholarships to employees or children of employees of a particular employer if the employee is seriously injured or killed as a result of a qualified disaster within the meaning of § 139(c)(1), (2), or (3). The foundation will determine whether these criteria are satisfied using objective standards that are consistently applied.

Section 139(c) provides that the term “qualified disaster” includes (1) a disaster that results from a terroristic or military action (as defined in § 692(c)), (2) a Presidentially declared disaster (as defined in § 1033(h)(3)), or (3) a disaster that results from an accident involving a common carrier, or from any other event, which is determined by the Secretary to be of a catastrophic nature.

The group of employees or children of employees from whom grantees are selected is sufficiently broad to constitute a charitable class. The foundation’s scholarship program will satisfy the requirements of § 4945(g)(1) and the guidelines of

April 7, 2003 689 2003–14 I.R.B.

vate foundation under an employer-related loan program will satisfy the requirements of § 4945(g)(3) and will not be taxable expenditures under § 4945(d)(3).

DRAFTING INFORMATION

The principal author of this revenue ruling is Janet E. Gitterman of the Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this revenue ruling, contact Ms. Gitterman at (202) 283–9458 (not a toll-free call).

Section 6103.— Confiden- tiality and Disclosure of Returns and Return Information

26 CFR 301.6103(n)–1: Disclosure of returns and return information in connection with procurement of property and services for tax administration purposes.

T.D. 9044

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

Amendment of 26 CFR §301.6103(n)–1 to Incorporate Taxpayer Browsing Protection Act

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

SUMMARY: This final regulation requires persons to whom returns or return information is or may be disclosed as authorized by §301.6103(n)–1(a) (generally, contractors employed to perform tax administration services) to notify their officers and employees of the prohibitions against and penalties for unauthorized inspection of returns or return information.

DATES: Effective Date: This final regulation is effective March 12, 2003.

§§ 4.01 through 4.07 of Rev. Proc. 76– 47, 1976–2 C.B. 670; however, the foundation will award grants without regard to the percentage limitation test of § 4.08 of Rev. Proc. 76–47. The foundation intends to make grants to all eligible applicants.

LAW AND ANALYSIS

A grant by a private foundation to an individual for travel, study, or other similar purposes is a taxable expenditure by the private foundation under § 4945(d)(3) unless such grant satisfies the requirements of § 4945(g). Such a grant, awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the Secretary, may satisfy the requirements of § 4945(g)(1) if it is demonstrated to the satisfaction of the Secretary that the grant (i) constitutes a scholarship or fellowship grant that is subject to the provisions of § 117(a) as in effect on the day before the date of the enactment of the Tax Reform Act of 1986 and (ii) is to be used for study at an educational organization described in § 170(b)(1)(A)(ii).

When an employer makes educational grants available to its employees on a preferential basis, the employer-employee relationship immediately suggests that the grant may be compensatory. To ensure that employer-related grant programs are outside the pattern of employment and, therefore, not compensatory, substantial factors not related to employment must control and limit grant programs to such an extent that the preferential treatment derived from employment does not continue to be of any significance beyond being an initial qualifier.

Rev. Proc. 76–47, 1976–2 C.B. 670, provides guidelines for determining whether a grant made by a private foundation under an employer-related grant program to an employee or to a child of an employee of the particular employer is a scholarship under §§ 117 and 4945(g)(1), rather than a form of compensation, an employment incentive, or an employee fringe benefit. The Service will assume that grants awarded under an employer-related grant program will be scholarships or fellowship grants under §§ 117 and 4945(g)(1) if the program satisfies the seven conditions in §§ 4.01 through 4.07 and the percentage test described in § 4.08 of Rev. Proc. 76–47.

Rev. Proc. 76–47, 1976–2 C.B. 670, provides that if an employer-related private foundation’s educational grant program satisfies the seven conditions of Rev. Proc. 76– 47, §§ 4.01 through 4.07, but does not meet the percentage test of § 4.08, then all the facts and circumstances will be reviewed in determining whether the primary purpose of the program is to provide extra compensation or another employment incentive, or whether the primary purpose is to educate recipients in their individual capacities.

For this program, employment is the initial, but not the sole, qualifier. An employee or the child of an employee is eligible for an educational grant only in the event the employee is seriously injured or killed as a result of a qualified disaster. These eligibility criteria provide sufficient assurance that the primary purpose of the grant is to educate recipients in their individual capacities, outside of any pattern of employment, rather than to compensate employees or provide an employment fringe benefit. Therefore, this educational grant program is not required to satisfy the percentage test of § 4.08 because its eligibility requirements meet the facts and circumstances test of Rev. Proc. 76–47.

HOLDING

Under the facts set forth above, grants awarded under the program satisfy the requirements of Rev. Proc. 76–47, 1976–2 C.B. 670, and constitute scholarships subject to the provisions of § 117. Therefore, grants awarded under the program satisfy the requirements of § 4945(g)(1) and will not be taxable expenditures under § 4945(d)(3). This revenue ruling does not address the extent to which the grants meet the requirements of “qualified scholarships” that may be excluded from the gross income of recipients under § 117(a). See Notice 87–31, 1987–1 C.B. 475, for further information relating to the exclusion of qualified scholarships from gross income.

APPLICATION

This ruling also applies to Revenue Procedure 80–39, 1980–2 C.B. 772, which provides parallel guidelines for determining whether educational loans made by a pri

2003–14 I.R.B. 690 April 7, 2003

tory requirements to conform to the present law for both unauthorized inspection and disclosure.

