Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 59.—Other Definitions and Special Rules

26 CFR 1.59–1: Optional 10-year writeoff of certain tax preferences.

T.D. 9168

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

Optional 10-Year Writeoff of Certain Tax Preferences

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

SUMMARY: This document contains final regulations relating to the optional 10-year writeoff of certain tax preference items under section 59(e) of the Internal Revenue Code (Code). The final regulations affect taxpayers who utilize section 59(e) for the optional 10-year writeoff of certain tax preferences. These final regulations provide guidance on the time and manner of making an election under section 59(e). The regulations also provide guidance on revoking an election under section 59(e). The regulations reflect changes to the law made by the Tax Reform Act of 1986, the Technical and Miscellaneous Revenue Act of 1988, and the Omnibus Budget Reconciliation Act of 1989.

DATES: Effective Date: These regulations are effective December 22, 2004.

Applicability Date: These regulations apply to a section 59(e) election made for a taxable year ending, or a request to revoke a section 59(e) election submitted, on or after December 22, 2004.

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 1545–1903. Responses to this collection of information are required to obtain the benefit of the section 59(e) election.

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 one hour.

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

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

Background

This document contains amendments to 26 CFR part 1 under section 59(e) of the Code. Section 59(e)(1) allows taxpayers to elect to deduct any qualified expenditure ratably over a 10-year period (3-year period in the case of circulation expenditures described in section 173) beginning with the taxable year in which the expenditure was made (or, in the case of a qualified expenditure under section 263(c), over the 60-month period beginning with the month in which such expenditure was paid or incurred). Section 59(e)(2) defines qualified expenditure as any amount that, but for an election under section 59(e), would have been allowed as a deduction (determined without regard to section 291) for the taxable year in which paid or incurred under section 173 (relating to circulation expenditures), section

174 (relating to research and experimental expenditures), section 263(c) (relating to intangible drilling and development expenditures), section 616(a) (relating to development expenditures), or section 617(a) (relating to mining exploration expenditures).

Section 59(e)(4)(A) states that an election under section 59(e) (section 59(e) election) may be made with respect to any portion of any qualified expenditure. The legislative history of section 59(e) suggests that this allows a section 59(e) election to be made “dollar for dollar.” See H.R. Rep. 99–426, 99th Cong., 1st Sess. 327 (1985), 1986–3 (Vol. 2) C.B. 1, 327; S. Rep. No. 99–313, 99th Cong., 2d Sess. 539 (1986), 1986–3 (Vol. 3) C.B. 1, 539. Section 59(e)(4)(B) states that a section 59(e) election may only be revoked with the consent of the Secretary.

Provisions similar to those currently contained in section 59(e) were originally enacted as section 58(i) under the Tax Equity and Fiscal Responsibility Act of 1982 (Public Law 97–248; 96 Stat. 324). Under section 58(i)(1), the optional 10-year writeoff was available only to individuals. Section 58(i)(5)(C) directed the Secretary to promulgate regulations governing the time and manner for making an election under section 58(i) (section 58(i) election).

Section 5f.0(a)(2)(i)(A) and (B) of the temporary Income Tax Regulations that were promulgated under section 58(i) required that a section 58(i) election be made by the later of the due date (including extensions) of the income tax return for the taxable year for which the election was to be effective, or April 15, 1983. T.D. 7870, 1983–1 C.B. 13 [48 FR 1486]. Section 5f.0(a)(3) provided that a section 58(i) election was made by attaching a statement to the income tax return (or amended return) for the taxable year in which the election was made. Section 5f.0 was redesignated as §301.9100–5T by T.D. 8435, 1992–2 C.B. 324 [57 FR 43893], on October 15, 1992.

Section 59(e) was enacted as part of the Tax Reform Act of 1986 (Public Law 99–514; 100 Stat. 2085) and, unlike section 58(i), is not limited to individuals. While both the Senate Finance Committee

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The preamble to the proposed regulations stated that, with respect to an otherwise valid section 59(e) election filed for a taxable year ending prior to the effective date of the final regulations, such election would not be challenged by the IRS merely because the election was made later than the date prescribed by law for filing the taxpayer’s original income tax return (including any extensions of time) for the taxable year in which the amortization of the qualified expenditures subject to the section 59(e) election begins. One commentator requested guidance on what the IRS considers an otherwise valid section 59(e) election filed for a tax year ending prior to the effective date of the final regulations. Although the IRS will treat a section 59(e) election prepared in a manner described in the final regulations as sufficient for a tax year ending prior to the effective date of the final regulations, because the final regulations only apply prospectively the final regulations do not provide guidance on what constitutes an otherwise valid section 59(e) election filed for a tax year prior to the effective date of the final regulations.

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. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that the reporting burden, as discussed earlier in this preamble, is expected to be insignificant. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding this regulation 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 final regulations is Eric B. Lee of the Office of As

Report and the House Ways and Means Committee Report state that the time and manner of the election would be governed by regulations, Congress did not include a provision similar to former section 58(i)(5)(C) directing the Secretary to promulgate regulations governing the time and manner for making a section 59(e) election. See H.R. Rep. No. 99–426, 99th Cong., 1st Sess. 327 (1985), 1986–3 (Vol. 2) C.B. 1, 327; S. Rep. No. 99–313, 99th Cong., 2d Sess. 539 (1986), 1986–3 (Vol. 3) C.B. 1, 539. A notice of proposed rulemaking (REG–124405–03, 2004–35 I.R.B. 394

[69 FR 43367]) was published in the Fed- eral Register on July 20, 2004. Two requests for a public hearing were received. A public hearing was held on December 7, 2004. The IRS received written and electronic comments responding to the notice of proposed rulemaking. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury decision. The revisions are discussed below.

Summary of Comments and Explanation of Revisions

Several commentators recommended changes regarding the information taxpayers would be required to submit as part of their section 59(e) election. Specifically, commentators requested that the IRS reconsider §1.59–1(b)(1)(ii) and (iii) of the proposed regulations, which would require taxpayers to identify (i) the type and amount, for each activity or project, of qualified expenditures identified in section 59(e)(2) the taxpayer elects to deduct ratably over the applicable period described in section 59(e)(1), and (ii) a description of each specific activity or project to which the qualified expenditures relate. The commentators suggest that the majority of taxpayers who incur research and experimentation expenditures under section 174(a) and make a section 59(e) election with respect to such expenditures do not currently maintain records on a project-by-project basis. As a result, the commentators stated that requiring taxpayers to account for their section 59(e) qualified expenditures on a project-by-project basis would be a financial and administrative burden. Some of the commentators also discussed section

1016(a)(20), which provides that proper adjustment in respect of the property shall in all cases be made for amounts allowed as deductions under section 59(e) (relating to optional 10-year writeoff of certain tax preferences). Compliance with section 1016(a)(20) requires that taxpayers be able to account for their section 59(e) expenditures through appropriate basis adjustments for each property, project, or activity.

Sections 1.59–1(b)(1)(ii) and (iii) of the proposed regulations were intended to improve compliance with section 1016(a)(20) by requiring that section 59(e) qualified expenditures be allocated among the properties, projects or activities to which they relate. Comments received regarding this provision indicate that, for taxpayers incurring section 174(a) expenditures, the basis rules of section 1016(a)(20) are only of importance when a project to which a section 59(e) election relates is disposed of, and that it is rare for a research project to be disposed of prior to the full amortization of the allocable section 59(e) qualified expenditures. As such, the commentators argue that the burden of requiring taxpayers to identify on a section 59(e) election the type and amount of qualified expenditures for each activity or project greatly exceeds the potential harm caused by non-compliance with section 1016(a)(20).

