Part III. Administrative, Procedural, and Miscellaneous

2005–2 C.B. 786) regarding the application of § 409A. See 70 Fed. Reg. 57930 (Oct. 4, 2005). The proposed regulations incorporate and expand on the guidance provided in Notice 2005–1. As stated in the preamble to the proposed regulations, taxpayers may rely on the proposed regulations for periods preceding the effective date of the final regulations. However, the proposed regulations do not affect the applicability of this notice (and generally do not affect the application of other guidance issued with respect to § 409A, including Notice 2005–1).

D. Notice 2005–94

On December 27, 2005, the IRS issued Notice 2005–94, 2005–2 C.B. 1208, which provided the following guidance to employers and payers on their reporting and withholding obligations with respect to deferrals of compensation and amounts includible in gross income under § 409A during calendar year 2005:

payers’ reporting requirements under §§ 6041 and 6051 for calendar year 2005 with respect to annual deferrals of compensation within the meaning of § 409A.

ployers are not required to include in the total amount of wages as defined in § 3401(a) amounts includible in gross income of an employee under § 409A that the employee neither actually nor constructively received during the 2005 calendar year. Additionally, the notice suspended employers’ reporting requirements for calendar year 2005 with respect to such amounts.

ing requirements for 2005 with respect to amounts includible in the gross income of a nonemployee under § 409A that the nonemployee neither actually nor constructively received during the 2005 calendar year.

lished guidance may require an employer or payer to file a corrected information return and to furnish a

Reporting and Wage Withholding Under Internal Revenue Code § 409A

Notice 2006–100

I. PURPOSE

This notice provides guidance to employers and payers on their reporting and wage withholding requirements for calendar years 2005 and 2006 with respect to deferrals of compensation and amounts includible in gross income under § 409A of the Internal Revenue Code. This notice does not affect the application of § 3121(v)(2) or an employer’s reporting obligations under § 31.3121(v)(2)–1 of the Employment Tax Regulations. In addition, this notice provides guidance to service providers on their income tax reporting and tax payment requirements with respect to amounts includible in gross income under § 409A for 2005 and 2006.

II. BACKGROUND

A. The American Jobs Creation Act of 2004

Section 885 of the American Jobs Creation Act of 2004, Pub. Law No. 108–357, 118 Stat. 1418 (the Act), added § 409A, which provides, inter alia, that all amounts deferred under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income, unless certain requirements are met. Section 885(b) of the Act amended the Code to impose the following reporting and wage withholding requirements with respect to deferrals of compensation within the meaning of § 409A.

to require that an employer or payer report all deferrals for the year under a nonqualified deferred compensation plan on a Form W–2 (Wage and Tax Statement) or a Form 1099–MISC (Miscellaneous Income), regardless of whether such deferred compensation is includible in gross income under § 409A(a).

vide that the term “wages” includes any amount includible in the gross income of an employee under § 409A.

that a payer report amounts includible in gross income under § 409A that are not treated as wages under § 3401(a).

B. Notice 2005–1

On December 20, 2004, the IRS issued Notice 2005–1, 2005–1 C.B. 274 (published as modified on January 6, 2005), which provides guidance with respect to the application of § 409A. Additionally, in accordance with the amendments made by § 885(b) of the Act, Notice 2005–1 provides the following with respect to reporting and wage withholding requirements for deferred amounts:

ployee the total amount of deferrals for the year under a nonqualified deferred compensation plan in box 12 of Form W–2 using code Y. See Q&A–29.

includible in gross income under § 409A and in wages under § 3401(a) in box 1 of Form W–2 as wages paid to the employee during the year and subject to income tax withholding. An employer should also report such amounts in box 12 of Form W–2 using code Z. See Q&A–33.

ployee the total amount of deferrals for the year under a nonqualified deferred compensation plan in box 15a of Form 1099–MISC. See Q&A–30.

ble in gross income under § 409A and not treated as wages under § 3401(a) as nonemployee compensation in box 7 of Form 1099–MISC. A payer should also report such amounts in box 15b of Form 1099–MISC. See Q&A–35.

C. Proposed Regulations

On September 29, 2005, the IRS issued proposed regulations (REG–158080–04,

2006–51 I.R.B. 1109 December 18, 2006

purposes of this notice, the amount includible in gross income under § 409A(a) and required to be reported by the employer or payer equals the portion of the total amount deferred under the plan that, as of December 31, 2006, is not subject to a substantial risk of forfeiture as defined in Notice 2005–1, Q&A–10, or the proposed regulations, and has not been included in income in a previous year, plus any amounts of deferred compensation paid or made available to the service provider under the plan during the calendar year 2006. For purposes of this paragraph, an employer or payer may treat an amount as previously included in income if properly reported by the employer or payer on a 2005 Form W–2, Form 1099–MISC, or Form W–2c or corrected Form 1099–MISC. Thus, amounts properly reported on a 2005 Form W–2 or Form 1099–MISC, or Form W–2c or corrected Form 1099–MISC should not be reported again on a 2006 Form W–2 or Form 1099–MISC. For the definition of a plan, including the plan aggregation rules, see Notice 2005–1, Q&A–9, and proposed § 1.409A–1(c).

Amounts includible in gross income under § 409A(a) include only amounts deferred that are subject to § 409A. Accordingly, for purposes of this section III.B.1., references to amounts deferred under a plan, including references to account balances, refer solely to amounts deferred that are subject to § 409A and not, for example, to amounts deferred that were earned and vested prior to January 1, 2005 and that are not otherwise subject to § 409A due to the application of the effective date provisions. For rules regarding the application of the effective date provisions of § 409A to nonqualified deferred compensation plans, see Notice 2005–1, Q&A–16 to Q&A–18, and proposed § 1.409A–6.

The provisions of this notice addressing the calculation of the amounts includible in income are intended as interim guidance only. The Treasury Department and the IRS are currently formulating general guidance with respect to the calculation of the amounts includible in income, as well as other related issues. For information regarding the submission of comments on these topics, see section V. of this notice.

corrected payee statement for calendar year 2005 reporting any previously unreported amounts includible in gross income under § 409A.

vided that the IRS will not assert penalties under §§ 6651(a)(1) and (2), 6654, and 6662, with respect to amounts includible in gross income under § 409A for calendar year 2005 if the service provider reports and pays any taxes due with respect to such amounts in accordance with subsequent published guidance. The notice stated that such subsequent guidance would provide a period during which the service provider may report and pay such taxes due without incurring such penalties.

III. INTERIM EMPLOYER AND PAYER REPORTING AND WAGE WITHHOLDING PROVISIONS

This section provides guidance on employers’ and payers’ reporting and wage withholding requirements for calendar years 2005 and 2006 with respect to annual deferrals of compensation within the meaning of § 409A and with respect to amounts includible in gross income under § 409A.

A. 2005 and 2006 Annual Deferrals

1. Amounts Reportable on Form W–2

For calendar years 2005 and 2006, an employer is not required to report amounts deferred during the year under a nonqualified deferred compensation plan subject to § 409A in box 12 of Form W–2 using code Y.

2. Amounts Reportable on Form 1099–MISC

For calendar years 2005 and 2006, a payer is not required to report amounts deferred during the year under a nonqualified deferred compensation plan subject to § 409A in box 15a of Form 1099–MISC.

