Part I. Rulings — Internal Revenue Bulletin 2008-39

Section 42.—Low-Income Housing Credit

26 CFR 1.42–10: Utility allowances.

T.D. 9420

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Section 42 Utility Allowance Regulations Update

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final Regulations.

SUMMARY: This document contains final regulations that amend the utility allowances regulations concerning the lowincome housing tax credit. The final regulations update the utility allowance regulations to provide new options for estimating tenant utility costs. The final regulations affect owners of low-income housing projects who claim the credit, the tenants in those low-income housing projects, and the State and local housing credit agencies that administer the credit.

DATES: Effective Date: These regulations are effective July 29, 2008.

Applicability Date: For dates of applicability, see §1.42–12(a)(4).

FOR FURTHER INFORMATION CONTACT: David Selig (202) 622–3040 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26 CFR Part 1) relating to the low-income housing credit under section 42 of the Internal Revenue Code (Code). On June 19, 2007, the IRS and Treasury Department published in the Federal Register proposed

regulations under section 42(g)(2)(B)(ii) (REG–128274–03, 2007–33 I.R.B. 356

[72 FR 33703]). Written and electronic comments responding to the proposed regulations were received and a public hearing was held on the proposed regulations on October 9, 2007. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury decision.

General Overview

Section 42(a) provides that, for purposes of section 38, the amount of the low-income housing credit determined under section 42 for any taxable year in the credit period is an amount equal to the applicable percentage of the qualified basis of each qualified low-income building. A qualified low-income building is defined in section 42(c)(2) as any building that is part of a qualified low-income housing project.

A qualified low-income housing project is defined in section 42(g)(1) as any project for residential rental property if the project meets one of the following tests elected by the taxpayer: (1) at least 20 percent of the residential units in the project are rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income; or (2) at least 40 percent of the residential units in the project are rent-restricted and occupied by individuals whose income is 60 percent or less of area median gross income. If a taxpayer does not meet the elected test, the project is not eligible for the section 42 credit.

Under section 42(g)(4), section 142(d)(2)(B) applies when determining whether any project is a qualified low-income housing project under section 42(g)(1). Section 142(d)(2)(B) provides that the income of individuals and area median gross income is determined by the Secretary in a manner consistent with determinations of lower income families and area median gross income under section 8 of the United States Housing Act of 1937. Under Rev. Rul. 94–57, 1994–2 C.B. 5, taxpayers may rely on a list of income limits released by the Department of Housing and Urban Development (HUD)

until 45 days after HUD releases a new list of income limits, or until HUD’s effective date for the new list, whichever is later.

In order to qualify as a rent-restricted unit within the meaning of section 42(g)(2), the gross rent for the unit must not exceed 30 percent of the imputed income limitation applicable to the unit. Section 42(g)(2)(B)(ii) requires the inclusion in gross rent of a utility allowance determined by the Secretary after taking into account the determinations under section 8 of the United States Housing Act of 1937. Section 1.42–10(a) provides that if utility costs (other than telephone) for a residential rental unit are paid directly by the tenant, then the gross rent for that unit includes the applicable utility allowance as determined under § 1.42–10. Section 1.42–10(b) provides rules for calculating the appropriate utility allowance based upon whether (1) the building receives rental assistance from the Farmers Home Administration (FmHA), now known as the Rural Housing Service; (2) the building has any tenant that receives FmHA rental assistance; (3) the building is not described in (1) or (2) above and the building’s rents and utility allowances are reviewed by HUD on an annual basis; or (4) the building is not described in (1), (2), or (3) above (other buildings).

Currently, under §1.42–10(b)(4), other buildings generally use the applicable Public Housing Authority (PHA) utility allowance established for the Section 8 Existing Housing Program or use a local utility company estimate. The local utility company estimate may be obtained by any interested party (including a low-income tenant, a building owner, or a State or local housing credit agency (Agency)).

The proposed regulations proposed two additional options for calculating utility allowances. The first option would permit a building owner to obtain a utility estimate for each unit in a building from the Agency that has jurisdiction over the building (the Agency estimate). The Agency estimate must take into account the local utility rates data, property type, climate variables by region in the State, taxes and fees on utility charges,

2008–39 I.R.B. 750 September 29, 2008

owners may change the options used for calculating utilities from time to time.

An energy consumption model developed by a qualified professional that takes into account specific information about the design and location of the building for which the utility allowances are being developed should produce the most accurate utility estimates. It is expected that this more accurate model will be the model most commonly used by most building owners, particularly those with buildings that are not very old. However, if a building owner selects an option that yields higher utility allowances, the building owner should be free to accept a lower amount of rent from tenants. Therefore, there is no need for a stated default option or option ordering rule. Further, the final regulations neither prohibit using different options for different utilities nor prohibit changing the options used for calculating utilities. If an Agency determines that a building owner has understated the utility allowances for the building under the particular option chosen by the owner for calculating the utility allowance, and the building’s units are not rent-restricted units under section 42(g)(2) as a result, the Agency must report the noncompliance on Form 8823, Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition .

Application of newly calculated utility allowances

Under current §1.42–10(c) of the regulations, if the applicable utility allowance for units changes, the new utility allowance must be used to compute gross rent of rent-restricted units due 90 days after the change (the 90-day period). The proposed regulations limited the effective date of any new utility allowances to the earlier of the date the building has achieved 90 percent occupancy for a period of 90 consecutive days or the end of the first year of the credit period. The proposed regulations also modified §1.42–10(c) by requiring that a building owner must review at least annually the basis on which utility allowances have been established and must update the applicable utility allowance. The review must take into account any changes to the building such as any energy conservation

and property building materials and mechanical systems. An Agency may also use actual utility company usage data and rates for the building. The second option would permit a building owner to calculate utility allowances using the “HUD Utility Schedule Model” found on the Low-Income Housing Tax Credits page at www.huduser.org/datasets/lihtc.html (or successor URL). The HUD Utility Schedule Model is based on data from the Residential Energy Consumption Survey (RECS) conducted by the Department of Energy. RECS data provides energy consumption by structure for heating, air conditioning, cooking, water heating, and other electric (lighting and refrigeration). The HUD Utility Schedule Model incorporates building location and climate.

Summary of Comments and Explanation of Changes

Exclusions from utility allowance

Prior to these final regulations, §1.42–10(a) provided for the exclusion of telephone costs in determining the amount of the utility allowance to be included in gross rent. The proposed regulations excluded cable television costs as well as telephone costs. The final regulations retain the exclusions for cable television and telephone costs and also exclude Internet costs. The IRS and Treasury Department believe it is appropriate to exclude cable television and Internet costs as comparable to telephone costs.

Additional option for determining utility allowances

Commentators stated that the Agency estimate in the proposed regulations may be administratively burdensome for some Agencies. As an alternative, commentators suggested adding an option that would allow utility estimates to be calculated by a state-certified engineer or other qualified professional. The commentators specified that, under this option, computer software could be developed that would estimate the energy or water and sanitary sewer service cost for each type of unit in a building. The estimates would be determined based on the applicable current local utility billing rate schedule and would be applied to all comparable units in the building using spe

cific information about the design, materials, equipment, and location of the building.