Having fully considered all comments received, the final regulations are modified to reflect the comments discussed above. Taxpayers making a section 59(e) election will not be required to identify on the election the type and amount of qualified expenditures for each activity or project nor will they be required to provide a description of each specific activity or project to which the qualified expenditures relate. Instead, taxpayers will be required only to identify the type and amount of qualified expenditures identified in section 59(e)(2) that the taxpayer elects to deduct ratably over the applicable period described in section 59(e)(1). However, taxpayers remain responsible for full compliance with the requirements of section 1016(a)(20). Specifically, taxpayers who allocate their section 59(e) expenditures to reduce the gain otherwise recognized on the disposition of a property, project, or activity must maintain books and records sufficient to support that allocation.

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in section 59(e)(1) ends. The application for consent to revoke the election must be submitted to the Internal Revenue Service in the form of a letter ruling request.

(3) Information to be provided . A request to revoke a section 59(e) election must contain all of the information necessary to demonstrate the rare and unusual circumstances that would justify granting revocation.

(4) Treatment of unamortized costs . The unamortized balance of the qualified expenditures subject to the revoked section 59(e) election as of the first day of the taxable year the revocation is effective is deductible in the year the revocation is effective (subject to the requirements of any other provision under the Code, regulations, or any other published guidance) and the taxpayer will be required to amend any federal income tax returns affected by the revocation.

(d) Effective date . These regulations apply to a section 59(e) election made for a taxable year ending, or a request to revoke a section 59(e) election submitted, on or after December 22, 2004.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 3. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 4. 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.

sociate Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.

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Adoption of Amendments to the Regulations

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

Paragraph 1. The authority citation for part 1 reads, in part, as follows:

Authority: 26 U.S.C. 7805, * * * Par. 2. Section 1.59–1 is added to read as follows:

§1.59–1 Optional 10-year writeoff of certain tax preferences.

(a) In general . Section 59(e) allows any qualified expenditure to which an election under section 59(e) applies to be deducted ratably over the 10-year period (3-year period in the case of circulation expenditures described in section 173) beginning with the taxable year in which the expenditure was made (or, in the case of intangible drilling and development costs deductible under section 263(c), over the 60-month period beginning with the month in which the expenditure was paid or incurred).

(b) Election —(1) Time and manner of election . An election under section 59(e) shall only be made by attaching a statement to the taxpayer’s income tax return (or amended return) for the taxable year in which the amortization of the qualified expenditures subject to the section 59(e) election begins. The statement must be filed no later than the date prescribed by law for filing the taxpayer’s original income tax return (including any extensions of time) for the taxable year in which the

CFR part or section where identified and described

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amortization of the qualified expenditures subject to the section 59(e) election begins. Additionally, the statement must include the following information —

(i) The taxpayer’s name, address, and taxpayer identification number; and

(ii) The type and amount of qualified expenditures identified in section 59(e)(2) that the taxpayer elects to deduct ratably over the applicable period described in section 59(e)(1).

(2) Elected amount . A taxpayer may make an election under section 59(e) with respect to any portion of any qualified expenditure paid or incurred by the taxpayer in the taxable year to which the election applies. An election under section 59(e) must be for a specific dollar amount and the amount subject to an election under section 59(e) may not be made by reference to a formula. The amount elected under section 59(e) is properly chargeable to a capital account under section 1016(a)(20), relating to adjustments to basis of property.

(c) Revocation —(1) In general . An election under section 59(e) may be revoked only with the consent of the Commissioner. Such consent will only be granted in rare and unusual circumstances. The revocation, if granted, will be effective in the first taxable year in which the section 59(e) election was applicable. However, if the period of limitations for the first taxable year the section 59(e) election was applicable has expired, the revocation, if granted, will be effective in the earliest taxable year for which the period of limitations has not expired.

(2) Time and manner for requesting consent . A taxpayer requesting the Commissioner’s consent to revoke a section 59(e) election must submit the request prior to the end of the taxable year the applicable amortization period described

1.59–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1903

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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

Section 330 of title 31 of the United States Code authorizes the Secretary of the Treasury to regulate practice before the Treasury Department. The Secretary has published the regulations in Circular 230 (31 CFR part 10). On December 30, 2003, the Treasury Department and the IRS published in the Federal Register (68 FR 75186) proposed amendments to the regulations (REG–122379–02, 2004–5 I.R.B. 392) (the proposed regulations) to set forth best practices for tax advisors providing advice to taxpayers relating to Federal tax issues or submissions to the IRS and to modify the standards for certain tax shelter opinions. A public hearing was held on February 19, 2004. Written public comments responding to the proposed regulations were received. After thorough consideration of the public comments, the proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

Tax advisors play a critical role in the Federal tax system, which is founded on principles of compliance and voluntary self-assessment. The tax system is best served when the public has confidence in the honesty and integrity of the professionals providing tax advice. To restore, promote, and maintain the public’s confidence in those individuals and firms, these final regulations set forth best practices applicable to all tax advisors. These regulations also provide mandatory requirements for practitioners who provide covered opinions. The scope of these regulations is limited to practice before the IRS. These regulations do not alter or supplant other ethical standards applicable to practitioners.

On October 22, 2004, the President signed the American Jobs Creation Act of 2004, Public Law 108–357 (118 Stat. 1418) (the Act), which amended section 330 of title 31 of the United States Code to clarify that the Secretary may impose standards for written advice relating to a

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

Approved December 15, 2004.

Gregory F. Jenner, Acting Assistant Secretary of the

Treasury (Tax Policy) .

(Filed by the Office of the Federal Register on December 21, 2004, 8:45 a.m., and published in the issue of the Federal Register for December 22, 2004, 69 F.R. 76614)

Section 330 (31 USC).—Best Practices for Tax Advisors

31 CFR 10.33: Best practices for tax advisors.

T.D. 9165

DEPARTMENT OF THE TREASURY Office of the Secretary 31 CFR Part 10

Regulations Governing Practice Before the Internal Revenue Service

AGENCY: Office of the Secretary, Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations revising the regulations governing practice before the Internal Revenue Service (Circular 230). These regulations affect individuals who practice before the Internal Revenue Service. These final regulations set forth best practices for tax advisors providing advice to taxpayers relating to Federal tax issues or submissions to the IRS. These final regulations also provide standards for covered opinions and other written advice.

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

Applicability Date : For dates of applicability, see §§10.33(c), 10.35(g), 10.36(b), 10.37(b), 10.38(b), 10.52(b) and 10.93.

FOR FURTHER INFORMATION CONTACT: Heather L. Dostaler at (202)

622–4940, or Brinton T. Warren at (202) 622–7800 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545–1871. The collections of information (disclosure requirements) in these final regulations are in §10.35(e). Section 10.35(e) requires a practitioner providing a covered opinion to make certain disclosures in the beginning of marketed opinions, limited scope opinions and opinions that fail to conclude at a confidence level of at least more likely than not. In addition, certain relationships between the practitioner and a person promoting or marketing a tax shelter must be disclosed. A practitioner may be required to make one or more disclosures. The collection of this material helps to ensure that taxpayers who receive a tax shelter opinion are informed of any facts or circumstances that might limit the use of the opinion. The collection of information is mandatory.

Estimated total annual disclosure burden is 13,333 hours.

Estimated annual burden per disclosing practitioner varies from 5 to 10 minutes, depending on individual circumstances, with an estimated average of 8 minutes.

Estimated number of disclosing practitioners is 100,000.

Estimated annual frequency of responses is on occasion.

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.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503. Books or records relating to a collection of information must

January 24, 2005 357 2005–4 I.R.B.

that are included in offering materials, including an official statement, are excluded from the definition of covered opinions in these final regulations. Thus, State or local bond opinions included in offering materials will not be subject to the opinion standards of §10.35 or proposed §10.39 until 120 days after the proposed regulations are finalized.