B. Reporting and Withholding on Amounts Includible in Gross Income under § 409A

Section 3401(a) provides that for income tax withholding purposes the term

“wages” includes any amount includible in gross income of an employee under § 409A, and payment of such amount is treated as having been made in the taxable year in which the amount is includible in gross income. Thus, for calendar year 2006, an employer must treat amounts includible in gross income under § 409A as wages for income tax withholding purposes. An employer is required to report such amounts as wages paid on line 2 of Form 941, Employer’s Quarterly Federal Tax Return, and in box 1 of Form W–2. An employer must also report such amounts as § 409A income in box 12 of Form W–2 using code Z. If the employee has received other regular wages from the employer during the calendar year, amounts includible in gross income under § 409A are supplemental wages for purposes of determining the amount of income tax required to be deducted and withheld under § 3402(a). See Publication 15 for the withholding rules with respect to supplemental wages. The amount required to be withheld is not increased on account of the additional income taxes imposed under § 409A(a)(1)(B). Employees should thus be aware that estimated tax payments may be required to avoid penalties under § 6654.

For nonemployees, § 6041(g)(2) requires a payer to report to a nonemployee any amount that is includible in gross income under § 409A that is not treated as wages under § 3401(a). Thus, for calendar year 2006, a payer must report amounts includible in gross income under § 409A and not treated as wages under § 3401(a) as nonemployee compensation in box 7 of Form 1099–MISC. A payer must also report such amounts as § 409A income in box 15b of Form 1099–MISC.

1. Calculation of Amounts Includible in Income under § 409A(a) — In General

Section 409A(a)(1)(A)(i) provides that if at any time during a taxable year a nonqualified deferred compensation plan fails to meet the requirements of § 409A(a)(2), (3) or (4), all compensation deferred under the plan for the taxable year and all preceding taxable years shall be includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Accordingly, for

December 18, 2006 1110 2006–51 I.R.B.

defined in § 31.3121(v)(2)–1(c)(2)(i), where the amount deferred is reasonably ascertainable within the meaning of § 31.3121(v)(2)–1(e)(4), the amount deferred as of December 31, 2006 equals the present value of all future payments to which the employee has obtained a legally binding right as of December 31, 2006, calculated in accordance with § 31.3121(v)(2)–1(c)(2) as if the employee had obtained all of such rights on December 31, 2006. Section 31.3121(v)(2)–1(e)(4)(i)(B) provides that an amount deferred is considered reasonably ascertainable on the first date on which the amount, form, and commencement date of the benefit payments attributable to the amount deferred are known, and the only actuarial or other assumptions regarding future events or circumstances needed to determine the amount deferred are interest and mortality. An amount does not fail to be reasonably ascertainable if alternative forms or commencement dates are available that provide an actuarially equivalent benefit to the normal benefit commencing at the normal commencement date. These same rules apply for purposes of determining the amount reported on Form 1099–MISC for calendar year 2006 with respect to a nonemployee participating in a plan that would be subject to § 3121(v)(2) if the nonemployee service provider were an employee and that otherwise is a nonaccount balance plan as defined in § 31.3121(v)(2)–1(c)(2)(i).

c. Amounts Deferred Under Stock Rights Covered by § 409A

For a plan that is not subject to § 3121(v)(2) and is a stock right as defined in proposed § 1.409A–1(l), the amount deferred as of December 31, 2006 equals the amount that the service provider would be required to include in income if the stock right were immediately exercisable and exercised on December 31, 2006. In general, this will mean with respect to a stock right outstanding as of December 31, 2006, the amount deferred as of December 31, 2006 equals the fair market value of the underlying stock less the sum of the exercise price and any amount paid by the service provider for the stock right.

2. Wage Payment Date of Amounts Includible in Income under § 409A(a)

Amounts includible in gross income under § 409A(a) in 2006 that are either actually or constructively received (disregarding the application of § 409A) by an employee during the calendar year 2006, are considered a payment of wages by the employer when received by the employee for purposes of withholding, depositing, and reporting the income tax at source on wages under § 3401(a).

Amounts includible in gross income under § 409A(a) in 2006 that are neither actually nor constructively received (disregarding the application of § 409A) by the employee during the calendar year 2006, are treated as a payment of wages on December 31, 2006 for purposes of withholding, depositing, and reporting the income tax at source on wages under § 3401(a). If as of December 31, 2006 the employer does not withhold income tax from the employee on such wages, or withholds less than the amount of income taxes required to be withheld under § 3402 from the employee, the employee will receive credit under § 31 for 2006 if the employer follows one of two possible options. Under the first option, notwithstanding § 31.6205–1(c)(4), the employer withholds or recovers from the employee the amount of the undercollection after December 31, 2006 and before February 1, 2007, and reports as wages for the quarter ending December 31, 2006 such amounts that were neither actually nor constructively received but are includible in income under § 409A on Form 941 for that quarter and in box 1 of the employee’s Form W–2 for 2006. Under the second option, the employer pays the income tax withholding liability on behalf of the employee (without deduction from the employee’s wages or other reimbursement by the employee), and reports the gross amount of wages and the income tax withholding liability for the quarter ending December 31, 2006 as including such amounts that were neither actually nor constructively received but are includible in income under § 409A as well as the wages resulting from paying the income tax on the employee’s behalf on Form 941 and in box 1 of the employee’s Form W–2 for 2006. See Rev. Rul. 58–113, 1958–1 C.B. 362, for methods of com

puting gross wages when paying income tax on behalf of an employee. In addition, for purposes of the deposit requirements associated with such wages, if the income tax withholding liability with respect to such wages is paid to the IRS by the due date of the Form 941 for the quarter ending December 31, 2006 on which the wages are reported, then the amount of income tax withholding liability will be considered to have been deposited in accordance with the rules of § 31.6302–1(c). Thus, penalties for failure to deposit taxes under § 6656 will not be imposed with respect to such amount.

3. 2006 Amounts Includible in Income under § 409A(a)

The following sections provide guidance for calculating the total amount deferred under the plan as of December 31, 2006 for purposes of determining the amount required to be included in gross income under § 409A(a) in accordance with the rules described in section III.B.1. of this notice.

a. Account Balance Plans

For plans subject to § 3121(v)(2) that are account balance plans as defined in § 31.3121(v)(2)–1(c)(1)(ii)(A), the amount deferred as of December 31, 2006 equals the amount that would be treated as an amount deferred under § 31.3121(v)(2)–1(c)(1) on December 31, 2006 if the entire account balance (including all principal amounts, adjusted for income, gain or loss credited to the employee’s account) as of December 31, 2006 were treated as a principal amount credited to the employee’s account on December 31, 2006. These same rules apply for purposes of determining the amount reported on Form 1099–MISC for calendar year 2006 with respect to a nonemployee participating in a plan that would be subject to § 3121(v)(2) if the nonemployee service provider were an employee and that otherwise is an account balance plan as defined in § 31.3121(v)(2)–1(c)(1)(ii)(A).

b. Nonaccount Balance Plans — Amounts that are Reasonably Ascertainable

For plans subject to section 3121(v)(2) that are nonaccount balance plans as

2006–51 I.R.B. 1111 December 18, 2006

5. Amounts Includible in Income under § 409A(b)

Section 409A(b)(1) provides generally that in the case of assets set aside (directly or indirectly) in a trust (or other arrangement determined by the Secretary) for purposes of paying deferred compensation under a nonqualified deferred compensation plan, such assets shall be treated as property transferred in connection with the performance of services for purposes of § 83 whether or not such assets are available to satisfy claims of general creditors at the time set aside if such assets (or such trust or other arrangement) are located outside of the United States, or at the time transferred if such assets (or such trust or other arrangement) are subsequently transferred outside of the United States.

