SECTION 2. BACKGROUND

Notice 2002–35 identifies as a listed transaction under § 1.6011–4(b)(2) a transaction that uses a notional principal contract (NPC) to claim current deductions

for periodic payments made by a taxpayer while disregarding the accrual of a right to receive offsetting payments in the future. The specific facts of the listed transaction are set forth in Notice 2002–35.

On February 26, 2004, the Treasury Department and the IRS published in the Federal Register (REG–166012–02, 2004–1 C.B. 655 [69 FR 8886]) proposed regulations (hereinafter the “Contingent NPC Proposed Regulations”) under § 446(b) of the Code. Section 1.446–3(g)(6) of the Contingent NPC Proposed Regulations describes an accounting method for contingent nonperiodic payments under an NPC. That method requires that contingent nonperiodic payments be spread over the term of the NPC. Section 1.446–3(i) of the Contingent NPC Proposed Regulations also provides an elective mark-to-market regime for certain NPCs with nonperiodic payments.

The preamble to the Contingent NPC Proposed Regulations states; “With respect to NPCs that provide for contingent nonperiodic payments and that are in effect or entered into on or after 30 days after [February 26, 2004], if a taxpayer has not adopted a method of accounting for these NPCs, the taxpayer must adopt a method that takes contingent nonperiodic payments into account over the life of the contract under a reasonable amortization method, which may be, but need not be, a method that satisfies the specific rules in these proposed regulations.”

Section 1.6011–4(c)(3)(i)(A) of the Income Tax Regulations provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in published guidance that lists the transaction under § 1.6011–4(b)(2). Section 1.6011–4(c)(3)(i)(A) also provides that a taxpayer has participated in a listed transaction if the taxpayer knows or has reason to know that the taxpayer’s tax benefits are derived directly or indirectly from tax consequences or a tax strategy that is a listed transaction.