Part I. Rulings — Internal Revenue Bulletin 2005-12

Section 61.—Gross Income Defined

26 CFR 1.61–21: Taxation of fringe benefits.

Fringe benefits aircraft valuation for- mula. The Standard Industry Fare Level (SIFL) cents-per-mile rates and terminal charges in effect for the first half of 2005 are set forth for purposes of determining the value of noncommercial flights on employer-provided aircraft under section 1.61–21(g) of the regulations.

Period During Which the Flight Is Taken

Rev. Rul. 2005–14

For purposes of the taxation of fringe benefits under section 61 of the Internal Revenue Code, section 1.61–21(g) of the Income Tax Regulations provides a rule for valuing noncommercial flights on employer-provided aircraft. Section 1.61–21(g)(5) provides an aircraft valuation formula to determine the value of such flights. The value of a flight is determined under the base aircraft valuation formula (also known as the Standard Industry Fare

Terminal Charge

Level formula or SIFL) by multiplying the SIFL cents-per-mile rates applicable for the period during which the flight was taken by the appropriate aircraft multiple provided in section 1.61–21(g)(7) and then adding the applicable terminal charge. The SIFL cents-per-mile rates in the formula and the terminal charge are calculated by the Department of Transportation and are reviewed semi-annually.

The following chart sets forth the terminal charges and SIFL mileage rates:

SIFL Mileage Rates

1/1/05 – 6/30/05 $35.49 Up to 500 miles = $.1942 per mile

501–1500 miles = $.1480 per mile

Over 1500 miles = $.1423 per mile

DRAFTING INFORMATION

The principal author of this revenue ruling is Kathleen Edmondson of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this revenue ruling, contact Ms. Edmondson at (202) 622–0047 (not a toll-free call).

Section 280F.—Limitation on Depreciation for Luxury Automobiles; Limitation Where Certain Property Used for Personal Purposes

26 CFR 1.280F–7: Property leased after December 31, 1986.

This procedure provides owners and lessees of passenger automobiles (including electric automobiles) with tables detailing the limitations on depreciation deductions for automobiles first placed in service during calendar year 2005 and the amounts to be included in income for automobiles first leased during calendar year 2005. See Rev. Proc. 2005-13, page 759.

Section 817.—Treatment of Variable Contracts

26 CFR 1.817–5: Diversification requirements for variable annuity, endowment, and life insurance con- tracts.

T.D. 9185

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Diversification Requirements for Variable Annuity, Endowment, and Life Insurance Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations removing provisions of the Income Tax Regulations that apply a look-through rule to assets of a nonregistered partnership for purposes of satisfying

the diversification requirements of section 817(h) of the Internal Revenue Code.

DATES: Effective Date : These regulations are effective as of March 1, 2005. However, arrangements in existence on March 1, 2005, will be considered to be adequately diversified if: (i) those arrangements were adequately diversified within the meaning of section 817(h) prior to March 1, 2005, and (ii) by December 31, 2005, the arrangements are brought into compliance with the final regulations.

Applicability Date : For dates of applicability, see §1.817–5(i).

FOR FURTHER INFORMATION CONTACT: James Polfer, (202) 622–3970 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Under section 817(h), a variable contract based on a segregated asset account is not treated as an annuity, endowment, or life insurance contract unless the segregated asset account is adequately diversified. For purposes of testing diversifica

2005–12 I.R.B. 749 March 21, 2005

examples contained in §1.817–5(g). In response to these comments, the final regulations revise §1.817–5(g) Example 1 to remove the reference to partnership P as a publicly registered partnership. The Treasury Department and the IRS believe that, with this change, the examples contained in §1.817–5(g) adequately explain the application of §1.817–5 to partnership interests. Any questions concerning the application of §1.817–5 to more specific factual scenarios may be addressed by the letter ruling process or by subsequent published guidance.