Section 409A(b)(2) provides that in the case of compensation deferred under a nonqualified deferred compensation plan, there is a transfer of property within the meaning of § 83 with respect to such compensation as of the earlier of the date on which the plan first provides that assets will become restricted to the provision of benefits under the plan in connection with a change in the employer’s financial health, or the date on which assets are so restricted, whether or not such assets are available to satisfy claims of general creditors.

Section 409A(b)(3) as amended by the Pension Protection Act of 2006, Public Law 109–280 (120 Stat. 780), provides that if, during a restricted period with respect to a single-employer defined benefit pension plan, assets are set aside or reserved in, or transferred to, a trust or other arrangement for purposes of paying deferred compensation for an applicable covered employee under a nonqualified deferred compensation plan of the plan sponsor or a member of its controlled group, or a nonqualified deferred compensation plan of the plan sponsor or a member of its controlled group provides that assets will become restricted to the provision of benefits, or assets are so restricted, in connection with such restricted period (or similar financial measure determined by the Secretary), the assets are treated as a transfer of property for purposes of § 83 whether or not such assets are available to satisfy claims of general creditors.

d. Other Deferred Amounts

For all deferred amounts not addressed in section III.B.2.a., b., or c. of this notice, the amount deferred as of December 31, 2006 must be determined under a reasonable, good faith application of a reasonable, good faith method. For this purpose, a reasonable, good faith application of a reasonable, good faith method generally must reflect reasonable, good faith assumptions with respect to any contingencies as to the timing or amount of any payment. Generally, the use of an assumption with respect to a contingency that results in the amount deferred being the lowest potential value of the future payment will be presumed not to be a reasonable, good faith assumption unless clear and convincing evidence demonstrates that the assumption is reasonable. For example, where a payment may be made in more than one form, the assumption that the payment will be made in the least valuable form will be presumed not to be a reasonable, good faith assumption unless clear and convincing evidence demonstrates otherwise. If a portion of a deferred amount can be calculated under section III.B.2.a., b., or c. of this notice, a reasonable, good faith method of calculation will in fact be a combination of two methods. The method applicable under section III.B.2.a., b., or c. of this notice must be applied to the portion, and the balance of the deferred amount must be determined under a reasonable good faith method.

e. Mandatory bifurcation

For purposes of the application of this section, the portion of a nonqualified deferred compensation plan that qualifies as an account balance plan under § 31.3121(v)(2)–1(c)(1)(ii), or would qualify as an account balance plan if the service provider were an employee, and provides that the amount payable to the service provider under the portion is determined independently of the amount payable under the other portion of the plan, must be treated separately as an account balance plan. Cf. § 31.3121(v)(2)–1(c)(1)(iii)(B).

4. 2005 Amounts Includible in Gross Income under § 409A(a)

Employers and payers, including employers and payers who relied on Notice 2005–94 for calendar year 2005, which suspended employers’ and payers’ reporting requirements with respect to deferrals of compensation includible in gross income under § 409A, are required to file an original or a corrected information return and furnish an original or a corrected payee statement (Form W–2 or 1099–MISC) for calendar year 2005 reporting any previously unreported amounts includible in gross income under § 409A for calendar year 2005 as determined under guidance provided by this notice for calendar year 2006. (If the employer or payer paid no wages or income to the service provider in 2005 other than amounts taxable under § 409A, the payer will be preparing an original Form W–2 or Form 1099–MISC, not a Form W–2c or a corrected Form 1099–MISC for 2005.) Failure to file information returns and furnish payee statements as specified in this notice may result in liability for penalties under §§ 6721 and 6722. The original or corrected information return and the original or corrected payee statement for calendar year 2005 must be filed and furnished by the deadlines applicable for filing an information return and furnishing a payee statement reporting amounts includible in income in calendar year 2006. (Generally, this means the original or corrected information return must be filed by February 28, 2007, and the original or corrected payee statement must be furnished by January 31, 2007. See the 2006 instructions for Form W–2 and Form 1099.) An employer or payer who is required to file an original or a corrected information return and furnish an original or a corrected payee statement for calendar year 2005 must calculate the amounts includible in gross income using the rules provided in this notice. An employer or payer is not liable for income tax withholding under § 3403 or penalties for 2005 with respect to any previously unreported amounts of gross income includible under § 409A reported on an original Form W–2 or Form 1099–MISC, or Form W–2c or a corrected Form 1099–MISC for 2005 in accordance with the guidance provided by this notice.

December 18, 2006 1112 2006–51 I.R.B.

A. Amounts Required to be Included in Income

A service provider must report as income and pay any taxes due relating to amounts includible in gross income under § 409A for calendar year 2006. In addition, if a service provider has not reported as income and paid any tax due relating to amounts includible in gross income under § 409A for calendar year 2005, calculated in accordance with this notice, the service provider must file an amended return and pay any taxes due relating to such amounts. If the service provider files an amended return and pays any taxes due relating to such amounts calculated in accordance with this notice, the IRS will not assert penalties under §§ 6651(a)(1) and (2), 6654, and 6662. If the service provider is required to file an amended return for 2005 in order to report amounts includible in income under § 409A, the service provider must file such amended return and pay any additional taxes owing by the due date for the service provider’s 2006 income tax return, including extensions, in order to avoid penalties.

For purposes of determining the amount required to be included in income under § 409A, the same standards apply to a service provider as apply to an employer or payer when calculating the amount required to be reported, provided that an amount is treated as previously included in income only if the amount has been included in the service provider’s income in a previous taxable year (regardless of whether reported on a Form W–2 or 1099–MISC). Accordingly, an employee or other service provider must calculate the amounts required to be included in gross income under the same methods and standards as set forth in section III. Whether a service provider has complied with the requirements of this notice is determined independently of whether the employer or payer has complied with the requirements of this notice. Thus, if the service provider includes in income the same amount reported by the employer or payer, the service provider has not necessarily complied with the terms of this notice.

If the service provider does not report and pay taxes due with respect to amounts includible in gross income under § 409A for calendar year 2005 or 2006 in

Section 409A(b)(4), as amended by the Pension Protection Act, provides that for each taxable year that assets treated as transferred under § 409A(b) remain set aside in a trust or other arrangement subject to § 409A(b)(1) or (2), any increase in value in, or earnings with respect to, such assets shall be treated as an additional transfer of property under this subsection (to the extent not previously included in income).

Notice 2006–33, 2006–15 I.R.B. 754, April 10, 2006, provides transition guidance related to the application of § 409A(b) to certain arrangements outstanding as of March 21, 2006. Under that relief, amounts transferred to trusts under the arrangement on or before March 21, 2006 that triggered the income inclusion and additional taxes under § 409A(b), or arrangements that otherwise triggered the income inclusion and additional taxes under § 409A(b) on or before March 21, 2006, generally are treated as not having triggered the inclusion or additional tax provisions of § 409A(b), provided that the arrangements become compliant with § 409A(b) before January 1, 2008. Nothing in this notice is intended to modify that relief.

