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 March 2012. See Rev. Rul. 2012-9, page 475.

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of March 2012. See Rev. Rul. 2012-9, page 475.

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 March 2012. See Rev. Rul. 2012-9, page 475.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of March 2012. See Rev. Rul. 2012-9, page 475.

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 March 2012. See Rev. Rul. 2012-9, page 475.

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 March 2012. See Rev. Rul. 2012-9, page 475.

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 March 2012. See Rev. Rul. 2012-9, page 475.

26 CFR 1.482–7: Methods to determine taxable in- come in connection with a cost sharing arrangement.

T.D. 9569

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Use of Differential Income Stream as a Consideration in Assessing the Best Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains temporary regulations that implement the use of the differential income stream as a consideration in assessing the best method in connection with a cost sharing arrangement. The text of these temporary regulations also serves as part of the text of proposed regulations contained in a crossreference notice of proposed rulemaking (REG–145474–11) published in this issue of the Bulletin. This document also contains final regulations that provide crossreferences in the final cost sharing regulations to relevant sections of these temporary regulations.

DATES: Effective Date: These regulations are effective on December 19, 2011.

Applicability Dates: For dates of applicability, see §1.482–7T(l).

FOR FURTHER INFORMATION CONTACT: Joseph L. Tobin or Mumal R. Hemrajani, (202) 435–5265 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Background

A notice of proposed rulemaking and notice of public hearing regarding additional guidance to improve compliance with, and administration of, the rules in connection with a cost sharing arrangement (CSA) were published in the Federal Register (70 FR 51116) (REG–144615–02, 2005–2 C.B. 625) on August 29, 2005 (2005 proposed regulations). A correction to the notice of proposed rulemaking and notice of public hearing was published in the Federal Register (70 FR 56611) on September 28, 2005. A public hearing was held on December 16, 2005.

The Treasury Department and the IRS received numerous comments on a wide range of issues addressed in the 2005 proposed regulations. In response to these comments, temporary and proposed regulations were published in the Federal Reg- ister (74 FR 340–01 and 74 FR 236–01) (REG–144615–02) on January 5, 2009 (2008 temporary regulations). Corrections to the 2008 temporary regulations were published in the Federal Register on February 27, 2009 (74 FR 8863–01), March 5, 2009 (74 FR 9570–01, 74 FR 9570–02, and 74 FR 9577–01), and March 19, 2009 (74 FR 11644–01). A public hearing was held on April 21, 2009.

The Treasury Department and the IRS received comments on a range of issues addressed in the 2008 temporary regulations. Final regulations were issued in a previous issue of the Federal Regis- ter (REG–144615–02) (T.D. 9568) in December 2011 ("final regulations"). Certain guidance regarding discount rates was reserved in the final regulations because the Treasury Department and the IRS believe it is appropriate to solicit public comments on that subject matter. As explained herein, these temporary regulations provide a portion of that reserved guidance on discount rates. Simultaneous with these temporary regulations, the other portion of such reserved guidance concerning discount rates is being provided in proposed

2012–11 I.R.B. 465 March 12, 2012

present value of the differential income stream is consistent with reliable direct evidence of the appropriate discount rate applicable for activities reasonably anticipated to generate an income stream with a similar risk profile to the differential income stream (such as those of the uncontrolled companies described in §1.482–7T(g)(4)(viii) Example 8 ). The Treasury Department and the IRS have added §1.482–7T(g)(4)(viii) Example 8 to illustrate how §1.482–7T(g)(4)(vi)(F)( 2 ) may be used to evaluate the reliability of a particular application of the income method.

The Treasury Department and the IRS are also proposing a new specified application of the income method in §1.482–7(g)(4)(v), which provides that the determination of the arm’s length charge for the PCT Payment can be derived by discounting the differential income stream at an appropriate rate. The differential income stream approach to determining PCT Payments depends on reliably determining the discount rate associated with the differential income stream. This, in turn, requires an understanding of the economic meaning of the differential income stream. For example, assume a CSA in which the PCT Payor does not contribute any platform or operating contributions, and undertakes only routine exploitation activities for which it anticipates a routine return. In such case, the total undiscounted anticipated profits (before PCT Payments) to the CSA in the PCT Payor’s territory can be thought of as comprising the anticipated routine exploitation profits plus the anticipated profits associated with the development of the cost shared intangibles in the PCT Payor’s territory. Under the licensing alternative, on the other hand, the PCT Payor’s total undiscounted anticipated profits consist solely of the anticipated routine exploitation profits. Thus, the differential income stream conceptually corresponds to the anticipated development profits of the cost shared intangibles. For these reasons, an appropriate discount rate for the differential income stream might be determined based, for example, on the weighted average cost of capital of uncontrolled companies whose activities consist primarily of developing intangibles similar to the cost shared intangibles, and whose resources, capabilities, or rights are similar to the