The exclusion for State or local bond opinions applies only to the requirements for covered opinions set forth in §10.35. State or local bond opinions are subject to the standards set forth in §10.37 relating to requirements for other written advice, and practitioners who prepare bond opinions must comply with any other applicable requirement provided in Circular 230.

Requirements for Covered Opinions

In general, the requirements for all covered opinions are adopted as proposed. The final regulations provide that a practitioner providing a covered opinion, including a marketed opinion, must not assume that a transaction has a business purpose or is potentially profitable apart from tax benefits, or make an assumption with respect to a material valuation issue.

Required Disclosures

In general, the required disclosures of §10.35(e) are adopted as proposed. These disclosures ensure that taxpayers receive information that is necessary to their evaluation of, and reliance on, a covered opin- ion .

Requirements for other written advice

The final regulations also set forth requirements for written advice that is not a covered opinion . Under §10.37, a practitioner must not give written advice if the practitioner: (1) bases the written advice on unreasonable factual or legal assumptions; (2) unreasonably relies upon representations, statements, findings or agreements of the taxpayer or any other person; (3) fails to consider all relevant facts; or (4) takes into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or that an issue will be settled. Section 10.37, unlike §10.35, does not require that the practitioner describe in the written advice the relevant facts (including assumptions and

matter that is identified as having a potential for tax avoidance or evasion. The Act also authorizes the Treasury Department and the IRS to impose a monetary penalty against a practitioner who violates any provision of Circular 230. These final regulations do not reflect amendments made by the Act. The Treasury Department and the IRS expect to propose additional regulations implementing the Act’s provisions.

Best Practices

The final regulations adopt the best practices set forth in the proposed regulations with modifications. These best practices are aspirational. A practitioner who fails to comply with best practices will not be subject to discipline under these regulations. Similarly, the provision relating to steps to ensure that a firm’s procedures are consistent with best practices, now set forth in §10.33(b), is aspirational. Although best practices are solely aspirational, tax professionals are expected to observe these practices to preserve public confidence in the tax system.

Standards for Covered Opinions

The opinion standards of §10.35 are adopted with modifications. The provisions of §10.35 in the final regulations are reorganized to clarify the provisions. Opinions subject to §10.35 are defined as covered opinions .

Definition of Covered Opinion

Under the final regulations, the definition of a covered opinion includes written advice (including electronic communications) that concerns one or more Federal tax issue(s) arising from: (1) a listed transaction; (2) any plan or arrangement, the principal purpose of which is the avoidance or evasion of any tax; or (3) any plan or arrangement, a significant purpose of which is the avoidance or evasion of tax if the written advice (A) is a reliance opinion, (B) is a marketed opinion, (C) is subject to conditions of confidentiality, or (D) is subject to contractual protection. A reliance opinion is written advice that concludes at a confidence level of at least more likely than not that one or more significant Federal tax issues would be resolved in the taxpayer’s favor.

Written advice will not be treated as a reliance opinion if the practitioner prominently discloses in the written advice that it was not written to be used and cannot be used for the purpose of avoiding penalties. Similarly, written advice generally will not be treated as a marketed opinion if it does not concern a listed transaction or a plan or arrangement having the principal purpose of avoidance or evasion of tax and the written advice contains this disclosure. The Treasury Department and the IRS intend to amend 26 CFR 1.6664–4 to clarify that a taxpayer may not rely upon written advice that contains this disclosure to establish the reasonable cause and good faith defense to the accuracy-related penalties.

Written advice regarding a plan or arrangement having a significant purpose of tax avoidance or evasion is excluded from the definition of a covered opinion if the written advice concerns the qualification of a qualified plan or is included in documents required to be filed with the Securities and Exchange Commission. The final regulations also adopt an exclusion for preliminary advice if the practitioner is reasonably expected to provide subsequent advice that satisfies the requirements of the regulations.

Written advice that is not a covered opinion for purposes of §10.35 is subject to the standards set forth in new §10.37.

Municipal Bond Opinions

After careful consideration, the Treasury Department and the IRS have concluded that practitioners rendering opinions concerning the tax treatment of municipal bonds should be subject to the same professional standards that are applicable to all other practitioners. The standards for certain opinions concerning the tax treatment of municipal bonds ( State or local bond opinions ) that are included in offering materials that otherwise would be covered opinions are being issued separately in proposed form. The proposed standards will require practitioners to exercise the same degree of diligence with respect to ascertaining the relevant facts and discussing the significant Federal tax issues, but will take into account the unique circumstances of the municipal bond market.

To give bond practitioners an opportunity to comment on the proposed standards for State or local bond opinions, opinions

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representation concerning Federal tax issues by adhering to best practices in providing advice and in preparing or assisting in the preparation of a submission to the Internal Revenue Service. In addition to compliance with the standards of practice provided elsewhere in this part, best practices include the following:

(1) Communicating clearly with the client regarding the terms of the engagement. For example, the advisor should determine the client’s expected purpose for and use of the advice and should have a clear understanding with the client regarding the form and scope of the advice or assistance to be rendered.

(2) Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.

(3) Advising the client regarding the import of the conclusions reached, including, for example, whether a taxpayer may avoid accuracy-related penalties under the Internal Revenue Code if a taxpayer acts in reliance on the advice.

(4) Acting fairly and with integrity in practice before the Internal Revenue Service.

(b) Procedures to ensure best practices for tax advisors . Tax advisors with responsibility for overseeing a firm’s practice of providing advice concerning Federal tax issues or of preparing or assisting in the preparation of submissions to the Internal Revenue Service should take reasonable steps to ensure that the firm’s procedures for all members, associates, and employees are consistent with the best practices set forth in paragraph (a) of this section.

(c) Applicability date . This section is effective after June 20, 2005.

Par. 3. Sections 10.35, 10.36, 10.37 and 10.38 are added to subpart B to read as follows:

§10.35 Requirements for covered opinions.

(a) A practitioner who provides a covered opinion shall comply with the standards of practice in this section.

(b) Definitions . For purposes of this subpart—

representations), the application of the law to those facts, or the practitioner’s conclusion with respect to the law and the facts. The scope of the engagement and the type and specificity of the advice sought by the client, in addition to all other facts and circumstances, will be considered in determining whether a practitioner has failed to comply with the requirements of §10.37.

Procedures to Ensure Compliance

In general, the procedures to ensure compliance with requirements of §10.35 are adopted as proposed and set forth in §10.36.

Advisory Committees on the Integrity of Tax Professionals

Newly designated §10.38, formerly §10.37 in the proposed regulations, is adopted as proposed with the following modifications. Section 10.38 is modified to clarify that an advisory committee may not make recommendations about actual practitioner cases, or have access to information pertaining to actual cases. The section also is modified to clarify that the Director of the Office of Professional Responsibility should ensure that membership of these committees is balanced among those individuals who practice as attorneys, accountants and enrolled agents.

Applicability Dates

To eliminate any adverse impact that the adoption of the new requirements for covered opinions or other written advice could have on pending or imminent transactions, the applicability date of the standards for covered opinions under §10.35 and other written advice under §10.37 (and the procedures to ensure compliance as they relate to covered opinions under §10.36) is June 20, 2005.

Special Analyses

It has been determined that this final rule is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. Persons authorized to practice before the IRS have long been

required to comply with certain standards of conduct. The added disclosure requirements for tax shelter opinions imposed by these regulations will not have a significant economic impact on a substantial number of small entities because, as previously noted, the estimated burden of disclosures is minimal. Practitioners have the information needed to determine whether any of the disclosures will be required before the opinion is prepared and, for some disclosures, the regulations provide practitioners with the language to be included in the opinion. Therefore, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the proposed regulations preceding these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Drafting Information

The principal authors of the regulations are Heather L. Dostaler and Brinton T. Warren of the Office of the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division.

