SECTION 6. DRAFTING

INFORMATION

The principal author of this notice is Stephen B. Tackney of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in its development. For further information regarding this notice, contact Mr. Tackney at (202) 927–9639 (not a toll-free call).

til December 31, 2006, but only to the extent a cancellation and resissuance in 2006 does not result in the cancellation of a deferral in exchange for cash or vested property in 2006. Except with respect to certain discounted stock rights described in section 3.07 below, the period during which the cancellation and reissuance may occur is extended until December 31, 2007, but only to the extent such cancellation and reissuance in 2007 does not result in the cancellation of a deferral in exchange for cash or vested property in 2007. For example, a discounted option generally may be replaced through December 31, 2007 with an option that would not have provided for a deferral of compensation, although the exercise of such a discounted option in 2007 before the cancellation and replacement generally would result in a violation of section 409A.

Where replacement stock options or stock appreciation rights that would not constitute deferred compensation subject to section 409A are issued in accordance with the conditions set forth in Notice 2005–1, Q&A–18(d), the preamble to the proposed regulations and this notice, such replacement stock options or stock appreciation rights will be treated for purposes of section 409A as if granted on the grant date of the original stock option or stock appreciation right. For a discussion of certain methods that commentators proposed to use to compensate option holders for the value of a lost discount, see section XI.H. of the preamble to the proposed regulations.

.05 Collectively bargained arrange- ments .

A nonqualified deferred compensation arrangement maintained pursuant to one or more collective bargaining agreements in effect on October 3, 2004 is not required to comply with the provisions of section 409A on or before the earlier of the date on which the last of such collective bargaining agreements terminates (determined without regard to any extension thereof after October 3, 2004) or December 31, 2009.

.06 Other transition issues Notice 2005–1, Q&A–21 provided relief with respect to certain initial deferral elections, generally providing that certain requirements would not be applicable to elections made on or before March 15, 2005. One of the conditions of the requirement was that the plan be amended to

comply with the requirements of section 409A in accordance with Notice 2005–1, Q&A–19. Notice 2005–1, Q&A–19 generally required that plans be amended by December 31, 2005. The March 15, 2005 deadline for initial deferral elections was not extended in the preamble to the proposed regulations; however, the plan amendment requirement generally was extended to December 31, 2006. Although the initial deferral election relief contained in Notice 2005–1, Q&A–21 only referred to the requirements of Notice 2005–1, Q&A–19, the Treasury Department and the IRS have become aware that many taxpayers interpreted the extension of the plan amendment deadlines as flowing through to the requirements of Notice 2005–1, Q&A–21. To avoid unintentional noncompliance in this area, the deadline for a plan to be amended to reflect use of the relief provided in Notice 2005–1, Q&A–21 is extended to December 31, 2007. However, taxpayers retain the burden of demonstrating satisfaction of the requirement by showing that the deferral election was made by the March 15, 2005 deadline, in accordance with the plan terms in effect on or before December 31, 2005 (other than a requirement to make a deferral election on or before March 15, 2005). See Notice 2005–1, Q&A–21. .07 Transition relief not extended for certain discounted stock rights

The transition relief provided in the preamble to the proposed regulations and described in this notice is not extended for any stock option or stock appreciation right (stock right) that:

(A) was granted with respect to stock of a corporation that as of the date of grant had issued any class of common equity securities required to be registered under section 12 of the Securities Exchange Act of 1934;

(B) was granted to a person who, as of the date of grant, was subject to the disclosure requirements of section 16(a) of the Securities Exchange Act of 1934 with respect to such issuer; and

(C) with respect to the grant of such stock right, such corporation either has reported or reasonably expects to report a financial expense due to the issuance of a stock right with an exercise price lower than the fair market value of the underlying stock at the date of grant that was not timely reported on financial statements or

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Determination of Housing Cost Amount Eligible for Exclusion or Deduction

Notice 2006–87

This notice provides adjustments to the limitation on housing expenses for purposes of section 911 of the Internal Revenue Code (Code) for specific locations, on the basis of geographic differences in housing costs relative to housing costs in the United States.