However, where amounts have been transferred to a trust under an arrangement that triggers the income inclusion and additional taxes under § 409A(b), or the arrangement otherwise triggers the income inclusion and additional taxes under § 409A(b), and the transfer is not eligible for the relief in Notice 2006–33 (for example because the transfer occurred after March 21, 2006), employers and payers must make a reasonable, good faith application of a reasonable, good faith method to determine the amount includible in income for purposes of reporting. In addition, employers must treat the amount as wages for purposes of § 3401. Amounts includible in income under § 409A(b) that are not eligible for the relief in Notice 2006–33 are treated as wages paid on the date the deemed transfer of property under § 83 described in § 409A(b) would be required to be included in income under the rules of § 83, for purposes of withholding, depositing and reporting the income tax at source on wages under § 3401(a).

C. Protection from Future Additional Reporting or Withholding for 2005 and 2006

An employer or payer who complies with the rules of this notice regarding computing amounts includible in gross income under § 409A and withholding and reporting for calendar years 2005 and 2006 will not be liable for additional income tax withholding or penalties, or be required to file a subsequent corrected information return or furnish a corrected payee statement, as a result of future published guidance with respect to the computation of amounts includible in gross income under § 409A. If it is subsequently determined that the employer did not apply the rules of this notice in determining amounts includible in gross income under § 409A and in wages under § 3401(a) for calendar years 2005 or 2006 as provided in this notice, any recalculation of these amounts will result in additional liability for income tax withholding under § 3403 for these years, plus any applicable penalties. In addition, an employer or payer who does not apply the rules of this notice in determining amounts includible in gross income under § 409A and in wages under § 3401(a) for calendar years 2005 or 2006 will be required to file an original or a corrected information return and furnish an original or a corrected payee statement. For purposes of determining any amount includible in income under § 409A in a subsequent year, an amount will not be treated as previously included in income unless the amount has been reported appropriately on an information return and payee statement, or has been included in income by the service provider in a previous year.

IV. SERVICE PROVIDER REQUIREMENTS WITH RESPECT TO AMOUNTS INCLUDIBLE IN GROSS INCOME UNDER § 409A

This section provides guidance on service providers’ income tax reporting and tax payment requirements for calendar years 2005 and 2006 with respect to deferrals of compensation that are includible in gross income under § 409A.

2006–51 I.R.B. 1113 December 18, 2006

vision Counsel/Associate Chief Counsel (Tax Exempt and Governments Entities), although other Treasury and IRS officials participated in its development. For further information on the provisions of this notice addressing the calculation of the amount includible in income under § 409A, contact Stephen Tackney at (202) 927–9639; for further information on other provisions of this notice, including the reporting and withholding provisions contained in this notice, contact Mr. Parkinson at (202) 622–6040 (not toll-free numbers).

Diversification Requirements for Qualified Defined Contribution Plans Holding Publicly Traded Employer Securities

Notice 2006–107

I. PURPOSE

This notice provides transitional guidance on § 401(a)(35) of the Internal Revenue Code, added by section 901 of the Pension Protection Act of 2006, Public Law 109–280, 120 Stat. 780 (PPA ’06), which provides diversification rights with respect to publicly traded employer securities held by a defined contribution plan. This notice also states that Treasury and the Service expect to issue regulations under § 401(a)(35) that incorporate the transitional relief in this notice and requests comments on the transitional guidance in this notice and on the topics that need to be addressed in the regulations.

II. BACKGROUND

Section 401(a)(35), as added by section 901 of PPA ‘06, provides that, to remain qualified under § 401(a), a defined contribution plan (other than certain employee stock ownership plans) must provide applicable individuals with the right to divest employer securities in their accounts and reinvest those amounts in certain diversified investments. Section 901 also added a parallel provision, section 204(j), to the Employee Retirement Income Se

accordance with the guidance contained in this notice, the IRS may assert additional income taxes and penalties under §§ 6651(a)(1) and (2), 6654, and 6662 if it is determined that the amount of taxes reported and paid for calendar year 2005 or 2006 was underreported or underpaid. Interest imposed under Chapter 67 of the Code will apply to any underpayments of tax resulting from a service provider’s failure to include amounts includible in gross income under § 409A for calendar year 2005 or 2006. For purposes of determining the amount includible in income under § 409A in a subsequent year, the service provider may treat an amount as previously included in income only if the service provider has actually included the amount in gross income in a previous year.

B. Calculation of Additional Tax under § 409A(a)(1)(B)(i)(I)

Section 409A(a)(1)(B)(i)(I) provides that if compensation is required to be included in gross income under § 409A(a)(1)(A), the tax imposed on such income is increased by the sum of two additional taxes equal to the amount of interest determined under § 409A(a)(1)(B)(ii) plus an amount equal to 20% of the compensation which is required to be included in gross income. Section 409A(a)(1)(B)(ii) provides that the amount of interest is the amount of interest at the underpayment rate plus 1 percentage point on the underpayments that would have occurred had the deferred compensation been includible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such deferred compensation is not subject to a substantial risk of forfeiture.

Section 885(d)(1) of the Act provides that § 409A generally applies to amounts deferred after December 31, 2004. Section 885(d)(2)(B) of the Act provides that amounts deferred in taxable years beginning before January 1, 2005, shall be treated as amounts deferred in a taxable year beginning on or after such date if the plan under which the deferral is made is materially modified after October 3, 2004. Accordingly, for purposes of the calculation of the additional tax under § 409A(a)(1)(B)(ii), taxpayers may treat amounts deferred under a plan that were originally deferred on or before January 1,

2005 but became subject to § 409A due to the material modification of the plan after October 3, 2004 as deferred on January 1, 2005.

V. REQUEST FOR COMMENTS

The provisions of this notice are intended as interim guidance only. The Treasury Department and the IRS are currently formulating general guidance with respect to the income inclusion requirements, the additional taxes, and the reporting and withholding requirements of § 409A. The Treasury Department and the IRS request comments on all aspects of these requirements, including but not limited to the topics addressed in this notice.

Comments must be submitted by March 18, 2007. All materials submitted will be available for public inspection and copying.

Comments may be submitted to Internal Revenue Service, CC:PA:LPD:RU (Notice 2006–100), Room 5203, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may also be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to the Courier’s Desk at 1111 Constitution Avenue, NW, Washington, DC 20224, Attn: CC:PA:LPD:RU (Notice 2006–100), Room 5203. Submissions may also be sent electronically via the internet to the following email address: Notice.comments@irscounsel.treas.gov . Include the notice number (Notice 2006–100) in the subject line.

VI. EFFECT ON OTHER DOCUMENTS

Notice 2005–94 is superseded. Notice 2005–1 is modified.

VII. EFFECTIVE DATE

This notice is effective with respect to employers’ and payers’ reporting and wage withholding requirements and with respect to service providers’ filing requirements and tax payment obligations relating to amounts includible in gross income under § 409A for calendar years 2005 and 2006.

VIII. DRAFTING INFORMATION

The principal author of this notice is Don M. Parkinson of the Office of Di

December 18, 2006 1114 2006–51 I.R.B.

curity Act of 1974 (ERISA). ¹ In addition, section 101(m) of ERISA, as added by section 507 of PPA ‘06, requires a plan to provide applicable individuals with a notice describing diversification rights under section 204(j) of ERISA and providing information on the importance of diversifying investments.