regulations elsewhere in this issue of the Bulletin (proposed regulations).

Explanation of Provisions

The Treasury Department and the IRS are aware that some taxpayers are taking unreasonable positions in applying the income method by using relatively low licensing discount rates, and relatively high cost sharing discount rates, without sufficiently considering the appropriate interrelationship of the discount rates and financial projections, thus deriving PCT Payments that are not in accordance with the arm’s length standard.

In light of these concerns, the Treasury Department and the IRS are providing additional guidance as follows: (1) in the final regulations, further guidance on comparing the financial projections associated with the cost sharing alternative discounted at the rate appropriate for the cost sharing alternative with the financial projections associated with the licensing alternative discounted at the rate appropriate for the licensing alternative, and evaluating reliability considerations associated with such a comparison (§1.482–7(g)(4)(vi)(F)( 1 ) (Reflection of similar risk profiles in cost sharing alternative and licensing alternative)); (2) in these temporary regulations, further guidance on evaluating results of application of the income method (§1.482–7T(g)(2)(v)(B)( 2 ) (Implied discount rates) and (4)(vi)(F)( 2 ) (Use of differential income stream as a consideration in assessing the best method)); and (3) in proposed regulations, a new specified application of the income method for directly determining the arm’s length charge for PCT Payments (§1.482–7(g)(4)(v) (Application of income method using differential income stream)).

As discussed in the Preamble to the final regulations, any difference, if any, in market-correlated risks between the licensing and cost sharing alternatives is due solely to the different effects on risks of the PCT Payor’s making licensing payments under the licensing alternative on the one hand, and the PCT Payor’s making cost contributions and PCT Payments under the cost sharing alternative on the other hand. Thus, the difference in risk between the two scenarios should reflect solely (1) the incremental risk, if any, associated with

the cost contributions taken on by the PCT Payor in developing cost shared intangibles under the cost sharing alternative, and (2) any difference in risk associated with the particular payment forms of the licensing payments and the PCT Payments, in light of the fact that the licensing payments in the licensing alternative are partially replaced by cost contributions and partially replaced by PCT Payments in the cost sharing alternative, each with its own payment form. Accordingly, the final regulations added §1.482–7(g)(4)(vi)(F)( 1 ) (Reflection of similar risk profiles in cost sharing alternative and licensing alternative), which provides that an analysis under the income method that uses a different discount rate for the cost sharing alternative than the licensing alternative will be more reliable the greater the extent to which any difference between the two discount rates reflects solely those differences in risk profiles of these two alternatives.

These temporary regulations build upon §1.482–7(g)(4)(vi)(F)( 1 ) of the final regulations by providing additional guidance relating to analysis of the interrelationship between the discount rate for the cost sharing alternative and the discount rate for the licensing alternative, and evaluation of the reasonableness of the implied discount rate that may be derived from the differential income stream between the licensing alternative and the cost sharing alternative. The differential income stream is the difference between the PCT Payor’s undiscounted operating income under the cost sharing alternative (before PCT Payments) and the PCT Payor’s undiscounted operating income under the licensing alternative. This difference equals the licensing payments to be made under the licensing alternative minus the PCT Payor’s cost contributions to be made under the cost sharing alternative. The differential income stream should be discounted at an appropriate rate in order to evaluate the reliability of a determination of the arm’s length charge for the PCT Payment. Accordingly, these temporary regulations add §1.482–7T(g)(4)(vi)(F)( 2 ), which provides that an analysis under the income method that uses a different discount rate for the cost sharing alternative than for the licensing alternative will be more reliable the greater the extent to which the implied discount rate for the projected

