Part I. Rulings — Internal Revenue Bulletin 2004-32

Section 42.—Low-Income Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement; determination of correct tax liability.

Bankruptcy; golden parachute pay- ments. This ruling provides rules for the application of section 280G of the Code, concerning golden parachute payments, in the context of a bankruptcy. Specifically, this ruling addresses whether the acquisition of stock by the former creditors results in a change in ownership or control, whether a corporation whose stock is de-listed is eligible for the exemption for certain corporations whose stock is not readily tradeable on an established securities market if the shareholder approval and disclosure requirements described in the final regulations are satisfied, and whether stock that is de-listed from a securities market is considered readily tradeable if it is traded on an over-the-counter market (such as the pink sheets).

Rev. Rul. 2004–87

ISSUE

In the situations described below, has there been a change in ownership or control for purposes of §§ 280G and 4999 of the Internal Revenue Code? If so, are any contingent payments potentially exempt under § 280G(b)(5)(A)(ii) (concerning payments from certain corporations that are approved by its shareholders)?

FACTS

Situation 1 . On March 1, 2005, Corporation A, files a voluntary petition for

relief under Chapter 11 of the Bankruptcy Code. See 11 U.S.C. § 1101, et seq . Corporation A common stock is widely held and actively traded on the New York Stock Exchange. There are no other shares of Corporation A outstanding. Committees of creditors holding unsecured claims and equity security holders are appointed pursuant to 11 U.S.C. § 1102.

After negotiations between the unsecured creditors’ committee, the equity committee, and Corporation A, a plan of reorganization is presented to the bankruptcy court and approved. Under the plan of reorganization, all of the existing shares of Corporation A common stock are cancelled and new shares of common stock are authorized. Under the plan of reorganization, the unsecured creditors of Corporation A will receive 75% of the new common stock, distributed in proportion to their claims. Certain shareholders will receive 25% of the new common stock, distributed in proportion to their pre-reorganization stock holdings. No single unsecured creditor will receive 20% or more of the outstanding shares of Corporation A after the reorganization.

Under the plan of reorganization, the existing Board of Directors is replaced by a new Board of Directors that is endorsed by the pre-reorganization Board of Directors.

Situation 2 . Assume the same facts as in Situation 1 except that after the reorganization the largest creditor of Corporation A will receive 25% of the outstanding shares of Corporation A.

Situation 3 . Common stock of Corporation B is widely-held and actively traded on the New York Stock Exchange. No other shares of Corporation B are outstanding. Since January 2000, Corporation B has experienced financial difficulties.

On June 15, 2005, Corporation B determines that it is insolvent and files a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. Committees of creditors holding unsecured claims and equity security holders are appointed pursuant to 11 U.S.C. § 1102.

On January 15, 2006, Corporation B’s stock is de-listed from the New York Stock Exchange and is thereafter no longer tradeable on any established securities market

(as defined in § 1.897–1(m)). No trading occurred with respect to stock in Corporation B on any other market, including any over-the-counter market ( e.g., the pink sheets, the over-the-counter-bulletin board (OTCBB), the automated confirmation transaction service (ACT), or any similar market).

In March 2006, Corporation C proposes to purchase more than one-third of the total gross fair market value of the assets of Corporation B. Corporation B files a motion in the bankruptcy court for approval of the sale. Pursuant to an employment contract, the sale would trigger certain payments to Executive E, a disqualified individual with respect to Corporation B. E files a request in the bankruptcy court to allow Corporation B to make the payments as administrative expenses of the bankruptcy estate under 11 U.S.C. § 503(a). The request specifies that the payments will be made because of the sale of assets to Corporation C, the total amount of each payment, and a brief description of each payment. The request also explains why the payments are actual, necessary costs and expenses of preserving the bankruptcy estate.

After notice and hearing, the bankruptcy court approves the sale of assets and the request for payment of administrative expense by orders dated September 15, 2006. On October 1, 2006, Corporation C acquires the assets from Corporation B, and the payments are made to E.

Situation 4 . Assume the same facts as in Situation 3 except that the stock of Corporation B is tradeable on an over-thecounter market after de-listing from the New York Stock Exchange.

LAW

Section 280G of the Code was enacted to discourage substantial payments to top executives and other personnel of a target corporation in connection with an acquisition. In some situations, the existence of golden parachute arrangements could encourage executives and other key personnel to favor a proposed takeover that may not be in the best interests of the shareholders. To the extent amounts must be paid

2004–32 I.R.B. 154 August 9, 2004

tal voting power of the stock of such corporation. Q/A–27(b) provides that persons will not be considered to be acting as a group merely because they happen to purchase or own stock of the same corporation at the same time, or as a result of the same public offering.

Q/A–28(a) provides, in part, that a change in the effective control of a corporation is presumed to occur on the date that either (1) any one person, or more than one person acting as a group (as defined in Q/A–28(d)), acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of the corporation possessing 20 percent or more of the total voting power of the stock of such corporation; or (2) a majority of the members of the corporation’s board of directors is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the corporation’s board of directors prior to the date of the appointment or election. The presumption may be rebutted by showing that the acquisition of stock or replacement of the board does not transfer the power to control (directly or indirectly) from any one person (or more than one person acting as a group) to another person (or group). Q/A–28(d) contains the same language as Q/A–27(b) concerning when more than one person is considered to be acting as a group.

Q/A–29 provides that a change in the ownership of a substantial portion of a corporation’s assets occurs on the date that any one person, or more than one person acting as a group (as defined in Q/A–29(c)) acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) assets from the corporation that have a total gross fair market value equal to or more than one-third of the total gross fair market value of all of the assets of the corporation immediately prior to such acquisition or acquisitions. For this purpose, gross fair market value means the value of the assets of the corporation, or the value of the assets being disposed of, determined without regard to any liabilities associated with such assets. Q/A–29(c) contains the same language as Q/A–27(b) concerning when person will be considered to be acting as a group.

to executives and other key personnel of the target corporation because of golden parachutes or similar arrangements, there is less for the shareholders of that corporation. See, S. Prt. No. 98–169, at 195 (1984); JOINT COMMITTEE ON TAXATION, 98 ^th CONG., GENERAL EXPLANATION OF THE REVENUE PROVISIONS OF THE DEFICIT REDUCTION ACT OF 1984, at 199–200 (1984).

Section 280G denies a deduction for any excess parachute payment. Section 4999 imposes a nondeductible 20-percent excise tax on the recipient of any excess parachute payment, within the meaning of § 280G(b).

An excess parachute payment is defined in § 280G(b)(1) as an amount equal to the excess of any parachute payment over the portion of the disqualified individual’s base amount that is allocated to such payment.