The diversification requirements of § 401(a)(35) are generally effective with respect to plan years beginning after December 31, 2006, subject to certain special effective date rules, including a special rule with respect to plans maintained pursuant to a collective bargaining agreement. See section 901(c) of PPA ’06. The notice requirements of section 101(m) of ERISA are effective with respect to plan years beginning after December 31, 2006.

III. TRANSITIONAL GUIDANCE

This Part III provides transitional guidance with respect to § 401(a)(35). The transitional guidance provided in this Part III applies pending the issuance of further guidance.

A. Scope of Application.

Section 401(a)(35) imposes diversification requirements for defined contribution plans that hold publicly traded employer securities. Section 401(a)(35)(G)(iv) provides that the term employer security has the meaning given such term by section 407(d)(1) of ERISA. Under § 401(a)(35)(G)(v), the term publicly traded employer securities means employer securities which are readily tradable on an established securities market. For this purpose, if a plan holds employer securities that are not publicly traded, then, except as provided in Treasury regulations, those employer securities are nevertheless treated as publicly traded employer securities if any employer corporation, or any member of the controlled group of corporations that includes an employer corporation, has issued a class of stock that is a publicly traded employer security. For this purpose, an employer corporation means any corporation that is an employer maintaining the plan and a controlled group of corporations has the

meaning given under § 1563(a), except that 50% is substituted for 80% wherever it occurs in § 1563. ²

However, under this notice, a plan (and an investment option described in the last paragraph of Part IIIC of this notice) is not treated as holding employer securities to which § 401(a)(35) applies with respect to any securities held by either an investment company registered under the Investment Company Act of 1940 or a similar pooled investment vehicle that is regulated and subject to periodic examination by a State or Federal agency and with respect to which investment in the securities is made both in accordance with the stated investment objectives of the investment vehicle and independent of the employer and any affiliate thereof, but only if the holdings of the investment company or similar investment vehicle are diversified so as to minimize the risk of large losses.

In addition, § 401(a)(35) does not apply to an employee stock ownership plan (ESOP) if (1) there are no contributions held in the plan (or earnings thereunder) which are elective deferrals, employee after-tax contributions, or matching contributions that are subject to § 401(k) or (m) and (2) the plan is, for purposes of § 414(l) and §1.414(l)–1 of the Income Tax Regulations, a separate plan from any other plan maintained by the employer. Thus, an ESOP is subject to § 401(a)(35) if either the ESOP holds any contributions to which § 401(k) or (m) applies (or earnings thereon) or the ESOP is a portion of a plan that holds any amounts that are not part of the ESOP.

B. Applicable Individuals Who Have Diversification Rights.

Section 401(a)(35) provides applicable individuals with diversification rights with respect to publicly traded employer securities held in the plan under subparagraphs (B) and (C) of § 401(a)(35). The diversification rights under subparagraph (B) of § 401(a)(35) apply with respect to elective deferrals and employee contributions (and earnings thereon) and are required to be available to (1) any participant, (2) any alternate payee who has an account under the plan, and (3) any beneficiary of

a deceased participant. For this purpose, employee contributions include both employee after-tax contributions and rollover contributions held under the plan. The diversification rights under subparagraph (C) of § 401(a)(35) apply with respect to other employer contributions (and earnings thereon) and are required to be available to each applicable individual who is either (1) a participant who has completed at least three years of service, (2) an alternate payee who has an account under the plan with respect to a participant who has completed at least three years of service, or (3) a beneficiary of a deceased participant. For purposes of this notice, persons who are entitled to receive diversification rights are termed “applicable individuals.”

For purposes of § 401(a)(35)(C) and § 401(a)(35)(H) (the transitional rule described in paragraph E of this Part III), the date on which a participant completes three years of service occurs immediately after the end of the third vesting computation period provided for under the plan that constitutes the completion of a third year of service under § 411(a)(5). However, for a plan that uses the elapsed time method of crediting service for vesting purposes (or a plan that provides for immediate vesting without using a vesting computation period or the elapsed time method of determining vesting), the date on which a participant completes three years of service is the third anniversary of the participant’s date of hire.

C. Basic Divestiture Rules.

An applicable individual is required to be permitted to elect to direct the plan to divest any publicly traded employer securities held in his or her account under the plan and to reinvest an equivalent amount in other investment options offered under the plan with respect to the portion of the account that is subject to subparagraph (B) or (C) of § 401(a)(35) to the extent applicable. This diversification right only applies when publicly traded employer securities are held under the plan and allocated to the participant’s or beneficiary’s account.

Under § 401(a)(35)(D)(i), the investment options offered must include not less than three investment options, other than

1 Under section 101 of Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of the Treasury has interpretive jurisdiction over the subject matter addressed in this notice for purposes of section 204(j) of ERISA. Thus, the transitional guidance provided in this notice with respect to § 401(a)(35) also applies for purposes of section 204(j) of ERISA.

2 See §401(a)(35)(F)(ii) for an exception that applies to certain controlled groups with publicly traded securities.

2006–51 I.R.B. 1115 December 18, 2006

days following an initial public offering of the employer’s stock.

3. Transition Rule Through March 30, 2007 for Continuation of Existing Restric- tions or Conditions . For the period from January 1, 2007, through March 30, 2007, a plan does not impose a restriction or condition prohibited by § 401(a)(35)(D)(ii)(II) merely because the plan restricts diversification rights with respect to employer securities pursuant to a plan provision that was in effect on December 18, 2006. However, any such restriction that continues to be imposed on or after March 31, 2007, violates § 401(a)(35)(D)(ii)(II).

4. Transition Rule for 2007 for Grand- fathered Investments . For the period prior to January 1, 2008, a plan does not impose a restriction or condition prohibited by § 401(a)(35)(D)(ii)(II) merely because the plan, as in effect on December 18, 2006, (1) does not impose an otherwise applicable restriction on a stable value fund or (2) allows applicable individuals the right to divest employer securities on a periodic basis, but permits divestiture of another investment on a more frequent basis, provided that the other investment is not a generally available investment ( e.g., the other investment is only available to a fixed class of participants). However, any such restriction that continues to be imposed after December 31, 2007, violates § 401(a)(35)(D)(ii)(II).

E. Transition Rule under § 401(a)(35)(H).

Section 401(a)(35)(H) provides a special transition rule under which, for employer securities acquired in a plan year beginning before January 1, 2007, the diversification rights under subparagraph (C) of §401(a)(35) only apply to the applicable percentage of the number of shares of those securities. The applicable percentage is 33% for the first plan year to which § 401(a)(35) applies, 66% for the second plan year, and 100% for all subsequent plan years. If a plan holds more than one class of securities, § 401(a)(35)(H) applies separately with respect to each class. This transition rule does not apply to a participant who, before the first plan year beginning after December 31, 2005, had attained age 55 and completed at least three years of service.

employer securities, to which the applicable individual may direct the proceeds of the divestment of employer securities, and each investment option must be diversified and have materially different risk and return characteristics. For this purpose, investment options that satisfy the requirements of § 2550.404c–1(b)(3) of the Department of Labor Regulations are treated as being diversified and having materially different risk and return characteristics.

