Part IV. Items — Internal Revenue Bulletin 2007-37

Notice of Proposed Rulemaking

Severance of a Trust for Generation-Skipping Transfer (GST) Tax Purposes II

REG–128843–05

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: These proposed regulations provide guidance regarding the generation-skipping transfer (GST) tax consequences of the severance of trusts in a manner that is effective under state law, but that does not meet the requirements of a qualified severance under section 2642(a)(3) of the Internal Revenue Code. These proposed regulations also provide guidance regarding the GST tax consequences of a qualified severance of a trust with an inclusion ratio between zero and one into more than two resulting trusts. These proposed regulations also provide special funding rules applicable to the non_pro rata_ division of certain assets between or among resulting trusts. The regulations will affect trusts that are subject to the GST tax.

DATES: Written or electronic comments and requests for a public hearing must be received by October 31, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–128843–05), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG–128843–05), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or sent electronically, via the Federal eRulemaking Portal at www.regulations.gov (IRS-REG–128843–05).

FOR FURTHER INFORMATION CONTACT: Mayer R. Samuels, (202) 622–3090 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On August 24, 2004, proposed regulations under section 2642(a)(3) regarding qualified severances were published in the Federal Register (REG–145987–03, 2004–2 C.B. 519 [69 FR 51967]). Final regulations were published on August 2, 2007. The Treasury Department and the IRS determined that certain comments received in response to the proposed regulations under section 2642(a)(3) should be addressed in a separate notice of proposed rulemaking, instead of in the final regulations published on August 2, 2007. Accordingly, this notice of proposed rulemaking proposes additional changes to the regulations in response to those comments.

Section 2642(a)(3) was added to the Internal Revenue Code (Code) by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Public Law 107–16 (115 Stat. 38 (2001)). Under section 2642(a)(3), if a trust is divided into two or more trusts in a “qualified severance,” the trusts resulting from the severance (resulting trusts), which may have different inclusion ratios, will be recognized as separate trusts for GST tax purposes. Once the resulting trusts are recognized as separate trusts, the transferor’s lifetime GST tax exemption may be allocated separately to either trust. In addition, whether or not a GST taxable event occurs is determined separately for each resulting trust.

One commentator with respect to the notice of proposed rulemaking under section 2642(a)(3) suggested that those regulations should expressly address the GST tax consequences of dividing a trust in a manner that does not satisfy the regulatory requirements of a qualified severance, but nonetheless is effective to create separate trusts under applicable state law. Specifically, the commentator requested that the regulations be amended to provide that the separate trusts created as the result of a trust’s division that is effective under state law, but that does not qualify as a qualified severance, will be respected prospectively as separate trusts for GST tax purposes, but that the inclusion ratio of each of the resulting trusts will be the same as the inclusion

ratio of the original trust immediately before its severance.

As noted by a commentator, however, such a result would require an amendment to the existing regulations under section 2654. Generally, section 2654(b)(2) provides that “substantially separate and independent shares” of different beneficiaries in a trust will be treated as separate trusts for GST tax purposes. Section 26.2654–1(a)(1)(i) provides that, for purposes of section 2654(b)(2), the term “substantially separate and independent shares” generally has the same meaning as provided in §1.663(c)(3). However, these regulations further provide that a portion of a trust is not a separate share “unless such share exists from and at all times after creation of the trust.”

Section 26.2654–1(a)(5), Example 8, illustrates this rule. In Example 8, T creates a discretionary trust with discretionary power in the trustee to distribute income and principal among T’s children and grandchildren. The trust agreement directs that, when T’s youngest child reaches age 21, the trust be divided into separate shares, with one such share for each child of T; the income from a particular share is to be paid to T’s child (for whom that share was created) for life, with the remainder from that share to be distributed to that child’s own children. The example concludes that the separate shares that come into existence when the youngest child reaches age 21 are not recognized as separate trusts for GST tax purposes because the separate shares did not constitute separate and independent shares of a single trust at all times from the date of creation of the original trust, as required by §26.2654–1(a)(1). Thus, any allocation of GST tax exemption to the original trust, or to any of the separate shares after the division, will apply with respect to the entire trust. The example provides that the result would be the same if the original trust was divided into separate trusts rather than separate shares.

Another commentator with respect to the notice of proposed rulemaking under section 2642(a)(3) requested that the regulations provide additional flexibility in severing a trust that has an inclusion ratio between zero and one. Generally, the final

September 10, 2007 587 2007–37 I.R.B.

that resulting trust. This clarification is proposed to be effective with respect to severances occurring on or after the date these proposed regulations are published in the Federal Register .

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) applies only to §26.2642–6(d)(7)(ii) of these regulations. It is hereby certified that this provision will not have a significant economic impact on a substantial number of small entities. Accordingly, a Regulatory Flexibility Analysis is not required. This provision directly affects individuals, not entities. Because the remaining sections of these regulations do not impose on small entities a collection of information requirement, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Requests for Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department request comments on the substance of the proposed regulations, as well as on the clarity of the proposed rules and how they may be made easier to understand. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register .

Drafting Information

The principal author of these proposed regulations is Mayer R. Samuels,

regulations apply section 2642(a)(3)(B)(ii) by requiring that the trust first be severed into two identical trusts, one of which would then have an inclusion ratio of zero and the other an inclusion ratio of one. The final regulations confirm that either or both of these trusts may then be further severed into a trust for the benefit of the skip person(s) and a trust for the benefit of the non-skip person(s). However, under this two-step procedure, one of the resulting trusts for the benefit of skip persons would have an inclusion ratio of one, and one of the trusts for the benefit of the non-skip persons would have an inclusion ratio of zero. The commentator requested that the regulations allow severances in a manner that would permit a more effective utilization of the exemption.

The Treasury Department and the IRS believe that each of these suggestions merits further consideration in a new notice of proposed rulemaking. In addition, the new proposed regulations clarify the rules in the final regulations regarding the funding of resulting trusts.

