SECTION 2. BACKGROUND

.01 Section 103(a) generally provides that gross income does not include interest on any State or local bond. Under § 103(b)(2), however, interest on an arbitrage bond (within the meaning of §148) is includable in gross income.

.02 Section 148(f)(1) generally provides that a bond that is part of an issue shall be treated as an arbitrage bond unless the issuer pays to the United States the amounts described in § 148(f)(2) for the issue ( rebate amounts ) in accordance with § 148(f)(3).

a trade or business, any gain or loss is capital gain or loss.

Under certain circumstances, some or all of the gain must be recharacterized and reported as ordinary income. If an Owner previously deducted (1) the cost of acquiring a quota, (2) amounts for amortization, depletion, or depreciation, or (3) amounts to reflect a reduction in the quota pounds, any gain is taxed as ordinary income up to the amount previously deducted. The Owner must report this amount of ordinary income on the Owner’s return for the taxable year that includes the effective date applicable to the Owner, even if the Owner uses the installment method to report the remainder of the gain.

Q–6. Are Owner Payments received under the Act subject to Self-Employ- ment Contributions Act (SECA) tax (see § 1402)?

A–6. No. Q–7. Is any portion of an Owner Pay- ment treated as interest for federal tax pur- poses ?

A–7. (a) If the total amount to be paid under a contract does not exceed $3,000, no portion of an Owner Payment is treated as interest for federal tax purposes.

(b) If § 483 applies to a contract, a portion of each Owner Payment (other than an Owner Payment due within six months of the effective date applicable to the Owner) is treated as interest for federal tax purposes. For example, § 483 generally applies to a contract if the total amount to be paid under the contract does not exceed $250,000 or if a cash method election is made under §§ 1274A and 1.1274A–1(c). A contract is eligible for the cash method election only if the total amount to be paid under the contract does not exceed the inflation-adjusted amount for a cash method debt instrument ($3,202,100 for 2005).

(c) In all situations not described in (a) or (b) above, a portion of each Owner Payment is treated as interest for federal tax purposes under § 1274.

(d) In general, to determine the amount of an Owner Payment that is treated as interest, see § 483 or § 1274, whichever is applicable, and the regulations thereunder. You may wish to consult a tax advisor for assistance in determining the portion of an Owner Payment that is treated as interest and the taxable year in which the interest is includible in income.

Q–8. Does an individual Owner’s gain or loss from Owner Payments qualify for farm income averaging?

A–8. No. A tobacco quota is considered an interest in land, and farm income averaging is not available for gain or loss arising from the sale or other disposition of land.

Q–9. Are Owner Payments subject to information reporting?

A–9. Yes. Because a tobacco quota is considered an interest in land, the total amount received under a contract by an owner in a taxable year generally will be reported by USDA on Form 1099–S, Proceeds From Real Estate Transactions, if the amount is $600 or more. In addition, any portion of an Owner Payment treated as interest for federal tax purposes generally will be reported by USDA on Form 1099–INT, Interest Income, if the total amount of interest received in a taxable year is $600 or more.

Q–10. Is the termination of a tobacco quota under the Act an involuntary conver- sion of the quota?

A–10. No. Q–11. May an Owner enter into a like- kind exchange of a quota?

A–11. Yes. An Owner may postpone reporting the gain or loss from the termination of a quota by entering into a like-kind exchange if the Owner complies with the requirements of § 1031 and the regulations thereunder. For purposes of § 1031, the date on which an Owner is deemed to relinquish a quota is the effective date applicable to the Owner.

SUBSEQUENT GUIDANCE

Section 623 of the Act provides that USDA will offer to enter into a contract with an eligible tobacco producer (Grower) under which the Grower may receive total payments of up to $3 per pound of quota in 10 equal annual payments in fiscal years 2005 through 2014 (Grower Payments) in exchange for the termination of the tobacco marketing quotas and related price support. Grower Payments are determined by reference to the amount of quota under which the Grower produced (or planted) tobacco during the 2002, 2003, and 2004 tobacco marketing years and are prorated based on the number of years that the Grower produced (or planted) quota tobacco during those

2005–28 I.R.B. 75 July 11, 2005

.03 Section 148(f)(3) provides that, except to the extent provided by the Secretary, rebate amounts must be paid in installments that are made at least once every five years. The last installment must be made no later than 60 days after the day on which the last bond of the issue is redeemed.

.04 Section 1.148–3(g) provides that a rebate payment is paid when it is filed with the Internal Revenue Service at the place or places designated by the Commissioner. See § 7502(a) for the treatment of certain payments made by U.S. mail.

.05 Section 1.148–1T, which was initially published on May 12, 1989, as part of T.D. 8252 and which expired in May of 1992 (the 1989 regulations ), provides rules for complying with the rebate requirement with respect to certain bonds issued before the expiration of the 1989 regulations. Section 1.148–1T(b)(3)(v) of the 1989 regulations provides that a rebate or correction amount is paid when filed with the Internal Revenue Service Center, Philadelphia, Pennsylvania 19255.

.06 Section 1.148–1, which was published on May 18, 1992, as part of T.D. 8418 and which expired on June 30, 1993 (the 1992 regulations ), provides rules for complying with the rebate requirement with respect to certain bonds issued before July 1, 1993. Section 1.148–1(b)(3)(v) of the 1992 regulations provides that a rebate or correction amount is paid when filed with the Internal Revenue Service Center, Philadelphia, Pennsylvania 19255.