D. Restrictions or Conditions on Divestiture Rights.

1. Conditions or Restrictions . Under § 401(a)(35)(D)(ii)(I), a plan is not treated as failing to meet the requirements of § 401(a)(35) merely because the plan limits the time for divestment and reinvestment to periodic, reasonable opportunities occurring no less frequently than quarterly. Section 401(a)(35)(D)(ii)(II) prohibits a plan from imposing restrictions or conditions with respect to the investment of employer securities that are not imposed on the investment of other assets of the plan. For purposes of this prohibition in § 401(a)(35)(D)(ii)(II), except as described below in this Part IIID, a restriction or condition with respect to employer securities includes: (1) a restriction on an applicable individual’s rights to divest an investment in employer securities that is not imposed on an investment that is not in employer securities; and (2) a benefit that is conditioned on investment in employer securities. Thus, the following are examples of prohibited restrictions or conditions:

the right to divest employer securities on a periodic basis (such as quarterly), but permits divestiture of another investment on a more frequent basis (such as daily). However, see paragraph 4 of this Part IIID for a transitional rule.

divests his or her account of employer securities receives less favorable treatment (such as a lower rate of matching contributions) than a participant whose account remains invested in employer securities.

Similarly, the following are examples of restrictions or conditions that are not prohibited by § 401(a)(35)(D)(ii)(II), provided that the limitations apply without regard to a prior exercise of rights to divest employer securities:

which an individual’s account balance can be invested in employer securities. Thus, a provision that does not allow more than 10% of an individual’s account balance to be invested in employer securities is permitted.

securities investment fund is closed, i.e., other amounts invested under the plan cannot be transferred into an investment in a class of employer securities (and no contributions are permitted to be invested in that class of employer securities).

However, a provision under which, if a participant divests his or her account balance with respect to investment in a class of employer securities, the participant is not permitted for a period of time thereafter to reinvest in that class of employer securities is a restriction that is prohibited by § 401(a)(35)(D)(ii)(II), because this limitation takes into account a prior exercise of rights to divest employer securities.

2. Permitted Restrictions . A restriction imposed by reason of the application of securities laws or a restriction that is reasonably designed to ensure compliance with such laws is not an impermissible restriction or condition under § 401(a)(35)(D)(ii)(II). Thus, for example, for purposes of ensuring compliance with Rule 10b–5 of the Securities and Exchange Commission, a plan may limit divestiture rights for participants who are subject to Section 16(b) of the Securities Exchange Act of 1934 to a period (such as 3 to 12 days) following publication of the employer’s quarterly earnings statements. In addition, an impermissible restriction or condition under § 401(a)(35)(D)(ii)(II) does not include the imposition of fees on other investment options under the plan merely because fees are not imposed with respect to investments in employer securities. Further, a plan may restrict the application of otherwise applicable diversification rights under the plan for up to 90

December 18, 2006 1116 2006–51 I.R.B.

G. Model Notice.

Section 507(c) of PPA ’06 directs the Secretary of the Treasury to prescribe a model notice for purposes of section 101(m) of ERISA ³ . The model below is being issued pursuant to that directive.

The model may have to be adapted to reflect particular plan provisions. For example, changes would generally be necessary if either the plan has more than one class of employer securities, the plan provides the same diversification rights for participants without regard to whether they have three years of service, some of the plan’s investment options are closed, the plan receives participant elections electronically, or the transition rule at § 401(a)(35)(H) is being applied.

F. Notice under Section 101(m) of ERISA.

In addition to amending the Code and ERISA to provide applicable individuals with the divestiture rights discussed in this notice, PPA ’06 also added section 101(m) to ERISA, which requires plans to notify applicable individuals of these rights. Specifically, plan administrators must provide a notice to applicable individuals not later than 30 days before the first date on which the individuals are eligible to exercise their rights. The notice must set forth the diversification rights provided under § 401(a)(35) and describe the importance of diversifying the investment of retirement account assets. Section 101(m) of ERISA is effective for plan years beginning after December 31, 2006.

Although some plans will be required to comply with § 401(a)(35) as early as January 1, 2007, the Department of Labor has advised Treasury and the Service that section 101(m) of ERISA does not require plans to furnish notices before January 1, 2007. Pursuant to this interpretation, plans with plan years beginning on or after January 1, 2007, but before February 1, 2007, are not required to furnish the model notice included herein (or a notice otherwise meeting the requirements of section 101(m) of ERISA) earlier than January 1, 2007. The Department, however, encourages plans to furnish notice on the earliest possible date.

Notice of Your Rights Concerning

Employer Securities

This notice informs you of an important change in Federal law that provides specific rights concerning investments in employer securities (company stock). Because you may now or in the future have investments in company stock under the [ insert name of plan ], you should take the time to read this notice carefully.

Your Rights Concerning Employer Securities

For plan years beginning after December 31, 2006, the Plan must allow you to elect to move any portion of your account that is invested in company stock from that investment into other investment alternatives under the Plan. This right extends to all of the company stock held under the Plan, except that it does not apply to your account balance attributable to [ identify any accounts to which the rights apply only after three years of service ] until you have three years of service. [ Insert description of any advance notice requirement before a diversification election becomes effective. ] You may contact the person identified below for specific information regarding this new right, including how to make this election. In deciding whether to exercise this right, you will want to give careful consideration to the information below that describes the importance of diversification. All of the investment options under the Plan are available to you if you decide to diversify out of company stock.

The Importance of Diversifying Your Retirement Savings

To help achieve long-term retirement security, you should give careful consideration to the benefits of a well-balanced and diversified investment portfolio. Spreading your assets among different types of investments can help you achieve a favorable rate of return, while minimizing your overall risk of losing money. This is because market or other economic conditions that cause one category of assets, or one particular security, to perform very well often cause another asset category, or another particular security, to perform poorly. If you invest more than 20% of your retirement savings in any one company or industry, your savings may not be properly diversified. Although diversification is not a guarantee against loss, it is an effective strategy to help you manage investment risk.

In deciding how to invest your retirement savings, you should take into account all of your assets, including any retirement savings outside of the Plan. No single approach is right for everyone because, among other factors, individuals have different financial goals, different time horizons for meeting their goals, and different tolerances for risk. Therefore, you should carefully consider the rights described in this notice and how these rights affect the amount of money that you invest in company stock through the Plan.

It is also important to periodically review your investment portfolio, your investment objectives, and the investment options under the Plan to help ensure that your retirement savings will meet your retirement goals.

For More Information

If you have any questions about your rights under this new law, including how to make this election, contact [ enter name and contact information ].

3 Section 101(m) of ERISA is under the jurisdiction of the Department of Labor.

2006–51 I.R.B. 1117 December 18, 2006

tax treatment of payments made by the USDA under land diversion programs. Announcement 83–43, 1983–10 I.R.B. 29, provides guidance in a Question and Answer format related to land diversion programs sponsored by the USDA for purposes of special use valuation under section 2032A of the Code, estate tax deferral under section 6166 of the Code, and the SECA tax. In Q&A 3, the Service stated that a farmer who receives cash or a payment in kind from the USDA for participation in a land diversion program is liable for self-employment tax on the cash or payment in kind received. The announcement was consistent with guidance provided in Rev. Rul. 60–32, 1960–1 C.B. 23, with respect to two earlier land diversion programs conducted under the Soil Bank Act. Both the announcement and the revenue ruling concluded that participants in the land diversion programs were subject to SECA taxes on their payments if the participants were otherwise operating a farm or materially participating in the production of commodities on a farm operated by others.