Explanation of Provisions

The proposed regulations amend the regulations under §26.2642–6 to provide that trusts resulting from a severance that does not meet the requirements of a qualified severance nevertheless will be treated, after the severance, as separate trusts for GST tax purposes, provided that the resulting trusts are recognized as separate trusts under applicable state law. Because the severance is not a qualified severance, each such resulting trust will have the same inclusion ratio immediately after the severance as the original trust immediately before the severance. Nevertheless, GST tax exemption allocated after the severance may be separately allocated to one or more of the resulting trusts, and the trusts will otherwise be treated as separate trusts for GST tax purposes. An example of a nonqualified severance is added to the regulations.

The proposed regulations also revise §26.2654–1(a)(1)(i) and (a)(5), Example 8 .

In addition, pursuant to the authority granted in section 2642(a)(3)(B)(iii), these proposed regulations provide for an additional type of qualified severance. Specifically, the proposed regulations provide that a trust with an inclusion ratio between

zero and one may be severed in a qualified severance into more than two resulting trusts. One or more of the resulting trusts in the aggregate must receive that fractional share of the total value of the original trust as of the date of severance that is equal to the applicable fraction used to determine the inclusion ratio of the original trust immediately before the severance. The trust or trusts receiving such fractional share shall have an inclusion ratio of zero, and each of the other resulting trust or trusts shall have an inclusion ratio of one. Further, the trustee may designate the beneficiary of each separate resulting trust, provided that the designation results in each beneficiary having the same beneficial interest (within the meaning of §26.2642–6(d)(5)) after the severance as that beneficiary had in the original trust corpus. Guidance illustrating the application of this rule is included in §26.2642–6(d)(7)(ii) and Example 9 of §26.2642–6(j) of these proposed regulations.

Finally, these proposed regulations clarify a provision of the final regulations (T.D. 9348) issued contemporaneously with these proposed regulations. Specifically, §26.2642–6(d)(4) requires that each resulting trust be funded with a fraction or percentage of the entire trust and that, although particular assets may be divided among the resulting trusts on a non- pro rata basis based on the fair market value of the assets on the date of severance, the sum of those fractions or percentages must be one or one hundred percent, respectively. Thus, if the resulting trusts are funded on a non- pro rata basis, the sum of the values distributed to the resulting trusts must equal the fair market value of the trust being severed. These proposed regulations clarify that no discounts or other reductions from the value of an asset owned by the original trust, arising by reason of the division of the original trust’s interest in the asset between or among the resulting trusts, are permitted in funding the resulting trusts. Instead, solely for funding purposes, each resulting trust’s interest in the stock of a closely held corporation, partnership interest, or other single asset must be valued by multiplying the fair market value of the asset held in the original trust as of the date of severance by the fractional or percentage interest in that asset being distributed to

2007–37 I.R.B. 588 September 10, 2007

and (c), used to determine the inclusion ratio of the original trust immediately before the severance. The other resulting trust must receive that fractional share of the total value of the original trust as of the date of severance that is equal to the excess of one over the fractional share described in the preceding sentence. The trust receiving the fractional share equal to the applicable fraction shall have an inclusion ratio of zero, and the other trust shall have an inclusion ratio of one. If the applicable fraction with respect to the original trust is .50, then, with respect to the two equal trusts resulting from the severance, the Trustee may designate which of the resulting trusts will have an inclusion ratio of zero and which will have an inclusion ratio of one. Each separate trust resulting from the severance then may be further divided in accordance with the rules of this section. See paragraph (j), Example 7 of this section.

(ii) The trust is severed initially into more than two resulting trusts. One or more of the resulting trusts in the aggregate must receive that fractional share of the total value of the original trust as of the date of severance that is equal to the applicable fraction used to determine the inclusion ratio of the original trust immediately before the severance. The trust or trusts receiving such fractional share shall have an inclusion ratio of zero, and each of the other resulting trust or trusts shall have an inclusion ratio of one. (If, however, two or more of the resulting trusts each receives the fractional share of the total value of the original trust equal to the applicable fraction, the trustee may designate which of those resulting trusts will have an inclusion ratio of zero and which will have an inclusion ratio of one.) The resulting trust or trusts with an inclusion ratio of one must receive in the aggregate that fractional share of the total value of the original trust as of the date of severance that is equal to the excess of one over the fractional share described in the second sentence of this paragraph. See paragraph (j), Example 9 of this section.

- - - (h) Treatment of trusts resulting from a severance that is not a qualified sever- ance . Trusts resulting from a severance (other than a severance under §26.2654–1) that does not meet the requirements of a qualified severance under paragraph (b) of

Office of the Associate Chief Counsel (Passthroughs and Special Industries), IRS. Other personnel from the IRS and the Treasury Department participated in their development.

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Proposed Amendments to the Regulations

Accordingly, 26 CFR part 26 is proposed to be amended as follows:

PART 26—GENERATION-SKIPPING TRANSFER TAX REGULATIONS UNDER THE TAX REFORM ACT OF 1986

Paragraph 1. The authority citation for part 26 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. In §26.2600–1, the table of contents is amended by adding the entry for §26.2642–6(h) to read as follows:

§26.2600–1 Table of contents.

§26.2642–6 Qualified severance .

- - - (h) Treatment of trusts resulting from a severance that is not a qualified severance.
- - - Par. 3. Section 26.2642–6 is amended as follows:

Paragraph (d)(4) and (d)(7) are revised.
Paragraph (h) is added.
Paragraph (j) Examples 6, 9, 12, and 13 are added.
Paragraph (k)(1) is revised. The additions and revisions read as follows:

§26.2642–6 Qualified severance .