Section 280G(b)(2)(A) defines a parachute payment as any payment in the nature of compensation to (or for the benefit of) a disqualified individual if (i) such payment is contingent on a change in the ownership of a corporation, the effective control of a corporation, or the ownership of a substantial portion of the assets of a corporation (a change in ownership or control), and (ii) the aggregate present value of the payments in the nature of compensation which are contingent on such change equals or exceeds an amount equal to 3 times the base amount.

Section 280G(b)(5)(A)(ii) of the Code provides, in part, that a parachute payment does not include any payment to a disqualified individual with respect to a corporation (other than a small business corporation as defined in § 1361(b) but without regard to paragraph (1)(C) thereof) if (I) immediately before the change described in § 280G(b)(2)(A) no stock in such corporation was readily tradeable on an established securities market or otherwise, and (II) the shareholder approval requirements of § 280G(b)(5)(B) are met with respect to such payment.

Section 280G(b)(5)(B)(ii) of the Code provides that the shareholder approval requirements of § 280G(b)(5) are met with respect to any payment if (i) such payment was approved by a vote of the persons who owned, immediately before the change described in § 280G(b)(2)(A)(i), more than 75 percent of the voting power

of all outstanding stock of the corporation, and (ii) there was adequate disclosure to shareholders of all material facts concerning all payments which (but for this paragraph) would be parachute payments with respect to a disqualified individual.

Under §1.280G–1 of the Income Tax Regulations, Q/A–6(a), a parachute payment does not include any payment to a disqualified individual with respect to a corporation if (1) immediately before the change in ownership or control, no stock in such corporation was readily tradeable on an established securities market or otherwise, and (2) the shareholder approval requirements of Q/A–7 are met with respect to such payment. Under §1.280G–1, Q/A–6(e) of the regulations, stock is treated as readily tradeable if it is regularly quoted by brokers or dealers making a market in such stock. Section 1.280G–1 of the regulations, Q/A–6(f) provides that an established securities market means an established securities market as defined in §1.897–1(m) of the regulations.

Section 1.280G–1, Q/A–7(a), of the regulations provides that the shareholder approval requirements are met with respect to the payment if (1) the payment is approved by more than 75% of the voting power of all outstanding stock entitled to vote (as described in Q/A–7) immediately before the change in ownership or control, and (2) before the vote there is adequate disclosure to all persons entitled to vote (as described in Q/A–7) of all material facts concerning all material payments which (but for Q/A–6) would be parachute payments with respect to the disqualified individual.

Section 1.280G–1 of the regulations, Q/As 27, 28, and 29 provides guidance concerning when a corporation is considered to have undergone a change in ownership of a corporation, a change in effective control of a corporation, or a change in the ownership of a substantial portion of the assets of a corporation (a change in ownership or control).

Q/A–27(a) provides that a change in the ownership of a corporation occurs on the date that any one person, or more than one person acting as a group, acquires ownership of stock of the corporation that, together with stock held by such person (or more than one person acting as a group under Q/A–27(b)) possesses more than 50 percent of the total fair market value or to

August 9, 2004 155 2004–32 I.R.B.

the ultimate owners from unnecessary or excessive payments made to executives. Consequently, for purposes of § 280G, the shareholder approval and disclosure requirements of § 280G(b)(5)(A)(i)(II) and Q/A–7 are deemed satisfied, and the payments to E are not parachute payments.

ANALYSIS — Situation 4

Similar to Situation 3, there has been a change in ownership of Corporation B under Q/A–29. Additionally, if Corporation B qualifies as a corporation described in § 280G(b)(5)(A)(ii)(I) (concerning payments from corporations that meet certain shareholder approval and disclosure requirements) on the date of the change in control and the requirements of § 280G(b)(5)(A)(ii)(II) are satisfied, the payments are exempt from the definition of parachute payment.

The trading of stock on an over-thecounter market ( e.g., the pink sheets, the OTCBB, the ACT, or any similar market) when the corporation is a debtor in a case under the Bankruptcy Code is impaired, and therefore, the stock is not considered “readily tradeable” for purposes of § 280G.

Accordingly, for the reasons discussed in Situation 3, the payments to E are not parachute payments.

HOLDINGS — Situation 1

In Situation 1, because no person (or persons acting as a group) acquired more than 50 percent of the total fair market value or total voting power of Corporation A (Q/A–27); because no person (or persons acting as a group) acquired within a 12-month period 20% or more of the outstanding stock of Corporation B and the new Board of Directors is approved by the pre-reorganization Board of Directors (Q/A–28); and because there is no acquisition of the assets of Corporation A (Q/A–29), Corporation A did not undergo a change in ownership or control under § 280G.

HOLDINGS — Situation 2

Corporation A is presumed to have experienced a change in effective control under § 280G. The presumption may be rebutted in accordance with Q/A–28(b).

In a bankruptcy case, an entity may file a request for payment of an administrative expense of the bankruptcy estate. See 11 U.S.C. § 503(a). Pursuant to 11 U.S.C. § 503(b)(1)(A), after notice and hearing, the bankruptcy court shall allow the payment of administrative expenses which were actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case. 11 U.S.C. § 503(b)(1)(A).

ANALYSIS — Situation 1

The receipt of stock by a creditor under a bankruptcy plan of reorganization is often involuntary in that the creditors of a bankrupt estate typically would prefer that the debt be paid in cash rather than in stock of the debtor. The fact that unsecured creditors are represented by a committee and that the plan of reorganization of the debtor provides for the creditors to receive stock instead of cash is ordinarily a function of the financial resources of the estate and is not necessarily indicative of any intention of the creditors to act as a group to acquire control of the debtor. In this situation, Corporation A filed a voluntary petition for relief in the bankruptcy court and the pre-bankruptcy creditors did not act together to force Corporation A into bankruptcy. The fact that the pre-bankruptcy creditors were appointed to a committee of creditors and received stock in proportion to their pre-bankruptcy debt does not indicate that the creditors acted together to acquire stock in Corporation A. Thus, the creditors are not acting as a group, within the meaning of Q/A–27(b) or Q/A–28(d), to acquire the stock of Corporation A.

ANALYSIS — Situation 2

Because one creditor acquired 20 percent or more of Corporation A’s stock within a 12-month period, Corporation A is presumed, under Q/A–28(a), to have experienced a change in effective control. However, this presumption may be rebutted by a showing that the largest creditor will not act to control the management and policies of Corporation A.

ANALYSIS — Situation 3

Because Corporation C acquired more than one third of the total gross fair market

value of all of the assets of Corporation B, there is a change in ownership of Corporation B under Q/A–29. However, if Corporation B qualifies as a corporation described in § 280G(b)(5)(A)(ii)(I), concerning payments from corporations that meet certain shareholder approval and disclosure requirements, and the requirements of § 280G(b)(5)(A)(ii)(II) are satisfied, the payments are exempt from the definition of parachute payment.