Section 911(a) of the Code allows a qualified individual to elect to exclude from U.S. gross income the foreign earned income and housing cost amount of such individual. Section 911(c)(1), as amended by section 515 of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), defines the term “housing cost amount” as an amount equal to the excess of (A) the housing expenses of an individual for the taxable year to the extent such expenses do not exceed the amount determined under section 911(c)(2), over (B) 16 percent of the exclusion amount (computed on a daily basis) in effect under section 911(b)(2)(D) for the calendar year in which such taxable year begins ($67.73 per day for 2006, or $82,400 for the full year), multiplied by the number of days of that taxable year within the applicable period described in section 911(d)(1). The applicable period is the period during which the individual meets the tax home requirement of section 911(d)(1) and either the bona fide residence requirement of section 911(d)(1)(A) or the physical presence requirement of section 911(d)(1)(B). Assuming that the entire taxable year of a qualified individual is within the applicable period, the section 911(c)(1)(B) amount for 2006 is $13,184 ($82,400 x .16).

Section 515 of TIPRA also added a new section 911(c)(2)(A) of the Code, which limits the housing expenses taken

into account in section 911(c)(1)(A) to an amount equal to the product of - (i) 30 percent (adjusted as may be provided under the Secretary’s authority under section 911(c)(2)(B)) of the amount in effect under section 911(b)(2)(D) for the calendar year in which the taxable year of the individual begins, multiplied by (ii) the number of days of that taxable year within the applicable period described in section 911(d)(1). Thus, for the year 2006, a qualified individual whose entire taxable year is within the applicable period is limited to maximum housing expenses of $24,720 ($82,400 x .30). Accordingly, the maximum housing cost amount a qualified individual may exclude from income in year 2006 is $11,536 ($24,720 – $13,184). The TIPRA changes apply to taxable years beginning after December 31, 2005.

To the extent the housing cost amount of any individual for any taxable year is not attributable to employer provided amounts, section 911(c)(4)(A) of the Code provides that such amount shall be treated as a deduction in computing adjusted gross income. Under section 911(c)(4)(B), however, the amount of this deduction is limited to the excess of the foreign earned income of the individual for the taxable year over the amount of such income excluded from gross income under section 911(a). In addition, section 911(d)(7) of the Code prohibits the total amount excluded or deducted under section 911 for the taxable year from exceeding the individual’s foreign earned income for such year. Further, section 911(b)(1)(B) excludes from the definition of foreign earned income certain amounts, including amounts paid by the United States or an agency thereof to an employee of the United States or an agency thereof. As a result, the exclusion or deduction from gross income of the housing cost amount under section 911 is not available to an individual whose earned income consists solely of amounts

paid by the United States or an agency thereof to an employee of the United States or an agency thereof.

Section 911(c)(2)(B) of the Code authorizes the Secretary to issue regulations or other guidance to adjust the percentage under section 911(c)(2)(A)(i) based on geographic differences in housing costs relative to housing costs in the United States. The Joint Explanatory Statement of the Committee of Conference accompanying TIPRA states the conferees’ intent that the Secretary be permitted to use publicly available data, such as the Quarterly Report Indexes published by the U.S. Department of State or any other information that the Secretary deems reliable, in making adjustments. See H.R. Conf. Rep. No. 304, 109 ^th Cong., 1 ^st Sess. 309 (2005). Accordingly, the following table, which was derived from the Living Quarters Allowance table prepared by the Office of Allowances of the U.S. Department of State as of August 20, 2006, identifies locations within countries with high housing costs relative to housing costs in the United States, and provides an adjusted limitation on housing expenses for a qualified individual incurring housing expenses in one or more of these high cost localities in 2006 to use (in lieu of the otherwise applicable limitation of $24,720) in determining his or her housing expenses under section 911(c)(2)(A) of the Code. The table will be updated each year by administrative pronouncement ( e.g., through issuing a notice, amending Form 2555 or the instructions thereto, or by making a revised table available on the IRS website at http://www.irs.gov ), beginning in 2007, based on the living quarters allowance for employees of the U.S. Department of State who are in Group 2, with family, contained in the first Living Quarters Allowance table released in that calendar year by the Office of Allowances of the U.S. Department of State.

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imum housing expenses of $67.73 per day ($24,720 per year) in determining his or her housing cost amount.