Two commentators urged that existing arrangements either should be grandfathered in some fashion or should be given additional time to be brought into compliance with the final regulations. The notice of proposed rulemaking provided that arrangements in existence on the effective date of the revocation of §1.817–5(f)(2)(ii) will be considered to be adequately diversified if: (i) those arrangements were adequately diversified within the meaning of section 817(h) prior to the revocation of §1.817–5(f)(2)(ii), and (ii) by the end of the last day of the second calendar quarter ending after the effective date of the regulation, the arrangements are brought into compliance with the final regulations. The Treasury Department and the IRS do not believe it is appropriate to grandfather existing arrangements indefinitely. In response to these comments, however, the transition period for existing arrangements to be brought into compliance with the regulations is two calendar quarters longer than the period provided in the proposed regulations.

Finally, one commentator questioned the authority of the Treasury Department and the IRS to enact this final regulation because “the only substantive impetus for the regulation is a general statement in the legislative history.” Congress enacted the diversification requirements of section 817(h) to “discourage the use of tax-preferred variable annuity and variable life insurance primarily as investment vehicles,” H.R. Conf. Rep. No. 98–861, at 1055 (1984), and granted the Secretary broad regulatory authority to develop rules to carry out this intent. The Treasury Department and the IRS have determined that this final regulation and the rest of the regulations contained in §1.817–5 were

tion, section 817(h)(4) and §1.817–5(f) of the regulations provide a look-through rule for assets held through certain investment companies, partnerships, or trusts. Section 1.817–5(f)(2)(i) provides that lookthrough treatment is available with respect to any investment company, partnership, or trust only if all the beneficial interests in the investment company, partnership, or trust are held by one or more segregated asset accounts of one or more insurance companies, and public access to such investment company, partnership, or trust is available exclusively (except as otherwise permitted by section 1.817–5(f)(3)) through the purchase of a variable contract. Under §1.817–5(f)(2)(ii), the look-through rule applies to a partnership interest that is not registered under a Federal or state law regulating the offering or sale of securities. Unlike §1.817–5(f)(2)(i), satisfaction of the nonregistered partnership lookthrough rule of §1.817–5(f)(2)(ii) is not explicitly conditioned on limiting the ownership of interests in the partnership to certain specified holders.

On July 30, 2003, the Treasury Department and the IRS published a notice of proposed rulemaking (REG–163974–02, 2003–2 C.B. 595) under section 817 in the Federal Register (68 FR 44689). The proposed regulations would remove the rule that applies specifically to nonregistered partnerships for purposes of testing diversification. The proposed regulations also would remove an example that illustrates that rule.

The application of §1.817–5(f)(2)(i) to interests in nonregistered partnerships will be unchanged by the removal of §1.817–5(f)(2)(ii). Thus, look-through treatment will be available for interests in a nonregistered partnership if all the beneficial interests in the partnership are held by one or more segregated asset accounts of one or more insurance companies and public access to the partnership is available exclusively (except as otherwise permitted by §1.817–5(f)(3)) through the purchase of a variable contract.

Written comments were received in response to the notice of proposed rulemaking. A public hearing on the notice of proposed rulemaking was held on April 1, 2004. After consideration of all the comments and the hearing testimony, the proposed regulations are adopted as amended by this Treasury decision.

Explanation and Summary of Comments and Public Hearing

In addition to requesting comments on the clarity of the proposed rule and how the rule could be made easier to understand, the Treasury Department and the IRS specifically requested comments on: (1) whether revocation of §1.817–5(f)(2)(ii) necessitates other changes to the look-through rules of §1.817–5(f), in particular whether the list of holders permitted by §1.817–5(f)(3) should be amended or expanded, and whether a non- pro-rata distribution of the investment returns of a segregated asset account should be permitted to take account of certain bonus payments to investment managers commonly referred to as incentive payments, (2) whether §1.817–5 should be updated to take account of changes to variable contracts since the final regulations were published in 1986, and (3) whether regulations are needed to address when a holder of a variable contract will be treated as the owner of assets held in a segregated asset account and, therefore, required to include earnings on those assets in income.