A computer software model that incorporates specific information about the design and location of the building for which the utility allowances are being developed, and that can be updated with actual consumption data and with consumption estimates as new efficiency measures and improvements are undertaken, would provide more accurate estimates of utility consumption. Therefore, the final regulations also include a new option allowing building owners to retain the services of a qualified professional to calculate utility allowances based on an energy consumption model.

The use of this new option is subject to several special rules. First, the energy consumption model must, at a minimum, take into account specific factors including, but not limited to, unit size, building orientation, design and materials, mechanical systems, appliances, and characteristics of the building location. Second, the utility estimates must be calculated by either (1) a properly licensed engineer or (2) a qualified professional approved by the Agency that has jurisdiction over the building (together, qualified professional). The qualified professional and the building owner must not be related within the meaning of section 267(b) or 707(b). Third, the building owner must furnish a copy of the estimates derived from the energy consumption model to the Agency and make copies of the estimates available to all tenants in the building. Finally, the building owner must pay for all costs incurred in obtaining the utility estimates from the qualified professional and providing the estimates to the Agency and tenants.

Default option/option ordering

One commentator suggested that the final regulations should provide a default option because, in the absence of a definitive standard for determining utility allowances, building owners would use the option that yields the lowest utility estimates. Commentators further requested clarification as to which option should be used when multiple options are available, whether building owners may use different options for different utilities, and whether

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all tenants in the building at the beginning of the 90-day period before the utility allowances are used in determining the gross rents of rent-restricted units. Similarly, the final regulations require that any utility estimates obtained under the Agency estimate option must be made available to all tenants in the building at the beginning of the 90-day period. An Agency may continue to require additional information from the owner during the 90-day period.

Commentators suggested that the final regulations should limit the use of the HUD Utility Schedule Model to data for a twelve-month period ending in the most recent calendar year and require the owner to certify the accuracy of the data and the calculations of the utility allowances. However, the HUD Utility Schedule Model already incorporates consumption data derived from RECS data. Thus, building owners using this option need not be required to use consumption data for any particular twelve-month period. These final regulations, however, provide that the use of the energy consumption model is limited to consumption data for a twelve-month period ending no earlier than 60 days prior to the beginning of the 90-day period. In the case of newly constructed or renovated buildings with less than twelve months of consumption data, the energy consumption model allows a qualified professional to use consumption data for the twelve-month period of units of similar size and construction in the geographic area in which the building containing the units is located. Further, the final regulations require that utility rates used for the HUD Utility Schedule Model, the Agency estimate option, and the energy consumption model must be no older than the rates in place 60 days prior to the beginning of the 90-day period.

In addition to these safeguards, if an Agency determines that a building owner has understated the utility allowances for the owner’s building under the particular option chosen, and, therefore, some or all of the units in the building are not rent-restricted units under section 42(g)(2), then the Agency must report the noncompliance to the Service on Form 8823, Low-Income Housing Credit Agencies Report of Non- compliance or Building Disposition .

Commentators requested that building owners should be required to certify the estimate and the accuracy of the data used

measures that affect energy consumption and changes in utility rates.

Commentators suggested that building owners should be obligated to adjust utility allowances when utility rates increase by a stated percentage, for example, 10 percent, which is the rule for revising utility allowance schedules for PHAs under 24 CFR 982.517(c). This HUD rule provides that a PHA must review its schedule of utility allowances each year and revise its allowance for a utility category if the utility rate has changed by 10 percent or more since the utility allowance schedule was last revised. The commentators did not address decreases in utility rates. A commentator also suggested that the final regulations should require an Agency to review or have owners review local utility rates quarterly to determine if rates have increased sufficiently to require an adjustment. A different commentator suggested limiting reviews to no more than once per year.

The IRS and Treasury Department do not believe that fluctuations in utility rates within a given year should trigger recalculations of utility allowances more than once a year. The IRS and Treasury Department do not believe that the additional burden of updating the utility allowances more than once a year is warranted at this time. Utility rates generally do not change more than once a year, and yearly updated utility allowances would reflect average rates applicable to all tenants in a building from year to year. Therefore, the final regulations require building owners to calculate new utility allowances once during the calendar year regardless of any percentage change in utility rates. Building owners may choose, however, to calculate new utility allowances more frequently than once during the calendar year provided the owner complies with the requirements of these regulations, including the notification requirements to the Agency and tenants.

Another commentator suggested that new utility allowances should be implemented within 90 days after HUD publishes its annual income limits (which are used in determining section 42 rents), but in no case later than June 30 of any year. Section 42 rents under section 42(g)(2) may or may not increase depending on HUD’s calculation of area median gross income. Therefore, the IRS and Treasury

Department do not believe that the rules should require that the effective date of any new utility allowance coincide with the section 42 effective date of HUD’s income lists. Building owners, however, may choose to implement any new utility allowances on the section 42 effective date of HUD’s income lists.

To bring financial stability to a project during the beginning of its operations, the final regulations clarify that the building owner is not required to review the utility allowances, or implement new utility allowances, until the earlier of the date the building has achieved 90 percent occupancy for a period of 90 consecutive days or the end of the first year of the credit period.

Procedural safeguards for tenants

One commentator made several recommendations regarding procedural safeguards for tenants including: owners should be required to give tenants 30 days notice before the effective date of any utility allowance; tenants should be provided with all information used in calculating the utility allowances; tenants should be given the opportunity to comment on the proposed allowances; and owners should be required to review those comments prior to the utility allowances becoming effective. The commentator believed that the new options for determining utility allowances should be available only after one full year of occupancy and one full year after the building is placed in service. A commentator also recommended that a building owner should be allowed to use the new options only if the owner provides all data to the Agency no later than February 15 and the Agency informs the owner whether the proposed utility allowances are approved by March 31.

To provide tenants with the opportunity to comment on proposed utility allowances to the Agency and building owner, the final regulations apply the existing disclosure requirement under current §1.42–10(b)(4)(ii)(B) (regarding the utility company estimate) to an owner using a utility company estimate, the HUD Utility Schedule Model, or an energy consumption model. Therefore, an owner must submit copies of the proposed utility allowances to the Agency and make the proposed utility allowances available to

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the final regulations be effective earlier on the basis that if they are published after 2007, they would not be effective until 2009 for calendar year taxpayers. The IRS and Treasury Department believe that the burden associated with an earlier effective date is not warranted. Therefore, the final regulations do not adopt this suggestion. However, in order to allow a building owner to implement the utility allowances as of the first day of the owner’s taxable year beginning on or after July 29, 2008, the final regulations provide that taxpayers may rely on the rules for determining utility allowances before the first day of the owner’s taxable year beginning on or after July 29, 2008 provided that any utility allowances so calculated are effective no earlier than the first day of the owner’s taxable year beginning on or after July 29, 2008.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that the information has previously been reviewed and approved under OMB control number 1545–1102, and that the information required by these final regulations adds no new burden to the existing requirements. Accordingly, a Regulatory Flexibility Analysis under the provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is David Selig, Office of the Associate Chief Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the IRS and Treasury

under the new options. Because Agencies may request additional information at any time during their mandatory review of proposed utility allowances, and must report any noncompliance to the Service, the final regulations do not require building owners to provide such certification.