Explanation of Provisions

This final regulation adds a requirement that persons to whom returns or return information is or may be disclosed as authorized by §301.6103(n)–1(a) notify their officers and employees that such officers and employees are prohibited from willfully inspecting any returns or return information, except as authorized by the Code, and that they may be subject to a fine in any amount not exceeding $1,000, or imprisonment of not more than one year, or both, for any violation of section 7213A.

The IRS has a number of section 6103(n) agreements with federal agencies. This final regulation also clarifies the penalty provisions that are applicable to officers and employees of Federal agencies who are performing tax administration services for the IRS pursuant to section 6103(n).

Special Analyses

Section 553 of the Administrative Procedure Act (5 U.S.C. chapter 5) requires that a notice of proposed rulemaking be published in the Federal Register and, after such notice, that the Federal agency that issued the notice give interested persons an opportunity to participate in the rulemaking through submission of written comments, with or without opportunity for oral presentation. These requirements are subject to certain exceptions set forth in 5 U.S.C. 553(b), including when the agency for good cause finds that notice and public comment are impracticable, unnecessary, or contrary to the public interest. Because the final regulation merely amends an existing regulation to add an additional notification requirement that has already been imposed administratively, it is determined that the notice and public-comment procedure required by 5 U.S.C. 553 is unnecessary in this case. For the same reason, a delayed effective date is not required pursuant to 5 U.S.C. 553(d)(3).

It has also 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. Because no notice of proposed rulemaking is required, the provisions of the Regulatory Flexibility Act

FOR FURTHER INFORMATION CONTACT: Carol Marchant, 202–622–4590 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information in this final rule has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget (OMB) under 44 U.S.C. 3507 and assigned control number 1545–1821. The collection of information in this regulation is in §301.6103(n)–1(c). This information is required and will be used to promote compliance by officers and employees with the restrictions of sections 6103, 7213, and 7213A, and to protect the privacy of American taxpayers. The collection of information is required to obtain a benefit. The likely respondents are state or local governments, business or other for-profit institutions, Federal agencies, and/or small businesses or organizations.

Comments on the collection of information should be sent 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, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T: SP, Washington, DC 20224. Comments on the collection of information should be received by May 12, 2003.

Comments are specifically requested concerning: Whether the collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility; The accuracy of the estimated burden associated with the collection of information (see below); How the quality, utility, and clarity of the information to be collected may be enhanced; How the burden of complying with the collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of service to provide information. Estimated total annual reporting burden: 250 hours. Estimated average annual burden hours per respondent: 6 minutes. Estimated

number of respondents: 2500. Estimated annual frequency of responses: Annually.

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 Management and Budget. 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, returns and return information are confidential, as required by 26 U.S.C. 6103.

Background

Under section 7213A of the Internal Revenue Code (Code) as added by Public Law 105–35 (111 Stat. 1104) (the Taxpayer Browsing Protection Act of 1997), any person described in section 6103(n), or an officer or employee of any such person, is prohibited from willfully inspecting any returns or return information, except as authorized by the Code. Any person who violates section 7213A may be subject to a fine in any amount not exceeding $1,000, or imprisonment of not more than one year, or both. Currently, §301.6103(n)–1(c) provides that each officer or employee of any person to whom returns or return information is or may be disclosed as authorized by §301.6103(n)–1(a) must be notified of the prohibitions against unauthorized disclosure of returns or return information, and the potential penalties for such acts, imposed under section 7213. The regulation does not reflect the penalties imposed by section 7213A.

This document adopts a final regulation amending §301.6103(n)–1(c) to reflect the penalties contained in section 7213A. The regulation requires that each officer or employee of any person to whom returns or return information is or may be disclosed as authorized by §301.6103(n)– 1(a) must also receive notification of the prohibitions against unauthorized inspection of returns or return information and the potential penalties for such acts, in addition to the notifications of the penalties for unauthorized disclosure. The Internal Revenue Service (IRS) already requires, in all section 6103(n) contracts, that contractors notify their officers and employees of the penalties for unauthorized inspection. The final regulation updates the regula

April 7, 2003 691 2003–14 I.R.B.

(5 U.S.C. 601–612) do not apply. Pursuant to section 7805(f) of the Code, this regulation was submitted to the Chief Counsel of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of this final regulation is Carol Marchant, Office of Associate Chief Counsel (Procedure & Administration), Disclosure and Privacy Law Division.

* * * * *

Adoption of Amendments to the Regu- lations

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

PART 301 - PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. In §301.6103(n)–1, paragraph (c) is revised and paragraph (f) is added to read as follows:

CFR part or section where identified and described

* * * * *

§301.6103(n)–1 Disclosure of returns and return information in connection with procurement of property and services for tax administration purposes.