- - - (d) - - (4) The single trust (original trust) is severed on a fractional basis, such that each new trust (resulting trust) is funded with a fraction or percentage of the original trust, and the sum of those fractions or percentages is one or one hundred percent, respectively. For this purpose, the fraction or

percentage may be determined by means of a formula (for example, that fraction of the trust the numerator of which is equal to the transferor’s unused GST tax exemption, and the denominator of which is the fair market value of the original trust’s assets on the date of severance). The severance of a trust based on a pecuniary amount does not satisfy this requirement. For example, the severance of a trust is not a qualified severance if the trust is divided into two trusts, with one trust to be funded with $1,500,000 and the other trust to be funded with the balance of the original trust’s assets. With respect to the particular assets to be distributed to each resulting trust, each resulting trust may be funded with the appropriate fraction or percentage ( pro rata portion) of each asset held by the original trust. Alternatively, the assets may be divided among the resulting trusts on a non- pro rata basis, based on the fair market value of the assets on the date of severance. However, if a resulting trust is funded on a non- pro rata basis, each asset received by a resulting trust must be valued, solely for funding purposes, by multiplying the fair market value of the asset held in the original trust as of the date of severance by the fraction or percentage of that asset received by that resulting trust. Thus, the assets must be valued without taking into account any discount or premium arising from the severance, for example, any valuation discounts that might arise because the resulting trust receives less than the entire interest held by the original trust. See paragraph (j), Exam- ple 6 of this section.

- - - (7) In the case of a qualified severance occurring after GST tax exemption has been allocated to the trust (whether by an affirmative allocation, a deemed allocation, or an automatic allocation pursuant to the rules contained in section 2632), if the trust has an inclusion ratio as defined in §26.2642–1 that is greater than zero and less than one, then either paragraph (d)(7)(i) or (ii) of this section must be satisfied.

(i) The trust is severed initially into only two resulting trusts. One resulting trust must receive that fractional share of the total value of the original trust as of the date of severance that is equal to the applicable fraction, as defined in §26.2642–1(b)

September 10, 2007 589 2007–37 I.R.B.

this section will be treated, after the date of severance, as separate trusts for purposes of the generation-skipping transfer (GST) tax, provided that the trusts resulting from such severance are recognized as separate trusts under applicable state law. The post-severance treatment of the resulting trusts as separate trusts for GST tax purposes generally permits the allocation of GST tax exemption, the making of various elections permitted for GST tax purposes, and the occurrence of a taxable distribution or termination with regard to a particular resulting trust, with no GST tax impact on any other trust resulting from that severance. Each trust resulting from a severance described in this paragraph, however, will have the same inclusion ratio immediately after the severance as that of the original trust immediately before the severance. (See §26.2654–1 for the inclusion ratio of each trust resulting from a severance described in that section.)

- - - (j) - - Example 6 . Funding of severed trusts on a non- pro rata basis . T’s will establishes an irrevocable trust, Trust, for the benefit of T’s descendants. As a result of the allocation of GST tax exemption, the applicable fraction with respect to Trust is .60 and Trust’s inclusion ratio is .40 [1 - .60]. Pursuant to authority granted under applicable state law, on August 1, 2008, the trustee executes a document severing Trust into two trusts, Trust 1 and Trust 2, each of which is identical to Trust. The instrument of severance provides that the severance is intended to qualify as a qualified severance within the meaning of section 2642(a)(3) and designates August 3, 2008, as the date of severance (within the meaning of paragraph (d)(3) of this section). The instrument further provides that Trust 1 and Trust 2 are to be funded on a non- pro rata basis with Trust 1 funded with assets having a fair market value on the date of severance equal to 40% of the value of Trust’s assets on that date and Trust 2 funded with assets having a fair market value equal to 60% of the value of Trust’s assets on that date. The fair market value of the assets used to fund each trust is to be determined in compliance with the requirements of paragraph (d)(4) of this section. On August 3, 2008, the fair market value of the Trust assets totals $4,000,000, consisting of 52% of the outstanding common stock in Company, a closely-held corporation, valued at $3,000,000 and $1,000,000 in cash and marketable securities. Trustee proposes to divide the Company stock equally between Trust 1 and Trust 2, and thus transfer 26% of the Company stock to Trust 1 and 26% of the stock to Trust 2. In addition, the appropriate amount of cash and marketable securities will be distributed to each trust. In accordance with paragraph (d)(4) of this section, for funding purposes, the interest in the Company stock distributed to each trust is valued as a pro rata portion of the value of the 52% interest in Company held by Trust before severance, without

taking into account, for example, any valuation discount that might otherwise apply in valuing the noncontrolling interest distributed to each resulting trust. Accordingly, for funding purposes, each 26% interest in Company stock distributed to Trust 1 and Trust 2 is valued at $1,500,000 (.5 x $3,000,000). Therefore, Trust 1, which is to be funded with $1,600,000 (.40 x $4,000,000), receives $100,000 in cash and marketable securities valued as of August 3, 2008, in addition to the Company stock, and Trust 2, which is to be funded with $2,400,000 (.60 x $4,000,000), receives $900,000 in cash and marketable securities in addition to the Company stock. Therefore, the severance is a qualified severance, provided that all other requirements of section 2642(a)(3) and this section are satisfied.