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Adoption of Amendments to the Regulations

Accordingly, 31 CFR part 10 is amended as follows:

PART 10 — PRACTICE BEFORE THE INTERNAL REVENUE SERVICE

Paragraph 1. The authority citation for subtitle A, part 10 continues to read as follows:

[Authority: Sec. 3, 23 Stat. 258, secs. 2–12, 60 Stat. 237 et seq. ; 5 U.S.C. 301, 500, 551–559; 31 U.S.C. 330, as amended by P.L. 108–357, 118 Stat. 1418; Reorg. Plan No. 26 of 1950, 15 FR 4935, 64 Stat. 1280, 3 CFR, 1949–1953 Comp., P. 1017.] Par. 2. Section 10.33 is revised to read as follows:

§10.33 Best practices for tax advisors.

(a) Best practices . Tax advisors should provide clients with the highest quality

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(C) The taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.

(6) Conditions of confidentiality . Written advice is subject to conditions of con- fidentiality if the practitioner imposes on one or more recipients of the written advice a limitation on disclosure of the tax treatment or tax structure of the transaction and the limitation on disclosure protects the confidentiality of that practitioner’s tax strategies, regardless of whether the limitation on disclosure is legally binding. A claim that a transaction is proprietary or exclusive is not a limitation on disclosure if the practitioner confirms to all recipients of the written advice that there is no limitation on disclosure of the tax treatment or tax structure of the transaction that is the subject of the written advice.

(7) Contractual protection . Written advice is subject to contractual protection if the taxpayer has the right to a full or partial refund of fees paid to the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) if all or a part of the intended tax consequences from the matters addressed in the written advice are not sustained, or if the fees paid to the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) are contingent on the taxpayer’s realization of tax benefits from the transaction. All the facts and circumstances relating to the matters addressed in the written advice will be considered when determining whether a fee is refundable or contingent, including the right to reimbursements of amounts that the parties to a transaction have not designated as fees or any agreement to provide services without reasonable compensation.

(8) Prominently disclosed . An item required to be prominently disclosed must be set forth in a separate section at the beginning of the written advice in a bolded typeface that is larger than any other typeface used in the written advice.

(9) State or local bond opinion . A State or local bond opinion is written advice with respect to a Federal tax issue included in any materials delivered to a purchaser of a State or local bond in connection with the issuance of the bond in a public or private offering, including an official statement (if one is prepared), that concerns only the excludability of interest on a State or local

(1) A practitioner includes any individual described in §10.2(e).

(2) Covered opinion —(i) In general . A covered opinion is written advice (including electronic communications) by a practitioner concerning one or more Federal tax issues arising from—

(A) A transaction that is the same as or substantially similar to a transaction that, at the time the advice is rendered, the Internal Revenue Service has determined to be a tax avoidance transaction and identified by published guidance as a listed transaction under 26 C.F.R. §1.6011–4(b)(2);

(B) Any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, the principal purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code; or

(C) Any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code if the written advice—

( 1 ) Is a reliance opinion ; ( 2 ) Is a marketed opinion ; ( 3 ) Is subject to conditions of confiden- tiality ; or

( 4 ) Is subject to contractual protection . (ii) Excluded advice . A covered opinion does not include—

(A) Written advice provided to a client during the course of an engagement if a practitioner is reasonably expected to provide subsequent written advice to the client that satisfies the requirements of this section; or

(B) Written advice, other than advice described in paragraph (b)(2)(i)(A) of this section (concerning listed transactions) or paragraph (b)(2)(i)(B) of this section (concerning the principal purpose of avoidance or evasion) that—

( 1 ) Concerns the qualification of a qualified plan;

( 2 ) Is a State or local bond opinion ; or ( 3 ) Is included in documents required to be filed with the Securities and Exchange Commission.

(3) A Federal tax issue is a question concerning the Federal tax treatment of an item of income, gain, loss, deduction, or credit, the existence or absence of a taxable transfer of property, or the value of property for Federal tax purposes. For purposes of this subpart, a Federal tax issue is signif

icant if the Internal Revenue Service has a reasonable basis for a successful challenge and its resolution could have a significant impact, whether beneficial or adverse and under any reasonably foreseeable circumstance, on the overall Federal tax treatment of the transaction(s) or matter(s) addressed in the opinion.

(4) Reliance opinion —(i) Written advice is a reliance opinion if the advice concludes at a confidence level of more likely than not (a greater than 50 percent likelihood) that one or more significant Federal tax issues would be resolved in the taxpayer’s favor.

(ii) For purposes of this section, written advice, other than advice described in paragraph (b)(2)(i)(A) of this section (concerning listed transactions) or paragraph (b)(2)(i)(B) of this section (concerning the principal purpose of avoidance or evasion), is not treated as a reliance opinion if the practitioner prominently discloses in the written advice that it was not intended or written by the practitioner to be used, and that it cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

(5) Marketed opinion —(i) Written advice is a marketed opinion if the practitioner knows or has reason to know that the written advice will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to one or more taxpayer(s).

(ii) For purposes of this section, written advice, other than advice described in paragraph (b)(2)(i)(A) of this section (concerning listed transactions) or paragraph (b)(2)(i)(B) of this section (concerning the principal purpose of avoidance or evasion), is not treated as a marketed opinion if the practitioner prominently discloses in the written advice that—

(A) The advice was not intended or written by the practitioner to be used, and that it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer;

(B) The advice was written to support the promotion or marketing of the transaction(s) or matter(s) addressed by the written advice; and

2005–4 I.R.B. 360 January 24, 2005

(iv) Marketed opinions . In the case of a marketed opinion, the opinion must provide the practitioner’s conclusion that the taxpayer will prevail on the merits at a confidence level of at least more likely than not with respect to each significant Federal tax issue. If the practitioner is unable to reach a more likely than not conclusion with respect to each significant Federal tax issue, the practitioner must not provide the marketed opinion, but may provide written advice that satisfies the requirements in paragraph (b)(5)(ii) of this section.

(v) Limited scope opinions . (A) The practitioner may provide an opinion that considers less than all of the significant Federal tax issues if—

( 1 ) The practitioner and the taxpayer agree that the scope of the opinion and the taxpayer’s potential reliance on the opinion for purposes of avoiding penalties that may be imposed on the taxpayer are limited to the Federal tax issue(s) addressed in the opinion;

( 2 ) The opinion is not advice described in paragraph (b)(2)(i)(A) of this section (concerning listed transactions), paragraph (b)(2)(i)(B) of this section (concerning the principal purpose of avoidance or evasion) or paragraph (b)(5) of this section (a mar- keted opinion ); and

( 3 ) The opinion includes the appropriate disclosure(s) required under paragraph (e) of this section.

(B) A practitioner may make reasonable assumptions regarding the favorable resolution of a Federal tax issue (an assumed issue) for purposes of providing an opinion on less than all of the significant Federal tax issues as provided in this paragraph (c)(3)(v). The opinion must identify in a separate section all issues for which the practitioner assumed a favorable resolution.

(4) Overall conclusion . (i) The opinion must provide the practitioner’s overall conclusion as to the likelihood that the Federal tax treatment of the transaction or matter that is the subject of the opinion is the proper treatment and the reasons for that conclusion. If the practitioner is unable to reach an overall conclusion, the opinion must state that the practitioner is unable to reach an overall conclusion and describe the reasons for the practitioner’s inability to reach a conclusion.