* * * * * (c) Notification requirements . Persons to whom returns or return information is or may be disclosed as authorized by paragraph (a) of this section shall provide written notice to their officers or employees —

(1) That returns or return information disclosed to such officer or employee can be used only for a purpose and to the extent authorized by paragraph (a) of this section;

(2) That further inspection of any returns or return information for a purpose or to an extent unauthorized by paragraph (a) of this section constitutes a misdemeanor, punishable upon conviction by a fine of as much as $1,000, or imprisonment for as long as 1 year, or both, together with costs of prosecution;

(3) That further disclosure of any returns or return information for a purpose or to an extent unauthorized by paragraph (a) of this section constitutes a felony, punishable upon conviction by a fine of as much as $5,000, or imprisonment for as long as 5 years, or both, together with the costs of prosecution;

(4) That any such unauthorized further inspection or disclosure of returns or

return information may also result in an award of civil damages against any person who is not an officer or employee of the United States in an amount not less than $1,000 for each act of unauthorized inspection or disclosure or the sum of actual damages sustained by the plaintiff as a result of such unauthorized disclosure or inspection as well as an award of costs and reasonable attorneys fees; and

(5) If such person is an officer or employee of the United States, a conviction for an offense referenced in paragraph (c)(2) or (c)(3) of this section shall result in dismissal from office or discharge from employment.

* * * * *

(f) Effective date. Section 301.6103(n)– 1(c) is applicable on March 12, 2003.

PART 602 - OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805. Par. 5. In §602.101, paragraph (b) is amended by adding an entry in numerical order to the table to read as follows:

§602.101 OMB Control numbers.

* * * * * (b) * * *

Current OMB control No.

301.6103(n)–1................................................................................................................................................. 1545–1841

* * * * *

David A. Mader, Assistant Deputy Commissioner

of Internal Revenue.

Approved February 11, 2003.

Pamela F. Olson, Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on March 11, 2003, 8:45 a.m., and published in the issue of the Federal Register for March 12, 2003, 68 F.R. 11739)

2003–14 I.R.B. 692 April 7, 2003

haust administrative remedies before a court may award damages under section 7426(h). The provisions of section 7433 relating to mitigation and the period for bringing an action also apply to actions brought under section 7426(h). IRS published a notice of proposed rulemaking reflecting these changes in the Federal Register on March 5, 2002. (REG–107366–00, 2002–1 C.B. 645 [67 FR 9929]). No written comments on the proposed regulations were received. No public hearing was held.

Explanation of Provisions

§301.7426–2

RRA 1998 added subsection (h) to section 7426. Subsection (h) authorizes persons to sue the United States in Federal district court for damages due to a wrongful levy caused by the reckless or intentional, or negligent, disregard of a provision of the Code. Plaintiffs may recover the lesser of actual direct economic damages and costs of the action or $1,000,000 ($100,000 in the case of negligence). The amendment also provided that the rules of section 7433(d) relating to exhaustion of administrative remedies, mitigation of damages, and the period for bringing an action shall apply. The regulations thus adopt rules like those promulgated under section 7433. Plaintiffs must mitigate damages and no damages may be awarded unless the court determines that the plaintiff has exhausted administrative remedies available within the IRS, e.g., by filing an administrative claim for damages. The regulations provide that any action for damages under this section must be brought within two years after the date the action accrues. This two-year limitations period is independent of the ninemonth period following the wrongful levy during which the third party may make a claim for wrongfully levied property.

§301.7430–8

Section 7430 provides that reasonable administrative costs may be awarded to the prevailing party in an administrative proceeding brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under Title 26 of the United States Code. Prior to the amendments in RRA 1998, taxpayers generally were not entitled to recover costs for administrative proceedings in connection with collection matters. Accordingly, the cur

Section 7433.—Civil Damages for Certain Unauthorized Collection Actions

26 CFR 301.7433–1: Civil cause of action for certain unauthorized collection actions.

T.D. 9050

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 301

Civil Cause of Action for Damages Caused by Unlawful Tax Collection Actions, Including Actions Taken in Violation of Section 362 or 524 of the Bankruptcy Code

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to civil causes of action for damages caused by unlawful collection actions of officers and employees of the IRS and the awarding of costs and certain fees. The regulations reflect amendments made by the Taxpayer Bill of Rights 2 and the Internal Revenue Service Restructuring and Reform Act of 1998. The regulations affect all persons who suffer damages caused by unlawful collection actions of officers or employees of the IRS.

EFFECTIVE DATES: These regulations are effective March 25, 2003.

FOR FURTHER INFORMATION CONTACT: Kevin B. Connelly, (202) 622–3630 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains final amendments to the Procedure and Administration Regulations (26 CFR part 301) relating to civil actions for damages caused by unlawful collection actions of officers or employees of the IRS. The Taxpayer Bill of Rights 2 (TBOR2), Public Law 104–168 (110 Stat. 1465), amended section 7433 of

the Internal Revenue Code of 1986 (Code) by increasing the maximum amount of damages a taxpayer may be awarded for unlawful collection actions from $100,000 to $1,000,000. TBOR2 also eliminated the jurisdictional requirement that administrative remedies be exhausted before a court may award damages; TBOR2 authorized the court, however, to reduce damages if it determined that the plaintiff did not exhaust administrative remedies. These TBOR2 provisions were effective for actions of IRS officers or employees after July 30, 1996. The Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 1998), Public Law 105–206 (112 Stat. 685), although retaining the pre-existing authorization for an award of damages in the case of reckless or intentional disregard of the Code or regulations, amended section 7433(a) by providing that taxpayers may file actions for damages caused by the negligent disregard of the Code or regulations. RRA 1998 also added subsection (e) to section 7433. This amendment provides that an action for damages could be brought for the IRS’s willful violation of section 362 (relating to the automatic stay) or section 524 (relating to the effect of discharge) of the Bankruptcy Code. Actions for damages caused by the violation of section 362 or 524 of the Bankruptcy Code are limited to willful violations. The maximum amount of damages that may be awarded for negligent disregard under section 7433(a) is $100,000. The maximum amount of damages that may be awarded for reckless or intentional disregard under subsection (a) or for willful violations of section 362 or 524 of the Bankruptcy Code under subsection (e) is $1,000,000. RRA 1998 also reinstated the requirement under section 7433 that the plaintiff must exhaust administrative remedies before a court may award damages. These RRA 1998 provisions apply to actions of IRS officers or employees after July 22, 1998.