Under these facts, the stock of Corporation B was de-listed from an established securities market and was not otherwise readily tradeable on the date of the change in control. Further, no trading occurred on any market (including any over-the-counter market). Thus, Corporation B is a corporation described in § 280G(b)(5)(A)(ii)(I) on the date of the change in control.

In order to satisfy the requirements of § 280G(b)(5)(A)(ii)(II) outside of the bankruptcy context, generally, Q/A–7(a) of the regulations requires that the payment must be adequately disclosed to shareholders and then approved by more than 75% of the voting power of all outstanding stock entitled to vote immediately before the change in ownership or control. However, for a corporation in bankruptcy, the continuing interests of equity owners can be difficult to determine or predict. Through the bankruptcy process, the pre-bankruptcy shareholders may end up with a continuing equity interest in the company or the equity may end up partially or fully transferred to creditors. Correspondingly, the pre-bankruptcy shareholders may lack a material continuing equity interest in the affairs of the corporation and therefore also lack the corresponding motivation to appropriately evaluate the payments at issue.

In Situation 3, the payments to E were approved by the bankruptcy court pursuant to 11 U.S.C. § 503(b)(1)(A). The bankruptcy court therefore made a factual finding that the payments were actual, necessary costs and expenses of preserving the bankruptcy estate. The legislative history of § 280G indicates that the golden parachute rules were enacted to discourage excessive payments to executives and other key personnel in order to protect the shareholders. See S. Rpt. No. 98–169 at 195. The bankruptcy court approval serves to protect the estate and

2004–32 I.R.B. 156 August 9, 2004

Rev. Rul. 2004–83

ISSUE

Under the facts described below, what is the proper tax treatment if, pursuant to an integrated plan, a parent corporation sells the stock of a wholly owned subsidiary for cash to another wholly owned subsidiary and the acquired subsidiary completely liquidates into the acquiring subsidiary.

FACTS

Situation 1

Corporation P owns all the stock of Corporation S and Corporation T. P, S, and T are members of a consolidated group. As part of an integrated plan, S purchases all the stock of T from P for cash and T completely liquidates into S. Assume that if T had sold its assets directly to S and T had completely liquidated into P, the transaction would have qualified as a reorganization under § 368(a)(1)(D) of the Internal Revenue Code.

Situation 2

The facts are the same as in Situation 1 except that P, S, and T are not members of a consolidated group.

LAW

Section 368(a)(1)(D) provides that a reorganization includes a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction that qualifies under § 354, 355, or 356.

In Rev. Rul. 70–240, 1970–1 C.B. 81, B owned all the outstanding stock of Corporation X and Corporation Y. X sold its operating assets to Y for cash equal to their fair market value and used its remaining assets to pay its debts. X then liquidated and B received a liquidating distribution in exchange for his X stock. The ruling

HOLDINGS — Situation 3

Because Corporation C acquired more than one third of the total gross fair market value of all of the assets of Corporation B, there is a change in ownership of Corporation B under Q/A–29. However, Corporation B is eligible for the exemption provided in § 280G(b)(5)(A)(ii). Under these facts, the shareholder approval and disclosure requirements described in § 280G(b)(5)(B) and Q/A–7 are deemed to be satisfied, and thus, the payments to E are exempt from the definition of parachute payment.

HOLDINGS — Situation 4

For purposes of §280G, the trading of stock on an over-the-counter market when the corporation is a debtor in a case under the Bankruptcy Code is impaired, and therefore, the stock is not considered “readily tradeable.” Thus, Corporation B is eligible for the exemption provided in § 280G(b)(5)(A)(ii). Under these facts, the shareholder approval and disclosure requirements described in § 280G(b)(5)(B) and Q/A–7 are deemed to be satisfied, and the payments to E are exempt from the definition of parachute payment.

EFFECTIVE DATE

This revenue ruling applies to any payment that is contingent on a change in ownership or control if the change of ownership or control occurs on or after July 19, 2004. Notwithstanding the foregoing, where a corporation is a debtor in a case under the Bankruptcy Code, its securities traded on an over-the-counter market also are not considered “readily tradeable” for purposes of § 280G(b)(5)(A)(ii) with respect to a change in ownership or control that occurred before July 19, 2004.

COMMENTS REQUESTED

Comments are requested concerning whether, or to what extent, the definition of “readily tradeable” under § 280G(b)(5)(A)(ii) should exclude stock of a corporation that is tradeable on an over-the-counter market ( e.g., the pink sheets, the OTCBB, the ACT, or any similar market).

Comments should be submitted by October 18, 2004, to CC:PA:LPD:PR (Rev

enue Ruling 2004–87), Room 5203, Internal Revenue Service, POB 7604 Ben Franklin Station, Washington, D.C. 20044. Comments may be hand delivered between the hours of 8 a.m. and 4 p.m., Monday through Friday to CC:PA:LPD:PR (Revenue Ruling 2004–87), Courier’s Desk, Internal Revenue Service, 1111 Constitution Ave., NW, Washington, D.C. Alternatively, comments may be submitted via the Internet at Notice.Comments@irscoun- sel.treas.gov . All comments will be available for public inspection.

DRAFTING INFORMATION

The principal author of this revenue ruling is Erinn Madden of the Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and Treasury Department participated in its development. For further information regarding this revenue ruling, contact Ms. Madden at (202) 622–6030 (not a toll-free call).

Section 304.—Redemption Through Use of Related Corporations

26 CFR 1.304–2: Acquisition by related corporation (other than subsidiary).

If, pursuant to an integrated plan, a parent corporation sells the stock of a wholly owned subsidiary for cash to another wholly owned subsidiary and the acquired subsidiary completely liquidates into the acquiring subsidiary, the transaction is treated as a reorganization under § 368(a)(1)(D). See Rev. Rul. 2004-83, page 157.

Section 368.—Definitions Relating to Corporate Reorganizations

26 CFR 1.368–1: Purpose and scope of exception of reorganization exchanges.

Corporate reorganizations. This ruling provides that if, pursuant to an integrated plan, a parent corporation sells the stock of a subsidiary to another subsidiary and the acquired subsidiary liquidates into the acquiring subsidiary, the transaction is a reorganization under section 368(a)(1)(D) of the Code.

August 9, 2004 157 2004–32 I.R.B.

There is no policy that requires § 304 to be applied when § 368(a)(1)(D) would otherwise apply. See J. Comm. on Tax’n., 98th Cong. 2nd Sess., General Expla- nation of the Revenue Provisions of the Deficit Reduction Act of 1984 192 (Comm. Print 1984). Moreover, the legislative history to the Deficit Reduction Act of 1984, P.L. 98–369, 1984–3 (Vol. 1) C.B. 1, indicates that § 304 was not intended to override reorganization treatment. See H.R. Rep. No. 98–432 Pt. 2, 1624 (1984). Accordingly, in Situation 2, as in Situation 1, the step transaction doctrine applies to treat the stock sale and liquidation as a reorganization under § 368(a)(1)(D).