A qualified individual incurring housing expenses in one or more of the high cost localities identified above for the year 2006 may use the adjusted limit provided in the table (in lieu of $24,720) in deter

mining his or her housing cost amount on Form 2555, Foreign Earned Income . A qualified individual who does not incur housing expenses in a locality identified above for the year 2006 is limited to max

October 23, 2006 771 2006–43 I.R.B.

performance of essential governmental functions but not in the performance of commercial activities (whether or not an essential government function). The Joint Committee on Taxation’s Technical Explanation ² provides that an employee all of whose services for an ITG are in the performance of essential governmental services and not in the performance of commercial activities (whether or not such activities are an essential governmental function) is an employee who can be covered under a governmental plan as described in § 414(d) of the Code. For example, a governmental plan includes a plan of a tribal government all of the participants of which are teachers in tribal schools, but a governmental plan does not include a plan covering tribal employees who are employed by a hotel, casino, service station, convenience store, or marina operated by a tribal government.

Section 906(c) of PPA ’06 provides that the amendments made by section 906 apply to any year beginning on or after the date of enactment, which is August 17, 2006. The Joint Committee on Taxation’s Technical Explanation (p. 244) states that the amendments apply to plan years beginning on or after the date of enactment.

Under section 1107 of PPA ’06, a plan amendment made pursuant to any amendment made by PPA ’06 may be retroactively effective, and does not violate the anti-cutback rules of § 411(d)(6) of the Code, except as provided by the Secretary of the Treasury, if, in addition to meeting the other applicable requirements, the amendment is made on or before the last day of the first plan year beginning on or after January 1, 2009 (2011 in the case of a governmental plan). Thus, an ITG must operate in accordance with the applicable changes to § 414(d) made by PPA ’06 as of the related PPA ’06 effective date, i.e., the first day of the first plan year beginning on or after August 17, 2006. Further, a plan established and maintained by an ITG that is designed to be a governmental plan under § 414(d) as amended by PPA ’06 must be amended to the extent necessary to reflect these changes by the last day of the first plan year beginning on or after January 1, 2011. This relief applies only if

EFFECTIVE DATE

This notice is effective for taxable years beginning on or after January 1, 2006.

DRAFTING INFORMATION

The principal author of this notice is Paul J. Carlino of the Office of Associate Chief Counsel (International). For further information regarding this notice, contact Mr. Carlino at (202) 622–3840 (not a tollfree call).

Request for Comments

Comments are requested on the method identified in the notice for annual updates to the list contained in this notice. If a taxpayer believes that the average housing costs for a specific location differ significantly from the amount provided in this notice, the IRS and Treasury Department are particularly interested in information on housing costs that can be verified through publicly available data. Comments may be submitted to CC:PA:LPD:PR (Notice 2006–87), Room 5203, Internal Revenue Service, PO Box 7604, Washington, DC 20044. Submissions may also be hand-delivered Monday through Friday between the hours of 8 a.m. and 4:30 p.m. to Crystal Mall 4, room 108, 1901 South Bell Street, Arlington, VA 22202, Attn: CC:PA:LPD:PR (Notice 2006–87). Submissions may also be sent electronically via the internet to the following email address: Notice.comments@irscounsel.treas.gov . Include the notice number (Notice 2006–87) in the subject line.

Transition Relief for Indian Tribal Governmental Plans

Notice 2006–89

I. Purpose

This notice summarizes the changes made to § 414(d) of the Internal Revenue Code (the Code) by section 906 of the Pension Protection Act of 2006 (PPA ’06) under which plans established and maintained by Indian tribal governments and

certain related entities are governmental plans. This notice also provides transition relief under a reasonable and good faith standard with respect to compliance with the PPA ’06 changes to § 414(d) pending further guidance, and invites comments from the public on whether additional transition issues need to be addressed. In addition, this notice provides approaches that give Indian tribal governments until September 30, 2007, to implement a new plan for commercial employees to satisfy the reasonable and good faith compliance standard as part of this transitional relief.

II. Background

Section 414(d) of the Code generally provides that a “governmental plan” includes a plan established and maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing. A governmental plan is exempt from many of the plan qualification requirements under § 401(a) and other sections of the Code. For example, governmental plans are exempt from the minimum participation and vesting requirements under §§ 410 and 411, certain nondiscrimination and coverage requirements, funding requirements under § 412, and the joint and survivor annuity rules under § 417. See the last sentence of § 401(a) (the flush language following § 401(a)(36)).