RRA 1998 also added section 7426(h), which authorizes persons who bring wrongful levy actions under section 7426 to sue for damages caused by the reckless or intentional, or negligent, disregard of any provision of the Code, plus costs of the action. Consistent with section 7433, damages awarded under section 7426(h) are limited to $1,000,000 for reckless or intentional disregard and $100,000 for negligent disregard. In addition, a plaintiff must ex

April 7, 2003 693 2003–14 I.R.B.

discharge injunction could request the Bankruptcy Court under Bankruptcy Code section 105 to hold the IRS in contempt and seek to recover damages under that Bankruptcy Code provision. Section 7433(e) now provides the exclusive remedy for the IRS’s willful violation of the discharge injunction.

The regulations set forth procedures relating to these claim and damage allowance provisions. Damages recoverable under section 7433(e) for a violation of the automatic stay or the discharge injunction are limited to (1) the actual, direct economic damages sustained by the taxpayer (and the taxpayer has a duty to mitigate those damages), plus (2) costs of the action. The maximum damage award is $1,000,000. No petition for damages under section 7433(e) may be filed in a bankruptcy court unless the taxpayer first exhausts administrative remedies within the IRS.

Similar to rules previously adopted with respect to other wrongful collection actions, the regulations define direct, economic damages as actual, pecuniary damages sustained by the taxpayer as a result of the willful violation of section 362 or 524 of the Bankruptcy Code. Injuries such as inconvenience, loss of reputation, and emotional distress, are not compensable except to the extent they result in actual pecuniary loss.

The regulations define costs of the action that are recoverable as damages under section 7433(e) as: (1) fees of the clerk and marshal; (2) fees of the court reporter for all or any part of the stenographic transcript necessarily obtained for use in the case; (3) fees and disbursements for printing and witnesses; (4) fees for exemplification and copies of paper necessarily obtained for use in the case; (5) docket fees; and (6) compensation of court appointed experts and interpreters. Costs of the action do not include any costs other than those enumerated in this paragraph.

Reasonable administrative and litigation costs, including attorneys fees, are not recoverable as direct economic damages. These costs are recoverable, if at all, under section 7430. The taxpayer generally will be entitled to reasonable administrative and litigation costs under section 7430 if the taxpayer (1) files an administrative claim with the IRS, (2) establishes that the IRS willfully violated either the automatic stay under Bankruptcy Code section 362 or

rent regulations exclude such collection matters, including proceedings under sections 7432 and 7433, from the definition of administrative proceedings. To reflect the RRA 1998 amendments, the regulations expand the definition of an administrative proceeding to include any administrative action for damages under section 7433(e) and any procedure or action brought before the IRS seeking relief with respect to a violation by the IRS of section 362 or 524 of the Bankruptcy Code.

The regulations provide that the prevailing party is a party who establishes that, in connection with the collection of his or her federal tax, the IRS has willfully violated a provision of section 362 or 524 of the Bankruptcy Code. The only administrative costs that may be awarded are those incurred after the date of the bankruptcy petition that gave rise to the section 362 stay or section 524 discharge injunction.

A claim with the IRS for administrative costs must be filed within 90 days after the date the IRS mails its decision on the taxpayer’s administrative claim for damages under §301.7433–2(e) or claim for relief from a violation of section 362 or 524 of the Bankruptcy Code.

§301.7433–1

Section 3102 of RRA 1998 amended section 7433(a) of the Code by providing that a taxpayer may sue the United States in a district court of the United States for damages caused by the negligent disregard of the Code or regulations in connection with the collection of the taxpayer’s tax liability. Section 801 of TBOR2 amended section 7433(b) by increasing the maximum amount of damages that a taxpayer may recover for damages caused by the reckless or intentional disregard of the Code or regulations from $100,000 to $1,000,000. Section 3102 of RRA 1998 caps the amount of damages that a taxpayer may recover for negligent disregard at $100,000. The regulations under §301.7433–1 reflect these changes.

§301.7433–2

RRA 1998 also amended section 7433 by adding subsection (e). Subsection (e) gives taxpayers the right to petition the bankruptcy court to recover damages if, in connection with the collection of a federal tax, any officer or employee of the IRS willfully violates section 362 or 524 of the

Bankruptcy Code or any regulation promulgated thereunder. Damages in connection with a claim under section 7433(e) for willful violations of section 362 or 524 are recoverable under section 7433(b) and are subject to the limitations imposed by section 7433(d). Under section 7433(b), if the IRS is found liable, the plaintiff may recover an amount equal to the lesser of $1,000,000 or the actual, direct economic damages sustained by the plaintiff as a proximate result of the IRS’s willful action plus costs of the action. A plaintiff may not recover damages for the mere negligent violation of section 362 or 524 of the Bankruptcy Code.