March 12, 2012 466 2012–11 I.R.B.

method that uses a different discount rate for the cost sharing alternative than for the licensing alternative will be more reliable the greater the extent to which the implied discount rate for the projected present value of the differential income stream is consistent with reliable direct evidence of the appropriate discount rate applicable for activities reasonably anticipated to generate an income stream with a similar risk profile to the differential income stream. Such differential income stream is defined as the stream of the reasonably anticipated residuals of the PCT Payor’s licensing payments to be made under the licensing alternative, minus the PCT Payor’s cost contributions to be made under the cost sharing alternative. See, for example, Ex- ample 8 of this paragraph (g)(4)(viii).

(g)(4)(vii) through (viii) ( Example 7 )

[Reserved]. For further guidance, see §1.482–7(g)(4)(vii) through (g)(4)(viii) ( Example 7 ).

(viii) Example 8 . (i) The facts are the same as in Example 1, except that the taxpayer determines that the appropriate discount rate for the cost sharing alternative is 20%. In addition, the taxpayer determines that the appropriate discount rate for the licensing alternative is 10%. Accordingly, the taxpayer determines that the appropriate present value of the PCT Payment is $146 million.

(ii) Based on the best method analysis described in Example 2, the Commissioner determines that the taxpayer’s calculation of the present value of the PCT Payments is outside of the interquartile range (as shown in the sixth column of Example 2 ), and thus warrants an adjustment. Furthermore, in evaluating the taxpayer’s analysis, the Commissioner undertakes an analysis based on the difference in the financial projections between the cost sharing and licensing alternatives (as shown in column 11 of Example 1 ). This column shows the anticipated differential income stream of additional positive or negative income for FS over the duration of the CSA Activity that would result from undertaking the cost sharing alternative (before any PCT Payments) rather than the licensing alternative. This anticipated differential income stream thus reflects the anticipated incremental undiscounted profits to FS from the incremental activity of undertaking the risk of developing the cost shared intangibles and enjoying the value of its divisional interests. Taxpayer’s analysis logically implies that the present value of this stream must be $146 million, since only then would FS have the same anticipated value in both the cost sharing and licensing alternatives. A present value of $146 million implies that the discount rate applicable to this stream is 34.4%. Based on a reliable calculation of discount rates applicable to the anticipated income streams of uncontrolled companies whose resources, capabilities, and rights consist primarily of software applications intangibles and research and development teams similar to USP’s platform contributions to the CSA, and which income streams, accordingly, may be reasonably anticipated to reflect a similar risk

platform contributions and cost shared intangibles under the CSA. The proposed regulations also add §1.482–7(g)(4)(viii) Example 9 to illustrate this newly specified application of the income method.

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 been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration (CCASBA) for comment on their impact on small business. CCASBA had no comments.

Drafting Information

The principal authors of these regulations are Joseph L. Tobin and Mumal R. Hemrajani, Office of the Associate Chief Counsel (International). However, other personnel from the Internal Revenue Service and the Treasury Department participated in the development of the regulations.

- - - -

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 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Sections 1.482–7 and 1.482–7T also issued under 26 U.S.C. 482. - * *

Par. 2. Section 1.482–7 is amended by revising paragraphs (g)(2)(v)(B)( 2 ) and (g)(4)(vi)(F)( 2 ), and adding Example 8 to paragraph (g)(4)(viii), to read as follows:

§1.482–7 Methods to determine taxable income in connection with a cost sharing arrangement .

• • • • (g)* * (2)* * (v)* * (B)* - ( 2 ) [Reserved]. For further guidance, see §1.482–7T(g)(2)(v)(B)( 2 ).
• • • • (4) - - (vi) - * (F) - - * ( 2 ) [Reserved]. For further guidance, see §1.482–7T(g)(4)(vi)(F)( 2 ).
• • • • (viii) * * * Example 8 . [Reserved]. For further guidance, see §1.482–7T(g)(4)(viii), Ex- ample 8 .
• • • • Par. 3. Section 1.482–7T is added to read as follows:

§1.482–7T Methods to determine taxable income in connection with a cost sharing arrangement (temporary) .

(a) through (g)(2)(v)(B)( 1 ) [Reserved]. For further guidance, see §1.482–7(a) through (g)(2)(v)(B)( 1 ).