Comments on the Proposed Regulations

Two comments on the proposed regulation concerned the definition of “security” in §1.817–5(h)(6). Under §1.817–5(b)(1)(ii)(A), all securities of the same issuer are treated as one investment for the purposes of satisfying the diversification requirements. Section 1.817–5(h)(6) provides that the term security includes “a cash item and any partnership interest registered under a Federal or State law regulating the offering or sale of securities,” but does not include “any other partnership interest.” The commentators stated that the definition of “security” that applies to §1.817–5 should be amended to include an interest in a non-registered partnership. The Treasury Department and the IRS agree that, in light of the revocation of former §1.817–5(f)(2)(ii), the definition of security should be modified to remove the distinction between registered and nonregistered partnership interests. The final regulations reflect this change.

A number of commentators also suggested that the regulation should be clarified by adding to or otherwise revising the

March 21, 2005 750 2005–12 I.R.B.

of this chapter) provides guidance on the application of the diversification look-through rule to tiered investment companies.

Comments on Investor Control

Finally, some comments concerned the need for additional guidance addressing circumstances under which the holder of a variable contract will be treated as the owner of assets held by a segregated asset account by virtue of the control the contract holder has over those assets. Under Rev. Rul. 81–225, 1981–2 C.B. 12 (see §601.601(d)(2)(ii)( b ) of this chapter), the owner of a variable annuity contract funded by publicly available mutual fund shares is treated as the owner of those shares. Rev. Rul. 2003–92, 2003–2 C.B. 350 (see §601.601(d)(2)(ii)( b ) of this chapter), clarified and amplified Rev. Rul. 81–225 by applying the same rule to variable life insurance contracts, and by treating as publicly available a nonregistered partnership, interests in which are sold only to qualified purchasers that are accredited investors or to no more than one hundred accredited investors. See also Rev. Rul. 2003–91, 2003–2 C.B. 347; Rev. Rul. 82–54, 1982–1 C.B. 11; Rev. Rul. 80–274, 1980–2 C.B. 27; Rev. Rul. 77–85, 1977–1 C.B. 12.; Christoffersen v. U.S., 749 F.2d 513 (8 ^th Cir. 1984), rev’g 578 F. Supp. 398 (N.D. Iowa 1984). See §601.601(d)(2)(ii)( b ) of this chapter.

One commentator urged that Rev. Rul. 2003–92 should not be applied retroactively to treat certain investors as the “general public” as that term is used in Rev. Rul. 81–225. Specifically, the commentator requested relief for investments in real estate partnerships, interests in which are held directly by (1) organizations described in section 501(c)(3), and (2) such partnerships’ investment managers, if those managers are not described in §1.817–5(f)(3)(ii) because of bonus payment arrangements. The commentator believed such relief is warranted because of uncertainty concerning the meaning of “general public” as that term is used in Rev. Rul. 81–225. Several other commentators suggested that regulations under section 817 should clarify that the permitted investors under §1.817–5(f)(3) do not constitute the “general” public as that term is used in Rev. Rul. 2003–92

prescribed within the delegation of authority provided by Congress.

Comments on §1.817–5 More Generally

Many comments concerned the list of permitted investors under §1.817–5(f)(3). Notwithstanding the limitations on public access to an investment company, partnership, or trust that is subject to look-through treatment under §1.817–5(f), §1.817–5(f)(3) permits look-through treatment if the beneficial interests of the investment company, partnership, or trust are held by certain other “permitted investors,” including the general account of a life insurance company (if certain requirements are met), the manager or a corporation related to the manager (if certain requirements are met), or the trustee of a qualified plan. Commentators suggested that the list of permitted investors be expanded to include, for example, qualified tuition programs described in section 529; segregated asset accounts of foreign insurance companies; foreign pension plans; persons or entities related to the manager of an investment company, partnership, or trust in a manner specified in section 707(b); certain investment professionals operating as service providers; or persons who receive interests in a partnership as a result of inadvertent transfers, such as by bankruptcy or death of the permitted investor. The sole speaker at the public hearing on the notice of proposed rulemaking testified that the list of investors permitted by §1.817–5(f)(3) should be expanded to include “floor specialists” as that term is defined in section 1236(d)(2).