HOLDING

Under the facts presented, if, pursuant to an integrated plan, a parent corporation sells the stock of a wholly owned subsidiary for cash to another wholly owned subsidiary and the acquired subsidiary completely liquidates into the acquiring subsidiary, the transaction is treated as a reorganization under § 368(a)(1)(D).

DRAFTING INFORMATION

The principal author of this revenue ruling is Lisa S. Dobson of the Office of Associate Chief Counsel (Corporate). For further information regarding this revenue ruling, contact Ms. Dobson at (202) 622–7790 (not a toll-free call).

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 August 2004. See Rev. Rul. 2004-84, page 163.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

concludes that the transfer by X of its operating assets to Y is regarded as the acquisition by Y of substantially all the assets of X and is a reorganization under § 368(a)(1)(D). Accord Atlas Tool Co. v. Commissioner, 70 T.C. 86 (1978), aff’d, 614 F.2d 860 (3rd Cir. 1980), cert. denied, 449 U.S. 836 (1980); Armour v. Commis- sioner, 43 T.C. 295 (1964).

In determining whether a transaction qualifies as a reorganization under § 368(a), the transaction must be evaluated under relevant provisions of law, including the step transaction doctrine. Section 1.368–1(a) of the Income Tax Regulations. The step transaction doctrine “treats a series of formally separate ‘steps’ as a single transaction if such steps are in substance integrated, interdependent, and focused toward a particular result.” Penrod v. Commissioner, 88 T.C. 1415, 1428 (1987). In Rev. Rul. 67–274, 1967–2 C.B. 141, pursuant to a plan of reorganization, Corporation Y acquired all the stock of Corporation X in exchange for voting stock of Y. Thereafter, X completely liquidated into Y. The ruling concludes that the two steps do not qualify as a reorganization under § 368(a)(1)(B) followed by a liquidation under § 332, but instead qualify as a single acquisition of X’s assets in a reorganization under § 368(a)(1)(C). See also Rev. Rul. 72–405, 1972–2 C.B. 217 (treating the acquisition of the assets of a target corporation in a forward triangular merger followed by the liquidation of the acquiring subsidiary as a reorganization under § 368(a)(1)(C)); Rev. Rul. 2001–46, 2001–2 C.B. 321 (applying the approach reflected in Rev. Rul. 67–274 to a stock acquisition followed by a merger of the acquired corporation into the acquiring corporation).

Section 1.1361–4(a)(2) provides that if an S corporation makes a QSub election with respect to a subsidiary (an election to disregard a subsidiary as an entity separate from its S corporation parent), the subsidiary is deemed to have liquidated into the S corporation. In Example 3 of § 1.1361–4(a)(2)(ii), pursuant to a plan, Individual A contributes all the outstanding stock of Y to his wholly owned S corporation, X, and immediately causes X to make

a QSub election for Y. The example concludes that the transaction is a reorganization under § 368(a)(1)(D), assuming the other conditions for reorganization treatment are satisfied.

Section 304(a)(1) provides, in general, for purposes of §§ 302 and 303, if one or more persons are in control of each of two corporations and, in return for property, one of the corporations acquires stock in the other corporation from the person (or persons) so in control, then such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock.

Section 1.1502–80(b), which relates to consolidated returns, provides that § 304 does not apply to any acquisition of stock of a corporation in an intercompany transaction.

ANALYSIS

In Situation 1, because P, S, and T are members of a consolidated group, and S’s purchase of the T stock from P is an intercompany transaction under § 1.1502–80(b), § 304 cannot apply to P’s sale of T stock to S. As described above, if T had transferred its assets directly to S and T had completely liquidated into P, the stock sale and liquidation would have qualified as a reorganization under § 368(a)(1)(D). Consistent with Rev. Ruls. 67–274 and 72–405 and Example 3 of § 1.1361–4(a)(2)(ii), the step transaction doctrine applies to treat the stock sale and liquidation as a reorganization under § 368(a)(1)(D). Authorities that reject the application of the step transaction doctrine based on the policy of § 338, such as § 1.338–3(d) and Rev. Rul. 90–95, 1990–2 C.B. 67, are not relevant in this case because there is no purchase of T stock within the meaning of § 338(h)(3)(A) and § 1.338–3(b).

Situation 2 differs from Situation 1 only in that P, S, and T are not members of a consolidated group. As a result, if the step transaction doctrine does not apply to step together the stock sale and liquidation, the stock sale would be treated as a distribution in redemption of the S stock under § 304(a)(1) and the liquidation of T into S would qualify as a liquidation under § 332.

2004–32 I.R.B. 158 August 9, 2004

Section 461.—General Rule for Taxable Year of Deduction

26 CFR 1.461–2: Contested liabilities.

T.D. 9140

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Transfers to Provide for Satisfaction of Contested Liabilities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to transfers of money or other property to provide for the satisfaction of contested liabilities. The regulations affect taxpayers that are contesting an asserted liability and that transfer their own stock or indebtedness, the stock or indebtedness of a related party, or a promise to provide services or property in the future, to provide for the satisfaction of the liability prior to the resolution of the contest. The regulations also affect taxpayers that transfer money or other property to a trust, an escrow account, or a court to provide for the satisfaction of a liability for which payment is economic performance.

DATES: Effective Date: These regulations are effective July 20, 2004.

Applicability Dates: For dates of applicability, see §1.461–2(g).

FOR FURTHER INFORMATION CONTACT: Norma Rotunno, (202) 622–7900 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to 26 CFR Part 1 under section 461(f) of the Internal Revenue Code (Code). On November 21, 2003, temporary regulations (T.D. 9095, 2003–49 I.R.B. 1175) were published in the Federal Register (68 FR 65634) relating to the transfer of

money or other property to provide for the satisfaction of an asserted liability that a taxpayer is contesting. A notice of proposed rulemaking (REG–136890–02, 2003–49 I.R.B. 1191) cross-referencing the temporary regulations also was published in the Federal Register (68 FR 65645) on November 21, 2003. No public hearing was requested or held. One comment was received responding to the notice of proposed rulemaking. After consideration of the comment, the proposed regulations are adopted by this Treasury decision.

Summary of Comment

The temporary regulations clarify that, in general, economic performance does not occur in the taxable year in which a taxpayer transfers money or other property to a trust, escrow account, or court to provide for the satisfaction of an asserted liability under section 461(f) for which payment constitutes economic performance. Rather, economic performance occurs in the taxable year in which a taxpayer transfers money or other property to the person asserting the liability that the taxpayer is contesting, or in the taxable year in which payment from the trust, escrow account, or court registry is made to the person to which the liability is owed. The temporary regulations also indicate that economic performance may be satisfied under section 468B and the regulations thereunder (relating to designated settlement funds and qualified settlement funds).