( 2 ) Implied discount rates . In some circumstances, the particular discount rate or rates used for certain activities or transactions logically imply that certain other activities will have a particular discount rate or set of rates (implied discount rates). To the extent that an implied discount rate is inappropriate in light of the facts and circumstances, which may include reliable direct evidence of the appropriate discount rate applicable for such other activities, the reliability of any method is reduced where such method is based on the discount rates from which such an inappropriate implied discount rate is derived. See paragraphs (g)(4)(vi)(F)( 2 ) and (g)(4)(viii), Example 8 of this section.

(g)(2)(v)(B)( 3 ) through (g)(4)(vi)(F)( 1 )

[Reserved]. For further guidance, see §1.482–7(g)(2)(v)(B)( 3 ) through (g)(4)(vi)(F)( 1 ).

( 2 ) Use of differential income stream as a consideration in assessing the best method . An analysis under the income

2012–11 I.R.B. 467 March 12, 2012

as the text of the proposed regulations (REG–113903–10) set forth in the notice of proposed rulemaking on this subject published elsewhere in this issue of the Bulletin.

DATES: Effective Date: These regulations are effective on January 17, 2012.

Applicability Dates: For dates of applicability, see §§1.861–9T(k) and 1.861–11T(h).

FOR FURTHER INFORMATION CONTACT: Jeffrey L. Parry, (202) 622–3850 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

I. Interest Expense Allocation by Partners

Section 1.861–9T(e) provides rules governing the apportionment of interest expense by a partner in a partnership. In general, §1.861–9T(e) adopts an aggregate, or look-through, approach to apportioning a partner’s distributive share of interest expense incurred by the partnership. Section 1.861–9T(e)(1) provides the general rule that a partner’s distributive share of the interest expense of a partnership is considered related to all income-producing activities and assets of the partner. Similarly, §1.861–9T(e)(2) requires that a corporate partner whose direct or indirect interest in the partnership is 10 percent or more apportion its distributive share of partnership interest expense by reference to the partner’s assets, including the partner’s pro rata share of the partnership’s assets.

By contrast, limited partners (whether individual or corporate) and corporate general partners with a less-than-10-percent partnership interest are excepted from aggregate treatment. Under §1.861–9T(e)(4)(i), such partners must directly allocate their distributive share of partnership interest expense to their distributive share of partnership gross income. In addition, for purposes of allocating other interest expense incurred directly by such a partner, §1.861–9T(e)(4)(ii) provides that the relevant asset is the partner’s interest in the partnership, and not the partner’s share of the partnership assets.

profile to the differential income stream, the Commissioner concludes that an appropriate discount rate for the anticipated income stream associated with USP’s platform contributions (that is, the additional positive or negative income over the duration of the CSA Activity that would result, before PCT Payments, from switching from the licensing alternative to the cost sharing alternative) is 16%, which is significantly less than 34.4%. This conclusion further suggests that Taxpayer’s analysis is unreliable. See paragraphs (g)(2)(v)(B)( 2 ) and (4)(vi)(F)( 1 ) and ( 2 ) of this section.

(iii) The Commissioner makes an adjustment of $296 million, so that the present value of the PCT Payments is $442 million (the median results as shown in column 6 of Example 2 ).

(g)(5) through (k) [Reserved]. For further guidance, see §1.482–7(g)(5) through (k).

(l) Effective/Applicability Date . Treas. Reg. §1.482–7T(g)(2)(v)(B)( 2 ), (g)(4)(vi)(F)( 2 ) and (g)(4)(viii), Example 8 apply to taxable years beginning on or after December 19, 2011.

(m) [Reserved]. For further guidance, see §1.482–7(m).

(n) Expiration date . The applicability of this section expires on December 19, 2014.

Steven T. Miller, Deputy Commissioner for Services and Enforcement .

Approved December 8, 2011.

Emily S. McMahon, Acting Assistant Secretary of the Treasury (Tax Policy) .

(Filed by the Office of the Federal Register on December 19, 2011, 11:15 a.m., and published in the issue of the Federal Register for December 23, 2011, 76 F.R. 80249)

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 March 2012. See Rev. Rul. 2012-9, page 475.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of March 2012. See Rev. Rul. 2012-9, page 475.