Other comments suggested guidance on non- pro-rata manager compensation. In order for the manager (or a corporation related in a manner specified in section 267(b) to the manager) of an investment company, partnership, or trust, to be a permitted investor under §1.817–5(f)(3)(ii), (1) its interest must be held in connection with the creation or management of the investment company, partnership, or trust; (2) the return on such interest must be computed in the same manner as the return on an interest held by a segregated asset account is computed (determined without regard to expenses attributable to variable contracts); and (3) there must be no intent to sell such interest to the public. A number of commentators stated that the re

quirement that the return on a manager’s interest be computed in the same manner as the return on a segregated asset account’s interest - essentially a pro-rata distribution requirement — is inconsistent with prevailing market practices concerning manager bonuses, discourages the creation of insurance dedicated funds, and is not necessary to prevent abuse of the lookthrough rules contained in §1.817–5(f).

Some comments stated there is a need to clarify the consequences to a variable contract and variable contract holder when the contract’s segregated asset account contains an asset in which beneficial interests are held by investors (such as qualified plans) that qualified as permitted investors in §1.817–5(f)(2) or (3) at the time of initial investment, but subsequently lose their status. Similarly, one commentator urged that if an insurance company has a reasonable basis to believe that an investment company, partnership, or trust satisfies the requirements of §1.817–5(f)(2), a variable contract of that insurance company should be permitted to look-through that entity for purposes of testing a segregated asset account on which that contract is based, even if the investment company, partnership, or trust has investors not described in §1.817–5(f)(2) or (3). The commentator suggested that this standard would be consistent with the standard of determination often used in the Federal securities laws.

Other comments included a request for clarification of the treatment of fund-offunds and master-feeder arrangements for purposes of testing diversification; the desirability of an updated correction procedure for failure to satisfy the diversification requirements of section 817(h) and §1.817–5; guidance concerning the use of independent investment advisors; and extension of the special diversification rules for United States Treasury securities under section 817(h)(3) and §1.817–5(b)(3) to variable annuity contracts. (The latter comment presumably would require a change to section 817(h)(3), as well as to the regulations.)

Although the comments on §1.817–5 generally are not adopted in this Treasury decision, the Treasury Department and IRS will consider these comments in the event of future published guidance. For example, Rev. Rul. 2005–7, 2005–6 I.R.B. 464 (see §601.601(d)(2)(ii)( b )

2005–12 I.R.B. 751 March 21, 2005

The first sentence of paragraph (g) Example 1 is revised.
Paragraph (g) Example 4 is redesignated as paragraph (g) Example 3 .
Paragraph (h)(6) is revised.
New paragraph (i)(2)(v) is added. The revisions read as follows:

§ 1.817–5 Diversification requirements for variable annuity, endowment, and life insurance contracts.

- - - (g) - * Example 1 . (i) The assets underlying variable contracts issued by a life insurance company consist of two groups of assets: (a) a diversified portfolio of debt securities and (b) interests in P, a partnership.
- (h) - * (6) Security . The term security shall include a cash item and any partnership interest, whether or not registered under a Federal or State law regulating the offering or sale of securities. The term shall not include any interest in real property, or any interest in a commodity.
- - - (i) - - (2) - * (v) A segregated asset account in existence before March 1, 2005, will be considered to be adequately diversified if—

(A) As of March 1, 2005, the account was adequately diversified within the meaning of section 817(h) and this regulation as in effect prior to that date; and

(B) By December 31, 2005, the account is adequately diversified within the meaning of section 817(h) and this regulation.

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

Approved February 15, 2005.

Eric Solomon, Acting Deputy Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on February 28, 2005, 8:45 a.m., and published in the issue of the Federal Register for March 1, 2005, 70 F.R. 9869)

and Rev. Rul. 81–225. According to these commentators, it would be anomalous for ownership by a permitted investor under §1.817–5(f)(3) to result in a variable contract holder being treated as the owner of an investment company, partnership, or trust, when the look-through rule itself appears to endorse ownership by that same investor for purposes of testing diversification. Still another commentator noted that when determining whether a contract holder is treated as the owner of segregated account assets, communications between investment advisors or officers and variable contract holders should be permitted if the communications are consistent with Federal securities and commodities laws.

