Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 42.—Low-Income Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

26 CFR 1.42–14: Allocation rules for post-1989 State housing credit ceiling amounts.

Guidance is provided to state housing credit agencies of qualified states that request an allocation of unused housing credit carryover under section 42(h)(3)(D) of the Internal Revenue Code. See Rev. Proc. 2011-57, page 836.

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 382.—Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 451.—General Rules for Taxable Year of Inclusion

26 CFR 1.451–1: General rule for taxable year of inclusion.

Rules are provided under which trusts for Indian tribal members who are minors or legally incompetent for the distribution of gaming revenues under the Indian Gaming Regulatory Act are treated as grantor trusts and the trust beneficiary is not taxed on distributions to the trust or income earned by the trust until actually or constructively received. See Rev. Proc. 2011-56, page 834.

Section 461.—General Rule for Taxable Year of Deduction

26 CFR 1.461–1: General rule for taxable year of deduction.

Accrual of liability to unknown pay- ees. This ruling holds that an employer can establish the “fact of the liability” under section 461 of the Code for bonuses payable to a group of employees even though the employer does not know the identity of any particular bonus recipient and the amount payable to that recipient until after the end of the taxable year. Rev. Rul. 76–345 revoked.

Rev. Rul. 2011–29

ISSUE

Can an employer establish the “fact of the liability” under § 461 of the Internal Revenue Code for bonuses payable to a group of employees if the employer does not know the identity of any particular bonus recipient and the amount payable to that recipient until after the end of the taxable year?

FACTS

X uses an accrual method of accounting for federal income tax purposes. X pays bonuses to a group of employees pursuant to a program that defines the terms and conditions under which the bonuses are paid for a taxable year. X communicates the general terms of the bonus program to employees when they become eligible and whenever the program is changed.

Under the program, bonuses are paid to X ’s employees for services performed during the taxable year. The minimum total amount of bonuses payable under the program to X ’s employees as a group is determinable either (a) through a formula that is fixed prior to the end of the taxable year, taking into account financial data reflecting results as of the end of that taxable year, or (b) through other corporate action, such as a resolution of X ’s board of directors or compensation committee, made before the end of the taxable year,

that fixes the bonuses payable to the employees as a group. To be eligible for a bonus, an employee must perform services during the taxable year and be employed on the date that X pays bonuses. Under the program, bonuses are paid after the end of the taxable year in which the employee performed the related services but before the 15th day of the 3rd calendar month after the close of that taxable year.

Under the program, any bonus amount allocable to an employee who is not employed on the date on which X pays bonuses is reallocated among other eligible employees. Thus, the aggregate minimum amount of bonuses X pays to its group of eligible employees is not reduced by the departure of an employee after the end of the taxable year but before bonuses are paid for that year.

LAW

Section 461(a) provides that the amount of any deduction or credit must be taken for the taxable year that is the proper taxable year under the method of accounting the taxpayer uses to compute taxable income.

Section 1.461–1(a)(2)(i) of the Income Tax Regulations provides that, under an accrual method of accounting, a liability is incurred, and is generally taken into account for federal income tax purposes, in the taxable year in which (1) all the events have occurred that establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred for the liability (collectively, the “all events test”). See also § 1.446–1(c)(1)(ii)(A). This revenue ruling addresses only whether the first prong of the all events test is met.

The first prong of the all events test requires that all the events have occurred that establish the fact of the liability. Generally, all events occur to establish the fact of a liability when (1) the event fixing the liability, whether that be the required performance or other event, occurs, or (2) payment is unconditionally due. Rev. Rul. 2007–3, 2007–1 C.B. 350; Rev. Rul. 80–230, 1980–2 C.B. 169; Rev. Rul.

2011–49 I.R.B. 824 December 5, 2011

Section 467.—Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 468.—Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 482 .—Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 671.—Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners

26 CFR 1.671–1: Grantors and others treated as sub- stantial owners; scope.

Rules are provided under which trusts for Indian tribal members who are minors or legally incompetent for the distribution of gaming revenues under the Indian Gaming Regulatory Act are treated as grantor trusts of which the tribe is the grantor and owner. See Rev. Proc. 2011-56, page 834.

79–410, 1979–2 C.B. 213, amplified by Rev. Rul. 2003–90, 2003–2 C.B. 353. Although an expense may be deductible before it is due and payable, liability for the expense first must be firmly established. United States v. General Dynamics Corp., 481 U.S. 239, 243–4 (1987).