PPA ’06 changed § 414(d) ¹ to amend the definition of “governmental plan” with respect to plans of an Indian tribal government, a subdivision of an Indian tribal government, or an agency or instrumentality thereof (ITG). Section 906(a)(1) of PPA ’06 states:

The term ‘governmental plan’ includes a plan which is established and maintained by an Indian tribal government (as defined in section 7701(a)(40)), a subdivision of an Indian tribal government (determined in accordance with section 7871(d)), or an agency or instrumentality of either, and all of the participants of which are employees of such entity substantially all of whose services as such an employee are in the

1 Section 906(a) of PPA ’06 made similar amendments to section 3(32) and section 4021(b)(2) of the Employee Retirement Income Security Act of 1974 (ERISA).

2 Joint Committee on Taxation, Technical Explanation of H.R. 4, the “Pension Protection Act of 2006” as passed by the House on July 28, 2006, and considered by the Senate on August 3, 2006 (JCX–38–06), August 3, 2006, 109 ^th Cong., 2 ^nd Sess. 244 (2006).

2006–43 I.R.B. 772 October 23, 2006

17, 2006 ( i.e., the level of accruals or nonelective contributions (including matching contributions) under that plan is not reduced for this year).

This relief applies even if benefits for commercial ITG employees for service before the first day of the first plan year beginning on or after August 17, 2006 are retained under the ITG plan covering governmental employees.

C. Example

The following example illustrates the relief provided in A. and B. of this section III.

Example. (i) Facts. An ITG maintains a mixed ITG plan (Plan A) for its employees. Plan A covers governmental ITG employees substantially all of whose services are in the performance of essential governmental functions that are not commercial activities, and also commercial ITG employees, i.e., employees whose services are for commercial activities (such as a hotel, casino, service station, convenience store, or marina operated by the ITG). The first day of Plan A’s plan year is October 1. Accordingly, section 906(a)(1) of PPA ’06 is effective for Plan A on October 1, 2006.

(ii) Reasonable and good faith compliance . In order to comply with the requirements of section 906(a)(1) of PPA ’06 to be a governmental plan, action is taken by the ITG on July 1, 2007, to freeze benefits under Plan A with respect to the commercial ITG employees, as of September 30, 2006, so that Plan A only provides benefits for the commercial ITG employees for years of service before October 1, 2006. A continuing plan (Plan B) is adopted on July 1, 2007, effective as of October 1, 2006, the terms of which are the same as Plan A, but which only applies to the commercial ITG employees. Since October 1, 2006, Plan B provides the same level of benefits as were provided under Plan A before October 1, 2006, and Plan B complies with the qualification requirements for plans that are not governmental plans (including the operations of Plan B being consistent with the terms of Plan B). Accordingly, Plan B is treated as a continuation of Plan A from and after October 1, 2006.

(iii) Alternative reasonable and good faith com- pliance . As an alternative to the action under (ii) of this Example, the ITG takes action on July 1, 2007, effective as of October 1, 2006, to spin off all (or a portion) of the assets and liabilities of Plan A with respect to commercial ITG employees as a separate Plan B for service from and after October 1, 2006. Since October 1, 2006, Plan B provides the same level of benefits as were provided under Plan A before October 1, 2006, and Plan B (including benefits for service before October 1, 2006) complies with the qualification requirements for plans that are not governmental plans beginning on October 1, 2006 (including the operations of Plan B being consistent with the terms of Plan B). Accordingly, Plan B is treated as a continuation of Plan A from and after October 1, 2006.

the amendment is effective as of the related PPA ’06 effective date and the plan has been operated in accordance with the amendment.

III. Transition Relief

A. Reasonable Good Faith Compliance Pending Guidance

1. In General . The IRS and the Department of the Treasury anticipate issuing guidance on § 414(d) of the Code, including the amendment made by section 906 of PPA ’06. Until such guidance is issued, a plan established and maintained by an ITG for its employees (ITG plan) will be treated as satisfying the requirements of section 906(a)(1) of PPA ’06 to be a governmental plan under § 414(d) of the Code if it complies with those requirements based on a reasonable and good faith interpretation of the amendment made by section 906(a)(1) of PPA ’06.