One commentator suggested that the preamble to this Treasury decision should confirm the intended scope of Rev. Proc. 99–44, 1999–2 C.B. 598. Under Rev. Proc. 99–44, a contract is treated as an annuity contract described in sections 403(a), 403(b), or 408(b), notwithstanding that contract premiums are invested at the direction of the contract holder in publicly available securities, so long as certain requirements are met. Those requirements include a limitation that no additional Federal tax liability would have been incurred if the employer of the contract holder had instead paid amounts into a custodial account in an arrangement that satisfied the requirements of section 403(b)(7)(A) or no additional Federal tax liability would have been incurred if the consideration for the contract had instead been held as part of a trust that would satisfy the requirements of section 408(a), as applicable. The commentator urged that the preamble to this Treasury decision clarify that the “no additional Federal tax liability” limitation was intended to apply only to tax on unrelated business income. Finally, one commentator noted that, given the inherent factual nature of the determination whether a contract holder is treated as the owner of segregated account assets, the issue is better addressed by letter ruling or revenue ruling, rather than by regulations.

Although the comments on investor control are not adopted in this Treasury decision, they are responsive to the request for comments in the July 30, 2003, notice

of proposed rulemaking and will receive careful attention in the event of further guidance on investor control.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is James Polfer, Office of the Associate Chief Counsel (Financial Institutions and Products), Office of Chief Counsel, Internal Revenue Service. However, personnel from other offices of the Treasury Department and the IRS participated in their development.

- - - -

Adoption of Amendment to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAX

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

Authority: 26 U.S.C. 7805 * * * Section 1.817–5 also issued under 26 U.S.C. 817(h). - * *

Par. 2. Section 1.817–5 is amended as follows:

Paragraphs (f)(2)(ii) and (g) Example 3 are removed.
Paragraph (f)(2)(iii) is redesignated as paragraph (f)(2)(ii).

March 21, 2005 752 2005–12 I.R.B.

Section 860F.—Other Rules

26 CFR 1.860F–4: Remic reporting requirements and other administrative rules.

T.D. 9184

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Real Estate Mortgage Investment Conduits

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final Regulation.

SUMMARY: This document contains final regulations relating to the application of the unified partnership audit procedures to disputes regarding the ownership of residual interests in a Real Estate Mortgage Investment Conduit (REMIC). These regulations will affect taxpayers that invest in REMIC residual interests.

DATES: These regulations apply after December 31, 1986.

FOR FURTHER INFORMATION CONTACT: Arturo Estrada, (202) 622–3900 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This regulation amends 26 CFR Part 1 under section 860F of the Internal Revenue Code (Code) relating to the application of the unified partnership audit procedures of subchapter C of chapter 63 of the Code to REMICs and the holders of residual interests. Section 860F(e) provides that a REMIC is treated as a partnership (and holders of residual interests in that REMIC shall be treated as partners) for purposes of subtitle F of the Code, which includes the unified partnership audit procedures. The taxable income of a holder of a REMIC residual interest is determined under the REMIC provisions of part IV of subchapter M, which require the holder to take into account its daily portion of the REMIC’s

taxable income or net loss for each day during the taxable year on which the holder holds its interest. Section 860C(a)(1). The provisions of subchapter K relating to the determination of the taxable income of a partnership and its partners do not apply to REMICs or the holders of REMIC residual interests. Section 860A(a).

Questions have arisen regarding whether the identity of the holder of a REMIC residual interest is treated as a partnership item for purposes of the unified partnership audit procedures. Questions also have arisen regarding the applicability of the unified partnership audit procedures when a determination is made under the REMIC regulations to disregard certain transfers of REMIC residual interests and continue to treat the transferor as the holder of the transferred REMIC residual interests. See §§1.860E–1(c) and 1.860G–3. The IRS and Treasury Department have determined that the identity of a holder of a REMIC residual interest is more appropriately determined at the residual interest holder level than at the REMIC entity level.