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of March 2012. See Rev. Rul. 2012-9, page 475.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of March 2012. See Rev. Rul. 2012-9, page 475.

Section 861.—Income From Sources Within the United States

26 CFR 1.861–9T: Allocation and apportionment of interest expense (temporary).

T.D. 9571

Department of the Treasury Internal Revenue Service 26 CFR Part 1

Allocation and Apportionment of Interest Expense

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations that provide guidance regarding the allocation and apportionment of interest expense. These temporary regulations provide guidance concerning the allocation and apportionment of interest expense by corporations owning a 10 percent or greater interest in a partnership, as well as the allocation and apportionment of interest expense using the fair market value method. These temporary regulations also update the interest allocation regulations to conform to the statutory changes made by section 216 of the legislation commonly referred to as the Education Jobs and Medicaid Assistance Act (EJMAA), enacted on August 10, 2010, affecting the affiliation of certain foreign corporations for purposes of section 864(e). These regulations affect taxpayers that allocate and apportion interest expense. The text of these temporary regulations also serves

March 12, 2012 468 2012–11 I.R.B.

out also treating the related party debt as an asset in the creditor’s hands distorts the relative values of assets assigned to each statutory grouping. This result is contrary to the general principles of the §1.861–9 regulations, which are based on the concept that interest expense must be apportioned on the basis of the value of all assets. Accordingly, these temporary regulations amend §1.861–9T(h)(4) to reflect the fact that related party debt is an asset that must be taken into account whether held by the taxpayer or a related person.

These temporary regulations first revise §1.861–9T(h)(4) by adding a new paragraph §1.861–9T(h)(4)(i) to provide for the valuation of related party debt. Prior to its revision by these temporary regulations, §1.861–9T(h)(4) provided for the valuation of the stock of a related person, but the regulations did not provide any explanation of how the related party debt is to be valued. As revised by these temporary regulations, §1.861–9T(h)(4)(i) provides that a related party debt obligation held by a taxpayer or another person related to the taxpayer has a value equal to the amount of the liability of the obligor related person. These temporary regulations also revise §1.861–9T(h)(4) by providing that the value of stock in a related person includes the taxpayer’s pro rata share of related party debt held by the related person. Finally, these temporary regulations provide a new example illustrating the changes made to §1.861–9T(h)(4).

These amendments make clear that related party debt is an asset in the hands of the creditor for purposes of applying the asset method and is included in the valuation of stock of a related person. Very broadly, these changes ensure that both the receivable and the payable sides of related party debt are included for valuation purposes under the FMV method, and that the value of each side is determined in a consistent manner. No inference is intended regarding the interpretation of prior regulations as a result of these modifications.

III. Affiliated Groups

The interest expense of each member of an affiliated group is allocated and apportioned as if all members of such group were a single corporation. Section 864(e)(1). Prior to its amendment by the EJMAA, section 864(e)(5)(A) defined the

This approach for such minority partners avoids the potential administrative burden that an aggregate approach would impose on such minority partners.

These temporary regulations revise §1.861–9T(e)(2) to clarify that a corporate partner with a 10 percent or greater interest in a partnership must allocate its direct interest expense to all of its assets, including its proportionate share of partnership assets. The IRS and the Treasury Department believe that an aggregate approach for corporate partners with a 10 percent or greater interest in the partnership is appropriate and consistent with the aggregate approach applicable to apportioning such partner’s distributive share of interest expense incurred by the partnership.

These temporary regulations also revise §1.861–9T(e)(2) to provide that when a corporate partner with a 10 percent or greater interest in a partnership uses the tax book value or alternative tax book value method, and therefore must use the partnership’s inside basis in its assets when allocating interest expense, the partnership’s inside basis includes any section 734(b) adjustments and any section 743(b) adjustments of the corporate partner for this purpose. Section 1.861–9T(e)(3) is also revised to provide a similar rule for individual partners who are general partners or limited partners with a 10 percent or greater interest in the partnership.