Utility allowances for tenants with special needs

One commentator suggested that the calculation of utility allowances should take into account any special needs tenants such as people with disabilities who require high energy consumption equipment. Section 42 does not require that the owner’s calculation of utility allowances be based on a tenant’s particular use of utility services. If such a requirement were imposed, owners and Agencies would have to determine the utility allowance for the tenants in each unit, as opposed to allowances based on the size of the unit, which would greatly increase burden. Additionally, it is unclear whether it is appropriate to implement rules that might encourage tenants to be indifferent to their energy consumption. Such indifference could lead to cost overruns by owners, and the viability of low-income housing could be jeopardized. Therefore, the final regulations do not require the calculation of utility allowances based on consumption by particular tenants.

Calculation of utility company estimate option for deregulated utilities

Section 1.42–10(b)(4)(ii)(B) currently provides that any interested party (including an owner, low-income tenant, or Agency) may obtain a local utility company estimate for a unit. The estimate is obtained when the interested party receives, in writing, information from a local utility company providing the estimated cost of that utility for a unit of similar size and construction for the geographic area in which the building containing the units is located. In light of utility services deregulation, the proposed regulations proposed to amend this option by requiring the interested party to obtain cost estimates from the local utility company that include combined rate charges from multiple utility companies.

Commentators thought this proposed amendment would require the interested

party to obtain utility consumption estimates from every utility company providing the same utility service and stated that this would present an unworkable administrative burden in deregulated jurisdictions with multiple utility providers. In some jurisdictions, many utility providers may be available for a given building. The proposed amendment was not intended to require the interested party to obtain utility consumption estimates from every utility company providing the same utility service. The amendment was proposed to address deregulation by requiring the interested party to obtain estimates for all the components of the utility service if the service is divided between two or more types of service providers (for example, electric generation and electric transmission). The final regulations clarify that, in the case of deregulated utility services, the interested party is required to obtain an estimate from only one utility company even if multiple companies can provide the same utility service to a unit. However, the utility company furnishing the estimate must offer utility services to the building in order for that utility company’s rates to be used in calculating utility allowances. The estimate should include all component charges for providing the utility service.

Agency costs/administrative burden

One commentator requested that specific language be added to address when Agencies may charge a reasonable fee for making a determination pursuant to the Agency estimate option, and who bears the fee when a particular option is used. The proposed regulations provided that costs incurred in obtaining an Agency estimate are borne by the building owner. The final regulations adopt this provision, and further require building owners to pay for all costs incurred in obtaining the estimates under the HUD Utility Schedule Model and the energy consumption model and in providing estimates to Agencies and tenants.

Effective/applicability date

The proposed regulations were proposed to be effective for taxable years beginning on or after the date of publication of the final regulations in the Federal Register . A commentator suggested that

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ulated charges for providing the utility service. - - *

(C) Agency estimate . A building owner may obtain a utility estimate for each unit in the building from the Agency that has jurisdiction over the building provided the Agency agrees to provide the estimate. The estimate is obtained when the building owner receives, in writing, information from the Agency providing the estimated per-unit cost of the utilities for units of similar size and construction for the geographic area in which the building containing the units is located. The Agency estimate may be obtained by a building owner at any time during the building’s extended use period (see section 42(h)(6)(D)). Costs incurred in obtaining the estimate are borne by the building owner. In establishing an accurate utility allowance estimate for a particular building, an Agency (or an agent or other private contractor of the Agency that is a qualified professional within the meaning of paragraph (b)(4)(ii)(E) of this section) must take into account, among other things, local utility rates, property type, climate and degree-day variables by region in the State, taxes and fees on utility charges, building materials, and mechanical systems. If the Agency uses an agent or other private contractor to calculate the utility estimates, the agent or contractor and the owner must not be related within the meaning of section 267(b) or 707(b). An Agency may also use actual utility company usage data and rates for the building. However, use of the Agency estimate is limited to the building’s consumption data for the twelve-month period ending no earlier than 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section and utility rates used for the Agency estimate must be no older than the rates in place 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section. In the case of newly constructed or renovated buildings with less than 12 months of consumption data, the Agency (or an agent or other private contractor of the Agency that is a qualified professional within the meaning of paragraph (b)(4)(ii)(E) of this section) may use consumption data for the 12-month period of units of similar size and construction in the geographic area in which the building containing the units is located.

Department participated in their development.

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is 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 1.42–10 is amended by:

Revising the first sentence of paragraph (a).
Revising paragraphs (b)(1), (b)(2), and (b)(3), and the introductory text of paragraph (b)(4).
Adding two sentences at the end of paragraph (b)(4)(ii)(A).
Adding three sentences after the second sentence in paragraph (b)(4)(ii)(B).
Adding paragraphs (b)(4)(ii)(C), (b)(4)(ii)(D), and (b)(4)(ii)(E).
Revising paragraph (c).
Adding paragraph (d). The additions and revisions read as follows:

§1.42–10 Utility allowances .

(a) * * * If the cost of any utility (other than telephone, cable television, or Internet) for a residential rental unit is paid directly by the tenant(s), and not by or through the owner of the building, the gross rent for that unit includes the applicable utility allowance determined under this section. - * *

(b) Applicable utility allowances —(1) Buildings assisted by the Rural Housing Service . If a building receives assistance from the Rural Housing Service (RHS-assisted building), the applicable utility allowance for all rent-restricted units in the building is the utility allowance determined under the method prescribed by the Rural Housing Service (RHS) for the building (whether or not the building or its tenants also receive other state or federal assistance).

(2) Buildings with Rural Housing Ser- vice assisted tenants . If any tenant in a building receives RHS rental assistance payments (RHS tenant assistance), the ap

plicable utility allowance for all rent-restricted units in the building (including any units occupied by tenants receiving rental assistance payments from the Department of Housing and Urban Development (HUD)) is the applicable RHS utility allowance.

(3) Buildings regulated by the Depart- ment of Housing and Urban Development . If neither a building nor any tenant in the building receives RHS housing assistance, and the rents and utility allowances of the building are reviewed by HUD on an annual basis (HUD-regulated building), the applicable utility allowance for all rent-restricted units in the building is the applicable HUD utility allowance.

(4) Other buildings . If a building is neither an RHS-assisted nor a HUD-regulated building, and no tenant in the building receives RHS tenant assistance, the applicable utility allowance for rent-restricted units in the building is determined under the following methods.

- - - (ii) * * * (A) * * * However, if a local utility company estimate is obtained for any unit in the building under paragraph (b)(4)(ii)(B) of this section, a State or local housing credit agency (Agency) provides a building owner with an estimate for any unit in a building under paragraph (b)(4)(ii)(C) of this section, a cost estimate is calculated using the HUD Utility Schedule Model under paragraph (b)(4)(ii)(D) of this section, or a cost estimate is calculated by an energy consumption model under paragraph (b)(4)(ii)(E) of this section, then the estimate under paragraph (b)(4)(ii)(B), (C), (D), or (E) becomes the applicable utility allowance for all rent-restricted units of similar size and construction in the building. Paragraphs (b)(4)(ii)(B), (C), (D), and (E) of this section do not apply to units to which the rules of paragraphs (b)(1), (2), (3), or (4)(i) of this section apply.