In Washington Post Co. v. United States, 405 F.2d 1279 (Ct. Cl. 1969), the United States Court of Claims held that a taxpayer incurred a liability to pay bonuses under a plan maintained for the benefit of its circulation dealers as a group. Under the plan, if a dealer did not meet certain specified conditions, a portion of the dealer’s share would be forfeited and reallocated to other dealers. Thus, even though the amount and time of actual payout to individual recipients were, at least in part, not determined, the court held that the total amount of the liability was fixed at the end of the taxable year. In Rev. Rul. 76–345, 1976–2 C.B. 134, the Internal Revenue Service announced that it would not follow Washington Post in similar cases.

In United States v. Hughes Properties, Inc., 476 U.S. 593 (1986), the Supreme Court allowed a casino operator to deduct amounts guaranteed for payment of progressive slot machine jackpots that had not yet been won by casino patrons. The Court reasoned that the taxpayer had a fixed obligation to pay the guaranteed amounts, and that the identification of the eventual recipients of the progressive jackpots was inconsequential. The Court noted that “[t]he obligation is there, and whether it turns out that the winner is one patron or another makes no conceivable difference as to basic liability.” Hughes Properties, 476 U.S. at 602.

ANALYSIS

X ’s liability to pay a minimum amount of bonuses to the group of eligible employees is fixed at the end of the year in which the services are rendered. X is obligated under the program to pay to the group the minimum amount of bonuses determined by the end of the taxable year. Any bonus allocable to an employee who is not employed on the date on which bonuses are paid is reallocated to other eligible employees. Thus, the fact of X ’s liability for the minimum amount of bonuses is established by the end of the year in which

the services are rendered. See Rev. Rul. 55-446, 1955-2 C.B. 531, as modified by Rev. Rul. 61-127, 1961-2 C.B. 36 (holding that bonuses payable to ascertainable employees under an incentive compensation plan that has been communicated to the employees, the exact amounts of which are determinable through a formula in effect prior to the end of the taxable year, are properly accruable for Federal income tax purposes for the year to which they relate). This is true even though the identity of the ultimate recipients and the amount, if any, each employee will receive cannot be determined prior to the end of the taxable year. See Hughes Properties, supra. Accordingly, for purposes of the first prong of the all events test under § 1.461-1(a)(2)(i), all the events have occurred by the end of the taxable year that establish the fact of X ’s liability to pay the minimum amount of bonuses.

HOLDING

An employer can establish the “fact of the liability” under § 461 for bonuses payable to a group of employees even though the employer does not know the identity of any particular bonus recipient and the amount payable to that recipient until after the end of the taxable year.

APPLICATION

Any change in a taxpayer’s treatment of bonuses to conform with this revenue ruling is a change in method of accounting that must be made in accordance with §§ 446 and 481, the regulations thereunder, and the applicable administrative procedures. See section 19.01(2) of the APPENDIX of Rev. Proc. 2011–14, 2011–4 I.R.B. 330, 403.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 76–345 is revoked.

DRAFTING INFORMATION

The principal author of this revenue ruling is Jason D. Kristall of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Kristall at (202) 622–5020 (not a toll-free call).

December 5, 2011 825 2011–49 I.R.B.

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 995.—Taxation of DISC Income to Shareholders

2011 base period T-bill rate. The “base period T-bill rate” for the period ending September 30, 2011, is published as required by section 995(f) of the Code.

Rev. Rul. 2011–30

Section 995(f)(1) of the Internal Revenue Code provides that a shareholder of a DISC shall pay interest each taxable year in an amount equal to the product of the shareholder’s DISC-related deferred tax liability for the year and the “base period T-bill rate.” Under section 995(f)(4), the base period T-bill rate is the annual rate of interest determined by the Secretary to be equivalent to the average of the 1-year constant maturity Treasury yields, as published by the Board of Governors of the Federal Reserve System, for the 1-year period ending on September 30 of the calendar year ending with (or of the most recent calendar year ending before) the close of the taxable year of the shareholder. The base period T-bill rate for the period ending September 30, 2011, is 0.22 percent.