2. Commercial Activities . The reasonable and good faith interpretation standard extends to the question of whether activities are commercial for purposes of § 414(d) of the Code. However, for purposes of section III.A.1, it is not a reasonable and good faith interpretation of section 906(a)(1) of PPA ’06 that an ITG plan is a governmental plan if employees who perform the following commercial activities continue to accrue benefits under the ITG plan. These are employees who are employed by a hotel, casino, service station, convenience store, or marina operated by the ITG from the first day of the first plan year beginning on or after August 17, 2006 (disregarding employees substantially all of whose services as an employee of the ITG are in the performance of essential governmental functions but not in the performance of services for a hotel, casino, service station, convenience store, or marina operated by the ITG).

B. Relief for Mixed ITG plans that Cover Both Governmental and Commercial Employees

Some ITG plans (“mixed ITG plans”) provide benefits both to employees substantially all of whose work is in essential governmental functions that are not commercial activities (“governmental ITG

employees”) and to employees who perform commercial activities (“commercial ITG employees”). Furthermore, section 906(a)(1) of PPA ’06 is effective for some ITG plans soon after its enactment. The IRS and the Department of the Treasury recognize that mixed ITG plans may have substantial difficulty in complying in operation with this provision by the provision’s effective date. Accordingly, this section III.B provides guidance under which, until September 30, 2007, an ITG plan for commercial ITG employees will be treated as a continuation of the mixed ITG plan.

From the first day of the first plan year beginning on or after August 17, 2006, an existing mixed ITG plan will be treated for that plan year as satisfying the reasonable and good faith compliance standard for transitional relief under this notice if, by September 30, 2007, it takes the following steps to provide coverage for governmental ITG employees and commercial ITG employees under separate ITG plans. If an existing mixed ITG plan freezes benefits for the commercial ITG employees, and adopts a new plan covering those commercial ITG employees, in accordance with the steps below, the new ITG plan covering the commercial ITG employees will be treated as a continuation of the relevant portion of the mixed ITG plan that covered the commercial ITG employees prior to the first day of the first plan year beginning on or after August 17, 2006. These steps are:

(1) not later than September 30, 2007, the ITG adopts a separate plan covering commercial ITG employees and that plan complies with the applicable qualification rules under § 401(a) for plans that are not governmental plans under § 414(d) effective as of the first day of the first plan year beginning on or after August 17, 2006;

(2) the ITG takes action, not later than September 30, 2007, to freeze benefit accruals under the mixed ITG plan for commercial ITG employees (including commercial ITG employees who perform services for a hotel, casino, service station, convenience store, or marina operated by the ITG), effective as of the first day of the first plan year beginning on or after August 17, 2006; and (3) there is no reduction in the benefit formula provided to participants in the continuing commercial ITG plan for the first plan year beginning on or after August

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D. Definition of Essential Governmental Function

The definition of an essential governmental function under § 7871(e) of the Code for purposes of determining the availability of tax-exempt bond financing for an ITG (including the summary of which activities are considered an essential governmental function customarily performed by State and local governments) described in the advance notice of proposed rulemaking under § 7871 published by the IRS on August 9, 2006 ³ will be considered a reasonable and good faith interpretation of what constitutes an essential government function under § 414(d).

E. Relief Only Applies Pending Further Guidance

The relief provided in this section III applies pending the issuance of further guidance relating to § 414(d), including the amendment made by section 906(a)(1) of PPA ’06.

IV. Request for Comments

The IRS and the Department of the Treasury request public comments on issues relating to the amendment made by section 906(a)(1) of PPA ’06, including transitional issues not addressed in this notice (such as issues for ITG plans with a cash or deferred arrangement under § 401(k)). Written comments should be submitted by January 22, 2007. Send submissions to: CC:PA:LPD:PR (Notice 2006–89), room 5203, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8:30 a.m. and 4:30 p.m. to: Crystal Mall 4 Building, 1901 S. Bell St., room 108, Arlington, VA 22202. Alternatively, taxpayers may submit comments electronically to notice.comments@irscounsel.treas.gov (Notice 2006–89).

Drafting Information

The principal author of this notice is Ingrid Grinde of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding

this notice, please contact the Employee Plans taxpayer assistance telephone service at (877) 829–5500 (a toll-free number) between the hours of 8:30 am and 4:30 pm Eastern Time, Monday through Friday . Ms. Grinde may be reached at (202) 283–9888 (not a toll-free number).

Alternative Fuel and Alternative Fuel Mixtures; Blood Collector Organizations

Notice 2006–92