However, Rev. Rul. 60–32 also states that participants in land diversion programs are not subject to SECA tax on the payments, if they do not operate a farm or materially participate in farming activities. The material participation factor is relevant for SECA under these circumstances only with respect to the exception from net income from self-employment provided in section 1402(a)(1) for rentals from real property. Some taxpayers may have read the reference to material participation as implying that the rental exception could potentially apply to payments under a land diversion program.

More recently, the treatment of CRP payments for purposes of SECA, and more specifically, the potential application of the rental exception under section 1402(a)(1) was addressed by the Court of Appeals for the Sixth Circuit in Wuebker v. Commis- sioner, 205 F.3d 897 (6 ^th Cir. 2000). The Court held that CRP payments were net income from self-employment because they were received in exchange for performing tasks “that are intrinsic to the farming trade or business” such as tilling, seeding, fertilizing and weed control. Moreover, notwithstanding the fact that the CRP statutes labeled the payments as “rent”, the court concluded the payments are not rent

IV. REGULATIONS

The Service and Treasury plan to issue regulations under § 401(a)(35) and those regulations will be consistent with the transitional guidance issued in this notice.

V. COMMENTS REQUESTED

Comments are requested on § 401(a)(35), including the issues raised in Part III of this notice and issues that should be addressed in regulations. Any comments received on the notice rules, including the model notice above, will be provided to the Department of Labor.

Written comments should be submitted by March 18, 2007. Send submissions to CC:PA:LPD:DRU (Notice 2006–107), Room 5203, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, D.C. 20044. Comments may be hand delivered to CC:PA:LPD:DRU (Notice 2006–107), Room 5203, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, comments may be submitted via the Internet at notice.comments@irscounsel.treas.gov (Notice 2006–107). All comments will be available for public inspection.

VI. Paperwork Reduction Act

The collection of information contained in this notice has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–2049. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of information in this notice is in the model notice provision of IIIF. This information is required under section 507 of PPA’06. This information will be used to allow individual plans to comply with applicable law. The likely respondents are businesses or other for-profit institutions, and small businesses or organizations.

The estimated total annual reporting and/or recordkeeping burden is 7,725 hours.

The estimated annual burden per respondent and/or recordkeeper varies from

1 minute to 3 hours, depending on individual circumstances, with an estimated average of ³ /4’s of an hour. The estimated number of respondents and/or recordkeepers is 10,300. The estimated frequency of responses is occasional.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. § 6103.

DRAFTING INFORMATION

The principal drafter of this notice is Robert Gertner 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 a.m. and 4:30 p.m. Eastern Time, Monday through Friday. Mr. Gertner may be reached at (202) 283–9888 (not a toll-free number).

Application of the Self-Employment Contributions Act (SECA) Tax to Payments Made by the U.S. Department of Agriculture (USDA) Under the Conservation Reserve Program (CRP)

Notice 2006–108

I. Overview and Purpose

This notice sets forth a proposed revenue ruling concerning the application of the Self-Employment Contributions Act (SECA) tax to payments made by the U.S. Department of Agriculture (USDA) under the Conservation Reserve Program (CRP), 16 U.S.C. 3831. CRP was authorized in 1985. It is one of several programs administered by the USDA that provide payments in exchange for diverting land from agricultural use to other uses.

The Service has previously issued an announcement addressing the SECA

December 18, 2006 1118 2006–51 I.R.B.

to ensure the establishment and maintenance of the approved cover, and (7) file annual CRP reports. In order to implement the conservation plan, the terms of the contract require significantly more activities to be performed in the first year of the contract than in the later years. A personally completes the activities required under the CRP contract for tilling, seeding, fertilizing, and weed control using his own farm equipment. A also satisfies the other requirements of the contract. In return, A receives CRP rental payments each year during the contract term. A also receives cost sharing payments based on the costs A incurs in performing A’s obligations under the CRP contract.

Situation 2.

The facts are the same as in Situation 1, except that B, who owns the land, ceases all activities related to the business of farming in the year before he enters into the CRP contract. In the next calendar year B rents out a portion of his land to another farmer and enters into a 10-year CRP contract with respect to the remaining portion of his land. B arranges for a third party to perform the tilling, seeding, fertilizing and weed control required under the CRP contract and to fulfill the other contractual requirements. In return, B receives CRP rental payments each year during the contract term. B also receives cost sharing payments based on the costs B incurs in implementing CRP on the land.

LAW

Section 1401 of the Internal Revenue Code (Code) imposes a tax on the selfemployment income of every individual (SECA tax). The term “self-employment income” is defined in section 1402(b) as the net earnings from self-employment derived by an individual, with certain limitations.

Section 1402(a) defines an individual’s “net earnings from self-employment” as the gross income derived by an individual from any trade or business carried on by such individual, also with certain limitations. Section 1402(a)(1) generally excludes from the computation of “net earnings from self-employment” rentals from real estate and from personal property leased with the real estate (including

for tax purposes because they are not payments for use or occupation of the property. The court stated that “the essence of the program is to prevent participants from farming the property and to require them to perform various activities in connection with the land, both at the start of the program and continuously throughout the life of the contract, with the government’s access limited to compliance inspections.” Id . at 904. Thus, under the Court’s reasoning, CRP payments do not fall within the exception that excludes rent from net income from self-employment provided by section 1402(a).

Like the 1983 announcement and the 1960 revenue ruling, Wuebker addresses CRP recipients who are engaged in the business of farming while also receiving CRP payments. The IRS has received questions asking whether CRP payments are subject to SECA if the recipient is retired or not otherwise actively engaged in farming. This proposed revenue ruling is intended to respond to those questions. In addition, in light of the fact that the USDA no longer operates programs under the Soil Bank Act, and to remove any confusion that may arise from its holding, the proposed revenue ruling would obsolete Rev. Rul. 60–32. The IRS and Treasury are soliciting comments regarding the proposed revenue ruling. The Department of the Treasury and the Internal Revenue Service anticipate issuing a final revenue ruling after the comments have been considered.

II. Proposed Revenue Ruling

Section 1402.—Definitions

26 CFR 1.1402(a)–1: Definition of net earnings from

self-employment.

(Also: Section 1401.)

Rev. Rul. XXXX–XX

ISSUE

Whether Conservation Reserve Program (CRP) rental payments (including incentive payments) by the U.S. Department of Agriculture (USDA) to (1) a farmer actively engaged in the trade or business of farming who enrolls land in CRP and fulfills the CRP contractual obligations personally or to (2) an individual not otherwise actively engaged in the

trade or business of farming who enrolls land in CRP and fulfills the CRP contractual obligations by arranging for a third party to perform the required activities, are included in net earnings from self-employment for purposes of the Self-Employment Contributions Act (SECA) tax and not excluded from net income from self-employment as rentals from real estate.

FACTS

Situation 1.

A is engaged in the business of farming on land that A owns. A farms a portion of his cropland and has enrolled the remaining portion of his cropland in the CRP program. The CRP, 16 U.S.C. §§ 3801, 3831–3836, is a voluntary program under which the USDA through the Commodities Credit Corporation makes annual payments to participants. Participants include farm owners and operators who agree to place environmentally sensitive cropland in conserving uses for 10 to 15 years. Participants receive an annual “rental” payment (including incentive payments) and cost sharing assistance to establish and maintain approved groundcover, and participants agree to plant grasses, trees, and other conserving cover crops, restore wetlands and establish buffers. Generally, a participant is eligible to enroll land in CRP if the participant has owned or operated the land for at least twelve months prior to the close of the CRP sign up period. Land is eligible for placement in CRP if it is cropland or marginal pasture land.

