Part III. Administrative, Procedural, and Miscellaneous

Termination of Tobacco Quotas and Price Support Programs

Notice 2005–51

PURPOSE

This notice provides answers to frequently asked questions regarding the tax treatment of federal payments made pursuant to § 622 of the Fair and Equitable Tobacco Reform Act of 2004, Title VI of the American Jobs Creation Act of 2004, Pub. L. No. 108–357, 118 Stat. 1418, 1521–36 (2004) (the Act).

BACKGROUND

Sections 611 and 612 of the Act terminate the tobacco marketing quota program and the tobacco price support program. Section 622 of the Act provides that the United States Department of Agriculture (USDA) will offer to enter into a contract with an eligible tobacco quota holder (Owner) under which the Owner may receive total payments of $7 per pound of quota in 10 equal annual payments in fiscal years 2005 through 2014 (Owner Payments) in exchange for the termination of the tobacco marketing quotas and related price support. Section 622 does not provide for stated interest on payments due under the contracts.

For federal income tax purposes, Owner Payments are the proceeds from a sale of the Owner’s tobacco quota as of the effective date applicable to the Owner. The effective date applicable to an Owner is the earlier of (1) June 30, 2005, for flue-cured tobacco and September 30, 2005, for all other types of tobacco, or (2) the date on which an Owner and USDA enter into a contract for Owner Payments with respect to the quota.

QUESTIONS AND ANSWERS

Q–1. Are Owner Payments received un- der the Act subject to federal income tax?

A–1. Yes, Owner Payments are subject to federal income tax. If the amounts received by the Owner are more than the Owner’s adjusted basis in the quota, the Owner has a taxable gain; if the Owner receives less than the Owner’s adjusted ba

sis, the Owner has a loss that may be deductible for tax purposes if the requirements for deduction under § 165 of the Internal Revenue Code are satisfied. In determining an Owner’s gain or loss, the amount received for the quota does not include any amount treated as interest for federal tax purposes. See Q&A–7 for help in determining whether any portion of an Owner Payment is treated as interest for federal tax purposes.

Q–2. How does an Owner determine the adjusted basis of a quota?

A–2. The adjusted basis of a quota is determined differently depending upon how the Owner acquired the quota.

derived from an original grant by the federal government has a basis of zero in the quota.

quota as a gift has the same basis in the quota as the person who gave the quota to the Owner. Under certain circumstances, the basis is increased by an amount related to the amount of gift tax paid. If the basis is greater than the fair market value of the quota at the time of the gift, the basis for determining loss is that fair market value.

inherited generally is the fair market value of the quota at the time of the decedent’s death.

The basis of a tobacco quota is not subject to adjustment through amortization, depletion, or depreciation. However, if an Owner improperly has deducted any amount for these purposes, the Owner must reduce the basis by the amount deducted before determining the Owner’s gain or loss. A similar reduction in the basis of a quota must be made for any amount previously deducted as a loss because of a reduction in the number of pounds of tobacco allowable under the quota. If an Owner purchased a quota and deducted the entire cost in the year of purchase, then the Owner’s basis in the quota is zero.

Q–3. If an Owner has a gain and re- ports Owner Payments under the install- ment method, when must the gain be in- cluded in income?

A–3. The installment method may be used to report gain if an Owner receives at least one Owner Payment after the close of the Owner’s taxable year that includes the effective date applicable to the Owner. The amount of the gain is the excess of the total amount of Owner Payments to be received, reduced by any amount treated as interest, over the Owner’s adjusted basis in the quota. Under the installment method, a proportionate amount of the gain is taken into account in each year in which an Owner Payment is received. See the instructions for Form 6252, Installment Sale Income .

Q–4. If an Owner has a gain and elects not to report Owner Payments under the installment method, when must the gain be included in income?

A–4. The Owner must report the entire gain on the Owner’s federal income tax return for the taxable year that includes the effective date applicable to the Owner.

Q–5. Is the gain or loss with respect to a quota ordinary or capital gain or loss?

A–5. Whether the gain or loss with respect to a quota is ordinary or capital depends on how the Owner used the quota.

or business of farming and, on the effective date applicable to the Owner, the Owner’s holding period for the quota was more than one year, then the transaction is reported under § 1231 on Form 4797, Sales of Business Prop- erty . If an Owner has no other § 1231 transactions reportable on Form 4797, any gain is treated as long-term capital gain and any loss is treated as ordinary loss. Even if an Owner has other reportable § 1231 transactions, the net result of all § 1231 transactions reported generally is either long-term capital gain or ordinary loss. See the instructions for Form 4797 for more detailed information.

ment purposes, or for the production of income, but did not use the quota in

July 11, 2005 74 2005–28 I.R.B.

years. The federal tax treatment of Grower Payments is expected to be addressed in subsequent guidance.

DRAFTING INFORMATION

The principal author of this notice is Marnette M. Myers of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding Q&A–7 of this notice, contact Pamela Lew of the Office of Associate Chief Counsel (Financial Institutions and Products) at (202) 622–3950 (not a toll-free call). For further information regarding the remainder of this notice, contact Ms. Myers at (202) 622–4920 (not a toll-free call).

Address Change for Arbitrage Rebate Payments

Notice 2005–52