(ii) In the case of a marketed opinion, the opinion must provide the practitioner’s

bond from gross income under section 103 of the Internal Revenue Code, the application of section 55 of the Internal Revenue Code to a State or local bond, the status of a State or local bond as a qualified tax-exempt obligation under section 265(b)(3) of the Internal Revenue Code, the status of a State or local bond as a qualified zone academy bond under section 1397E of the Internal Revenue Code, or any combination of the above.

(c) Requirements for covered opinions . A practitioner providing a covered opinion must comply with each of the following requirements.

(1) Factual matters . (i) The practitioner must use reasonable efforts to identify and ascertain the facts, which may relate to future events if a transaction is prospective or proposed, and to determine which facts are relevant. The opinion must identify and consider all facts that the practitioner determines to be relevant.

(ii) The practitioner must not base the opinion on any unreasonable factual assumptions (including assumptions as to future events). An unreasonable factual assumption includes a factual assumption that the practitioner knows or should know is incorrect or incomplete. For example, it is unreasonable to assume that a transaction has a business purpose or that a transaction is potentially profitable apart from tax benefits. A factual assumption includes reliance on a projection, financial forecast or appraisal. It is unreasonable for a practitioner to rely on a projection, financial forecast or appraisal if the practitioner knows or should know that the projection, financial forecast or appraisal is incorrect or incomplete or was prepared by a person lacking the skills or qualifications necessary to prepare such projection, financial forecast or appraisal. The opinion must identify in a separate section all factual assumptions relied upon by the practitioner.

(iii) The practitioner must not base the opinion on any unreasonable factual representations, statements or findings of the taxpayer or any other person. An unreasonable factual representation includes a factual representation that the practitioner knows or should know is incorrect or incomplete. For example, a practitioner may not rely on a factual representation that a transaction has a business purpose if the representation does not include a specific

description of the business purpose or the practitioner knows or should know that the representation is incorrect or incomplete. The opinion must identify in a separate section all factual representations, statements or findings of the taxpayer relied upon by the practitioner.

(2) Relate law to facts . (i) The opinion must relate the applicable law (including potentially applicable judicial doctrines) to the relevant facts.

(ii) The practitioner must not assume the favorable resolution of any significant Federal tax issue except as provided in paragraphs (c)(3)(v) and (d) of this section, or otherwise base an opinion on any unreasonable legal assumptions, representations, or conclusions.

(iii) The opinion must not contain internally inconsistent legal analyses or conclusions.

(3) Evaluation of significant Federal tax issues —(i) In general . The opinion must consider all significant Federal tax issues except as provided in paragraphs (c)(3)(v) and (d) of this section.

(ii) Conclusion as to each significant Federal tax issue . The opinion must provide the practitioner’s conclusion as to the likelihood that the taxpayer will prevail on the merits with respect to each significant Federal tax issue considered in the opinion. If the practitioner is unable to reach a conclusion with respect to one or more of those issues, the opinion must state that the practitioner is unable to reach a conclusion with respect to those issues. The opinion must describe the reasons for the conclusions, including the facts and analysis supporting the conclusions, or describe the reasons that the practitioner is unable to reach a conclusion as to one or more issues. If the practitioner fails to reach a conclusion at a confidence level of at least more likely than not with respect to one or more significant Federal tax issues considered, the opinion must include the appropriate disclosure(s) required under paragraph (e) of this section.

(iii) Evaluation based on chances of success on the merits . In evaluating the significant Federal tax issues addressed in the opinion, the practitioner must not take into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or that an issue will be resolved through settlement if raised.

January 24, 2005 361 2005–4 I.R.B.

of this section is subject to the requirements of §10.37.

(g) Effective date . This section applies to written advice that is rendered after June 20, 2005.

§10.36 Procedures to ensure compliance.

(a) Requirements for covered opinions . Any practitioner who has (or practitioners who have or share) principal authority and responsibility for overseeing a firm’s practice of providing advice concerning Federal tax issues must take reasonable steps to ensure that the firm has adequate procedures in effect for all members, associates, and employees for purposes of complying with §10.35. Any such practitioner will be subject to discipline for failing to comply with the requirements of this paragraph if—

(1) The practitioner through willfulness, recklessness, or gross incompetence does not take reasonable steps to ensure that the firm has adequate procedures to comply with §10.35, and one or more individuals who are members of, associated with, or employed by, the firm are, or have, engaged in a pattern or practice, in connection with their practice with the firm, of failing to comply with §10.35; or

(2) The practitioner knows or should know that one or more individuals who are members of, associated with, or employed by, the firm are, or have, engaged in a pattern or practice, in connection with their practice with the firm, that does not comply with §10.35 and the practitioner, through willfulness, recklessness, or gross incompetence, fails to take prompt action to correct the noncompliance.

(b) Effective date . This section is applicable after June 20, 2005.

§10.37 Requirements for other written advice.

(a) Requirements . A practitioner must not give written advice (including electronic communications) concerning one or more Federal tax issues if the practitioner bases the written advice on unreasonable factual or legal assumptions (including assumptions as to future events), unreasonably relies upon representations, statements, findings or agreements of the taxpayer or any other person, does not consider all relevant facts that the practitioner knows or should know, or, in evaluating

overall conclusion that the Federal tax treatment of the transaction or matter that is the subject of the opinion is the proper treatment at a confidence level of at least more likely than not.

(d) Competence to provide opinion; re- liance on opinions of others . (1) The practitioner must be knowledgeable in all of the aspects of Federal tax law relevant to the opinion being rendered, except that the practitioner may rely on the opinion of another practitioner with respect to one or more significant Federal tax issues, unless the practitioner knows or should know that the opinion of the other practitioner should not be relied on. If a practitioner relies on the opinion of another practitioner, the relying practitioner’s opinion must identify the other opinion and set forth the conclusions reached in the other opinion.

(2) The practitioner must be satisfied that the combined analysis of the opinions, taken as a whole, and the overall conclusion, if any, satisfy the requirements of this section.

(e) Required disclosures . A covered opinion must contain all of the following disclosures that apply—

(1) Relationship between promoter and practitioner. An opinion must prominently disclose the existence of—

(i) Any compensation arrangement, such as a referral fee or a fee-sharing arrangement, between the practitioner (or the practitioner’s firm or any person who is a member of, associated with, or employed by the practitioner’s firm) and any person (other than the client for whom the opinion is prepared) with respect to promoting, marketing or recommending the entity, plan, or arrangement (or a substantially similar arrangement) that is the subject of the opinion; or

(ii) Any referral agreement between the practitioner (or the practitioner’s firm or any person who is a member of, associated with, or employed by the practitioner’s firm) and a person (other than the client for whom the opinion is prepared) engaged in promoting, marketing or recommending the entity, plan, or arrangement (or a substantially similar arrangement) that is the subject of the opinion.

(2) Marketed opinions . A marketed opinion must prominently disclose that—

(i) The opinion was written to support the promotion or marketing of the transac

tion(s) or matter(s) addressed in the opinion; and

(ii) The taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.

(3) Limited scope opinions . A limited scope opinion must prominently disclose that—

(i) The opinion is limited to the one or more Federal tax issues addressed in the opinion;

(ii) Additional issues may exist that could affect the Federal tax treatment of the transaction or matter that is the subject of the opinion and the opinion does not consider or provide a conclusion with respect to any additional issues; and

(iii) With respect to any significant Federal tax issues outside the limited scope of the opinion, the opinion was not written, and cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

(4) Opinions that fail to reach a more likely than not conclusion . An opinion that does not reach a conclusion at a confidence level of at least more likely than not with respect to a significant Federal tax issue must prominently disclose that—

(i) The opinion does not reach a conclusion at a confidence level of at least more likely than not with respect to one or more significant Federal tax issues addressed by the opinion; and

(ii) With respect to those significant Federal tax issues, the opinion was not written, and cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

(5) Advice regarding required disclo- sures . In the case of any disclosure required under this section, the practitioner may not provide advice to any person that is contrary to or inconsistent with the required disclosure.