(B) * * * In the case of deregulated utility services, the interested party is required to obtain an estimate only from one utility company even if multiple companies can provide the same utility service to a unit. However, the utility company must offer utility services to the building in order for that utility company’s rates to be used in calculating utility allowances. The estimate should include all component dereg

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§1.42–12 Effective dates and transitional rules .

(a) * - (4) Utility allowances . The first sentence in §1.42–10(a), §1.42–10(b)(1), (2), (3), and (4), the last two sentences in §1.42–10(b)(4)(ii)(A), the third, fourth, and fifth sentences in §1.42–10(b)(4)(ii)(B), §1.42–10(b)(4)(ii)(C), (D), and (E), and §1.42–10(c) and (d) are applicable to a building owner’s taxable years beginning on or after July 29, 2008. Taxpayers may rely on these provisions before the beginning of the building owner’s taxable year beginning on or after July 29, 2008 provided that any utility allowances calculated under these provisions are effective no earlier than the first day of the building owner’s taxable year beginning on or after July 29, 2008. The utility allowances provisions that apply to taxable years beginning before July 29, 2008 are contained in §1.42–10 (see 26 CFR part 1 revised as of April 1, 2008).

Linda E. Stiff, Deputy Commissioner for Services and Enforcement.

Approved July 20, 2008.

Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on July 28, 2008, 8:45 a.m., and published in the issue of the Federal Register for July 29, 2008, 73 F.R. 43863)

Section 2642.—Inclusion Ratio

26 CFR 2642–6: Qualified severance.

T.D. 9421

Department of the Treasury Internal Revenue Service 26 CFR Part 26

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

AGENCY: Internal Revenue Service (IRS), Department of the Treasury (Treasury).

(D) HUD Utility Schedule Model . A building owner may calculate a utility estimate using the “HUD Utility Schedule Model” that can be found on the Low-Income Housing Tax Credits page at www.huduser.org/datasets/lihtc.html (or successor URL). Utility rates used for the HUD Utility Schedule Model must be no older than the rates in place 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section.

(E) Energy consumption model . A building owner may calculate utility estimates using an energy and water and sewage consumption and analysis model (energy consumption model). The energy consumption model must, at a minimum, take into account specific factors including, but not limited to, unit size, building orientation, design and materials, mechanical systems, appliances, and characteristics of the building location. The utility consumption estimates must be calculated by either a properly licensed engineer or a qualified professional approved by the Agency that has jurisdiction over the building (together, qualified professional), and the qualified professional and the building owner must not be related within the meaning of section 267(b) or 707(b). Use of the energy consumption model is limited to the building’s consumption data for the twelve-month period ending no earlier than 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section, and utility rates used for the energy consumption model must be no older than the rates in place 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section. In the case of newly constructed or renovated buildings with less than 12 months of consumption data, the qualified professional may use consumption data for the 12-month period of units of similar size and construction in the geographic area in which the building containing the units is located.

(c) Changes in applicable utility al- lowance —(1) In general . If, at any time during the building’s extended use period (as defined in section 42(h)(6)(D)), the applicable utility allowance for units changes, the new utility allowance must be used to compute gross rents of the units due 90 days after the change (the 90-day period). For example, if rent must be

lowered because a local utility company estimate is obtained that shows a higher utility cost than the otherwise applicable PHA utility allowance, the lower rent must be in effect for rent due at the end of the 90-day period. A building owner using a utility company estimate under paragraph (b)(4)(ii)(B) of this section, the HUD Utility Schedule Model under paragraph (b)(4)(ii)(D) of this section, or an energy consumption model under paragraph (b)(4)(ii)(E) of this section must submit copies of the utility estimates to the Agency that has jurisdiction over the building and make the estimates available to all tenants in the building at the beginning of the 90-day period before the utility allowances can be used in determining the gross rent of rent-restricted units. An Agency may require additional information from the owner during the 90-day period. Any utility estimates obtained under the Agency estimate under paragraph (b)(4)(ii)(C) of this section must also be made available to all tenants in the building at the beginning of the 90-day period. The building owner must pay for all costs incurred in obtaining the estimates under paragraphs (b)(4)(ii)(B), (C), (D), and (E) of this section and providing the estimates to the Agency and the tenants. The building owner is not required to review the utility allowances, or implement new utility allowances, until the building has achieved 90 percent occupancy for a period of 90 consecutive days or the end of the first year of the credit period, whichever is earlier.

(2) Annual review . A building owner must review at least once during each calendar year the basis on which utility allowances have been established and must update the applicable utility allowance in accordance with paragraph (c)(1) of this section. The review must take into account any changes to the building such as any energy conservation measures that affect energy consumption and changes in utility rates.

(d) Record retention . The building owner must retain any utility consumption estimates and supporting data as part of the taxpayer’s records for purposes of §1.6001–1(a).

Par. 3. Section 1.42–12 is amended by adding paragraph (a)(4) to read as follows:

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fractional or percentage interest in that asset being distributed to that resulting trust. Thus, for purposes of the requirements of a qualified severance, regardless of whether the funding is done on a pro rata basis, the cumulative value of the resulting trusts equals the value of the original trust.

The commentators pointed out that funding pursuant to this rule would result in an allocation different from the allocation that would normally be obtained from funding based on the state law fair market value standard which would take the discounts into account. The commentators expressed concern that the resulting shift in beneficial interests between or among the resulting trusts could violate the trustee’s fiduciary duty of impartiality under applicable state law. Further, the commentators pointed out that the proposed rule could be avoided through the post-severance purchase and sale of assets between resulting trusts at fair market value. The commentators recommended an alternative funding rule under which the value of the original trust would be calculated as the sum of the fair market value of the assets to be held by the resulting trusts.

This recommendation was not adopted in the final regulations. It is difficult to see how the fiduciary duty of impartiality is challenged more by this funding rule than by a pro rata division of each asset of the original trust. The funding rule in the proposed regulations was intended to facilitate the funding of the resulting trusts without the cost or need for review of appraisals of each severed interest, and thus to improve the administrability of the severance provisions. This funding rule produces a bright line test, the same result whether or not the trust assets are divided on a pro rata basis, and recognizes that in many circumstances, where a trust is severed for tax purposes into two identical trusts with the same or related beneficiaries, any closely held stock or partnership units divided between the two resulting trusts are likely to be sold as a unit without any actual reduction in value that may be reflected in the claimed discounts. Any use of post-severance sales between resulting trusts to avoid these funding rules may constitute mere steps in a pre-arranged transaction.

The commentators pointed out that the nonqualified severance illustrated in

ACTION: Final regulations.

SUMMARY: This document contains final regulations providing guidance regarding the generation-skipping transfer (GST) tax consequences of the severance of a trust 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 (Code). These final 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 final 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: Effective Date: The regulations are effective July 31, 2008.

Applicability Date: For dates of applicability, see §26.2642–6(k)(1).

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

SUPPLEMENTARY INFORMATION:

Background

Section 2642(a)(3) was added to the 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 separate trusts resulting from the severance (resulting trusts), which may have different inclusion ratios, will be recognized as separate trusts for GST tax purposes. (As used in this guidance, “resulting trust” has no relation to a resulting trust recognized under the common law of trusts and principles of equity.) 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.