- - - Example 9 . Regulatory qualified severance. In 2004, T establishes an inter vivos irrevocable trust (Trust) providing that Trust income is to be paid annually in equal shares to T’s children, A and B, for 10 years. If either (or both) dies prior to the expiration of the 10-year term, the deceased child’s share of trust income is to be paid to the child’s then living descendants, per stirpes, for the balance of the trust term. At the expiration of the 10-year trust term, the corpus is to be distributed equally to A and B; if A and B (or either or them) is not then living, then such decedent’s share is to be distributed instead to such decedent’s then living descendants, per stirpes. T allocates GST tax exemption to Trust such that Trust’s applicable fraction is .25 and its inclusion ratio is .75. In 2006, pursuant to applicable state law, the trustee severs the trust into three trusts: Trust 1, Trust 2, and Trust 3. The instrument severing Trust provides that Trust 1 is to receive 50% of Trust’s assets, Trust 2 is to receive 25% of Trust’s assets, and Trust 3 is to receive 25% of Trust’s assets. All three resulting trusts are identical to Trust, except that each has different beneficiaries: A and A’s issue are designated as the beneficiaries of Trust 1, and B and B’s issue are designated as the beneficiaries of Trust 2 and Trust 3. The severance constitutes a qualified severance, provided that all other requirements of section 2642(a)(3) and this section are satisfied. Trust 1 will have an inclusion ratio of 1. Because both Trust 2 and Trust 3 have each received the fractional share of Trust’s assets equal to Trust’s applicable fraction of .25, trustee designates that Trust 2 will have an inclusion ratio of one and that Trust 3 will have an inclusion ratio of zero.
- - - Example 12 . Mandatory severance that does not qualify as a qualified severance . In 1996, T creates an irrevocable inter vivos trust (Trust) that provides the trustee with the discretionary power to distribute income or corpus from time to time to one or more of T’s children and grandchildren. Trust provides that, when T’s youngest child reaches age 30, Trust is to be divided equally into separate trusts (resulting trusts), with one resulting trust for each child of T who is then living, and one resulting trust for each child of T who is then deceased and who has then living descendants. The income from a child’s resulting trust will be paid to that child during the child’s life, with the remainder passing to such child’s descendants (grandchildren and younger generation descendants of T). On a timely filed Form 709, “ United States Gift (and Generation-Skipping Transfer) Tax

Return, ” reporting the transfer, T allocates all of T’s remaining GST tax exemption to Trust. As a result of the allocation, the applicable fraction with respect to Trust is .20, so Trust’s inclusion ratio is .80 [1 -.20]. T’s youngest child reaches age 30 in 2008. (No additional gifts are made through 2008 and Trust’s inclusion ratio does not change.) In accordance with Trust’s terms, Trust is divided in 2008 into three separate trusts (Trust 1, Trust 2, and Trust 3), one trust for each of T’s three children, each of whom is then living. Trust 1, Trust 2, and Trust 3 are each recognized as a separate trust under applicable state law. With the consent of all interested parties, each resulting trust is funded with assets different from the assets distributed to the other two resulting trusts in a manner that does not meet the requirements of paragraph (d)(3) of this section. As a result, the severance does not satisfy the requirements of a qualified severance under this section. Under paragraph (h) of this section, however, Trust 1, Trust 2, and Trust 3 are each recognized as a separate trust for GST tax purposes prospectively from the date of severance, because the severance was effective to create three separate trusts under applicable state law. Therefore, after the severance, if T becomes entitled to any additional GST tax exemption pursuant to subsequent changes in applicable Federal tax law, T may allocate that additional GST tax exemption to any one or more of these three resulting trusts. Because the severance is not a qualified severance, however, the inclusion ratio of each of the three new trusts immediately after the severance will be .80, the same as Trust’s inclusion ratio immediately before the severance.

Example 13 . Other severance that does not qual- ify as a qualified severance . In 2004, T establishes an irrevocable inter vivos trust (Trust) providing that Trust income is to be paid to T’s children, A and B, in equal shares for their joint lives. Upon the death of the first to die of A and B, all Trust income will be paid to the survivor of A and B. At the death of the survivor, the corpus is to be distributed in equal shares to T’s grandchildren, W and X (with any then-deceased grandchild’s share being paid in accordance with that grandchild’s testamentary general power of appointment). W is A’s child and X is B’s child. T elects under section 2632(c)(5) not to have the automatic allocation rules contained in section 2632(c) apply with respect to T’s transfers to Trust, and T does not otherwise allocate GST tax exemption to Trust. In 2006, the trustee of Trust, as permitted by applicable state law, divides Trust into two separate trusts, Trust 1 and Trust 2. Trust 1 provides that trust income is to be paid to A for life and, on A’s death, the remainder is to be distributed to W (or pursuant to W’s testamentary general power of appointment). Trust 2 provides that trust income is to be paid to B for life and, on B’s death, the remainder is to be distributed to X (or pursuant to X’s testamentary general power of appointment). Because Trust 1 and Trust 2 do not provide A and B with the contingent survivor income interests that were provided to A and B under the terms of Trust, Trust 1 and Trust 2 do not provide for the same succession of interests in the aggregate as provided by Trust. Therefore, the severance does not satisfy the requirements of this section and is not a qualified severance. However, under paragraph (h) of this section, provided that Trust 1 and Trust 2 are recognized as separate trusts under applicable state law, Trust 1 and Trust 2 will be recognized as sepa

2007–37 I.R.B. 590 September 10, 2007

provides the trustee with the discretionary power to distribute income or corpus to T’s children and grandchildren. The trust provides that, when T’s youngest child reaches age 21, the trust will be divided into separate shares, one share for each child of T. The income from a respective child’s share will be paid to the child during the child’s life, with the remainder passing on the child’s death to such child’s children (grandchildren of T). The separate shares that come into existence when the youngest child reaches age 21 will be recognized as of that date as separate trusts for purposes of Chapter 13. Any allocation of GST tax exemption to the trust after T’s youngest child reaches age 21 may be made to any one or more of the separate shares. The result would be the same if the trust instrument provided that the trust was to be divided into separate trusts when T’s youngest child reached age 21, provided that the severance and funding of the separate trusts meets the requirements of this section.

Linda E. Stiff, Acting Deputy Commissioner for

Services and Enforcement.

(Filed by the Office of the Federal Register on August 1, 2007, 8:45 a.m., and published in the issue of the Federal Register for August 2, 2007, 72 F.R. 42340)

Notice of Proposed Rulemaking by Cross-Reference to Temporary Regulations

Clarification to Section 6411 Regulations

REG–118886–06

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by cross-reference to temporary regulations.