Pursuant to section 6222 of the Code, interest must be compounded daily. The table below provides factors for compounding the base period T-bill rate daily for any number of days in the shareholder’s taxable year (including a 52–53 week accounting period) for the 2011 base period T-bill rate. To compute the amount of the interest charge for the shareholder’s taxable year, multiply the amount of the shareholder’s DISC-related deferred tax liability (as defined in section 995(f)(2)) for that year by the base period T-bill rate factor corresponding to the number of days in the shareholder’s taxable year for

which the interest charge is being computed. Generally, one would use the factor for 365 days. One would use a different factor only if the shareholder’s taxable year for which the interest charge being determined is a short taxable year, if the shareholder uses the 52–53 week taxable year, or if the shareholder’s taxable year is a leap year.

For the base period T-bill rates for the periods ending in prior years, see Rev. Rul. 2010–28, 2010–49 I.R.B. 804; Rev. Rul. 2009–36, 2009–47 I.R.B. 650; Rev. Rul. 2008–51, 2008–2 C.B. 1171; Rev. Rul. 2007–64, 2007–2 C.B. 953; and Rev. Rul. 2006–54, 2006–2 C.B. 834.

DRAFTING INFORMATION

The principal author of this revenue ruling is Teresa Burridge Hughes of the Office of Associate Chief Counsel (International). For further information regarding this revenue ruling, contact Teresa B. Hughes at (202) 622–3850 (not a toll-free call).