Section 362 relates to the automatic stay, which arises by operation of law when a debtor files a bankruptcy petition. The stay prohibits certain collection actions against the debtor, the debtor’s property, and the property of the bankruptcy estate. Prior to enactment of section 7433(e), individuals injured by the IRS’s willful violation of the automatic stay could only sue to recover actual damages, including costs and attorneys’ fees, under Bankruptcy Code section 362(h). Section 7433(e) provides an alternative cause of action to recover damages, but still permits an individual to recover damages under section 362(h) of the Bankruptcy Code, in lieu of an action under section 7433(e). However, section 7433(e) explicitly provides that administrative and litigation costs incurred in pressing a claim under section 362(h) of the Bankruptcy Code may only be paid pursuant to, and subject to the conditions described in, section 7430 of the Code. Section 7430 authorizes the payment of administrative and litigation costs only if a taxpayer exhausts administrative remedies. The regulations provide that in order to qualify for an award of administrative and litigation costs in an action under section 362(h) of the Bankruptcy Code, a taxpayer must (as in the case of damages actions under section 7433(e)) file an administrative claim with the IRS relating to the violation of the automatic stay.

Section 524 sets forth the effect of a discharge under the Bankruptcy Code. A discharge operates as an injunction against the commencement or continuation of any action to collect a discharged debt as a personal liability of the debtor. Prior to enactment of section 7433(e), a debtor who believed the IRS had willfully violated the

2003–14 I.R.B. 694 April 7, 2003

the discharge injunction under section 524, (3) substantially prevails with respect to the amount of damages or the most significant issue in controversy, and (4) meets the requirements of sections 7430(c)(4)(A)(ii) regarding net worth.

A petition for damages under section 7433 may not be filed in a bankruptcy court unless the taxpayer first files an administrative claim for damages with the IRS. The claim must be made in writing to the Chief, Local Insolvency Unit, for the judicial district in which the taxpayer filed the underlying bankruptcy case giving rise to the alleged violation. The claim must include: (1) the claimant taxpayer’s name, taxpayer identification number, current address, current home and work telephone numbers and any convenient times to be contacted; (2) the court and case number of the bankruptcy case in which the violation occurred; (3) a description, in reasonable detail, of the violation (with copies of any available substantiating documentation or correspondence with the IRS); (4) a description of the injuries incurred by the taxpayer filing the claim (with copies of any available substantiating documentation or evidence); (5) the dollar amount of the claim, including any damages that have not yet been incurred but which are reasonably foreseeable (along with any available substantiating documentation or evidence); and (6) the signature of the taxpayer or any duly authorized representative.

The regulations provide that, after an administrative claim for damages has been filed, a petition for damages under section 7433 may not be filed in a bankruptcy court until the earlier of (1) the time a decision is rendered on the claim or (2) six months from the date the administrative claim is filed. Because a taxpayer must petition the bankruptcy court for damages within two years after the cause of action accrues, the regulations contain an exception for claims filed in the last six months before the two-year limitation period expires. In those circumstances, taxpayers may file petitions for damages at any time after they file their administrative claims and before the period of limitations expires. A cause of action accrues under this section when the taxpayer has had a reasonable opportunity to discover all essential elements of a possible cause of action.

Special Analysis

It has been determined that this final regulation 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 regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Kevin B. Connelly, Office of Associate Chief Counsel (Procedure and Administration), Collection, Bankruptcy & Summonses Division, CC:PA:CBS, IRS. However, other personnel from the IRS and the Treasury Department participated in their development.

* * * * *

Adoption of Amendments to the Regu- lations

Accordingly, 26 CFR part 301 is amended as follows:

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 301.7426–2 is added to read as follows:

§301.7426–2 Recovery of damages in certain cases.

(a) In general. In addition to remedies related to wrongful levy set forth in §301.7426–1(b), if a district court of the United States finds in any action brought under section 7426 that any officer or employee of the Internal Revenue Service recklessly or intentionally, or by reason of negligence, disregarded any provision of this title, the United States shall be liable to the

plaintiff for damages. The plaintiff has a duty to mitigate damages. The total amount of damages recoverable under this section is the lesser of $1,000,000 ($100,000 in the case of negligence), or the sum of—

(1) Actual, direct economic damages as defined in §301.7433–1(b) sustained as a proximate result of the reckless, intentional, or negligent actions of the officer or employee, reduced by the amount of any damages awarded under §301.7426–1(b); and

(2) Costs of the action as defined in §301.7433–1(c).

(b) Administrative remedies must be ex- hausted. The court may not award a judgment for damages under paragraph (a) of this section unless the court determines that the plaintiff has filed an administrative claim pursuant to paragraph (d) of this section, and has satisfied the requirements of paragraph (c) of this section.

(c) No request for damages in a dis- trict court of the United States prior to fil- ing an administrative claim. (1) Except as provided in paragraph (c)(2) of this section, no request for damages under paragraph (a) of this section shall be maintained in any district court of the United States before the earlier of the following dates—

(i) The date the decision is rendered on a claim filed in accordance with paragraph (d) of this section; or

(ii) The date that is six months after the date an administrative claim is filed in accordance with paragraph (d) of this section.

(2) If an administrative claim is filed in accordance with paragraph (d) of this section during the last six months of the period of limitations described in paragraph (f) of this section, the claimant may file an action in a district court of the United States any time after the administrative claim is filed and before the expiration of the period of limitations.