SUMMARY: In this issue of the Bulletin, the IRS is issuing temporary regulations (T.D. 9335) relating to the computation and allowance of the tentative carryback adjustment under section 6411 of the Internal Revenue Code. Those temporary regulations clarify that for purposes of allowing the tentative adjustment, the IRS may credit or reduce the tentative adjustment by an assessed tax liability, whether or not that tax liability was assessed before the date the application for tentative carryback is filed, and other unassessed liabilities in

rate trusts for GST tax purposes, prospectively from the date of the severance. Trust 1 and Trust 2 each have the same inclusion ratio immediately after the severance as Trust’s inclusion ratio immediately before the severance.

(k) - - (1) In general . Except as otherwise provided, this section applies to severances occurring on or after August 2, 2007. Paragraph (d)(7)(ii), paragraph (h), and Exam- ples 9, 12, and 13 of paragraph (j) of this section apply to severances occurring on or after August 2, 2007. Paragraph (d)(4) and Example 6 of paragraph (j) apply to severances occurring on or after August 2, 2007.

Par. 4. Section 26.2654–1 is amended as follows:

Paragraph (a)(1)(i) is revised.
A new paragraph (a)(1)(iii) is added.
In paragraph (a)(5), Example 8 is revised.

The additions and revisions read as follows:

§26.2654–1 Certain trusts treated as separate trusts .

(a) Single trust treated as separate trusts —(1) Substantially separate and independent shares —(i) In general . If a single trust consists solely of substantially separate and independent shares for different beneficiaries, the share attributable to each beneficiary (or group of beneficiaries) is treated as a separate trust for purposes of chapter 13. The phrase “substantially separate and independent shares” generally has the same meaning as provided in §1.663(c)–3 of this chapter. However, except as provided in paragraph (a)(1)(iii) of this section, a portion of a trust is not a separate share unless such share exists from and at all times after the creation of the trust. For purposes of this paragraph (a)(1), a trust is treated as created at the date of death of the grantor if the trust is includible in its entirety in the grantor’s gross estate for Federal estate tax purposes. Further, treatment of a single trust as separate trusts under this paragraph (a)(1) does not permit treatment of those portions as separate trusts for purposes of filing returns and payment of tax or for purposes of computing any other tax imposed under the Internal Revenue Code. Also, additions to, and distributions from, such trusts are allocated pro rata among the separate trusts, unless the governing instrument expressly provides

otherwise. See §26.2642–6 and paragraph (b) of this section regarding the treatment, for purposes of chapter 13, of separate trusts resulting from the actual severance of a single trust.

- - - (iii) Mandatory severances. For purposes of this section, if the governing instrument of a trust requires the division or severance of a single trust into separate trusts upon the future occurrence of a particular event not within the discretion of the trustee or any other person, and if the trusts resulting from such a division or severance are recognized as separate trusts under applicable state law, then each resulting trust is treated as a separate trust for purposes of chapter 13. For this purpose, the rules of paragraph (b)(1)(ii)(C) of this section apply with respect to the severance and funding of the trusts. Similarly, if the governing instrument requires the division of a single trust into separate shares under the circumstances described in this paragraph, each such resulting share is treated as a separate trust for purposes of chapter

The post-severance treatment of the resulting trusts or shares as separate trusts for GST tax purposes generally permits the allocation of GST tax exemption, the making of various elections permitted for GST tax purposes, and the occurrence of a taxable distribution or termination with regard to a particular resulting trust or share, with no GST tax impact on any other trust or share resulting from that severance. The treatment of a single trust as separate trusts under this paragraph (a)(1), however, does not permit treatment of those portions as separate trusts for purposes of filing returns and payment of tax or for purposes of computing any other tax imposed under the Internal Revenue Code. Also, additions to, and distributions from, such trusts are allocated pro rata among the separate trusts, unless the governing instrument expressly provides otherwise. Each separate share and each trust resulting from a mandatory division or severance described in this paragraph will have the same inclusion ratio immediately after the severance as that of the original trust immediately before the division or severance.

- - - (5) - - Example 8 . Subsequent mandatory division into separate trusts . T creates an irrevocable trust that

September 10, 2007 591 2007–37 I.R.B.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic and written comments (a signed original and eight (8) copies) that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed regulations and how they can be made easier to understand. All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by a person who timely submits comments. If a public hearing is scheduled, notice of the date, time, and place for the hearing will be published in the Federal Register .

Drafting Information

The principal author of these regulations is Cynthia A. McGreevy of the Office of the Associate Chief Counsel (Procedure and Administration).

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Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.6411–2 is revised to read as follows:

§1.6411–2 Computation of tentative carryback adjustment.

(a) [The text of proposed §1.6411–2(a) is the same as the text of §1.6411–2T(a) published elsewhere in this issue of the Bulletin].

(b) [The text of proposed §1.6411–2(b) is the same as the text of §1.6411–2T(b) published elsewhere in this issue of the Bulletin].

- - - Par. 3. Section 1.6411–3 is revised to read as follows:

certain other circumstances. Those regulations also remove all references to IRS district director or service center director, as these positions no longer exist within the IRS. The offices of the district director and service center director were eliminated by the IRS reorganization implemented pursuant to the IRS Reform and Restructuring Act of 1998. The text of the temporary regulations serves as the text of these proposed regulations.

DATES: Written and electronic comments and requests for a public hearing must be received by November 26, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–118886–06), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–118886–06), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or sent electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG–118886–06).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Cynthia A. McGreevy, (202) 622–4910; concerning submissions of comments, Richard Hurst, (202) 622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

These proposed regulations clarify the Income Tax Regulations (26 CFR part 1) under section 6411 relating to the computation and allowance of the tentative carryback adjustment. The tentative allowance is computed pursuant to §1.6411–2 but applied pursuant to §1.6411–3. These regulations clarify that for purposes of computing the allowance, the Commissioner will not consider amounts to which the taxpayer and the Commissioner are in disagreement. For purposes of applying the allowance, however, the Commissioner may credit or reduce the tentative adjustment by any assessed tax liabilities, unassessed liabilities determined in a

statutory notice of deficiency, unassessed liabilities identified in a proof of claim filed in a bankruptcy proceeding, and other unassessed liabilities in rare and unusual circumstances. Regarding unassessed liabilities determined in a statutory notice of deficiency, see Rev. Rul. 2007–51. Regarding unassessed liabilities identified in a proof of claim filed in a bankruptcy proceeding, see Rev. Rul. 2007–52. See §601.601(d)(2). The IRS plans to adopt procedures requiring IRS National Office review prior to a credit or reduction of the tentative adjustment by an unassessed liability that constitutes a rare and unusual circumstance.