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. 523 [69 FR 51967]). Final regulations were published on August 2, 2007 (T.D. 9348, 2007–37 I.R.B. 563 [72 FR 42291]). The Treasury Department and IRS determined that certain comments received in response to the proposed regulations, and certain additional rules under section 2642(a)(3), should be addressed in a separate notice of proposed rulemaking. On August 2, 2007, the Federal Register published a notice of proposed rulemaking (REG–128843–05, 2007–37 I.R.B. 587

[72 FR 42340]) addressing those comments and rules. The IRS received one submission containing several comments on the notice of proposed rulemaking. The comments contained in the submission are discussed below. No public hearing was requested or held.

Explanation of Provisions and Summary of Comments

Section 26.2642–6(d)(4) of the existing regulations provides that each of the trusts resulting from a qualified severance must be funded with a fraction or percentage of the original trust, and that the sum of those fractions or percentages must be one or one hundred percent, respectively. The existing regulations provide that this requirement may be satisfied by the funding of each resulting trust with that trust’s fraction or percentage share of each asset held by the original trust (a pro rata division). Section 26.2642–6(d)(4) of the proposed regulations permits the funding of the resulting trusts on a non- pro rata basis, provided that a special funding rule is also satisfied. Specifically, this section of the proposed regulations provides that, if the assets of the original trust are divided between or among the resulting trusts on a non- pro rata basis, no discounts or other reductions from the value of the 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 for purposes of determining the amount used to fund each resulting trust. Instead, solely for funding purposes, each resulting trust’s interest in the stock of a closely held corporation, partnership interest, or other 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

2008–39 I.R.B. 756 September 29, 2008

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 26 is 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:

Paragraphs (d)(4) and (d)(7) are revised.
Paragraph (h) is added.
Paragraph (j) Example 3 is revised.
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).

§26.2642–6(j), Example 3, of the existing regulations will result in a taxable event for GST tax purposes (that is, a taxable termination or taxable distribution) if that severance occurs on or after the proposed regulations are adopted as final. This is because, under the proposed regulations, the severed trust is treated as a separate trust for GST tax purposes. Accordingly, cautionary language has been added to this example to the effect that a GST taxable event will result as a consequence of the severance.

It was determined that §26.2642–6(j), Example 12 of the proposed regulations addresses the same issue covered in Exam- ple 8 of §26.2654–1(a)(5). Therefore, Ex- ample 12 has been removed from the final regulations and the examples have been renumbered accordingly.

As requested by the commentators, a new example, §26.2642–6(j), Example 13, has been added to confirm that a trust resulting from a nonqualified severance may subsequently be severed in a qualified severance.

The commentators noted that the proposed regulations under §26.2654–1(a)(1)(iii) address the treatment of severances resulting in separate trusts that are required under the terms of a trust instrument (mandatory severances) but that are neither severances otherwise recognized under section 2654 nor qualified severances under section 2642. The proposed regulations conclude that the separate shares or trusts resulting from such a severance, if recognized as separate trusts under state law, will be recognized as separate for GST tax purposes. The commentators questioned why the proposed changes to the regulations under section 2654 must address those severances that result in separate trusts when this issue is already addressed in §26.2642–6(h) of the proposed regulations dealing with nonqualified severances. Section 26.2654–1(a)(1)(iii) was intended to address only mandatory severances that, as with the other types of severances covered by §26.2654–1(a), are dictated by the terms of the trust. On the other hand, §26.2642–6(h) addresses discretionary severances, that is, severances that are elective and within the discretion of the trustee. The severances described in §26.2654–1 are governed by that section.

Therefore, the proposed addition to this section has not been removed.

The proposed regulations under section 2654 state a general rule that separate shares or trusts resulting from a mandatory severance, that are recognized as separate trusts for GST tax purposes, will not be treated as separate trusts for purposes of filing income tax returns or calculating any other taxes. The comments noted that this statement should not apply to shares or trusts that are recognized as separate trusts under local law. Rather, this statement should apply only to separate shares created within a single trust that are not recognized under local law as separate trusts. The final regulations reflect this change.

Special Analyses

It has been determined that this Treasury decision 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)(iii) 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, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these final regulations is Mayer R. Samuels, Office of the Associate Chief Counsel (Passthroughs and Special Industries), IRS. Other personnel from the IRS and Treasury participated in their development.

- - - -

September 29, 2008 757 2008–39 I.R.B.

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 (h), 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.) Further, any trust resulting from a nonqualified severance may be severed subsequently, pursuant to a qualified severance described in this §26.2642–6.

- - - (j) - - Example 3 . Severance based on actuarial value of beneficial interests . In 2004, T establishes Trust, an irrevocable trust providing that income is to be paid to T’s child C during C’s lifetime. Upon C’s death, Trust is to terminate and the assets of Trust are to be paid to GC, C’s child, if living, or, if GC is not then living, to GC’s estate. T properly 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 with respect to Trust. Thus, Trust has an inclusion ratio of one. In 2009, the trustee of Trust, pursuant to applicable state law, divides Trust into two separate trusts, Trust 1 for the benefit of C (and on C’s death to C’s estate), and Trust 2 for the benefit of GC (and on GC’s death to GC’s estate). The document severing Trust directs that Trust 1 is to be funded with an amount equal to the actuarial value of C’s interest in Trust prior to the severance, determined under section 7520 of the Internal Revenue Code. Similarly, Trust 2 is to be funded with an amount equal to the actuarial value of GC’s interest in Trust prior to the severance, determined under section 7520. Trust 1 and Trust 2 do not provide for the same succession of interests as provided under the terms of the original trust. Therefore, the severance is not a qualified severance. Furthermore, because the severance results in no non-skip person having an interest in Trust 2, Trust 2 constitutes a skip person under section 2613 and, therefore, the severance results in a taxable termination subject to GST tax.
- - - Example 6 . Funding of severed trusts on a non- pro rata basis . (i) 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

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 separate trust resulting from the severance, each such 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)(i) 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)(ii) or (iii) of this section must be satisfied.

(ii) 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) 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.

(iii) 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 severance . Trusts resulting from a severance (other than a severance recognized for GST tax purposes under §26.2654–1) that does not meet the requirements of a qualified severance under paragraph (b) of this section will be treated, after the date of severance, as separate trusts for purposes of the GST tax, provided that the trusts resulting from such severance are recognized as separate trusts under applicable state law. The

2008–39 I.R.B. 758 September 29, 2008

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.

(ii) 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.

(iii) 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. (i) 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. Trust provides that the trustee has discretion to make additional distributions of principal to A and B during the 10-year term without adjustments to their shares of income or the trust remainder. 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 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.

(ii) 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 . Other severance that does not meet the requirements of a qualified severance . (i) 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, but T allocates GST tax exemption to Trust resulting in Trust having an inclusion ratio of .30.

(ii) In 2009, 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. 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 separate trusts for GST tax purposes pursuant to paragraph (h) of this section, prospectively from the date of the severance. However, Trust 1 and Trust 2 each have an inclusion ratio of .30 immediately after the severance, the same as the inclusion ratio of Trust prior to severance.