(f) Effect of opinion that meets these standards —(1) In general . An opinion that meets the requirements of this section satisfies the practitioner’s responsibilities under this section, but the persuasiveness of the opinion with regard to the tax issues in question and the taxpayer’s good faith reliance on the opinion will be determined separately under applicable provisions of the law and regulations.

(2) Standards for other written advice . A practitioner who provides written advice that is not a covered opinion for purposes

2005–4 I.R.B. 362 January 24, 2005

Section 1372.—Partnership Rules to Apply for Fringe Benefit Purposes

A notice describes an S corporation’s contribution to the health savings account of a 2-percent shareholder-employee for services rendered to the S corporation. See Notice 2005-8, page 368.

Section 1374.—Tax Imposed on Certain Built-In Gains

26 CFR 1.1374–8: Section 1374(d)(8) transactions.

T.D. 9170

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Section 1374 Effective Dates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: These temporary regulations provide guidance concerning the applicability of section 1374 to S corporations that acquire assets in carryover basis transactions from C corporations on or after December 27, 1994, and to certain corporations that terminate S corporation status and later elect again to become S corporations. The text of the temporary regulations also serves as the text of the proposed regulations (REG–139683–04) set forth in the notice of proposed rulemaking on this subject in this issue of the Bulletin.

DATES: Effective Date : These regulations are effective December 22, 2004.

Applicability Date : Section 1.1374–8T applies to any transaction described in section 1374(d)(8) that occurs on or after December 27, 1994. Section 1.1374–10T applies for taxable years beginning after December 22, 2004. The applicability of §1.1374(d)–8T and §1.1374(d)–10T will expire on or before December 20, 2007.

FOR FURTHER INFORMATION CONTACT: Stephen R. Cleary, (202) 622–7750, (not a toll-free number).

a Federal tax issue, takes into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or that an issue will be resolved through settlement if raised. All facts and circumstances, including the scope of the engagement and the type and specificity of the advice sought by the client will be considered in determining whether a practitioner has failed to comply with this section. In the case of an opinion the practitioner knows or has reason to know will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) in promoting, marketing or recommending to one or more taxpayers a partnership or other entity, investment plan or arrangement a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code, the determination of whether a practitioner has failed to comply with this section will be made on the basis of a heightened standard of care because of the greater risk caused by the practitioner’s lack of knowledge of the taxpayer’s particular circumstances.

(b) Effective date . This section applies to written advice that is rendered after June 20, 2005.

§10.38 Establishment of Advisory Committees.

(a) Advisory committees . To promote and maintain the public’s confidence in tax advisors, the Director of the Office of Professional Responsibility is authorized to establish one or more advisory committees composed of at least five individuals authorized to practice before the Internal Revenue Service. The Director should ensure that membership of an advisory committee is balanced among those who practice as attorneys, accountants, and enrolled agents. Under procedures prescribed by the Director, an advisory committee may review and make general recommendations regarding professional standards or best practices for tax advisors, including whether hypothetical conduct would give rise to a violation of §§10.35 or 10.36.

(b) Effective date . This section applies after December 20, 2004.

Par. 4. Section 10.52 is amended to read as follows:

§10.52 Violation of regulations.

(a) Prohibited conduct . A practitioner may be censured, suspended or disbarred from practice before the Internal Revenue Service for any of the following:

(1) Willfully violating any of the regulations (other than §10.33) contained in this part; or

(2) Recklessly or through gross incompetence (within the meaning of §10.51(l)) violating §§10.34, 10.35, 10.36 or 10.37.

(b) Effective date . This section applies after June 20, 2005.

Par. 5. Section 10.93 is revised to read as follows:

§10.93 Effective date.

Except as otherwise provided in each section and subject to §10.91, Part 10 is applicable on July 26, 2002.

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

Approved December 8, 2004.

Arnold I. Havens, General Counsel, Department

of the Treasury .

(Filed by the Office of the Federal Register on December 17, 2004, 8:45 a.m., and published in the issue of the Federal Register for December 20, 2004, 69 F.R. 75839)

Section 707.—Transactions Between Partner and Partnership

A notice describes a partnership’s contribution to a partner’s health savings account treated as a section 707(c) distribution. See Notice 2005-8, page 368.

Section 731.—Extent of Recognition of Gain or Loss on Distribution

A notice describes a partnership’s contribution to a partner’s health savings account treated as a section 731 distribution. See Notice 2005-8, page 368.

January 24, 2005 363 2005–4 I.R.B.

some taxpayers contend that section 1374(d)(8) does not apply to carryover basis transfers from C corporations to S corporations that filed S elections before January 1, 1987, because the provisions in TAMRA that added section 1374(d)(8) indicated that the amendment was effective only if the return for the taxable year was filed pursuant to an S election made after December 31, 1986.

Section 337(d)(1) authorizes the Secretary to prescribe regulations to prevent the circumvention of the purposes of the repeal of the General Utilities doctrine through the use of any provision of law or regulations. The Treasury Department and the IRS believe that these temporary regulations are necessary to implement General Utilities repeal to prevent the use of corporations with pre–1987 S elections as a method for C corporations to transfer appreciated assets out of C corporation solution without gain recognition. Accordingly, these regulations confirm that section 1374(d)(8) applies to any transaction described in that section that occurs on or after December 27, 1994, the effective date of §1.1374–8, regardless of the date of the S corporation’s election under section 1362.

3. Revocation and Re-election of S Corporation Status

As discussed above, section 633(d)(8) of TRA, as amended by TAMRA, provides a transition rule granting a limited postponement of the general effective date of current section 1374 for qualified corporations that make an election to be an S corporation under section 1362 before January 1, 1989. In Colorado Gas Com- pression, Inc. v. Commissioner, 366 F.3d 863 (10 ^th Cir. 2004), reversing and re- manding 116 T.C. 1 (2001), a qualified corporation eligible for the special transition rule elected S corporation status on February 1, 1988 (before the extended effective date of January 1, 1989), revoked S status on December 1, 1989, and subsequently re-elected S status effective on January 1, 1994. During the years 1994 through 1996, the taxpayer sold assets. The Tax Court held that such sales were subject to current section 1374, and that the transition rule did not preclude the application of current section 1374 because the taxpayer’s most recent S election was

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

1. Section 1374 and its Effective Dates

Under the General Utilities doctrine, see General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), a C corporation, in certain cases, could distribute appreciated assets to its shareholders or sell appreciated assets without recognizing gain. Section 1374 of the Internal Revenue Code of 1986 (Code), amended in the Tax Reform Act of 1986 (TRA) as part of the repeal of the General Utilities doctrine, prevents a corporation from circumventing General Utilities repeal by converting to S corporation status before distributing appreciated assets to its shareholders or selling appreciated assets.

Section 1374 generally imposes a corporate level tax on an S corporation’s net recognized built-in gain attributable to assets that it held on the date it converted from a C corporation to an S corporation. This tax is imposed on built-in gain recognized during the 10-year period beginning on the first day the corporation is an S corporation. Section 1374(d)(8), which was added by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), imposes a corporate level tax on an S corporation’s net recognized built-in gain attributable to assets that it acquired in a carryover basis transaction from a C corporation for the 10-year recognition period beginning on the day of the carryover basis transaction.