In this issue of the Bulletin, the IRS is issuing temporary regulations relating to the computation and allowance of the tentative carryback adjustment under section 6411 of the Internal Revenue Code. The text of those temporary regulations also serves as the text of these proposed regulations. The preamble to the temporary regulations explains the temporary regulations and these proposed regulations.

Proposed Effective Date

These proposed amendments to §§1.6411–2 and 1.6411–3 apply with respect to applications for tentative refund filed on or after the date these rules are published as final regulations in the Fed- eral Register . No implication is intended concerning whether or not a rule to be adopted in these regulations is applicable law for applications filed prior to that date.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collection of information on small entities, the provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

2007–37 I.R.B. 592 September 10, 2007

must be adjusted on the basis of the investment return and the market value of the segregated asset account; for an annuity contract to be a variable contract, it must provide for the payment of annuities, and the amounts paid in, or the amount paid out, must reflect the investment return and the market value of the segregated asset account; for a contract that provides funding of insurance on retired lives to be a variable contract, the amounts paid in, or the amounts paid out, must reflect the investment return and the market value of the segregated asset account.

Section 817(h)(1) provides that a variable contract that is based on a segregated asset account is not treated as an annuity, endowment, or life insurance contract unless the segregated asset account is adequately diversified in accordance with regulations prescribed by the Secretary. If a segregated asset account is not adequately diversified for a calendar quarter, then the contracts supported by that segregated asset account are not treated as annuity, endowment, or life insurance contracts for that period and subsequent periods, even if the segregated asset account is adequately diversified in those subsequent periods. Under §1.817–5(a), if a segregated asset account is not adequately diversified, income earned by that segregated asset account is treated as ordinary income received or accrued by the policyholders. Section 1.817–5(a)(2) provides conditions an issuer of a variable contract must satisfy in order to correct an inadvertent failure to diversify. Rev. Proc. 92–25, 1992–1 C.B. 741, see §601.601(d)(2) of this chapter, sets forth in more detail the procedure by which an issuer may request the relief described in §1.817–5(a)(2).

Congress enacted the diversification requirements of section 817(h) to “discourage the use of tax-preferred variable annuity and variable life insurance primarily as investment vehicles.” H.R. Conf. Rep. No. 98–861, at 1055 (1984). In section 817(h)(1), Congress granted the Secretary broad regulatory authority to develop rules to carry out this intent. Congress directed that these standards be imposed because “by limiting a customer’s ability to select specific investments underlying a variable contract, [adequate diversification] will help ensure that a customer’s primary motivation in purchasing the contract is more likely to be the traditional economic

§1.6411–3 Allowance of adjustments .

(a) [The text of proposed §1.6411–3(a) is the same as the text of §1.6411–3T(a) published elsewhere in this issue of the Bulletin].

(b) [The text of proposed §1.6411–3(b) is the same as the text of §1.6411–3T(b) published elsewhere in this issue of the Bulletin].

(c) [The text of proposed §1.6411–3(c) is the same as the text of §1.6411–3T(c) published elsewhere in this issue of the Bulletin].

(d) [The text of proposed §1.6411–3(d) is the same as the text of §1.6411–3T(d) published elsewhere in this issue of the Bulletin].

Kevin M. Brown, Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on August 24, 2007, 8:45 a.m., and published in the issue of the Federal Register for August 27, 2007, 72 F.R. 48952)

Notice of Proposed Rulemaking

Diversification Requirements for Variable Annuity, Endowment, and Life Insurance Contracts

REG–118719–07

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of Proposed Rulemaking.

SUMMARY: This document proposes changes to the regulations concerning the diversification requirements of section 817(h) of the Internal Revenue Code (Code). The proposed changes would expand the list of holders whose beneficial interests in an investment company, partnership, or trust do not prevent a segregated asset account from looking through to the assets of the investment company, partnership, or trust, to satisfy the requirements of section 817(h). The proposed regulations also would remove

the sentence in §1.817–5(a)(2) that provides that the payment required to remedy an inadvertent diversification failure must be based on the tax that would have been owed by the policyholders if they were treated as receiving the income on the contract. These proposed regulations would affect insurance companies that issue variable contracts and would affect policyholders who purchase such contracts.

DATES: Written or electronic comments and requests for a public hearing must be received by October 29, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–118719–07), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–118719–07), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or sent electronically, via the Federal eRulemaking Portal at http://www.regulations.gov/ (IRS REG–118719–07).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, James Polfer, at (202) 622–3970 (not a toll-free number).

Concerning submissions of comments, the hearing, and/or to be placed on the building access list to attend the hearing, e-mail Richard.A.Hurst@irscousel.treas.gov.

SUPPLEMENTARY INFORMATION:

Background

Section 817(d) defines a variable contract for purposes of part I of subchapter L of the Code (sections 801–818). For a contract to be a variable contract, it must provide for the allocation of all or a part of the amounts received under the contract to an account that, pursuant to state law or regulation, is segregated from the general asset accounts of the issuing insurance company. In addition, for a life insurance contract to be a variable contract, it must qualify as a life insurance contract for Federal income tax purposes, and the amount of the death benefits (or the period of coverage)

September 10, 2007 593 2007–37 I.R.B.

nonresident aliens, and (iii) accounts that, pursuant to Puerto Rican law or regulation, are segregated from the general asset accounts of the life insurance companies that own the accounts, provided the requirements of section 817(d) and (h) are satisfied (without regard to the requirement the accounts be segregated pursuant to “State” law or regulation).