Example 13 . Qualified severance following a non-qualified severance . Assume the same facts as in Example 12, except that, as of November 4, 2010, the trustee of Trust 1 severs Trust 1 into two trusts, Trust 3 and Trust 4, in accordance with applicable local law. The instrument severing Trust 1 provides that both resulting trusts have provisions identical to Trust 1. The terms of the instrument severing Trust 1 further provide that Trust 3 is to be funded on a pro

rata basis with assets having a fair market value as of the date of severance equal to 70% of the value of Trust 1’s assets on that date, and Trust 4 is to be funded with assets having a fair market value as of the date of severance equal to 30% of the value of Trust 1’s assets on that date. The severance constitutes a qualified severance, provided that all other requirements of section 2642(a)(3) and this section are satisfied. Trust 3 will have an inclusion ratio of zero and Trust 4 will have an inclusion ratio of one.

(k) - * (1) In general . Except as otherwise provided in this paragraph (k), this section applies to severances occurring on or after August 2, 2007. Paragraph (d)(7)(iii), paragraph (h), and Examples 9, 12 and 13 of paragraph (j) of this section apply to severances occurring on or after September 2, 2008.

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

Paragraph (a)(1)(i) is revised.
Paragraph (a)(1)(iii) is added.
In paragraph (a)(5), Example 8 is revised.
Paragraph (d) is added. The additions and revisions read as follows:

§26.2654–1 Certain trusts treated as separate trusts .

(a) - - *(1) - - *(i) - - - 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. 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, except with respect to shares or trusts that are treated as separate trusts under local law, 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,

September 29, 2008 759 2008–39 I.R.B.

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 discretionary 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 share is treated as a separate trust for purposes of Chapter 13. The post-severance treatment of the resulting shares or 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 share or trust, 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, if those portions are not treated as separate trusts under local law. 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 orig

inal trust immediately before the division or severance.

- - - (5) - - Example 8 . Subsequent mandatory division into separate trusts . T creates an irrevocable trust that 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. The inclusion ratio of the separate trusts will be identical to the inclusion ratio of the trust before the severance. 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.
- - - (d) Effective date . Paragraph (a)(1)(i), paragraph (a)(1)(iii), and Example 8 of paragraph (a)(5) apply to severances occurring on or after September 2, 2008.

Sherri L. Brown, (Acting) Deputy Commissioner for

Services and Enforcement.

Approved July 20, 2008.

Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on July 30, 2008, 8:45 a.m., and published in the issue of the Federal Register for July 31, 2008, 73 F.R. 44649)

Section 6621.—Determina- tion of Rate of Interest

26 CFR 301.6621–1: Interest rate.

Interest rates; underpayments and overpayments. The rates of interest determined under section 6621 of the Code for the calendar quarter beginning October 1, 2008, will be 6 percent for overpayments (5 percent in the case of a corporation), 6 percent for underpayments, and 8 percent for large corporate underpayments. The rate of interest paid on the portion of a

corporate overpayment exceeding $10,000 will be 3.5 percent.

Rev. Rul. 2008–47

Section 6621 of the Internal Revenue Code establishes the rates for interest on tax overpayments and tax underpayments. Under section 6621(a)(1), the overpayment rate is the sum of the federal short-term rate plus 3 percentage points (2 percentage points in the case of a corporation), except the rate for the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the sum of the federal short-term rate plus 0.5 of a percentage point. Under section 6621(a)(2), the underpayment rate is the sum of the federal short-term rate plus 3 percentage points.

Section 6621(c) provides that for purposes of interest payable under section 6601 on any large corporate underpayment, the underpayment rate under section 6621(a)(2) is determined by substituting “5 percentage points” for “3 percentage points.” See section 6621(c) and section 301.6621–3 of the Regulations on Procedure and Administration for the definition of a large corporate underpayment and for the rules for determining the applicable date. Section 6621(c) and section 301.6621–3 are generally effective for periods after December 31, 1990.

Section 6621(b)(1) provides that the Secretary will determine the federal short-term rate for the first month in each calendar quarter.

Section 6621(b)(2)(A) provides that the federal short-term rate determined under section 6621(b)(1) for any month applies during the first calendar quarter beginning after that month. Section 6621(b)(3) provides that the federal short-term rate for any month is the federal short-term rate determined during that month by the Secretary in accordance with section 1274(d), rounded to the nearest full percent (or, if a multiple of ¹ /2 of 1 percent, the rate is increased to the next highest full percent).

Notice 88–59, 1988–1 C.B. 546, announced that, in determining the quarterly interest rates to be used for overpayments and underpayments of tax under section 6621, the Internal Revenue Service will use the federal short-term rate based on daily compounding because that rate is most consistent with section 6621 which,

2008–39 I.R.B. 760 September 29, 2008

for prior periods are set forth in the tables accompanying this revenue ruling.

DRAFTING INFORMATION

The principal author of this revenue ruling is Deborah Colbert-James of the Office of Associate Chief Counsel (Procedure & Administration). For further information regarding this revenue ruling, contact Ms. Colbert-James at (202) 622–8143 (not a toll-free call).

pursuant to section 6622, is subject to daily compounding.

Rounded to the nearest full percent, the federal short-term rate based on daily compounding determined during the month of July 2008 is 3 percent. Accordingly, an overpayment rate of 6 percent (5 percent in the case of a corporation) and an underpayment rate of 6 percent are established for the calendar quarter beginning October 1, 2008. The overpayment rate for the portion of a corporate overpayment exceeding $10,000 for the calendar quarter beginning October 1, 2008, is 3.5 percent. The un

derpayment rate for large corporate underpayments for the calendar quarter beginning October 1, 2008, is 8 percent. These rates apply to amounts bearing interest during that calendar quarter.

Interest factors for daily compound interest for annual rates of 3.5 percent, 5 percent, 6 percent, and 8 percent are published in Tables 12, 63, 65, and 69 of Rev. Proc. 95–17, 1995–1 C.B. 556, 566, 617, 619, and 623.

Annual interest rates to be compounded daily pursuant to section 6622 that apply

TABLE OF INTEREST RATES

PERIODS BEFORE JUL. 1, 1975 - PERIODS ENDING DEC. 31, 1986

OVERPAYMENTS AND UNDERPAYMENTS

PERIOD RATE

In 1995–1 C.B. DAILY RATE TABLE

Before Jul. 1, 1975 6% Table 2, pg. 557 Jul. 1, 1975—Jan. 31, 1976 9% Table 4, pg. 559 Feb. 1, 1976—Jan. 31, 1978 7% Table 3, pg. 558 Feb. 1, 1978—Jan. 31, 1980 6% Table 2, pg. 557 Feb. 1, 1980—Jan. 31, 1982 12% Table 5, pg. 560 Feb. 1, 1982—Dec. 31, 1982 20% Table 6, pg. 560 Jan. 1, 1983—Jun. 30, 1983 16% Table 37, pg. 591 Jul. 1, 1983—Dec. 31, 1983 11% Table 27, pg. 581 Jan. 1, 1984—Jun. 30, 1984 11% Table 75, pg. 629 Jul. 1, 1984—Dec. 31, 1984 11% Table 75, pg. 629 Jan. 1, 1985—Jun. 30, 1985 13% Table 31, pg. 585 Jul. 1, 1985—Dec. 31, 1985 11% Table 27, pg. 581 Jan. 1, 1986—Jun. 30, 1986 10% Table 25, pg. 579 Jul. 1, 1986—Dec. 31, 1986 9% Table 23, pg. 577

September 29, 2008 761 2008–39 I.R.B.