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

1 .000006027 2 .000012055 3 .000018082 4 .000024110 5 .000030137

6 .000036165 7 .000042193 8 .000048220 9 .000054248 10 .000060276

11 .000066303 12 .000072331 13 .000078359 14 .000084387 15 .000090415

16 .000096443 17 .000102471 18 .000108499 19 .000114527 20 .000120555

21 .000126583 22 .000132611 23 .000138639 24 .000144668 25 .000150696

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

26 .000156724 27 .000162752 28 .000168781 29 .000174809 30 .000180838

31 .000186866 32 .000192895 33 .000198923 34 .000204952 35 .000210981

36 .000217009 37 .000223038 38 .000229067 39 .000235095 40 .000241124

41 .000247153 42 .000253182 43 .000259211 44 .000265240 45 .000271269

46 .000277298 47 .000283327 48 .000289356 49 .000295385 50 .000301414

51 .000307444 52 .000313473 53 .000319502 54 .000325531 55 .000331561

56 .000337590 57 .000343620 58 .000349649 59 .000355679 60 .000361708

61 .000367738 62 .000373767 63 .000379797 64 .000385827 65 .000391856

66 .000397886 67 .000403916 68 .000409946 69 .000415976 70 .000422006

71 .000428035 72 .000434065 73 .000440095 74 .000446126 75 .000452156

2011–49 I.R.B. 826 December 5, 2011

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

76 .000458186 77 .000464216 78 .000470246 79 .000476276 80 .000482307

81 .000488337 82 .000494367 83 .000500398 84 .000506428 85 .000512458

86 .000518489 87 .000524519 88 .000530550 89 .000536581 90 .000542611

91 .000548642 92 .000554673 93 .000560703 94 .000566734 95 .000572765

96 .000578796 97 .000584827 98 .000590858 99 .000596889 100 .000602920

101 .000608951 102 .000614982 103 .000621013 104 .000627044 105 .000633075

106 .000639106 107 .000645138 108 .000651169 109 .000657200 110 .000663232

111 .000669263 112 .000675294 113 .000681326 114 .000687357 115 .000693389

116 .000699420 117 .000705452 118 .000711484 119 .000717515 120 .000723547

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

121 .000729579 122 .000735611 123 .000741643 124 .000747674 125 .000753706

126 .000759738 127 .000765770 128 .000771802 129 .000777834 130 .000783866

131 .000789898 132 .000795931 133 .000801963 134 .000807995 135 .000814027

136 .000820060 137 .000826092 138 .000832124 139 .000838157 140 .000844189

141 .000850222 142 .000856254 143 .000862287 144 .000868319 145 .000874352

146 .000880385 147 .000886417 148 .000892450 149 .000898483 150 .000904516

151 .000910549 152 .000916581 153 .000922614 154 .000928647 155 .000934680

156 .000940713 157 .000946746 158 .000952780 159 .000958813 160 .000964846

161 .000970879 162 .000976912 163 .000982946 164 .000988979 165 .000995012

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

166 .001001046 167 .001007079 168 .001013113 169 .001019146 170 .001025180

171 .001031213 172 .001037247 173 .001043280 174 .001049314 175 .001055348

176 .001061382 177 .001067415 178 .001073449 179 .001079483 180 .001085517

181 .001091551 182 .001097585 183 .001103619 184 .001109653 185 .001115687

186 .001121721 187 .001127755 188 .001133790 189 .001139824 190 .001145858

191 .001151892 192 .001157927 193 .001163961 194 .001169995 195 .001176030

196 .001182064 197 .001188099 198 .001194133 199 .001200168 200 .001206203

201 .001212237 202 .001218272 203 .001224307 204 .001230342 205 .001236376

206 .001242411 207 .001248446 208 .001254481 209 .001260516 210 .001266551

December 5, 2011 827 2011–49 I.R.B.

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

211 .001272586 212 .001278621 213 .001284656 214 .001290691 215 .001296727

216 .001302762 217 .001308797 218 .001314832 219 .001320868 220 .001326903

221 .001332938 222 .001338974 223 .001345009 224 .001351045 225 .001357080

226 .001363116 227 .001369151 228 .001375187 229 .001381223 230 .001387259

231 .001393294 232 .001399330 233 .001405366 234 .001411402 235 .001417438

236 .001423474 237 .001429510 238 .001435546 239 .001441582 240 .001447618

241 .001453654 242 .001459690 243 .001465726 244 .001471762 245 .001477799

246 .001483835 247 .001489871 248 .001495908 249 .001501944 250 .001507981

251 .001514017 252 .001520054 253 .001526090 254 .001532127 255 .001538163

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

256 .001544200 257 .001550237 258 .001556274 259 .001562310 260 .001568347

261 .001574384 262 .001580421 263 .001586458 264 .001592495 265 .001598532

266 .001604569 267 .001610606 268 .001616643 269 .001622680 270 .001628717

271 .001634754 272 .001640792 273 .001646829 274 .001652866 275 .001658904

276 .001664941 277 .001670979 278 .001677016 279 .001683054 280 .001689091

281 .001695129 282 .001701166 283 .001707204 284 .001713242 285 .001719279

286 .001725317 287 .001731355 288 .001737393 289 .001743431 290 .001749468

291 .001755506 292 .001761544 293 .001767582 294 .001773620 295 .001779659

296 .001785697 297 .001791735 298 .001797773 299 .001803811 300 .001809850

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

301 .001815888 302 .001821926 303 .001827965 304 .001834003 305 .001840041

306 .001846080 307 .001852118 308 .001858157 309 .001864196 310 .001870234

311 .001876273 312 .001882312 313 .001888350 314 .001894389 315 .001900428

316 .001906467 317 .001912506 318 .001918545 319 .001924584 320 .001930623

321 .001936662 322 .001942701 323 .001948740 324 .001954779 325 .001960818

326 .001966857 327 .001972897 328 .001978936 329 .001984975 330 .001991015

331 .001997054 332 .002003093 333 .002009133 334 .002015172 335 .002021212

336 .002027251 337 .002033291 338 .002039331 339 .002045370 340 .002051410

341 .002057450 342 .002063490 343 .002069530 344 .002075569 345 .002081609

2011–49 I.R.B. 828 December 5, 2011

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

346 .002087649 347 .002093689 348 .002099729 349 .002105769 350 .002111809

351 .002117850 352 .002123890 353 .002129930 354 .002135970 355 .002142010

356 .002148051 357 .002154091 358 .002160131 359 .002166172 360 .002172212

361 .002178253 362 .002184293 363 .002190334 364 .002196374 365 .002202415

366 .002208456 367 .002214497 368 .002220537

2011 ANNUAL RATE, COMPOUNDED DAILY

0.22 PERCENT

DAYS FACTOR

369 .002226578 370 .002232619

371 .002238660

Section 1274.—Determi- nation of Issue Price in the Case of Certain Debt Instru- ments Issued for Property

(Also Sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes of sections 382, 642, 1274, 1288, and other sections of the Code, tables set forth the rates for December 2011.

Rev. Rul. 2011–31

This revenue ruling provides various prescribed rates for federal income tax purposes for December 2011 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(1) for buildings placed in service during the current month. However, under section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service after July 30, 2008, and before December 31, 2013, shall not be less than 9%. Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520. Finally, Table 6 contains contains the 2012 interest rate for sections 846 and 807.