A commentator suggested that the regulations provide an example of a transfer to a contested liability fund that qualifies for a deduction in the taxable year of transfer because it also satisfies the requirements for a qualified settlement fund under §1.468B–1. The final regulations do not adopt this comment because the requirements for establishing a qualified settlement fund under §1.468B–1 are complex and are beyond the scope of these regulations.

Effective Date

In general, these final regulations apply to transfers made in taxable years beginning after December 31, 1953, and ending after August 16, 1954. However, these regulations apply to transfers of

any stock of the taxpayer or any stock or indebtedness of a related person on or after November 19, 2003. Additionally, §1.461–2(e)(2)(i), relating to economic performance, applies to transfers of money or other property after July 18, 1984, the effective date of section 461(h). Section 1.461–2(e)(2)(ii) applies to (1) transfers of money or other property after July 18, 1984, to satisfy workers compensation or tort liabilities, and (2) transfers of money or other property in taxable years beginning after December 31, 1991, the effective date of §1.461–4(g), to satisfy payment liabilities designated under §1.461–4(g) (other than liabilities for workers compensation or tort).

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 regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the proposed regulations preceding these regulations were 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 Norma Rotunno of the Office of the Associate Chief Counsel (Income Tax & Accounting). However, other personnel from the IRS and Treasury participated in their development.

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1— INCOME TAXES

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

August 9, 2004 159 2004–32 I.R.B.

(3) Paragraph (e)(2)(i) of this section applies to transfers of money or other property after July 18, 1984.

(4) Paragraph (e)(2)(ii) and paragraph (e)(3) Example 2 of this section apply to—

(i) Transfers after July 18, 1984, of money or other property to provide for the satisfaction of an asserted workers compensation or tort liability; and

(ii) Transfers in taxable years beginning after December 31, 1991, of money or other property to provide for the satisfaction of asserted liabilities designated in §1.461–4(g) (other than liabilities for workers compensation or tort).

Mark E. Matthews, Deputy Commissioner for Services and Enforcement .

Approved July 7, 2004.

Gregory F. Jenner, Acting Assistant Secretary of the Treasury .

(Filed by the Office of the Federal Register on July 19, 2004, 8:45 a.m., and published in the issue of the Federal Register for July 20, 2004, 69 F.R. 43302)

Section 463.—Accrual of Vacation Pay

26 CFR 1.463–1T: Removed.

T.D. 9138

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Transitional Rule for Vested Accrued Vacation Pay

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Removal of temporary regulation.

SUMMARY: This document removes a temporary regulation that provides a rule for an election to deduct vested accrued vacation pay for the first taxable year ending after July 18, 1984. The repeal of the underlying code section in 1987 has rendered the temporary regulation obsolete. The removal of this regulation will not affect taxpayers.

Authority: 26 U.S.C. 7805 * * * Par. 2. In §1.461–2, paragraphs (c)(1), (e)(2), (e)(3) Example 2, and (g) are revised to read as follows:

§1.461–2 Contested liabilities.

- - - (c) Transfer to provide for the satis- faction of an asserted liability —(1) In general . (i) A taxpayer may provide for the satisfaction of an asserted liability by transferring money or other property beyond his control to—

(A) The person who is asserting the liability;

(B) An escrowee or trustee pursuant to a written agreement (among the escrowee or trustee, the taxpayer, and the person who is asserting the liability) that the money or other property be delivered in accordance with the settlement of the contest;

(C) An escrowee or trustee pursuant to an order of the United States or of any State or political subdivision thereof or any agency or instrumentality of the foregoing, or of a court, that the money or other property be delivered in accordance with the settlement of the contest; or

(D) A court with jurisdiction over the contest.

(ii) In order for money or other property to be beyond the control of a taxpayer, the taxpayer must relinquish all authority over the money or other property.

(iii) The following are not transfers to provide for the satisfaction of an asserted liability—

(A) Purchasing a bond to guarantee payment of the asserted liability;

(B) An entry on the taxpayer’s books of account;

(D) A transfer of any indebtedness of the taxpayer or of any promise by the taxpayer to provide services or property in the future; and

(E) A transfer to a person (other than the person asserting the liability) of any stock of the taxpayer or of any stock or indebtedness of a person related to the taxpayer (as defined in section 267(b)).

- - - (e) - - (2) Application of economic perfor- mance rules to transfers under section 461(f) . (i) A taxpayer using an accrual

method of accounting is not allowed a deduction under section 461(f) in the taxable year of the transfer unless economic performance has occurred.

(ii) Economic performance occurs for liabilities requiring payment to another person arising out of any workers compensation act or any tort, or any other liability designated in §1.461–4(g), as payments are made to the person to which the liability is owed. Except as provided in section 468B or the regulations thereunder, economic performance does not occur when a taxpayer transfers money or other property to a trust, an escrow account, or a court to provide for the satisfaction of an asserted workers compensation, tort, or other liability designated under §1.461–4(g) that the taxpayer is contesting unless the trust, escrow account, or court is the person to which the liability is owed or the taxpayer’s payment to the trust, escrow account, or court discharges the taxpayer’s liability to the claimant. Rather, economic performance occurs in the taxable year the taxpayer transfers money or other property to the person that is asserting the workers compensation, tort, or other liability designated under §1.461–4(g) that the taxpayer is contesting or in the taxable year that payment is made from a trust, an escrow account, or a court registry funded by the taxpayer to the person to which the liability is owed.

(3) - *

- - - Example 2 . Corporation X is a defendant in a class action suit for tort liabilities. In 2002, X establishes a trust for the purpose of satisfying the asserted liability and transfers $10,000,000 to the trust. The trust does not satisfy the requirements of section 468B or the regulations thereunder. In 2004, the trustee pays $10,000,000 to the plaintiffs in settlement of the litigation. Under paragraph (e)(2) of this section, economic performance with respect to X’s liability to the plaintiffs occurs in 2004. X may deduct the $10,000,000 payment to the plaintiffs in 2004.
- - - (g) Effective dates . (1) Except as otherwise provided, this section applies to transfers of money or other property in taxable years beginning after December 31, 1953, and ending after August 16, 1954.

(2) Paragraph (c)(1)(iii)(E) of this section applies to transfers of any stock of the taxpayer or any stock or indebtedness of a person related to the taxpayer on or after November 19, 2003.

2004–32 I.R.B. 160 August 9, 2004

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

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores. The May 2004 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, May 31, 2004.

Rev. Rul. 2004–81

The following Department Store Inventory Price Indexes for May 2004 were issued by the Bureau of Labor Statistics. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to, May 31, 2004.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

DATES: This Treasury decision is effective on July 15, 2004.

