SECTION 7. SUBMISSION OF

COMMENTS

Taxpayers may submit comments to: CC:ITA:RU (PGP–125111–02), Room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:ITA:RU (PGP–125111–02), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by submitting comments directly to the IRS Internet site at http://www.irs.gov/tax_regs/regslist.htm .

2005–32 I.R.B. 265 August 8, 2005

Notice 2005–55 Table 1

APPLICABLE PERCENTAGE FOR MARGINAL PRODUCTION

Calendar Year Applicable Percentage

1991 15 percent 1992 18 percent 1993 19 percent 1994 20 percent 1995 21 percent 1996 20 percent 1997 16 percent 1998 17 percent 1999 24 percent 2000 19 percent 2001 15 percent 2002 15 percent 2003 15 percent 2004 15 percent 2005 15 percent

Because the reference price for the 2004 calendar year ($36.75) does not exceed $28 multiplied by the inflation adjustment factor for the 2005 calendar year, the enhanced oil recovery credit for qualified costs paid or incurred in 2005 is determined without regard to the phase-out for crude oil price increases.

Table 1 contains the GNP implicit price deflator used for the 2005 calendar year, as well as the previously published GNP implicit price deflators used for the 1991 through 2004 calendar years.

The principal author of this notice is Kelly R. Morrison-Lee of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact Ms. Morrison-Lee at (202) 622–3120 (not a toll-free call).

2005 Section 43 Inflation Adjustment

Notice 2005–56

Section 43(b)(3)(B) of the Internal Revenue Code requires the Secretary to

publish an inflation adjustment factor. The enhanced oil recovery credit under § 43 for any taxable year is reduced if the “reference price,” determined under § 29(d)(2)(C), for the calendar year preceding the calendar year in which the taxable year begins, is greater than $28 multiplied by the inflation adjustment factor for that year.

The term “inflation adjustment factor” means, with respect to any calendar year, a fraction the numerator of which is the GNP implicit price deflator for the preceding calendar year and the denominator of which is the GNP implicit price deflator for 1990.

Notice 2005–56 TABLE 1

GNP IMPLICIT PRICE DEFLATORS

Calendar Year GNP Implicit Price Deflator

1990 112.9 (used for 1991) 1991 117.0 (used for 1992) 1992 120.9 (used for 1993) 1993 124.1 (used for 1994) 1994 126.0 (used for 1995) 1995 107.5 (used for 1996) 1996 109.7 (used for 1997) 1997 112.35 (used for 1998) 1998 112.64 (used for 1999) 1999 104.59 (used for 2000) 2000 106.89 (used for 2001) 2001 109.31 (used for 2002) 2002 110.63 (used for 2003) 2003 105.67 (used for 2004) 2004 108.23 (used for 2005)

August 8, 2005 266 2005–32 I.R.B.

• Beginning in 1995, the GNP implicit price deflator was rebased relative to 1992. The 1990 GNP implicit price deflator used to compute the 1996 § 43 inflation adjustment factor is 93.6.

** Beginning in 1997, two digits follow the decimal point in the GNP implicit price deflator. The 1990 GNP price deflator used to compute the 1998 § 43 inflation adjustment factor is 93.63.

*** Beginning in 1999, the GNP implicit price deflator was rebased relative to 1996. The 1990 GNP implicit price deflator used to compute the 2000 § 43 inflation adjustment factor is 86.53.

**** Beginning in 2003, the GNP implicit price deflator was rebased relative to 2000. The 1990 GNP implicit price deflator used to compute the 2004 § 43 inflation adjustment factor is 81.59.

Notice 2005–56 TABLE 2

INFLATION ADJUSTMENT FACTORS AND PHASE-OUT AMOUNTS

Calendar Year Inflation Adjustment Factor Phase-out Amount

1991 1.0000 0 1992 1.0363 0 1993 1.0708 0 1994 1.0992 0 1995 1.1160 0 1996 1.1485 0 1997 1.1720 0 1998 1.1999 0 1999 1.2030 0 2000 1.2087 0 2001 1.2353 0 2002 1.2633 0 2003 1.2785 0 2004 1.2952 0 2005 1.3266 0

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 an Owner’s tobacco quota as of the date on which the Owner and USDA enter into a contract for Owner Payments with respect to the quota (Sale Date). See Q & A–12 for a special rule regarding when a transfer of a quota is deemed to

Table 2 contains the inflation adjustment factor and the phase-out amount for taxable years beginning in the 2005 calendar year as well as the previously published inflation adjustment factors and phase-out amounts for taxable years beginning in 1991 through 2004 calendar years.

DRAFTING INFORMATION

The principal author of this notice is Kelly R. Morrison-Lee of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact Ms. Morrison-Lee at (202) 622–3120 (not a toll-free call).

Termination of Tobacco Quotas and Price Support Programs

Notice 2005–57

INTRODUCTION

This notice modifies and supersedes Notice 2005–51, 2005–28 I.R.B. 74, dated July 11, 2005. The modifications to Notice 2005–51 are effective as of June 21, 2005, the date Notice 2005–51 was released.

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).

2005–32 I.R.B. 267 August 8, 2005

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 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 Sale Date, 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 Sale Date) 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

occur, under certain circumstances, for purposes of § 1031 of the Internal Revenue Code.

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 basis, the Owner has a loss that may be deductible for tax purposes if the requirements for deduction under § 165 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 Sale Date. 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 Sale Date.

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 Sale Date, 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 Property . 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

August 8, 2005 268 2005–32 I.R.B.

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).

26 CFR 601.204: Changes in accounting periods and in methods of accounting. (Also Part 1, §§ 446, 1272, 1273.)

Rev. Proc. 2005–47