Explanation of Provisions

The regulations provide that the determination of the identity of a holder of a REMIC residual interest is not a partnership item for purposes of the unified partnership audit procedures as applied to REMICs, whether or not such determination involves the application of a disregarded transfer rule. Unlike the identity of a partner in a partnership subject to subchapter K, the identity of the holder of a REMIC residual interest does not affect the calculation of the REMIC’s taxable income or net loss.

Effective Date

These regulations apply after December 31, 1986. See §1.860A–1(b)(1)(ii).

Special Analyses

not apply to these regulations, and because these regulations do not impose a collection requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Code, this Treasury decision has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Drafting Information

The principal author of these regulations is Arturo Estrada, Office of the Associate Chief Counsel (Financial Institutions and Products). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Section 860F–4 issued under 26 U.S.C. 860G(e) and 26 U.S.C. 6230(k).* * * Par. 2. In §1.860F–4, paragraph (a) is amended by adding a sentence at the end of the paragraph to read as follows:

§1.860F–4 REMIC reporting requirements and other administrative rules.

(a) - - - The identity of a holder of a residual interest in a REMIC is not treated as a partnership item with respect to the REMIC for purposes of subchapter C of chapter 63.

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

Approved February 15, 2005.

Eric Solomon, Acting Deputy Assistant Secretary

of the Treasury (Tax Policy).

2005–12 I.R.B. 753 March 21, 2005

PART 1—INCOME TAX

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

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.856–9 is added to read as follows:

§1.856–9 Treatment of certain qualified REIT subsidiaries.

(a) In general . A qualified REIT subsidiary, even though it is otherwise not treated as a corporation separate from the REIT, is treated as a separate corporation for purposes of:

(1) Federal tax liabilities of the qualified REIT subsidiary with respect to any taxable period for which the qualified REIT subsidiary was treated as a separate corporation.

(2) Federal tax liabilities of any other entity for which the qualified REIT subsidiary is liable.

(3) Refunds or credits of Federal tax. (b) Examples . The following examples illustrate the application of paragraph (a) of this section:

Example 1 . X, a calendar year taxpayer, is a domestic corporation 100 percent of the stock of which is acquired by Y, a real estate investment trust, in 2002. X was not a member of a consolidated group at any time during its taxable year ending in December 2001. Consequently, X is treated as a qualified REIT subsidiary under the provisions of section 856(i) for 2002 and later periods. In 2004, the Internal Revenue Service (“IRS”) seeks to extend the period of limitations on assessment for X’s 2001 taxable year. Because X was treated as a separate corporation for its 2001 taxable year, X is the proper party to sign the consent to extend the period of limitations.

Example 2 . The facts are the same as in Exam- ple 1, except that upon Y’s acquisition of X, Y and X jointly elect under section 856(l) to treat X as a taxable REIT subsidiary of Y. In 2003, Y and X jointly revoke that election. Consequently, X is treated as a qualified REIT subsidiary under the provisions of section 856(i) for 2003 and later periods. In 2004, the IRS determines that X miscalculated and underreported its income tax liability for 2001. Because X was treated as a separate corporation for its 2001 taxable year, the deficiency may be assessed against X and, in the event that X fails to pay the liability after notice and demand, a general tax lien will arise against all of X’s property and rights to property.

Example 3 . X is a qualified REIT subsidiary of Y under the provisions of section 856(i). In 2001, Z, a domestic corporation that reports its taxes on a calendar year basis, merges into X in a state law merger. Z was not a member of a consolidated group at any time during its taxable year ending in December 2000. Under the applicable state law, X is the successor to Z and is liable for all of Z’s debts. In 2004, the IRS seeks to extend the period of limitations on assessment for Z’s 2000 taxable year. Because X is the

(Filed by the Office of the Federal Register on February 24, 2005, 8:45 a.m., and published in the issue of the Federal Register for February 25, 2005, 70 F.R. 9218)

Section 7701.—Definitions

301.7701–2: Business entities; definitions.