FOR FURTHER INFORMATION CONTACT: Jamie J. Kim at (202) 622–4950 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Prior to repeal in 1987, section 463 of the Internal Revenue Code (Code) permitted taxpayers to elect to deduct reasonable additions to a reserve account for vacation pay, including amounts earned by employees before the close of the taxable year that, because of contingencies, would not be deductible under section 162(a) as an accrued expense. In connection with the enactment of the economic performance rules under section 461(h), section 91(i) of the Tax Reform Act of 1984, Public Law 98–369 (98 Stat. 494, 609), provided a transitional rule under which certain taxpayers could make an election under section 463 for the first taxable year ending after July 18, 1984. On February 4, 1986, the IRS and Treasury published temporary regulation §1.463–1T (T.D. 8073, 1986–1 C.B. 45) in the Federal Register (51 FR 4312), as amended on April 2, 1986, (51 FR 11302), to provide guidance on making the election under section 463 pursuant to the transitional rule. The repeal of section 463 by section 10201(a) of the Revenue Act of 1987, Public Law 100–203 (101 Stat. 1330–382, 1330–387), has rendered temporary regulation §1.463–1T obsolete.

Special Analyses

It has been determined that the removal of this regulation is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. Because this rule merely removes regulatory provisions made obsolete by statute, prior notice and comment

and a delayed effective date are unnecessary and contrary to the public interest. 5 U.S.C 553(b)(B) and (d)(3). Because no notice of proposed rulemaking is required, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.

Drafting Information

The principal author of this Treasury decision is Jamie J. Kim of the Office of Associate Chief Counsel (Income Tax and Accounting), IRS.

- - - -

Removal of Temporary Regulation

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 * * *

§1.463–1T [Removed]

Par. 2. Section 1.463–1T is removed.

Mark E. Matthews, Deputy Commissioner for Services and Enforcement .

Approved July 7, 2004.

Gregory F. Jenner, Acting Assistant Secretary of the

Treasury (Tax Policy).

(Filed by the Office of the Federal Register on July 15, 2004, 8:45 a.m., and published in the issue of the Federal Register for July 16, 2004, 69 F.R. 42559)

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

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

August 9, 2004 161 2004–32 I.R.B.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups May 2003 May 2004

Percent Change from May 2003

to May 2004 ¹

Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456.3 483.5 6.0
Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557.6 542.2 -2.8
Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 637.0 645.0 1.3
Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 855.8 868.4 1.5
Infants’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 599.6 575.6 -4.0
Women’s Underwear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 519.8 512.2 -1.5
Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349.5 338.2 -3.2
Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . . . . . . . . 550.2 567.5 3.1
Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . . . . . . . . 374.5 377.2 0.7
Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 562.3 548.4 -2.5
Men’s Furnishings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587.2 594.3 1.2
Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 463.5 445.2 -3.9
Jewelry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 877.9 905.2 3.1
Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 789.7 797.5 1.0
Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 979.7 1001.4 2.2
Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 620.2 613.8 -1.0
Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 578.9 587.9 1.6
Housewares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 730.9 714.8 -2.2
Major Appliances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213.7 201.6 -5.7
Radio and Television. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45.9 42.4 -7.6
Recreation and Education ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83.4 80.8 -3.1
Home Improvements ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126.1 129.1 2.4
Automotive Accessories ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111.6 112.1 0.4

Groups 1–15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 568.1 570.1 0.4 Groups 16–20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397.1 384.2 -3.2 Groups 21–23: Misc. Goods ² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94.7 93.4 -1.4

Store Total ³ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 506.0 503.2 -0.6

1Absence of a minus sign before the percentage change in this column signifies a price increase. 2Indexes on a January 1986 = 100 base. 3The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco and contract departments.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Burkom of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Burkom at (202) 622–7924 (not a toll-free call).

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 August 2004. See Rev. Rul. 2004-84, page 163.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

2004–32 I.R.B. 162 August 9, 2004

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

Section 1274.—Determi- nation of Issue Price in the Case of Certain Debt Instru- ments 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, 642, 1274, 1288, and other sections of the Code, tables set forth the rates for August 2004.

Rev. Rul. 2004–84

This revenue ruling provides various prescribed rates for federal income tax purposes for August 2004 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520.

Applicable Federal Rates (AFR) for August 2004

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Term

AFR 2.37% 2.36% 2.35% 2.35% 110% AFR 2.62% 2.60% 2.59% 2.59% 120% AFR 2.85% 2.83% 2.82% 2.81% 130% AFR 3.09% 3.07% 3.06% 3.05%

Mid-Term

AFR 4.00% 3.96% 3.94% 3.93% 110% AFR 4.41% 4.36% 4.34% 4.32% 120% AFR 4.81% 4.75% 4.72% 4.70% 130% AFR 5.22% 5.15% 5.12% 5.10% 150% AFR 6.03% 5.94% 5.90% 5.87% 175% AFR 7.05% 6.93% 6.87% 6.83%

Long-Term

AFR 5.21% 5.14% 5.11% 5.09% 110% AFR 5.73% 5.65% 5.61% 5.58% 120% AFR 6.27% 6.17% 6.12% 6.09% 130% AFR 6.79% 6.68% 6.63% 6.59%

REV. RUL. 2004–84 TABLE 2

Adjusted AFR for August 2004

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted AFR

1.71% 1.70% 1.70% 1.69%

Mid-term adjusted AFR 3.30% 3.27% 3.26% 3.25%

Long-term adjusted AFR

4.64% 4.59% 4.56% 4.55%

August 9, 2004 163 2004–32 I.R.B.

REV. RUL. 2004–84 TABLE 3

Rates Under Section 382 for August 2004

Adjusted federal long-term rate for the current month 4.64%

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.) 4.72%

REV. RUL. 2004–84 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for August 2004

Appropriate percentage for the 70% present value low-income housing credit 8.07%

Appropriate percentage for the 30% present value low-income housing credit 3.46%

REV. RUL. 2004–84 TABLE 5

Rate Under Section 7520 for August 2004

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 4.8%

Section 4051.—Imposition of Tax on Heavy Trucks and Trailers Sold at Retail

26 CFR 145.4051–1: Imposition of tax on heavy trucks and trailers sold at retail.

Retail excise tax; highway tractor; truck. This ruling applies the primarily designed tests in section 145.4051–1(e)(1) and (2) of the regulations under the Highway Revenue Act of 1982 (Pub. L. 97–424) for purposes of determining whether a vehicle is a truck or a highway tractor.

Rev. Rul. 2004–80

ISSUE

Is the vehicle described below a truck or a tractor for purposes of the retail excise tax imposed by § 4051 of the Internal Revenue Code?

FACTS

The vehicle tows trailers and semitrailers (trailers); the trailers exceed 35 feet in length and have a gross vehicle weight (GVW) rating of 20,000 pounds. The vehicle has a standard chassis cab (4-door with crew cab), accommodating five passengers, and is outfitted with certain luxury features. The cab has an electric trailer

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

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

Section 1361.—S Corpo- ration Defined

Under what circumstances can an eligible entity request relief for a late S corporation election when the entity also fails to timely file an election to be classified as an association taxable as a corporation? See Rev. Proc. 2004-48, page 172.