(d) Procedures for an administrative claim —(1) Manner. An administrative claim for the lesser of $1,000,000 ($100,000 in the case of negligence) or actual, direct economic damages as defined in §301.7433– 1(b) shall be sent in writing to the Area Director, Attn: Compliance Technical Support Manager of the area in which the taxpayer currently resides.

April 7, 2003 695 2003–14 I.R.B.

(2) Form. The administrative claim shall include—

(i) The name, taxpayer identification number, current address and current home and work telephone numbers (indicating any convenient times to be contacted) of the person making the claim;

(ii) The grounds, in reasonable detail, for the claim (include copies of any available substantiating documentation or correspondence with the Internal Revenue Service);

(iii) A description of the damages incurred by the claimant filing the claim (include copies of any available substantiating documentation or evidence);

(iv) The dollar amount of the claim, including any damages that have not yet been incurred but which are reasonably foreseeable (include copies of any available substantiating documentation or evidence); and

(v) The signature of the claimant or duly authorized representative.

(3) Duly authorized representative. For purposes of this paragraph (d), a duly authorized representative is any attorney, certified public accountant, enrolled actuary, or any other person permitted to represent the claimant before the Internal Revenue Service who is not disbarred or suspended from practice before the Internal Revenue Service and who has a written power of attorney executed to the claimant.

(e) No liability for damages for any sum in excess of the dollar amount sought in the administrative claim. See §301.7433–1(f).

(f) Period of limitations —(1) Time for filing. A civil action under paragraph (a) of this section must be brought in a district court of the United States within two years after the date the cause of action accrues.

(2) Right of action accrues. A cause of action under paragraph (a) of this section accrues when the plaintiff has had a reasonable opportunity to discover all essential elements of a possible cause of action.

(g) Recovery of costs under section 7430. See §301.7433–1(h).

(h) Effective date. This section is applicable March 25, 2003.

Par. 3. Section 301.7430–1 is amended by redesignating paragraphs (e), (f) and (g) as paragraphs (f), (g) and (h), respectively, revising the phrase “paragraph (e)(1), (e)(2), (e)(3), or (e)(4) of this section” to read “paragraph (f)(1), (f)(2), (f)(3), or (f)(4) of this section”, and adding a new paragraph (e) to read as follows:

§301.7430–1 Exhaustion of administrative remedies.

* * * * * (e) Actions involving willful violations of the automatic stay under section 362 or the discharge provisions under section 524 of the Bankruptcy Code —(1) Section 7433 claims. A party has not exhausted administrative remedies within the Internal Revenue Service with respect to asserted violations of the automatic stay under section 362 of the Bankruptcy Code or the discharge provisions under section 524 of the Bankruptcy Code unless it files an administrative claim for damages or for relief from a violation of section 362 or 524 of the Bankruptcy Code with the Chief, Local Insolvency Unit, for the judicial district in which the bankruptcy petition that is the basis for the asserted automatic stay or discharge violation was filed pursuant to §301.7433–2(e) and satisfies the other conditions set forth in §301.7433–2(d) prior to filing a petition under section 7433.

(2) Section 362(h) claims. A party has not exhausted administrative remedies within the Internal Revenue Service with respect to asserted violations of the automatic stay under section 362 of the Bankruptcy Code unless it files an administrative claim for relief from a violation of section 362 of the Bankruptcy Code with the Chief, Local Insolvency Unit, for the judicial district in which the bankruptcy petition that is the basis for the asserted automatic stay violation was filed pursuant to §301.7433–2(e) and satisfies the other conditions set forth in §301.7433–2(d) prior to filing a petition under section 362(h) of the Bankruptcy Code.

* * * * *

§301.7430–2 [Amended]

Par. 4. In §301.7430–2, paragraph (c)(2) is amended by:

Adding the language “, except that requests with respect to administrative proceedings defined by §301.7430–8(c) should be made to the Chief, Local Insolvency Unit” at the end of the first sentence.
Removing the language “District Director for the district” and adding “Internal Revenue Service office” in its place in the second sentence.

Par. 5. Section 301.7430–3 is amended by:

Revising paragraph (a)(4).
Paragraph (b) is amended by adding the language “, except those collection actions described by section 7433(e)” at the end of the penultimate sentence.

The revision reads as follows:

§301.7430–3 Administrative proceeding and administrative proceeding date.

(a) * * * (4) Proceedings in connection with collection actions (as defined in paragraph (b) of this section), including proceedings under section 7432 or 7433, except proceedings brought under section 7433(e) and §301.7433–2 or proceedings otherwise described in §301.7430–8(c). See §301.7430–8.

* * * * *

Par. 6. Section 301.7430–6 is amended by adding a sentence at the end of the section to read as follows:

§301.7430–6 Effective dates.

* * * Sections 301.7430–1(e), 301.7430– 2(c)(2), 7430–3(a)(4) and (b) are applicable with respect to actions taken by the Internal Revenue Service after July 22, 1998. Par. 7. Section 301.7430–8 is added to read as follows:

§301.7430–8 Administrative costs incurred in damage actions for violations of section 362 or 524 of the Bankruptcy Code.

(a) In general. The Internal Revenue Service may grant a taxpayer’s request for recovery of reasonable administrative costs incurred in connection with the administrative proceeding before the Internal Revenue Service relating to the willful violation of section 362 or 524 of the Bankruptcy Code only if the taxpayer is a prevailing party.