Reasons for Change

Proposed amendment to §1.817–5(a)(2) (remedy for inadvertent nondiversification.

The proposed regulations would remove the sentence in §1.817–5(a)(2) that provides that the payment required to remedy an inadvertent diversification failure must be based on the tax that would have been owed by the policyholders if they were treated as receiving the income on the contract. In Notice 2007–15, 2007–7 I.R.B. 503 (February 12, 2007), the IRS requested comments on how various correction procedures, including those described in §1.817–5(a)(2) and Rev. Proc. 92–25, may be improved. Section 5.03(e) and (f) of the notice specifically requested comments on the computation of the amounts required to be paid under these correction procedures. Moreover, in the past, the provision in §1.817–5(a)(2) of the amount required to be paid has caused confusion about the scope of the IRS’s authority to provide for amounts that depart from the plain language of the regulation. See, for example, Notice 2000–9, 2000–1 C.B. 449 (reduced amount applied for a limited period of time in the case of failures due to investments in U.S. Treasury securities). See §601.601(d)(2) of this chapter.

Even with the proposed modification of §1.817–5(a)(2), the amount required to be paid to remedy an inadvertent failure to diversify remains the amount set forth in Rev. Proc. 92–25, section 4.02. The modification of §1.817–5(a)(2) will preserve flexibility, however, should the IRS choose to modify this amount by publication in the Internal Revenue Bulletin in response to comments on Notice 2007–15.

Expansion of list of permitted investors under §1.817–5(f)(3).

On July 30, 2003, the Treasury Department and the IRS published a notice of

protections provided by annuities and life insurance.” S. Prt. 98–169, Vol. I at 546 (1984). A primary directive from Congress to Treasury in enacting the standards was to “deny annuity or life insurance treatment for investments that are publicly available to investors.” H.R. Conf. Rep. No. 98–861, at 1055 (1984).

Section 817(h)(4) provides a look-through rule under which taxpayers do not treat the interest in a regulated investment company (RIC) or trust as a single asset of the segregated asset account but rather apply the diversification tests by taking into account the assets of the RIC or trust. Section 817(h) further provides that the look-through rule applies only if all of the beneficial interests in a RIC or trust are held by one or more insurance companies (or affiliated companies) in their general account or segregated asset accounts, or by fund managers (or affiliated companies) in connection with the creation or management of the RIC or trust.

Under §1.817–5(f)(1), if look-through treatment is available, a beneficial interest in a RIC, real estate investment trust, partnership, or trust that is treated under sections 671 through 679 as owned by the grantor or another person (“investment company, partnership or trust”) is not treated as a single investment of a segregated asset account for purposes of testing diversification. Instead, a pro rata portion of each asset of the investment company, partnership, or trust is treated as an asset of the segregated asset account. Section 1.817–5(f)(2)(i) provides that the look-through rule applies to any investment company, partnership, or trust if (1) all the beneficial interests in the investment company, partnership, or trust are held by one or more segregated asset accounts of one or more insurance companies; and (2) public access to the investment company, partnership, or trust is available exclusively through the purchase of a variable contract (except as otherwise permitted in §1.817–5(f)(3)).

Under §1.817–5(f)(3), look-through treatment is not prevented by reason of beneficial interests in an investment company, partnership, or trust that are

(1) Held by the general account of a life insurance company or a corporation related to a life insurance company, but only if the return on such interests is computed in the same manner as the return on an in

terest held by a segregated asset account is computed, there is no intent to sell such interests to the public, and a segregated asset account of such life insurance company also holds or will hold a beneficial interest in the investment company, partnership, or trust;

(2) Held by the manager, or a corporation related to the manager, of the investment company, partnership or trust, but only if the holding of the interests is in connection with the creation or management of the investment company, partnership or trust, the return on such interest is computed in the same manner as the return on an interest held by a segregated asset account is computed, and there is no intent to sell such interests to the public;

(3) Held by the trustee of a qualified pension or retirement plan; or

(4) Held by the public, or treated as owned by the policyholders pursuant to Rev. Rul. 81–225, 1981–2 C.B. 12, see §601.601(d)(2) of this chapter, but only if (A) the investment company, partnership or trust was closed to the public in accordance with Rev. Rul. 82–55, 1982–1 C.B. 12, see §601.601(d)(2) of this chapter, or (B) all the assets of the segregated asset account are attributable to premium payments made by policyholders before September 26, 1981, to premium payments made in connection with a qualified pension or retirement plan, or to any combination of such premium payments.

Explanation of Provisions

This document contains proposed amendments to 26 CFR part 1 under section 817(h).

The amendments would remove the sentence from §1.817–5(a)(2) which provides that the amount required to be paid to remedy an inadvertent failure to diversify must be based on the tax that would have been owed by the policyholders if they were treated as receiving the income on the contract for the period or periods of nondiversification.

The amendments also would expand the list of permitted investors in §1.817–5(f)(3) to include (i) qualified tuition programs as defined in section 529, (ii) trustees of foreign pension plans established and maintained outside the United States, primarily for the benefit of individuals, substantially all of whom are

2007–37 I.R.B. 594 September 10, 2007

ment company, partnership, or trust does not prevent look-through treatment for the other holders of an interest in the same investment, company, partnership, or trust under §1.817–5(f)(2). The Treasury Department and the IRS believe that expanding the list of permitted investors as proposed would address this issue without implicating the interpretive question of what constitutes a “State” within the meaning of sections 817(d) and 7701(a)(10).

Proposed Effective Date

The Treasury Department and the IRS intend these regulations to be effective on the date the final regulations are published in the Federal Register .