Section 1362.—Election; Revocation; Termination

Section 2056.—Bequests, etc., to Surviving Spouse

Simplified alternate procedure (in lieu of requesting a letter ruling) for certain executors of estates and trustees of trusts in order to request relief to make a late reverse qualified terminable interest property

(QTIP) election under section 2652 of the Code. See Rev. Proc. 2004-47, page 169.

Section 2632.—Special Rules for Allocation of GST Exemption

26 CFR 26.2632–1: Allocation of GST exemption.

Section 2652.—Other Definitions

26 CFR 26.2652–1: Transferor defined; other defini- tions. 26 CFR 26.2652–2: Special election for qualified ter- minable interest property.

2004–32 I.R.B. 164 August 9, 2004

bed hitches is used. Even if neither of the vehicle’s two bed hitches is used, the design of the vehicle significantly reduces its cargo carrying capacity when compared to the cargo carrying capacity of a pickup truck body or a flatbed truck body installed on a comparable chassis. The significant reduction in cargo carrying capacity resulting from the vehicle’s platform with its rectangular well and sloping platform at the rear of the rectangular well is evidence that the vehicle is not primarily designed to carry cargo. By accommodating the bed hitches, however, this platform configuration increases the vehicle’s towing capacity and, in conjunction with the other features described above, makes it possible to safely tow a 20,000 pound trailer.

The vehicle’s physical characteristics, which maximize towing capacity at the expense of carrying capacity, establish that the vehicle is primarily designed to tow a vehicle, such as a trailer or semitrailer, rather than to carry cargo on its chassis.

HOLDING

The vehicle is a tractor for purposes of § 4051.

DRAFTING INFORMATION

The principal author of this revenue ruling is Celia Gabrysh of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Celia Gabrysh at (202) 622–3130 (not a toll-free call).

Section 6321.—Definitions and Special Rules

26 CFR 301.6231(a)–1(a)(2): Pass-thru partner disqualifies a partnership from the “small partner- ship” exception to the unified audit and litigation procedures of I.R.C. §§ 6221 through 6234. Also, § 301.6231(a)(7)–1(b); 301.7701–1; 301.7701–3.

TEFRA partnership; disregarded entity; pass-thru partner; tax matter partner. This ruling addresses whether a disregarded entity partner will disqualify a partnership from being a “small partnership” excluded from the TEFRA partnership provisions. The ruling also addresses whether a disregarded entity may be designated as the tax matters partner of a partnership.

brake control that connects to the brakes of a towed trailer and to a hook up for trailer lights. The vehicle has two storage boxes behind the cab that can accommodate incidental items such as small tools and vehicle repair equipment.

The chassis cab has a GVW rating of 23,000 pounds and a gross combination weight (GCW) rating of 43,000 pounds. The vehicle is equipped with hydraulic disc brakes with a four wheel automatic braking system, a 300 horsepower engine, and a six-speed automatic transmission. The front axle of the vehicle has an 8,000 pound rating and the rear axle has a 15,000 pound rating.

The vehicle has three types of hitching devices: a removable ball gooseneck hitch, a fifth wheel hitch, and a heavy duty trailer receiver hitch. The vehicle’s platform, which is approximately 139 inches long, is designed with a rectangular well to accommodate the gooseneck and fifth wheel hitches (bed hitches). This platform slopes at the rear of the rectangular well and has tie-down hooks. Optional removable steel stake rails can be placed around the platform.

LAW AND ANALYSIS

Section 4051(a)(1) imposes an excise tax on the first retail sale of automobile truck chassis and bodies, truck trailer and semitrailer chassis and bodies, and tractors of the kind chiefly used for highway transportation in combination with a trailer or semitrailer. The tax is not limited to commercial vehicles. Thus, a vehicle may be subject to tax even if sold for use or used as a recreational or private tow vehicle rather than for commercial purposes.

Section 145.4051–1(e)(1)(i) of the Temporary Excise Tax Regulations Under the Highway Revenue Act of 1982 (Pub. L. 97–424) defines “tractor” as a highway vehicle primarily designed to tow a vehicle, such as a trailer or semitrailer, but does not carry cargo on the same chassis as the engine. A vehicle equipped with air brakes and/or towing package will be presumed to be primarily designed as a tractor.

Section 145.4051–1(e)(2) defines “truck” as a highway vehicle that is primarily designed to transport its load on the same chassis as the engine even if it is

also equipped to tow a vehicle, such as a trailer or semitrailer.

“Primarily” means “principally” or “of first importance.” See Malat v. Riddle, 383 U.S. 569 (1966), 1966–1 C.B. 184. “Primarily” does not mean “exclusive.” See Rev. Rul. 77–36, 1977–1 C.B. 347. Therefore, in the context of the primarily designed test, the reference in § 145.4051–1(e)(1)(i) to vehicles not carrying cargo on the same chassis as the engine does not require an absolute inability to carry any cargo on the vehicle’s chassis. This limitation may be satisfied even if the vehicle can carry incidental items of cargo when towing a trailer or semitrailer or is capable of carrying limited amounts of cargo when not engaged in its primary function of towing a trailer or semitrailer.

Under the primarily designed test, a vehicle that can both carry cargo on its chassis and tow a trailer is characterized as either a truck or tractor depending on which function is of greater importance. The function for which a vehicle is primarily designed is evidenced by physical characteristics such as the vehicle’s capacity to tow a vehicle, carry cargo, and operate (including brake) safely when towing or carrying a cargo. Cargo carrying capacity depends on the vehicle’s GVW rating and the configuration of the vehicle’s bed or platform. Towing capacity depends on the vehicle’s GVW and GCW ratings and whether the vehicle is configured to tow a trailer or semitrailer.

Some characteristics of the vehicle such as its chassis cab with a GVW rating of 23,000 pounds, a 300 horsepower engine, a front axle with an 8,000 pound rating, and a rear axle with a 15,000 pound rating are consistent with either a cargo carrying or a towing function. In this case, however, the vehicle also has a GCW rating of 43,000 pounds and its engine, brakes, transmission, axle ratings, electric trailer brake control, trailer hook up lights, and hitches enable it to tow a 20,000 pound trailer that may exceed 35 feet in length.

When the vehicle’s bed hitches are used to tow, the cargo carrying capacity of the vehicle is limited to the storage boxes behind the cab and is minimal in comparison to the GVW of the towed trailer or semitrailer. Neither the steel stake bed rails nor the tie down hooks significantly increase cargo carrying capacity when either of the

August 9, 2004 165 2004–32 I.R.B.