T.D. 9183

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

Modification of Check the Box

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

SUMMARY: This document contains final regulations that clarify that qualified REIT subsidiaries, qualified subchapter S subsidiaries, and single owner eligible entities that are disregarded as entities separate from their owners are treated as separate entities for purposes of any Federal tax liability for which the entity is liable. These regulations affect disregarded entities that are liable for Federal taxes with respect to tax periods during which they were not disregarded or because they are successors or transferees of taxable entities.

DATES: Effective Date : These regulations are effective April 1, 2004.

Applicability Dates : For dates of applicability, see §§1.856–9(c), 1.1361–4(a)(6)(iii), and 301.7701–2(e).

FOR FURTHER INFORMATION CONTACT: Martin Schäffer, (202) 622–3070 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to 26 CFR parts 1 and 301. The amendments to 26 CFR part 1 are under sections 856 and 1361 of the Internal Revenue Code (Code). Section 856(i) was added by the Tax Reform Act of 1986 (Public Law 99–514, 100 Stat. 2085). Section 1361(b)(3) was added by the Small

Business Job Protection Act of 1996 (Public Law 104–188, 110 Stat. 1755). The amendments to 26 CFR part 301 are to §301.7701–2, first promulgated by T.D. 8697, 1997–1 C.B. 215 [61 FR 66584] (December 18, 1996). On April 1, 2004, a notice of proposed rulemaking (REG–106681–02, 2004–18 I.R.B. 852) relating to the taxation of disregarded entities was published in the Federal Register (69 FR 17117). A notice of correction was published in the Federal Register (69 FR 22463) on April 26, 2004. No comments were received from the public in response to the notice of proposed rulemaking. No public hearing was requested, and accordingly, no hearing was held. This Treasury decision adopts the language of the proposed regulations with only minor clarifying changes.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations and, because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the 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 business.

Drafting Information

The principal author of these regulations is James M. Gergurich of the Office of the Associate Chief Counsel (Passthroughs & Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Adoption of Amendments to the Regulations

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

March 21, 2005 754 2005–12 I.R.B.

successor to Z and is liable for Z’s 2000 taxes that remain unpaid, X is the proper party to sign the consent to extend the period of limitations.

Par. 3. Section 1.1361–4 is amended as follows:

In paragraph (a)(1) introductory text, the first sentence is amended by removing the language “paragraph (a)(3)” and adding “paragraphs (a)(3) and (a)(6)” in its place.
Paragraph (a)(6) is added. The additions read as follows:

§1.1361–4 Effect of Qsub election.

(a) - - (6) Treatment of certain QSubs —(i) In general . A QSub, even though it is generally not treated as a corporation separate from the S corporation, is treated as a separate corporation for purposes of:

(A) Federal tax liabilities of the QSub with respect to any taxable period for which the QSub was treated as a separate corporation.

(B) Federal tax liabilities of any other entity for which the QSub is liable.

(C) Refunds or credits of Federal tax. (ii) Examples . The following examples illustrate the application of paragraph (a)(6)(i) of this section:

Example 1 . X has owned all of the outstanding stock of Y, a domestic corporation that reports its taxes on a calendar year basis, since 2001. X and Y do not report their taxes on a consolidated basis. For 2003, X makes a timely S election and simultaneously makes a QSub election for Y. In 2004, the Internal Revenue Service (“IRS”) seeks to extend the period of limitations on assessment for Y’s 2001 taxable year. Because Y was treated as a separate corporation for its 2001 taxable year, Y is the proper party to sign the consent to extend the period of limitations.

Example 2 . The facts are the same as in Example 1, except that in 2004, the IRS determines that Y miscalculated and underreported its income tax liability for 2001. Because Y was treated as a separate corporation for its 2001 taxable year, the deficiency for Y’s 2001 taxable year may be assessed against Y and, in the event that Y fails to pay the liability after notice and demand, a general tax lien will arise against all of Y’s property and rights to property.