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are timely submitted to the IRS. In addition to comments on the proposed regulations more generally, the Treasury Department and the IRS specifically request comments on (i) the clarity of the proposed regulations and how they can be made easier to understand; and (ii) whether rules similar to those proposed to apply to accounts that are segregated pursuant to Puerto Rican law or regulation should apply to accounts that are segregated pursuant to the laws or regulations of other territories.

proposed rulemaking (REG–163974–02, 2003–2 C.B. 595) under section 817 in the Federal Register (68 FR 44689), proposing to remove a specific rule that applied to nonregistered partnerships for purposes of testing diversification. Written comments were received both on the proposed regulations and on the need for further guidance under section 817 more generally. Comments on the proposed regulations were taken into account in final regulations (T.D. 9185, 2005–1 C.B. 749) that were published March 1, 2005 in the Federal Register (70 FR 9869). Comments on section 817 more generally covered a broad range of issues. Two of those issues have since been addressed by revenue ruling. See Rev. Rul. 2005–7, 2005–1 C.B. 464 (concerning application of the look-through rule in the case of tiered regulated investment companies); Rev. Rul. 2007–7, 2007–7 I.R.B. 468 (February 12, 2007) (concluding that an interest held by a permitted investor is not treated as an interest held by the general public for purposes of Rev. Rul. 2003–92, 2003–2 C.B. 350). These proposed regulations would expand the list of permitted investors in §1.817–5(f)(3) to include two categories of holders that were the subject of comments in 2003: (i) qualified tuition programs as defined in section 529, and (ii) trustees of pension or retirement plans established and maintained outside of the United States primarily for the benefit of individuals substantially all of whom are nonresident aliens.

Section 529 provides for the exemption from Federal income tax of qualified tuition programs. The term “ qualified tu- ition program ” means a program established and maintained by a state or agency or instrumentality thereof or by one or more eligible educational institutions (A) under which a person (i) may purchase tuition credits or certificates on behalf of a designated beneficiary which entitle the beneficiary to the waiver or payment of qualified higher education expenses of the beneficiary, or (ii) in the case of a program established and maintained by a State or agency or instrumentality thereof, may make contributions to an account which is established for the purpose of meeting the qualified higher education expenses of the designated beneficiary of the account, and

(B) which meets the other requirements of section 529(b).

The Treasury Department and the IRS agree with the 2003 commentators that permitting qualified tuition programs and certain trustees of foreign pension plans to own a beneficial interest in an investment company, partnership, or trust that is also owned by one or more segregated asset accounts would be consistent with the purpose and operation of section 817(h). In addition, neither qualified tuition programs nor the foreign pension plans that are described in the proposed regulations present the possibility of investment by the general public, as that term is used in Rev. Rul. 81–225, 1981–2 C.B. 12, and Rev. Rul. 2003–92. See also Rev. Rul. 2007–7. The inclusion of qualified tuition programs in the list of permitted investors in §1.817–5(f)(3) does not relieve those programs of the need to satisfy all requirements of section 529 and the regulations under that section. In particular, the inclusion of such programs does not imply that an investment in a single investment company, partnership, or trust satisfying the minimum diversification requirements of §1.817–5(b) would necessarily be treated as a permitted investment under section 529, whether as a “broad-based investment strategy” within the meaning of Notice 2001–55, 2001–2 C.B. 299, or otherwise. The Treasury Department and the IRS will continue to evaluate other comments received in this area for future guidance by publication in the Internal Revenue Bulletin.

Finally, the proposed regulations would expand the list of permitted investors in §1.817–5(f)(3) to include investment by an account which, pursuant to Puerto Rican law or regulation, is segregated from the general asset accounts of the life insurance company that owns the account, provided the requirements of section 817(d) and (h) are satisfied (without regard to the requirement that the account be segregated pursuant to “State” law or regulation). The Treasury Department and the IRS have received a number of requests for guidance interpreting the term “ variable contract ” to include a contract issued by a Puerto Rican company, based on accounts that are segregated under Puerto Rican law or regulation. One reason for these requests is to ensure that a beneficial interest held by a Puerto Rican company in an invest

September 10, 2007 595 2007–37 I.R.B.

individuals substantially all of whom are nonresident aliens, as defined in section 7701(b)(1)(B); (vi) Held by an account which, pursuant to Puerto Rican law or regulation, is segregated from the general asset accounts of the life insurance company that owns the account, provided the requirements of section 817(d) and (h) are satisfied. Solely for purposes of this paragraph (f)(3)(vi), the requirement under section 817(d)(1) that the account be segregated pursuant to State law or regulation shall be disregarded; or

Kevin M. Brown, Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on July 30, 2007, 8:45 a.m., and published in the issue of the Federal Register for July 31, 2007, 72 F.R. 41651)

All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by any person that timely submits written or electronic comments. If a public hearing is scheduled, notice of the date, time, and place for the hearing will be published in the Federal Register .

Drafting Information

The principal author of these proposed regulations is James Polfer, Office of the Associate Chief Counsel (Financial Institutions and Products), Internal Revenue Service. However, personnel from other offices of the Treasury Department and the IRS participated in their development.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAX

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.817–5 also issued under 26 U.S.C. 817(h). - * *

Par. 2. Section 1.817–5 is amended as follows:

The last sentence of paragraph (a)(2)(iii) is removed.
Paragraph (f)(3)(iii) is revised.
Paragraph (f)(3)(iv) is redesignated as paragraph (f)(3)(vii).
New paragraphs (f)(3)(iv) through (vi) are added.

The revisions and additions read as follows:

§1.817–5 Diversification requirements for variable annuity, endowment, and life insurance contracts.

- - - (f) - - (3) - - (iii) Held by the trustee of a qualified pension or retirement plan;

(iv) Held by a qualified tuition program as defined in section 529;

(v) Held by the trustee of a pension plan established and maintained outside of the United States, as defined in section 7701(a)(9), primarily for the benefit of