Rev. Rul. 2004–88

ISSUE

Is a partnership that has a disregarded entity as a partner considered a “small partnership” that is excluded from the unified partnership audit and litigation procedures set forth in I.R.C. §§ 6221 through 6234 (the TEFRA partnership provisions)?
May a disregarded entity be designated the tax matters partner (TMP) of a partnership subject to the TEFRA partnership provisions?

FACTS

P is a limited partnership with one general partner and four limited partners. The sole general partner is a Limited Liability Company (LLC) that is treated as a disregarded entity under section 301.7701–3(b)(1)(ii). LLC is owned by A, an individual who is not a nonresident alien. The four limited partners in P are individuals who are not nonresident aliens. On its partnership return for the 2002 taxable year, P designates LLC as its TMP.

LAW AND ANALYSIS

Issue 1

Section 6231(a)(3) defines a partnership item as any item required to be taken into account for the partnership’s taxable year under subtitle A, to the extent regulations provide that the item is more appropriately determined at the partnership level than at the partner level. Under section 6221, the tax treatment of any partnership item shall be determined at the partnership level under the TEFRA partnership provisions. As a general rule, the TEFRA partnership provisions apply to any partnership required to file a return of partnership income under section 6031. Section 6231(a)(1)(A). The TEFRA partnership provisions do not apply to a partnership that qualifies as a small partnership under section 6231(a)(1)(B) unless the partnership elects to apply those provisions. For partnership taxable years ending after August 5, 1997, section 6231(a)(1)(B) defines a small partnership as a partnership in which there are ten or fewer partners, each of whom is an individual (other than a nonresident alien), an

estate of a deceased partner, or a C corporation.

Section 6231(a)(2) defines a “partner” as including both a partner in the partnership and any other person whose income tax liability under subtitle A is determined in whole or in part by taking into account directly or indirectly partnership items of the partnership.

Section 301.6231(a)(1)–1(a)(2) provides that the small partnership exception does not apply if any partner during the taxable year is a “pass-thru partner” as defined in section 6231(a)(9). A “pass-thru partner” is defined in section 6231(a)(9) as “a partnership, estate, trust, S corporation, nominee or other similar person through whom other persons hold an in- terest in the partnership . . . .” (Emphasis added). If legal title to a partnership interest is held in the name of a person other than the ultimate owner, the holder of legal title is considered a pass-thru partner within the meaning of section 6231(a)(9). Compare White v. Commissioner, T.C. Memo. 1991–552 (custodian for minor children was not a pass-thru partner because, under state Gift to Minors Act, the children held legal title to partnership interests rather than custodian; small partnership exception applicable) with Primco Management Co. v. Commis- sioner, T.C. Memo. 1997–332 (grantor trust holding legal title to an interest in an S corporation was a “pass-thru shareholder”; small S corporation exception under the parallel provisions of section 301.6241–1T(c)(2)(iii) inapplicable). Section 6231(a)(10) defines an indirect partner as a person holding an interest in a partnership through one or more pass-thru partners.

Section 301.7701–3(a) provides rules for the classification of certain business entities for federal tax purposes. A business entity that is not classified as a corporation is a “domestic eligible entity” and, in the absence of an election, the domestic eligible entity is “[d]isregarded as an entity separate from its owner if it has a single owner.” Section 301.7701–3(b)(1)(ii). If the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner. Section 301.7701–2(a).

Under the facts of this ruling, although LLC is a disregarded entity for federal tax purposes, LLC is a partner of P un

der the law of the state in which P is organized. Similarly, although A, LLC’s owner, is a partner of P for purposes of the TEFRA partnership provisions under section 6231(a)(2)(B) because A’s income tax liability is determined by taking into account indirectly the partnership items of P, A is not a partner of P under state law. Because A holds an interest in P through LLC, A is an indirect partner and LLC, the disregarded entity, is a pass-thru partner under the TEFRA partnership provisions. Consequently, the small partnership exception does not apply to P because P has a partner that is a pass-thru partner.

Issue 2

Section 6231(a)(7) provides that the TMP of any partnership is (A) the general partner designated as the tax matters partner, or (B) if there is no general partner who has been so designated, the general partner having the largest profits interest in the partnership. If no general partner has been designated as the TMP and the Secretary determines that it is impracticable to apply the largest profits interest rule, the partner selected by the Secretary shall be treated as the tax matters partner.

Section 301.6231(a)(7)–1(b) provides that the partnership may designate a person as the TMP of a partnership if that person (i) was a general partner in the partnership at some time during the taxable year for which the designation is made, or (ii) is a general partner in the partnership at the time the designation is made. A partnership may designate only a general partner as the TMP because only a general partner is authorized to bind the partnership. A partner’s status as a general partner is determined under state law for this purpose. Transpac Drilling Venture, 1983–63 v. United States, 26 Cl. Ct. 1245, 1247 (1992). Although the regulations under sections 301.7701–1 through 301.7701–3 provide that a disregarded entity is disregarded for all federal tax purposes, these regulations do not alter state law, which determines a partner’s status as a general partner.

Under the facts of this ruling, A, LLC’s owner, does not become a general partner under state law by operation of sections 301.7701–1 through 301.7701–3. Although LLC is a disregarded entity for federal tax purposes, LLC remains a part

2004–32 I.R.B. 166 August 9, 2004

Section 7701.—Definitions

26 CFR 301.7701–1: Classification of organizations for federal tax purposes. 26 CFR 301.7701–2: Business entities; definitions. 26 CFR 301.7701–3: Classification of business enti- ties.

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

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

ner in P and is the sole general partner authorized to bind the partnership under state law. A has no power to bind other partners as a general partner under state law. Accordingly, A cannot step into the shoes of LLC, the disregarded entity, as the TMP. See Transpac Drilling Venture, 1983–63, 26 Cl. Ct. at 1248 (limited partner could not be the TMP because limited partner was not a general partner under Delaware law). See also Montana Sap- phire Associates, Ltd. v. Commissioner, 95 T.C. 477, 481 (1990) (partnership could not designate a person who was not a member of the partnership as the TMP). Thus, only LLC, the disregarded entity, is eligible to be designated by P as its TMP or to become the TMP under the largest profits interest rule.

HOLDINGS

LLC, a disregarded entity for federal tax purposes, is a pass-thru partner under section 6231(a)(9). Consequently, because P has a pass-thru partner, LLC, as a partner, the small partnership exception

to the TEFRA partnership provisions does not apply to the partnership.

LLC, a disregarded entity for federal tax purposes, but a general partner of P under state law, may be designated the TMP of P, a partnership subject to the TEFRA partnership provisions.

DRAFTING INFORMATION

The principal author of this revenue ruling is William Heard of the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact Mr. Heard at (202) 622–7950 (not a toll-free call).

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of August 2004. See Rev. Rul. 2004-84, page 163.

August 9, 2004 167 2004–32 I.R.B.