(b) Prevailing party. A taxpayer is a prevailing party for purposes of this section only if—

(1) The taxpayer satisfies the net worth and size limitations in paragraph (f) of §301.7430–5;

(2) The taxpayer establishes that in connection with the collection of his or her federal tax an officer or employee of the Internal Revenue Service has willfully violated a provision of section 362 or 524 of the Bankruptcy Code; and

2003–14 I.R.B. 696 April 7, 2003

Internal Revenue Service willfully violates any provision of section 362 (relating to the automatic stay) or section 524 (relating to discharge) of title 11, United States Code, or any regulation promulgated under such provision, the taxpayer may file a petition for damages against the United States in Federal bankruptcy court. The taxpayer has a duty to mitigate damages. The total amount of damages recoverable under this section is the lesser of $1,000,000, or the sum of—

(i) Actual, direct economic damages sustained as a proximate result of the willful actions of the officer or employee; and

(ii) Costs of the action. (2) An action under this section constitutes the exclusive remedy under the Internal Revenue Code for violations of sections 362 and 524 of the Bankruptcy Code. In addition, taxpayers injured by violations of section 362 of the Bankruptcy Code may maintain actions under section 362(h) of the Bankruptcy Code (relating to an individual injured by a willful violation of the stay). However, any administrative or litigation costs in connection with an action under section 362(h) may be awarded, if at all, only under section 7430 of the Internal Revenue Code.

(b) Actual, direct economic damages (1) Definition. See §301.7433–1(b)(1).

(2) Litigation costs and administrative costs not recoverable as actual, direct eco- nomic damages. Litigation costs and administrative costs are not recoverable as actual, direct economic damages. These costs may be recoverable under section 7430 (see paragraph (h) of this section), or, solely to the extent described in paragraph (c) of this section, as costs of the action.

(c) Costs of the action. Costs of the action recoverable as damages under this section are limited to the costs set forth in §301.7433–1(c).

(d) No civil action in federal bankruptcy court prior to filing an administrative claim —(1) In general. Except as provided in paragraph (d)(2) of this section, no action under paragraph (a)(1) of this section shall be maintained in any bankruptcy court before the earlier of the following dates—

(i) The date the decision is rendered on a claim filed in accordance with paragraph (e) of this section; or

(3) The position of the Internal Revenue Service in the proceeding was not substantially justified.

(c) Administrative proceeding. For purposes of this section, an administrative proceeding is a proceeding related to an administrative claim presented to the Internal Revenue Service seeking relief from a violation of section 362 or 524 of the Bankruptcy Code by the Internal Revenue Service or recovery of damages from the Internal Revenue Service under §301.7433– 2(e). (d) Costs incurred after filing of bank- ruptcy petition. Administrative costs may be recovered only if incurred on or after the date of filing of the bankruptcy petition that formed the basis for the stay on collection under Bankruptcy Code section 362 or the discharge injunction under Bankruptcy Code section 524, as the case might be.

(e) Time for filing claim for adminis- trative costs. (1) For purposes of this section, the taxpayer must file a claim for administrative costs before the Internal Revenue Service not later than 90 days after the date the Internal Revenue Service mails to the taxpayer, or otherwise notifies the taxpayer of, the decision regarding the claim for relief from or damages relating to a violation of the collection stay or the discharge injunction.

(2) If the Internal Revenue Service denies the claim for administrative costs in whole or in part, the taxpayer must file a petition with the Bankruptcy Court for administrative costs no later than 90 days after the date on which the denial of the claim for administrative costs is mailed, or otherwise furnished, to the taxpayer. If the Internal Revenue Service does not respond on the merits to a request by the taxpayer for an award of reasonable administrative costs within six months after such request is filed, the Internal Revenue Service’s failure to respond may be considered by the taxpayer as a denial of an award of reasonable administrative costs.

(3) For purposes of paragraphs (e)(1) and (2) of this section, if the 90th day falls on a Saturday, Sunday, or a legal holiday, the 90-day period shall end on the next succeeding day which is not a Saturday, Sunday, or a legal holiday. The term legal holiday means a legal holiday in the District of Columbia. If the request for costs is to be filed with the Internal Revenue Service at an office of the Internal Revenue

Service located outside the District of Columbia, the term legal holiday also means a statewide legal holiday in the state where such office is located.

(f) Effective date. This section is applicable with respect to actions taken by the Internal Revenue Service after July 22, 1998. Par. 8. Section 301.7433–1 is amended as follows:

In paragraph (a) introductory text, in the first sentence, the language “, or by reason of negligence,” is added after the language “recklessly or intentionally”. In addition, the language “$100,000” in the third sentence is removed and “$1,000,000 ($100,000 in the case of negligence)” is added in its place.
In paragraph (b)(1), in the first sentence, the language “, or negligent,” is added after the language “reckless or intentional”.
In paragraph (e)(1), in the first sentence, the language “$100,000” is removed and “$1,000,000 ($100,000 in the case of negligence)” is added in its place. In addition, the language “district director (marked for the attention of the Chief, Special Procedures Function) of the district” is removed and “Area Director, Attn: Compliance Technical Support Manager of the area” is added in its place.
In paragraph (h), in the penultimate sentence, the language “7432(a)” is removed and “7433(a)” is added in its place.
Revising paragraph (i). The revision reads as follows:

§301.7433–1 Civil cause of action for certain unauthorized collection actions.