TABLE OF INTEREST RATES

FROM JANUARY 1, 1999 - PRESENT

NONCORPORATE OVERPAYMENTS AND UNDERPAYMENTS

1995–1 C.B. RATE TABLE PG

Jan. 1, 1999—Mar. 31, 1999 7% 19 573 Apr. 1, 1999—Jun. 30, 1999 8% 21 575 Jul. 1, 1999—Sep. 30, 1999 8% 21 575 Oct. 1, 1999—Dec. 31, 1999 8% 21 575 Jan. 1, 2000—Mar. 31, 2000 8% 69 623 Apr. 1, 2000—Jun. 30, 2000 9% 71 625 Jul. 1, 2000—Sep. 30, 2000 9% 71 625 Oct. 1, 2000—Dec. 31, 2000 9% 71 625 Jan. 1, 2001—Mar. 31, 2001 9% 23 577 Apr. 1, 2001—Jun. 30, 2001 8% 21 575 Jul. 1, 2001—Sep. 30, 2001 7% 19 573

2008–39 I.R.B. 762 September 29, 2008

TABLE OF INTEREST RATES

FROM JANUARY 1, 1999 - PRESENT - Continued

NONCORPORATE OVERPAYMENTS AND UNDERPAYMENTS

1995–1 C.B. RATE TABLE PG

Oct. 1, 2001—Dec. 31, 2001 7% 19 573 Jan. 1, 2002—Mar. 31, 2002 6% 17 571 Apr. 1, 2002—Jun. 30, 2002 6% 17 571 Jul. 1, 2002—Sep. 30, 2002 6% 17 571 Oct. 1, 2002—Dec. 31, 2002 6% 17 571 Jan. 1, 2003—Mar. 31, 2003 5% 15 569 Apr. 1, 2003—Jun. 30, 2003 5% 15 569 Jul. 1, 2003—Sep. 30, 2003 5% 15 569 Oct. 1, 2003—Dec. 31, 2003 4% 13 567 Jan. 1, 2004—Mar. 31, 2004 4% 61 615 Apr. 1, 2004—Jun. 30, 2004 5% 63 617 Jul. 1, 2004—Sep. 30, 2004 4% 61 615 Oct. 1, 2004—Dec. 31, 2004 5% 63 617 Jan. 1, 2005—Mar. 31, 2005 5% 15 569 Apr. 1, 2005—Jun. 30, 2005 6% 17 571 Jul. 1, 2005—Sep. 30, 2005 6% 17 571 Oct. 1, 2005—Dec. 31, 2005 7% 19 573 Jan. 1, 2006—Mar. 31, 2006 7% 19 573 Apr. 1, 2006—Jun. 30, 2006 7% 19 573 Jul. 1, 2006—Sep. 30, 2006 8% 21 575 Oct. 1, 2006—Dec. 31, 2006 8% 21 575 Jan. 1, 2007—Mar. 31, 2007 8% 21 575 Apr. 1, 2007—Jun. 30, 2007 8% 21 575 Jul. 1, 2007—Sep. 30, 2007 8% 21 575 Oct. 1, 2007—Dec. 31, 2007 8% 21 575 Jan. 1, 2008—Mar. 31, 2008 7% 67 621 Apr. 1, 2008—Jun. 30, 2008 6% 65 619 Jul. 1, 2008—Sep. 30, 2008 5% 63 617 Oct. 1, 2008—Dec. 31, 2008 6% 65 619

September 29, 2008 763 2008–39 I.R.B.

TABLE OF INTEREST RATES FOR LARGE CORPORATE UNDERPAYMENTS

FROM JANUARY 1, 1991 - PRESENT

1995–1 C.B. RATE TABLE PG

Jan. 1, 1991—Mar. 31, 1991 13% 31 585 Apr. 1, 1991—Jun. 30, 1991 12% 29 583 Jul. 1, 1991—Sep. 30, 1991 12% 29 583 Oct. 1, 1991—Dec. 31, 1991 12% 29 583 Jan. 1, 1992—Mar. 31, 1992 11% 75 629 Apr. 1, 1992—Jun. 30, 1992 10% 73 627 Jul. 1, 1992—Sep. 30, 1992 10% 73 627 Oct. 1, 1992—Dec. 31, 1992 9% 71 625 Jan. 1, 1993—Mar. 31, 1993 9% 23 577 Apr. 1, 1993—Jun. 30, 1993 9% 23 577 Jul. 1, 1993—Sep. 30, 1993 9% 23 577 Oct. 1, 1993—Dec. 31, 1993 9% 23 577 Jan. 1, 1994—Mar. 31, 1994 9% 23 577 Apr. 1, 1994—Jun. 30, 1994 9% 23 577 Jul. 1, 1994—Sep. 30, 1994 10% 25 579 Oct. 1, 1994—Dec. 31, 1994 11% 27 581 Jan. 1, 1995—Mar. 31, 1995 11% 27 581 Apr. 1, 1995—Jun. 30, 1995 12% 29 583 Jul. 1, 1995—Sep. 30, 1995 11% 27 581 Oct. 1, 1995—Dec. 31, 1995 11% 27 581