Under section 1374(d)(9), which also was added by TAMRA, any reference in section 1374 to the first taxable year the corporation was an S corporation is a reference to the first taxable year it was an S corporation pursuant to its most recent S corporation election under section 1362.

Section 1019 of TAMRA states that, except as otherwise provided, any amendments made by TAMRA are effective as if included in the provision of TRA to which such amendment relates.

The current version of section 1374 replaced a prior version of section 1374 that generally only taxed income or gain recognized within the three year period following the date the corporation converted from C to S status. Section 633 of TRA,

as amended by TAMRA, provides the effective dates of the current version of section 1374. Specifically, section 633(b)(1) of TRA, as amended by TAMRA, provides that the amendments to section 1374 apply to taxable years beginning after December 31, 1986, but only in cases where the return for the taxable year is filed pursuant to an S election made after December 31, 1986. Section 633(d)(8) of TRA, as amended by TAMRA, provides a transition rule granting a limited postponement of the above effective date for “qualified corporations”, which are certain small corporations as defined in that section. Under the transition rule, if a C corporation that is a qualified corporation makes an election to be an S corporation under section 1362 before January 1, 1989, then it is subject to former section 1374 for dispositions of long-term capital gain assets and current section 1374 for dispositions of short-term capital gain assets and ordinary income assets, without regard to whether such corporation is completely liquidated.

2. Section 1374(d)(8)

As discussed above, the general effective date of current section 1374, which is contained in section 633(b)(1) of the TRA, as amended by TAMRA, provides that current section 1374 applies to tax years beginning after December 31, 1986, but only in cases where the return for the taxable year is filed pursuant to an S election made after December 31, 1986. In TAMRA, Congress added subsection (d)(8) to section 1374, and provided that the provision was effective as if included in TRA.

Section 1.1374–8 provides regulations interpreting section 1374(d)(8). Example 1 of §1.1374–8(d) applies section 1374(d)(8) to a merger of a C corporation into an S corporation that elected S status before the effective date of TRA amendments, as further amended by TAMRA, to section 1374. Section 1.1374–10(a) provides that §1.1374–8 applies for taxable years ending on or after December 27, 1994, but only in cases where the corporation’s tax return is filed pursuant to an S election or a section 1374(d)(8) transaction occurring after December 27, 1994 (emphasis added).

Despite the provisions of §1.1374–8 and the effective date provisions of §1.1374–10, the IRS understands that

2005–4 I.R.B. 364 January 24, 2005

Section 1.1374–8T also issued under 26 U.S.C. 337(d) and 1374(e).* * *

Section 1.1374–10T also issued under 26 U.S.C. 337(d) and 1374(e).* * * Par. 2. Section 1.1374–8 is amended by redesignating paragraph (a) as paragraph (a)(1) and adding paragraph (a)(2) to read as follows:

§1.1374–8 Section 1374(d)(8) transactions.

(a)(1) * - (2) (Reserved) For further guidance, see §1.1374–8T(a)(2).

• • • • Par. 3. Section 1.1374–8T is added to read as follows:

§1.1374–8T Section 1374(d)(8) transactions (temporary).

(a)(1) (Reserved) For further guidance, see §1.1374–8(a).

(2) Section 1374(d)(8) applies to any section 1374(d)(8) transaction, as defined in paragraph (a)(1) of this regulation, that occurs on or after December 27, 1994, without regard to the date of the corporation’s election to be an S corporation under section 1362.

(b) through (d) (Reserved) For further guidance, see §1.1374–8(b) through (d).

Par. 4. Section 1.1374–10 is amended by adding paragraph (c) to read as follows:

§1.1374–10 Effective date and additional rules.

• • • • (c) (Reserved) For further guidance, see §1.1374–10T(c).

Par. 5. Section 1.1374–10T is added to read as follows:

§ 1.1374–10T Effective date and additional rules (temporary) .

(a) through (b)(4) (Reserved) For further guidance, see § 1.1374–10(a) through (b)(4).

(c) Revocation and re-election of S cor- poration status —(1) In general . For purposes of section 633(d)(8) of the Tax Reform Act of 1986, as amended, any reference to an election to be an S corporation under section 1362 shall be treated as a reference to the corporation’s most recent election to be an S corporation under

made after 1989. The Tax Court concluded that section 1374(d)(9) requires that the 1994 election, the taxpayer’s most recent election, be the election considered for effective date purposes. The Tenth Circuit reversed the Tax Court, holding that, because the 1988 election was made before the extended effective date, the corporation was exempt from current section 1374 despite the intervening revocation of S status.

The Treasury Department and the IRS believe that the Tenth Circuit’s holding is inconsistent with the legislative history and underlying policy of section 633 of TRA, as amended by TAMRA, and believe the Tax Court was correct in holding that a corporation’s most recent S election must have been made before the deadline of the transition rule ( i.e., before January 1, 1989) in order for the corporation to be entitled to the benefit of the transition rule. As indicated above, section 337(d)(1) authorizes the Secretary to prescribe regulations to prevent the circumvention of the purposes of the repeal of the General Util- ities doctrine through the use of any provision of law or regulations. The Treasury Department and the IRS believe that these temporary regulations are necessary to implement General Utilities repeal to prevent avoidance of corporate level tax on appreciation in the assets of a C corporation attributable to periods after the extended effective date of January 1, 1989. Accordingly, these regulations provide that the transition rule regarding qualified corporations in section 633(d)(8) of TRA, as amended by TAMRA, applies only if the corporation’s most recent S election was made before January 1, 1989. Although these regulations apply to built-in gain recognized in taxable years beginning after December 22, 2004, the IRS will continue to assert this position for prior taxable years.

In summary, the temporary regulations provide that (1) section 1374(d)(8) applies to any transaction described in that section that occurs on or after December 27, 1994, regardless of the date of the S corporation’s election under section 1362, and (2) for purposes of section 633(d)(8) of TRA, as amended by TAMRA, a corporation’s most recent S election, not an earlier election that has been revoked or terminated, determines whether or not it is subject to current section 1374.

Special Analyses

It has been determined that this temporary 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 §1.1374–8T(a)(2) of these regulations. With respect to §1.1374–10T(c) of these regulations, it has been determined, pursuant to 5 U.S.C. 553(b)(B), that it would be contrary to the public interest to issue the regulations with notice and public procedure and, pursuant to 5 U.S.C. 553(d)(3), that good cause exists to dispense with a delayed effective date. The regulations are necessary to provide immediate guidance to taxpayers with respect to the application of the transition rule regarding qualified corporations in section 633(d)(8) of TRA, as amended by TAMRA, and, accordingly, with respect to the application of current section 1374 to asset dispositions which occur during taxable years beginning after December 22, 2004. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analysis section of the Notice of Proposed Rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Code, these temporary regulations have been 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 Stephen R. Cleary of the Office of Associate Chief Counsel (Corporate). Other personnel from Treasury and the IRS 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 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

January 24, 2005 365 2005–4 I.R.B.

file the return reporting the tax due (determined without regard to any extension for filing the return). Section 6072(a) provides that individuals shall file income tax returns made on a calendar year basis on or before April 15 ^th of the year following the calendar year for which the tax is due. Accordingly, interest is imposed on individual calendar year taxpayers under section 6601 on any underpayment that is not paid on or before April 15 ^th of the year following the calendar year for which the tax is due for the period from April 15 ^th until the date on which the tax is paid.