* * * * * (i) Effective dates. The portions of this section relating to reckless or intentional acts are applicable to actions taken by Internal Revenue Service officials after July 30, 1996. The portions of this section relating to negligent acts are applicable to actions taken by the Internal Revenue Service officials after July 22, 1998.

Par. 9. Section 301.7433–2 is added to read as follows:

§301.7433–2 Civil cause of action for violation of section 362 or 524 of the Bankruptcy Code.

(a) In general. (1) If, in connection with the collection of a federal tax with respect to a taxpayer, an officer or employee of the

April 7, 2003 697 2003–14 I.R.B.

Internal Revenue Service does not respond on the merits to an administrative claim for damages within six months after the claim is filed, the Internal Revenue Service’s failure to respond will be considered a denial of the claim on the grounds that the Internal Revenue Service did not willfully violate Bankruptcy Code section 362 or 524. (2) Administrative costs —(i) In gen- eral. Administrative costs, as defined in §301.7433–1(b)(2)(ii), including attorneys’ fees, not recoverable under this section may be recoverable under section 7430. See §301.7430–8.

(ii) Limitation regarding recoverable ad- ministrative costs. Administrative costs may be awarded only if incurred on or after the date of filing of the bankruptcy petition that formed the basis for the stay on collection under Bankruptcy Code section 362 or the discharge injunction under Bankruptcy Code section 524, as the case might be.

(i) Effective date. This section is applicable to actions taken by the Internal Revenue Service officials after July 22, 1998.

David A. Mader, Assistant Deputy Commissioner

of Internal Revenue.

Approved March 5, 2003.

Pamela F. Olson, Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on March 24, 2003, 8:45 a.m., and published in the issue of the Federal Register for March 25, 2003, 68 F.R. 14316)

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

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

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month of April 2003. See Rev. Rul. 2003–35, page 687.

(ii) The date that is six months after the date an administrative claim is filed in accordance with paragraph (e) of this section.

(2) When administrative claim filed in last six months of period of limitations. If an administrative claim is filed in accordance with paragraph (e) of this section during the last six months of the period of limitations described in paragraph (g) of this section, the taxpayer may petition the bankruptcy court any time after the administrative claim is filed and before the expiration of the period of limitations.

(e) Procedures for an administrative claim —(1) Manner . An administrative claim for the lesser of $1,000,000 or actual, direct economic damages as defined in paragraph (b) of this section shall be sent in writing to the Chief, Local Insolvency Unit, for the judicial district in which the taxpayer filed the underlying bankruptcy case giving rise to the alleged violation.

(2) Form. The administrative claim shall include—

(i) The name, taxpayer identification number, current address, and current home and work telephone numbers (with an identification of any convenient times to be contacted) of the taxpayer making the claim;

(ii) The location of the bankruptcy court in which the underlying bankruptcy case was filed and the case number of the case in which the violation occurred;

(iii) A description, in reasonable detail, of the violation (include copies of any available substantiating documentation or correspondence with the Internal Revenue Service);

(iv) A description of the injuries incurred by the taxpayer filing the claim (include copies of any available substantiating documentation or evidence);

(v) The dollar amount of the claim, including any damages that have not yet been incurred but which are reasonably foreseeable (include copies of any available documentation or evidence); and

(vi) The signature of the taxpayer or duly authorized representative.

(3) Duly authorized representative de- fined. For purposes of this paragraph (e), a duly authorized representative is any attorney, certified public accountant, enrolled actuary, or any other person permitted to represent the taxpayer before the Internal Revenue Service who is not disbarred

or suspended from practice before the Internal Revenue Service and who has a written power of attorney executed by the taxpayer.

(f) No action in bankruptcy court for any sum in excess of the dollar amount sought in the administrative claim. No action for actual, direct economic damages under paragraph (a) of this section may be instituted in federal bankruptcy court for any sum in excess of the amount (already incurred and estimated) of the administrative claim filed under paragraph (e) of this section, except where the increased amount is based upon newly discovered evidence not reasonably discoverable at the time the administrative claim was filed, or upon allegation and proof of intervening facts relating to the amount of the claim.

(g) Period of limitations —(1) Time for filing. A petition for damages under paragraph (a) of this section must be filed in bankruptcy court within two years after the date the cause of action accrues.

(2) Right of action accrues. A cause of action under paragraph (a) of this section accrues when the taxpayer has had a reasonable opportunity to discover all essential elements of a possible cause of action.

(h) Recovery of litigation costs and ad- ministrative costs under section 7430 (1) In general. Litigation costs, as defined in §301.7433–1(b)(2)(i), including attorneys fees, not recoverable under this section may be recoverable under section 7430 if a taxpayer challenges in whole or in part an Internal Revenue Service denial of an administrative claim for damages by filing a petition in the bankruptcy court. If, following the Internal Revenue Service’s denial of an administrative claim for damages, a taxpayer files a petition in the bankruptcy court challenging that denial in whole or in part, substantially prevails with respect to the amount of damages in controversy, and meets the requirements of section 7430(c)(4)(A)(ii) (relating to net worth and size requirements), the taxpayer will be considered a prevailing party for purposes of section 7430, unless the Internal Revenue Service establishes that the position of the Internal Revenue Service in the proceeding was substantially justified. Such taxpayer will generally be entitled to attorneys’ fees and other reasonable litigation costs not recoverable under this section. For purposes of this paragraph (h), if the

2003–14 I.R.B. 698 April 7, 2003