Applicable Federal Rates (AFR) for December 2011

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term

AFR .20% .20% .20% .20% 110% AFR .22% .22% .22% .22% 120% AFR .24% .24% .24% .24% 130% AFR .26% .26% .26% .26%

Mid-term

AFR 1.27% 1.27% 1.27% 1.27% 110% AFR 1.40% 1.40% 1.40% 1.40% 120% AFR 1.53% 1.52% 1.52% 1.52% 130% AFR 1.66% 1.65% 1.65% 1.64% 150% AFR 1.92% 1.91% 1.91% 1.90% 175% AFR 2.23% 2.22% 2.21% 2.21%

Long-term

AFR 2.80% 2.78% 2.77% 2.76% 110% AFR 3.08% 3.06% 3.05% 3.04% 120% AFR 3.37% 3.34% 3.33% 3.32% 130% AFR 3.64% 3.61% 3.59% 3.58%

December 5, 2011 829 2011–49 I.R.B.

REV. RUL. 2011–31 TABLE 2

Adjusted AFR for December 2011

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted .45% .45% .45% .45% AFR

Mid-term adjusted AFR 1.69% 1.68% 1.68% 1.67%

Long-term adjusted 3.55% 3.52% 3.50% 3.49% AFR

REV. RUL. 2011–31 TABLE 3

Rates Under Section 382 for December 2011

Adjusted federal long-term rate for the current month 3.55%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 3.55%

REV. RUL. 2011–31 TABLE 4

Appropriate Percentages Under Section 42(b)(1) for December 2011

Note: Under Section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service

after July 30, 2008, and before December 31, 2013, shall not be less than 9%.

Appropriate percentage for the 70% present value low-income housing credit 7.47%

Appropriate percentage for the 30% present value low-income housing credit 3.20%

REV. RUL. 2011–31 TABLE 5

Rate Under Section 7520 for December 2011

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 1.6%

REV. RUL. 2011–31 TABLE 6

Rates Under Sections 846 and 807

Applicable rate of interest for 2012 for purposes of sections 846 and 807 2.89%

Section 1288.—Treatment of Original Issue Discount on Tax-Exempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

Section 2042.—Proceeds of Life Insurance

26 CFR 20.2042–1: Proceeds of life insurance.

Substitution of insurance policy. This ruling provides guidance regarding whether a grantor’s retention of a power, exercisable in a nonfiduciary capacity, to acquire an insurance policy held by a trust by substituting other assets of equivalent value will cause the value of the insurance policy to be includible in the grantor’s gross estate under section 2042 of the

Code. The ruling provides that a grantor’s retention of the power, exercisable in a nonfiduciary capacity, to acquire an insurance policy held in trust by substituting other assets of equivalent value will not, by itself, cause the value of the insurance policy to be includible in the grantor’s gross estate under section 2042, provided the trustee has a fiduciary obligation (under local law or the trust instrument) to ensure the grantor’s compliance with the terms of this power by satisfying itself that the properties acquired and substituted by

2011–49 I.R.B. 830 December 5, 2011

In Rev. Rul. 84–179, 1984–2 C.B. 195, the decedent purchased an insurance policy on his life and transferred all incidents of ownership to his spouse. His spouse designated their adult child as the policy beneficiary. Subsequently, the spouse died and her will established a residuary trust for the benefit of the child. The decedent was designated the trustee of this trust. The insurance policy on the decedent’s life, which was part of the residuary estate, passed to the testamentary trust. As trustee, the decedent had broad discretionary powers in the management of the trust property and the power to distribute or accumulate income. Under the terms of the policy, the owner could elect to have the proceeds made payable according to various plans, use the loan value to pay the premiums, borrow on the policy, assign or pledge the policy, and elect to receive annual dividends. The will did not preclude the decedent from exercising these powers, although the decedent could not do so for his own benefit. The decedent paid the premiums on the policy out of other trust property and was still serving as trustee when he died.

Citing the legislative history of § 2042(2), the ruling states that Congress intended § 2042 to parallel the statutory scheme governing those powers that would cause other types of property to be included in a decedent’s estate under §§ 2036 and 2038. Section 2036 applies to the transfer of property where rights or powers are retained incident to the transfer, and § 2038 pertains to situations where property is transferred and power over the property subsequently returns to the transferor-decedent.