Example 3 . X is a QSub of Y. In 2001, Z, a domestic corporation that reports its taxes on a calendar year basis, merges into X in a state law merger. Z was not a member of a consolidated group at any time during its taxable year ending in December 2000. Under the applicable state law, X is the successor to Z and

is liable for all of Z’s debts. In 2003, the IRS seeks to extend the period of limitations on assessment for Z’s 2000 taxable year. Because X is the successor to Z and is liable for Z’s 2000 taxes that remain unpaid, X is the proper party to execute the consent to extend the period of limitations on assessment.

(iii) Effective date . This paragraph (a)(6) applies on or after April 1, 2004.

PART 301—PROCEDURE AND ADMINISTRATION

Par. 4. The authority citation for part 301 continues to read, in part, as follows: Authority: 26 U.S.C. 7805 * * * Par. 5. Section 301.7701–2 is amended as follows:

Paragraph (c)(2)(iii) is added.
Paragraph (e) is revised. The addition and revision read as follows:

§301.7701–2 Business entities; definitions.

- - - (c) - - (2) - - (iii) Tax liabilities of certain disre- garded entities —(A) In general . An entity that is otherwise disregarded as separate from its owner is treated as an entity separate from its owner for purposes of:

( 1 ) Federal tax liabilities of the entity with respect to any taxable period for which the entity was not disregarded.

( 2 ) Federal tax liabilities of any other entity for which the entity is liable.

( 3 ) Refunds or credits of Federal tax. (B) Examples . The following examples illustrate the application of paragraph (c)(2)(iii)(A) of this section:

Example 1 . In 2001, X, a domestic corporation that reports its taxes on a calendar year basis, merges into Z, a domestic LLC wholly owned by Y that is disregarded as an entity separate from Y, in a state law merger. X was not a member of a consolidated group at any time during its taxable year ending in December 2000. Under the applicable state law, Z is the successor to X and is liable for all of X’s debts. In 2004, the Internal Revenue Service (“IRS”) seeks to extend the period of limitations on assessment for X’s 2000 taxable year. Because Z is the successor to X and is liable for X’s 2000 taxes that remain unpaid, Z is the proper party to sign the consent to extend the period of limitations.

Example 2 . The facts are the same as in Example 1, except that in 2002, the IRS determines that X mis

calculated and underreported its income tax liability for 2000. Because Z is the successor to X and is liable for X’s 2000 taxes that remain unpaid, the deficiency may be assessed against Z and, in the event that Z fails to pay the liability after notice and demand, a general tax lien will arise against all of Z’s property and rights to property.

- - - (e) Effective date . (1) Except as otherwise provided in this paragraph (e), the rules of this section apply as of January 1, 1997, except that paragraph (b)(6) of this section applies on or after January 14, 2002, to a business entity wholly owned by a foreign government regardless of any prior entity classification, and paragraph (c)(2)(ii) of this section applies to taxable years beginning after January 12, 2001. The reference to the Finnish, Maltese, and Norwegian entities in paragraph (b)(8)(i) of this section is applicable on November 29, 1999. The reference to the Trinidadian entity in paragraph (b)(8)(i) of this section applies to entities formed on or after November 29, 1999. Any Maltese or Norwegian entity that becomes an eligible entity as a result of paragraph (b)(8)(i) of this section in effect on November 29, 1999, may elect by February 14, 2000, to be classified for Federal tax purposes as an entity other than a corporation retroactive to any period from and including January 1, 1997. Any Finnish entity that becomes an eligible entity as a result of paragraph (b)(8)(i) of this section in effect on November 29, 1999, may elect by February 14, 2000, to be classified for Federal tax purposes as an entity other than a corporation retroactive to any period from and including September 1, 1997.

(2) Paragraph (c)(2)(iii) of this section applies on or after April 1, 2004.

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

Approved February 15, 2005.

Eric Solomon, Acting Deputy Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on February 24, 2005, 8:45 a.m., and published in the issue of the Federal Register for February 25, 2005, 70 F.R. 9220)

2005–12 I.R.B. 755 March 21, 2005