II. Fair Market Value Method

Section 864(e)(2) requires that the allocation and apportionment of interest expense be made on the basis of assets and not gross income (the asset method). Under the asset method, interest expense is apportioned between (or among) statutory and residual groupings of gross income in proportion to the average total values of assets within each such grouping for the taxable year. For this purpose, taxpayers may elect to value assets based on their fair market value (the FMV method), tax book value, or alternative tax book value. §§1.861–8T(c)(2) and 1.861–9(i).

The temporary regulations set forth a multi-step methodology for determining the fair market value of a taxpayer’s assets. Section 1.861–9T(h)(1) provides rules for determining the fair market value of the taxpayer’s intangible assets. First, the taxpayer determines the aggregate value of

assets that it and its subsidiaries own (Step 1); second, the taxpayer values its tangible assets, excluding any stock or indebtedness in a related person (Step 2); and third, it subtracts the amount determined in Step 2 from the amount determined in Step 1 to arrive at total intangible asset value (Step 3). The intangible assets owned by the taxpayer are then apportioned among the taxpayer’s affiliates under §1.861–9T(h)(2) on the basis of net income (Step 4).

Once a taxpayer has determined the fair market value of its intangible assets, those assets must be characterized as provided in §1.861–9T(h)(3) (Step 5). Finally, the rules of §1.861–9T(h)(4) apply to determine the value of stock in a related person held by the taxpayer (or by another person related to the taxpayer) (Step 6). Under those rules, §1.861–9T(h)(4) states that the value of such stock is equal to the sum of the following amounts, less the taxpayer’s pro rata share of liabilities of such related person: (i) the intangible assets apportioned to the related person in Step 4, above; (ii) the tangible assets (as determined in Step 2) held by the related person; and (iii) the total value of stock held in all other related persons held by the related person.

The IRS and the Treasury Department have become aware that certain taxpayers are taking the position that the language of Step 2 of the FMV method, which requires related party debt to be excluded as an asset as part of the process for determining total intangible asset value, means that such debt also is not treated as an asset in the hands of the taxpayer for the broader purpose of applying the asset method. In addition, for purposes of valuing the stock in related persons under Step 6, some taxpayers are taking the position that those rules exclude related party debt as an asset (because of the reference in §1.861–9T(h)(4) to §1.861–9T(h)(1)(ii)), but permit reduction of the value of the stock of the related person obligor by the amount of the related party debt as a liability (because the language of §1.861–9T(h)(4)(ii) does not limit the reduction for liabilities to unrelated party liabilities).

The IRS and the Treasury Department believe that interpreting the regulations to require that the related party debt be taken into account as a liability for purposes of valuing stock in the related person with

2012–11 I.R.B. 469 March 12, 2012

(e) * - (2) Corporate partners whose interest in the partnership is 10 percent or more . A corporate partner shall apportion its interest expense (including the partner’s distributive share of partnership interest expense) by reference to the partner’s assets, including the partner’s pro rata share of partnership assets, under the rules of paragraph (f) of this section if the corporate partner’s direct and indirect interest in the partnership (as determined under the attribution rules of section 318) is 10 percent or more. A corporation using the tax book value method or alternative tax book value method of apportionment shall use the partnership’s inside basis in its assets, including adjustments under sections 734(b) and 743(b), if any, and adjusted to the extent required under §1.861–10T(d)(2). - * *

(3) Individual partners who are general partners or who are limited partners with an interest in the partnership of 10 percent or more . - * * An individual using the tax book value or alternative tax book value method of apportionment shall use the partnership’s inside basis in its assets, including adjustments under sections 734(b) and 743(b), if any, and adjusted to the extent required under §1.861–10T(d)(2).

• • • • (h) - * (4) Valuing related party debt and stock in related persons - (i) Related party debt . For purposes of this section, the value of a debt obligation of a related person held by the taxpayer or another person related to the taxpayer equals the amount of the liability of the obligor related person.