Under the facts in Rev. Rul. 84–179, the decedent transferred the policy to his wife and subsequently, in an unrelated transaction, reacquired incidents of ownership over the policy in a fiduciary capacity. The ruling holds that the decedent will not be considered to possess incidents of ownership in the policy for purposes of § 2042(2), provided the decedent could not exercise the powers for the decedent’s personal benefit, the decedent did not transfer the policy or any of the consideration for purchasing or maintaining the policy to the trust from personal assets, and the devolution of the powers to the decedent was not part of a prearranged plan involving the participation of decedent.

the grantor are in fact of equivalent value, and further provided that the substitution power cannot be exercised in a manner that can shift benefits among the trust beneficiaries.

Rev. Rul. 2011–28

ISSUE

Whether a grantor’s retention of the power, exercisable in a nonfiduciary capacity, to acquire an insurance policy held by a trust by substituting other assets of equivalent value will cause the value of the insurance policy to be includible in the grantor’s gross estate under § 2042 of the Internal Revenue Code.

FACTS

D, a United States citizen, established and funded Trust with cash. Thereafter, Trust purchased a life insurance policy on D ’s life. Trust is an irrevocable trust for the benefit of D ’s descendants. T is the trustee of Trust, and the terms of Trust prohibit D from serving as trustee of Trust. D makes gifts every year to Trust, and Trust pays the premium on the insurance policy. The proceeds of the policy are payable to Trust upon D ’s death.

D cannot revoke, alter, amend, or terminate the trust. The governing instrument of Trust, however, provides D with the power, exercisable at any time, to acquire any property held in Trust by substituting other property of equivalent value. The trust instrument provides that the power is exercisable by D in a nonfiduciary capacity, without the approval or consent of any person acting in a fiduciary capacity. To exercise the power of substitution, D must certify in writing that the substituted property and the Trust property for which it is substituted are of equivalent value. In addition, under local law, T has a fiduciary obligation to ensure that the property that D seeks to substitute is equivalent in value to the property distributed to D . Moreover, if a trust has two or more beneficiaries, local law requires the trustee to act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries. Finally, under local law and without restriction in the trust instrument, T has the discretionary power to acquire, invest, reinvest, exchange, sell, convey, control, di

vide, partition, and manage the trust property in accordance with the standards provided by law.

D has no incidents of ownership in the insurance policy unless D’s right of substitution is considered an incident of ownership. D dies without having exercised the power to substitute with respect to the life insurance policy.

LAW AND ANALYSIS

Section 2042(2) provides that the value of the gross estate includes the value of all property to the extent of the amount receivable as insurance under policies on the life of the decedent by beneficiaries (other than the executor), with respect to which the decedent possessed at decedent’s date of death any of the incidents of ownership in the policies, exercisable either alone or in conjunction with any other person.

Section 20.2042–1(c)(2) of the Estate Tax Regulations provides that the meaning of the term “incidents of ownership” is not confined to ownership of the policy in the technical legal sense. Generally speaking, the term refers to the right of the insured or the insured’s estate to the economic benefits of the policy. Thus, the term includes without limitation the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy.

Section 20.2042–1(c)(4) provides that a decedent is considered to have an incident of ownership in a policy held in trust if, under the terms of the policy, the decedent (either alone or in conjunction with another person) has the power (as trustee or otherwise) to change the beneficial ownership in the policy or its proceeds, or the time or manner of enjoyment thereof, even though the decedent has no beneficial interest in the trust. Moreover, assuming the decedent created the trust, such a power may result in the inclusion in the decedent’s gross estate under § 2036 or 2038 of other property transferred by the decedent to the trust if, for example, the decedent has the power to surrender the insurance policy and if the income otherwise used to pay premiums on the policy would become currently payable to a beneficiary of the trust in the event that the policy were surrendered.

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by Trust is not, by itself, an incident of ownership under § 2042(2).

HOLDING

A grantor’s retention of the power, exercisable in a nonfiduciary capacity, to acquire an insurance policy held in trust by substituting other assets of equivalent value will not, by itself, cause the value of the insurance policy to be includible in the grantor’s gross estate under § 2042, provided the trustee has a fiduciary obligation (under local law or the trust instrument) to ensure the grantor’s compliance with the terms of this power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value, and further provided that the substitution power cannot be exercised in a manner that can shift benefits among the trust beneficiaries. A substitution power cannot be exercised in a manner that can shift benefits if: (a) the trustee has both the power (under local law or the trust instrument) to reinvest the trust corpus and a duty of impartiality with respect to the trust beneficiaries; or (b) the nature of the trust’s investments or the level of income produced by any or all of the trust’s investments does not impact the respective interests of the beneficiaries, such as when the trust is administered as a unitrust (under local law or the trust instrument) or when distributions from the trust are limited to discretionary distributions of principal and income.