2008–39 I.R.B. 764 September 29, 2008

TABLE OF INTEREST RATES FOR LARGE CORPORATE UNDERPAYMENTS

FROM JANUARY 1, 1991 - PRESENT - Continued

1995–1 C.B. RATE TABLE PG

Jan. 1, 1996—Mar. 31, 1996 11% 75 629 Apr. 1, 1996—Jun. 30, 1996 10% 73 627 Jul. 1, 1996—Sep. 30, 1996 11% 75 629 Oct. 1, 1996—Dec. 31, 1996 11% 75 629 Jan. 1, 1997—Mar. 31, 1997 11% 27 581 Apr. 1, 1997—Jun. 30, 1997 11% 27 581 Jul. 1, 1997—Sep. 30, 1997 11% 27 581 Oct. 1, 1997—Dec. 31, 1997 11% 27 581 Jan. 1, 1998—Mar. 31, 1998 11% 27 581 Apr. 1, 1998—Jun. 30, 1998 10% 25 579 Jul. 1, 1998—Sep. 30, 1998 10% 25 579 Oct. 1, 1998—Dec. 31, 1998 10% 25 579 Jan. 1, 1999—Mar. 31, 1999 9% 23 577 Apr. 1, 1999—Jun. 30, 1999 10% 25 579 Jul. 1, 1999—Sep. 30, 1999 10% 25 579 Oct. 1, 1999—Dec. 31, 1999 10% 25 579 Jan. 1, 2000—Mar. 31, 2000 10% 73 627 Apr. 1, 2000—Jun. 30, 2000 11% 75 629 Jul. 1, 2000—Sep. 30, 2000 11% 75 629 Oct. 1, 2000—Dec. 31, 2000 11% 75 629 Jan. 1, 2001—Mar. 31, 2001 11% 27 581 Apr. 1, 2001—Jun. 30, 2001 10% 25 579 Jul. 1, 2001—Sep. 30, 2001 9% 23 577 Oct. 1, 2001—Dec. 31, 2001 9% 23 577 Jan. 1, 2002—Mar. 31, 2002 8% 21 575 Apr. 1, 2002—Jun. 30, 2002 8% 21 575 Jul. 1, 2002—Sep. 30, 2002 8% 21 575 Oct. 1, 2002—Dec. 30, 2002 8% 21 575 Jan. 1, 2003—Mar. 31, 2003 7% 19 573 Apr. 1, 2003—Jun. 30, 2003 7% 19 573 Jul. 1, 2003—Sep. 30, 2003 7% 19 573 Oct. 1, 2003—Dec. 31, 2003 6% 17 571 Jan. 1, 2004—Mar. 31, 2004 6% 65 619 Apr. 1, 2004—Jun. 30, 2004 7% 67 621 Jul. 1, 2004—Sep. 30, 2004 6% 65 619 Oct. 1, 2004—Dec. 31, 2004 7% 67 621 Jan. 1, 2005—Mar. 31, 2005 7% 19 573 Apr. 1, 2005—Jun. 30, 2005 8% 21 575 Jul. 1, 2005—Sep. 30, 2005 8% 21 575 Oct. 1, 2005—Dec. 31, 2005 9% 23 577 Jan. 1, 2006—Mar. 31, 2006 9% 23 577 Apr. 1, 2006—Jun. 30, 2006 9% 23 577 Jul. 1, 2006—Sep. 30, 2006 10% 25 579 Oct. 1, 2006—Dec. 31, 2006 10% 25 579 Jan. 1, 2007—Mar. 31, 2007 10% 25 579 Apr. 1, 2007—Jun. 30, 2007 10% 25 579 Jul. 1, 2007—Sep. 30, 2007 10% 25 579 Oct. 1, 2007—Dec. 31, 2007 10% 25 579 Jan. 1, 2008—Mar. 31, 2008 9% 71 625 Apr. 1, 2008—Jun. 30, 2008 8% 69 623 Jul. 1, 2008—Sep. 30, 2008 7% 67 621 Oct. 1, 2008—Dec. 31, 2008 8% 69 623

September 29, 2008 765 2008–39 I.R.B.

TABLE OF INTEREST RATES FOR CORPORATE

OVERPAYMENTS EXCEEDING $10,000

FROM JANUARY 1, 1995 - PRESENT

1995–1 C.B. RATE TABLE PG

Jan. 1, 1995—Mar. 31, 1995 6.5% 18 572 Apr. 1, 1995—Jun. 30, 1995 7.5% 20 574 Jul. 1, 1995—Sep. 30, 1995 6.5% 18 572 Oct. 1, 1995—Dec. 31, 1995 6.5% 18 572 Jan. 1, 1996—Mar. 31, 1996 6.5% 66 620 Apr. 1, 1996—Jun. 30, 1996 5.5% 64 618 Jul. 1, 1996—Sep. 30, 1996 6.5% 66 620 Oct. 1, 1996—Dec. 31, 1996 6.5% 66 620 Jan. 1, 1997—Mar. 31, 1997 6.5% 18 572 Apr. 1, 1997—Jun. 30, 1997 6.5% 18 572 Jul. 1, 1997—Sep. 30, 1997 6.5% 18 572 Oct. 1, 1997—Dec. 31, 1997 6.5% 18 572 Jan. 1, 1998—Mar. 31, 1998 6.5% 18 572 Apr. 1, 1998—Jun. 30, 1998 5.5% 16 570 Jul. 1, 1998—Sep. 30, 1998 5.5% 16 570 Oct. 1, 1998—Dec. 31, 1998 5.5% 16 570 Jan. 1, 1999—Mar. 31, 1999 4.5% 14 568 Apr. 1, 1999—Jun. 30, 1999 5.5% 16 570 Jul. 1, 1999—Sep. 30, 1999 5.5% 16 570 Oct. 1, 1999—Dec. 31, 1999 5.5% 16 570 Jan. 1, 2000—Mar. 31, 2000 5.5% 64 618 Apr. 1, 2000—Jun. 30, 2000 6.5% 66 620 Jul. 1, 2000—Sep. 30, 2000 6.5% 66 620 Oct. 1, 2000—Dec. 31, 2000 6.5% 66 620 Jan. 1, 2001—Mar. 31, 2001 6.5% 18 572 Apr. 1, 2001—Jun. 30, 2001 5.5% 16 570 Jul. 1, 2001—Sep. 30, 2001 4.5% 14 568 Oct. 1, 2001—Dec. 31, 2001 4.5% 14 568 Jan. 1, 2002—Mar. 31, 2002 3.5% 12 566 Apr. 1, 2002—Jun. 30, 2002 3.5% 12 566 Jul. 1, 2002—Sep. 30, 2002 3.5% 12 566 Oct. 1, 2002—Dec. 31, 2002 3.5% 12 566 Jan. 1, 2003—Mar. 31, 2003 2.5% 10 564 Apr. 1, 2003—Jun. 30, 2003 2.5% 10 564 Jul. 1, 2003—Sep. 30, 2003 2.5% 10 564 Oct. 1, 2003—Dec. 31, 2003 1.5% 8 562 Jan. 1, 2004—Mar. 31, 2004 1.5% 56 610 Apr. 1, 2004—Jun. 30, 2004 2.5% 58 612 Jul. 1, 2004—Sep. 30, 2004 1.5% 56 610 Oct. 1, 2004—Dec. 31, 2004 2.5% 58 612 Jan. 1, 2005—Mar. 31, 2005 2.5% 10 564 Apr. 1, 2005—Jun. 30, 2005 3.5% 12 566 Jul. 1, 2005—Sep. 30, 2005 3.5% 12 566 Oct. 1, 2005—Dec. 31, 2005 4.5% 14 568 Jan. 1, 2006—Mar. 31, 2006 4.5% 14 568 Apr. 1, 2006—Jun. 30, 2006 4.5% 14 568 Jul. 1, 2006—Sep. 30, 2006 5.5% 16 570 Oct. 1, 2006—Dec. 31, 2006 5.5% 16 570 Jan. 1, 2007—Mar. 31, 2007 5.5% 16 570 Apr. 1, 2007—Jun. 30, 2007 5.5% 16 570 Jul. 1, 2007—Sep. 30, 2007 5.5% 16 570 Oct. 1, 2007—Dec. 31, 2007 5.5% 16 570

2008–39 I.R.B. 766 September 29, 2008

TABLE OF INTEREST RATES FOR CORPORATE

OVERPAYMENTS EXCEEDING $10,000

FROM JANUARY 1, 1995 - PRESENT - Continued

1995–1 C.B. RATE TABLE PG

Jan. 1, 2008—Mar. 31, 2008 4.5% 62 616 Apr. 1, 2008—Jun. 30, 2008 3.5% 60 614 Jul. 1, 2008—Sep. 30, 2008 2.5% 58 612 Oct. 1, 2008—Dec. 31, 2008 3.5% 12 566

September 29, 2008 767 2008–39 I.R.B.