A meets the eligibility requirements with respect to the portion of his land he is seeking to enroll in CRP. A enters into a 10 year CRP contract with the USDA for the primary purpose of earning a profit from the land. The terms of A’s CRP contract require that A will receive payments if A will (1) implement a conservation plan, (2) establish vegetative cover, (3) not engage in or allow grazing, harvesting, or other commercial use of the CRP land, (4) not use the land for agricultural purposes except as permitted by the USDA, (5) not harvest, sell, nor otherwise make commercial use of trees on the CRP land, (6) control on the CRP land all weeds, insects, pests, and other undesirable species

2006–51 I.R.B. 1119 December 18, 2006

such rentals paid in crop shares) together with the deductions attributable thereto, unless such rentals are received in the course of a trade or business as a real estate dealer, with an exception. Under this exception, any income derived by the owner or tenant of land must be included in the computation of “net earnings from self-employment” if—

(A) such income is derived under an arrangement, between the owner or tenant and another individual, which provides that such other individual shall produce agricultural or horticultural commodities (including livestock, bees, poultry, and fur-bearing animals and wildlife) on such land, and that there shall be material participation by the owner or tenant (as determined without regard to any activities of an agent of such owner or tenant) in the production or the management of the production of such agricultural or horticultural commodities, and

(B) there is material participation by the owner or tenant (as determined without regard to any activities of an agent of such owner or tenant) with respect to any such agricultural or horticultural commodity.

Section 1402(c) provides that the term “trade or business”, when used with reference to self-employment income or net earnings from self-employment, shall have the same meaning as when used in section 162 (relating to trade or business expenses), less allowable deductions.

Section 1.1402(c)–1 of the Income Tax Regulations generally provides that in order for an individual to have net earnings from self-employment, he must carry on a trade or business, either as an individual or as a member of a partnership. Whether or not he is engaged in carrying on a trade or business will depend upon all of the facts and circumstances in the particular case.

In considering whether an individual is engaged in a trade or business, the United States Supreme Court has stated that “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity, and the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity...does not qualify.” Commis- sioner v. Groetzinger, 480 U.S. 23, 35 (1987). The question of whether a taxpayer is engaged in a trade or business requires an examination of the relevant facts in each case. Id . at 36.

In Wuebker v. Commissioner, 205 F.3d 897 (6 ^th Cir. 2000), the Sixth Circuit held that CRP payments received by a farmer actively engaged in the business of farming were includible in self-employment income. The court concluded that their “agreement . . . required them to perform several ongoing tasks with respect to the land enrolled in the CRP, the very land they already owned and had previously farmed.” The Sixth Circuit noted that the taxpayers were required under the CRP contract to perform tasks intrinsic to the farming trade or business ( e.g., tilling, seeding, fertilizing, and weed control) that required the use of their farming equipment. Id . at 903. In addition, under the court’s view, the CRP payments were not payments of rent for the use or occupancy of property and therefore were not rentals from real estate excluded from SECA by section 1402(a)(1). The Court observed that the essence of the CRP program is to prevent participants from farming enrolled property and to require the participants to perform various activities in connection with the land continuously throughout the life of the contract with the government’s access limited to inspections. Id . at 904. Furthermore, the Sixth Circuit looked to the “substance, rather than the form, of the transaction” in determining that the income derived from the CRP contract is includible in self-employment income earned in lieu of farm income, for which SECA tax was due.

Under section 126(a), gross income does not include the excludable portion of payments received under certain conservation programs. Revenue Ruling 2003–59, 2003–1 C.B. 1014, holds that all or a portion of cost sharing payments received under the CRP are eligible for the exclusion from gross income permitted by section 126. The ruling also holds that rental payments and incentive payments received under the CRP are not cost sharing payments and therefore are not excludable from gross income.

ANALYSIS

Under Groetzinger, an activity will be a trade or business if the taxpayer “is involved in the activity with continuity and regularity and . . . the taxpayer’s primary purpose for engaging in the activity must be for income or profit.” Participa

tion in a CRP contract is a trade or business for both A and B. The participant is obligated to perform a number of activities, including but not limited to tilling, seeding, fertilizing, and weed control. Although more extensive activities are required at the beginning of the contract term than later, the obligation to perform activities extends throughout the ten-year period, giving participation in CRP the continuity and regularity necessary to be considered a trade or business. Also, both A and B enrolled land in the CRP program to earn a profit. Participation in a CRP contract meets the criteria to be a trade or business irrespective of whether the participant performs the required activities personally or arranges for his obligations to be satisfied by a third party. Thus, the trade or business treatment is the same for A and B even though A meets the CRP requirements for maintenance of the land himself whereas B arranges for someone else to do it. Furthermore, the CRP meets the criteria to be a trade or business based on the activities required directly under the program and without being affected by whether the participant is otherwise engaged in farming or any other trade or business. Finally, although 16 U.S.C. section 3801(a)(13) refers to some of these payments as “rent”, the treatment of these payments under the Code depends upon their substance. CRP rental payments are not payments for the right to use or occupy real property. CRP rental payments are made in exchange for conducting activities that meet the commitments of a CRP contract. Therefore, CRP rental payments are not excluded from net income from self-employment under section 1402(a)(1) as rentals from real estate. See Wuebker . Thus, for both A and B, the CRP rental payments are includible in their net income from self-employment.

To the extent that a cost sharing payment is excluded from gross income under section 126, that portion of the payment would also be excluded from the gross income derived by an individual from the trade or business carried on by the individual. Consequently, to the extent such payment is excluded from gross income under section 126, the payment is also excluded from net earnings from self-employment.

December 18, 2006 1120 2006–51 I.R.B.

HOLDING

CRP rental payments (including incentive payments) from USDA to a (1) farmer actively engaged in the trade or business of farming who enrolls land in CRP and fulfills the CRP contractual obligations personally and to (2) an individual not otherwise actively engaged in the trade or business of farming who enrolls land in CRP and fulfills the CRP contractual obligations by arranging for a third party to perform the required activities are both includible in net income from self-employment for purposes of the SECA tax and not excluded from net income from self-employment as rentals from real estate.

EFFECT ON OTHER REVENUE RULINGS

Revenue Ruling 60–32 is obsoleted.

III. Request for Comments

Comments are requested regarding the interaction of the proposed revenue ruling with the treatment of CRP payments under other Code provisions, such as sections 2032A and 6166. The comments will be available for public inspection and copying. Comments must be submitted by March 19, 2007. Comments should reference Notice 2006–108, and be addressed to:

Internal Revenue Service Office of the Associate Chief Counsel (Tax Exempt and Government Entities)

CC:TEGE 1111 Constitution Ave., N.W., Rm. 4000 Washington, DC 20224 Attn: Elliot Rogers

In addition, comments may be submitted electronically via the Internet by sending them in an e-mail to notice.comments@irscounsel.treas.gov and specifying the comments concern Notice 2006–108.

DRAFTING INFORMATION

The principal authors of this notice are Marie Cashman and Elliot Rogers of the Office of the Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from Treasury

and the Service participated in its development. For further information regarding this notice, contact Mr. Rogers at (202) 622–6040 (not a toll-free call).

Interim Guidance Regarding Supporting Organizations and Donor Advised Funds

Notice 2006–109