DRAFTING INFORMATION

The principal author of this revenue ruling is Mayer Samuels of the Office of the Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Samuels at (202) 622–3090 (not a toll-free call).

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

The ruling further states, however, that the decedent will be deemed to have incidents of ownership over an insurance policy on the decedent’s life where decedent’s powers are held in a fiduciary capacity and the decedent has transferred the policy or any of the consideration for purchasing and maintaining the policy to the trust. Also, where the decedent’s powers could have been exercised for decedent’s benefit, they will constitute incidents of ownership in the policy, without regard to how those powers were acquired and without consideration of whether the decedent transferred property to the trust. Thus, in such a situation, if the decedent reacquires powers over insurance policies in an individual capacity, the powers will constitute incidents of ownership even though the decedent is a transferee. See Estate of Fruehauf v. Com- missioner, 427 F.2d 80 (6th Cir. 1970); Estate of Skifter v. Commissioner, 468 F. 2d 699 (2d Cir. 1972).

In Estate of Jordahl v. Commissioner, 65 T.C. 92 (1975), acq. in result, 1977–2 C.B. 1, the decedent created an inter vivos trust. The corpus of the trust included insurance policies on the decedent’s life and other income producing assets. Under the terms of the trust, the decedent reserved the power to substitute other securities or property for those held in trust, provided the substituted property was equal in value to the property replaced. After the decedent’s death, the Service argued that the trust assets were includible in the decedent’s gross estate under § 2038 because the decedent’s power to substitute assets of equal value could be exercised to alter the beneficial interests in the trust. The Service also argued that the proceeds from the insurance policies should also be included under § 2042(2) because the power to substitute the insurance policies allowed the decedent to reacquire full ownership of the policies in the trust.

The Tax Court determined that, because the decedent was bound by fiduciary standards and was therefore accountable in equity to the succeeding income beneficiary and remaindermen, the decedent could not exercise the power to deplete the trust or to shift trust benefits among the beneficiaries. Accordingly, the Court held that the substitution power was not a power to alter, amend, or revoke the trust within the

meaning of § 2038. The court further concluded that the decedent’s power to substitute an insurance policy was merely a power to exchange at arm’s length. The Court held that such a power was in effect a right to purchase the policy and that such a right could not be considered an incident of ownership.

In Rev. Rul. 2008–22, 2008–16 I.R.B. 796, the grantor created an irrevocable inter vivos trust for the benefit of the grantor’s descendants. The grantor retained the power, exercisable in a nonfiduciary capacity, to acquire any property held in the trust by substituting other property of equivalent value. The ruling concludes that the grantor’s retained power to substitute assets of equivalent value will not, by itself, cause the value of the trust corpus to be includible in the grantor’s gross estate under § 2036 or 2038, provided the trustee has a fiduciary obligation (under local law or the trust instrument) to ensure the grantor’s compliance with the terms of this power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value. The ruling further provides that the substitution power cannot be exercised in a manner that would cause the shifting of benefits among the trust beneficiaries.

In the instant case, like the situation presented in Rev. Rul. 2008–22, the trust instrument expressly prohibits D from serving as trustee and states that D ’s power to substitute assets of equivalent value is held in a nonfiduciary capacity. However, under the terms of Trust, the assets that D may transfer into Trust must be equivalent in value to the insurance policies that D will receive. In addition, T has a fiduciary obligation to ensure that the assets substituted are of equivalent value. Thus, D cannot exercise the power to substitute assets in a manner that will reduce the value of the trust corpus or increase D ’s net worth. Further, in view of T ’s ability to reinvest the assets and T ’s duty of impartiality to the trust beneficiaries, there will be no shifting of benefits between or among the beneficiaries that could otherwise result from a substitution of property by D . Under these circumstances, D ’s retained power to substitute assets of equivalent value for a life insurance policy held

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Section 7872.—Treatment of Loans With Below-Market Interest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of December 2011. See Rev. Rul. 2011-31, page 829.

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