Section 6404(g) requires the Secretary to suspend the accrual of interest and time sensitive penalties if the Secretary does not provide a notice specifically stating the amount and basis for the taxpayer’s liability within 18 months following the date that is the later of (1) the original due date of the return (without regard to extensions) or (2) the date on which the taxpayer timely filed the return (the “notification period”). The suspension of the accrual of interest and penalties begins upon the expiration of the notification period and ends 21 days after the date on which the Service provides the notice to the taxpayer (the “suspension period”). Section 6404(g)(3). The legislative history to section 6404(g) states that section 6404(g) was enacted to limit the period during which interest and penalties accrue because the IRS should promptly inform taxpayers of their obligations with respect to tax deficiencies and additional amounts due. S. Rep. No. 174, 105 ^th Cong., 2d Sess., at 64–65, 1998–3 C.B. 537, 600–01.

Section 6404(g)(1) provides that the suspension of the accrual of interest and penalties under section 6404(g) only applies to taxpayers who file an income tax return “on or before the due date for the return (including extensions).” (Emphasis added.) Section 6404(g)(2)(C) provides that “any tax liability shown on the re- turn ” is excluded from the suspension provisions of section 6404(g)(1). (Emphasis added.) Because section 6404(g)(2) provides exceptions to 6404(g)(1), “the return” referred to in section 6404(g)(2)(C) is the timely filed return described in section 6404(g)(1), i.e., the original return.

An amended return (or other written notice to the Service of additional liability not listed on the original return) filed after the due date (including extensions) is not “the

section 1362. This paragraph (c) applies for taxable years beginning after December 22, 2004, without regard to the date of the corporation’s most recent election to be an S corporation under section 1362.

(2) Example . The following example illustrates the rules of this paragraph (c):

Example . (i) On February 1, 1988, X, a C corporation that is a qualified corporation under section 633(d) of the Tax Reform Act of 1986, as amended, elects to be an S corporation under section 1362. On December 1, 1989, X revokes its S status and becomes a C corporation. On January 1, 2004, X again elects to be an S corporation under section 1362. X disposes of assets in 2006, 2007, and 2008, recognizing gain.

(ii) X is not eligible for treatment under the transition rule of section 633(d)(8) of the Tax Reform Act of 1986, as amended, with respect to these assets. Accordingly, X is subject to section 1374, as amended by the Tax Reform Act of 1986 and TAMRA, and the 10-year recognition period begins on January 1, 2004. (iii) To the extent the gain that X recognizes on the asset sales in 2006, 2007, and 2008 reflects built-in gain inherent in such assets in X’s hands on January 1, 2004, such gain is subject to tax under section 1374 as amended by the Tax Reform Act of 1986 and TAMRA.

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

Approved December 15, 2004.

Gregory F. Jenner, Acting Assistant of the Treasury .

(Filed by the Office of the Federal Register on December 21, 2004, 8:45 a.m., and published in the issue of the Federal Register for December 22, 2004, 69 F.R. 76612)

Section 1402.—Definitions

A notice describes a partnership’s contribution to the health savings account (HSA) of a partner, treated as a section 707(c) guaranteed payment or as a section 731 distribution, and an S corporation’s contribution to the HSA of a 2-percent shareholder-employee for services rendered to the S corporation. See Notice 2005-8, page 368.

Section 6404(g).—Suspen- sion of Interest and Certain Penalties Where Secretary Fails to Contact Taxpayer

Interest suspension; time sensi- tive penalties. Section 6404(g) of the Code suspends interest and time sensitive penalties, additions to tax and additional amounts with respect to an increased tax liability reported on an individual’s

amended income tax return filed more than 18 months after the date that is the later of (1) the original due date of the return (without regard to extensions) or (2) the date on which the taxpayer timely filed the return.

Rev. Rul. 2005–4

ISSUES

Does section 6404(g) suspend interest and time sensitive penalties, additions to tax and additional amounts with respect to an increased tax liability reported on an individual’s amended income tax return (or other written notice to the Service of additional liability not listed on the original return) that is filed after the individual files a timely return? If so, when does the accrual of interest and time sensitive penalties, additions to tax and additional amounts begin and end with respect to the additional amount?

FACTS

Situation 1. TP, an individual taxpayer, files an income tax return for the 2002 taxable year on the due date of April 15, 2003. On October 4, 2004, within 18 months after the due date of TP’s return, TP files an amended income tax return that reports additional tax due for 2002. TP files the amended return before the Service notifies TP of the amount or the basis for the additional tax reported on the amended return. TP does not pay the additional tax due with the amended return.

Situation 2. The facts are the same as in Situation 1, except that TP files the amended return on November 26, 2004, more than 18 months after the due date of TP’s return, and TP remits payment with the amended return.

Situation 3. The facts are the same as Situation 2, except that TP does not remit payment with the amended return.

LAW AND ANALYSIS

Section 6601 requires the payment of interest on any amount of tax imposed by Title 26 that is not paid on or before the last date prescribed for payment of the tax. Interest is computed using the underpayment rate established under section 6621. Section 6151 provides that the date for payment of tax is the date a taxpayer must

2005–4 I.R.B. 366 January 24, 2005

the return. The suspension of the accrual of interest and time sensitive penalties, additions to tax and additional amounts begins 18 months and one day after the date that is the later of (1) the original due date of the return (without regard to extensions) or (2) the date on which the individual timely filed the return. The suspension of the accrual of interest and time sensitive penalties, additions to tax and additional amounts ends (1) on the date on which the individual files an amended return if the individual pays the additional tax due with the amended return or (2) on the date that is 21 days after the date on which the individual files the amended return if the individual does not pay the additional tax due with the amended return.

EFFECTIVE DATE

This revenue ruling is effective for tax years ending after July 22, 1998, for which the period of limitations on filing a claim for refund has not expired.

DRAFTING INFORMATION

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

return” described in sections 6404(g)(1) and 6404(g)(2)(C). Accordingly, interest and time sensitive penalties are suspended under section 6404(g) with respect to any tax shown on an amended return (or other written notice to the Service of additional liability not listed on the original return) if the Service does not provide to the taxpayer the notice described under section 6404(g)(1) within the notification period. When a taxpayer files an amended return (or other written notice to the Service of additional liability not listed on the original return), the taxpayer knows the amount and the basis for the additional tax reported on the amended return. The filing of the amended return (or other written notice to the Service of additional liability not listed on the original return), therefore, renders unnecessary notice to the taxpayer under section 6404(g)(1).

In Situation 1, TP filed an amended return on October 4, 2004, within 18 months of filing the income tax return. TP’s amended return renders unnecessary notice of the amount and the basis for the additional tax reported on the amended return prior to the termination of the notification period. Section 6404(g)(1) will not suspend interest and time sensitive penalties with respect to the additional tax liability reported on the amended return. Interest and time sensitive penalties will accrue on the additional tax liability from the due date of the original return.

In Situation 2, TP filed an amended return on November 26, 2004, more than 18

months after the filing of an income tax return. The Service did not provide TP with the notice required to be provided under section 6404(g) prior to October 14, 2004, the date on which the notification period expired. Section 6404(g) suspends the imposition of interest and time sensitive penalties beginning on October 15, 2004, until November 26, 2004, the date on which TP filed the amended return and paid the additional tax due.

In Situation 3, TP filed an amended return on November 26, 2004, more than 18 months after the filing of an income tax return, but did not pay the additional tax due. The Service did not provide TP with the notice required to be provided under section 6404(g) before October 14, 2004, the date on which the notification period expired. Section 6404(g) suspends the imposition of interest and time sensitive penalties beginning on October 15, 2004, and ending on December 17, 2004, the date that is 21 days after November 26, 2004, the date that TP filed an amended return.

HOLDINGS

Section 6404(g) suspends interest and time sensitive penalties, additions to tax and additional amounts with respect to an increased tax liability reported on an individual’s amended income tax return filed more than 18 months after the date that is the later of (1) the original due date of the return (without regard to extensions) or (2) the date on which the taxpayer timely filed

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