(ii) Stock in related persons . The value of stock in a related person held by the taxpayer or by another person related to the taxpayer equals the sum of the following amounts reduced by the taxpayer’s pro rata share of liabilities of such related person:

(A) The portion of the value of intangible assets of the taxpayer and related persons that is apportioned to such related person under paragraph (h)(2) of this section;

(B) The taxpayer’s pro rata share of tangible assets held by the related person (as determined under paragraph (h)(1)(ii) of this section);

term “affiliated group” by reference to the rules under section 1504 for determining whether corporations are eligible to file consolidated returns. The section 1504 rules generally exclude foreign corporations from an affiliated group. Section 1.861–11T(d)(6)(ii) provides that certain foreign corporations are nevertheless treated as affiliated corporations for purposes of allocating and apportioning interest expense if (1) at least 80 percent of either the vote or value of the corporation’s outstanding stock is owned directly or indirectly by members of an affiliated group, and (2) more than 50 percent of the corporation’s gross income for the taxable year is effectively connected with the conduct of a trade or business in the United States (effectively connected income).

In the case of a foreign corporation that is treated as an affiliated corporation for interest allocation and apportionment purposes, §1.861–11T(d)(6)(ii) provides that the percentage of assets and income that is taken into account for purposes of applying the affiliated group interest apportionment rules depends on the percentage of the corporation’s gross income that is effectively connected income. If 80 percent or more of the foreign corporation’s gross income is effectively connected income, then all of the corporation’s assets and interest expense are taken into account. If, instead, between 50 percent and 80 percent of the foreign corporation’s gross income is effectively connected income, then only the corporation’s assets that generate effectively connected income and a percentage of its interest expense equal to the percentage of its assets that generate effectively connected income are taken into account.

Section 864(e)(5)(A), as amended by the EJMAA, provides that a foreign corporation will be treated as a member of an affiliated group for interest allocation and apportionment purposes if (1) more than 50 percent of the gross income of such foreign corporation for the taxable year is effectively connected income, and (2) at least 80 percent of either the vote or value of all outstanding stock of such foreign corporation is owned directly or indirectly by members of the affiliated group. In such event, all of the qualifying foreign corporation’s assets and interest expense are taken into account for purposes of applying the affiliated group interest ap

portionment rules. These temporary regulations revise §1.861–11T(d)(6) to reflect these statutory changes.

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, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f), these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Jeffrey L. Parry of the Office of Chief Counsel (International). However, other personnel from the IRS and the Treasury Department participated in their development.

- - - -

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 1.861–9T is amended by:

1. Revising the first two sentences of paragraph (e)(2), the fifth sentence of (e)(3), and paragraph (h)(4);

2. Adding four sentences before the last sentence of paragraph (k); and

3. Adding paragraph (l). The revisions and additions read as follows:

§1.861–9T Allocation and apportionment of interest expense (temporary).

---

March 12, 2012 470 2012–11 I.R.B.

(Filed by the Office of the Federal Register on January 13, 2012, 8:45 a.m., and published in the issue of the Federal Register for January 17, 2012, 77 F.R. 2225)

Section 871.—Tax on Nonresident Alien Individuals

26 CFR 1.871–16T: Specified notional principal con- tracts (temporary).

T.D. 9572

Dividend Equivalents From Sources Within the United States

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to dividend equivalents for purposes of section 871(m) of the Internal Revenue Code (Code). The regulations provide guidance to nonresident aliens and foreign corporations that hold notional principal contracts (NPCs) providing for payments determined by reference to payments of dividends from sources within the United States. The text of the temporary regulations also serves as the text of the proposed regulations (REG–120282–10) set forth in the notice of proposed rulemaking on this subject in this issue of the Bulletin.

DATES: Effective Date: These regulations are effective January 23, 2012.

Applicability Date: For dates of applicability, see §§1.863–7T(f), 1.871–16T(g), 1.881–2T(f), 1.1441–2T(g), 1.1441–3T(k), 1.1441–4T(h), 1.1441–7T(h), and 1.1461–1T(j).

FOR FURTHER INFORMATION CONTACT: Mark E. Erwin or D. Peter Merkel at (202) 622–3870 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains temporary regulations under section 871(m). Congress enacted section 871(m) (originally designated as section 871(l)) on March 18, 2010

(C) The taxpayer’s pro rata share of debt obligations of any related person held by the related person (as valued under paragraph (h)(4)(i) of this section); and

(D) The total value of stock in all related persons held by the related person as determined under this paragraph (h)(4).

(iii) Example . (A) Facts . USP, a domestic corporation, wholly owns CFC1 and owns 80% of CFC2, both foreign corporations. The aggregate trading value of USP’s stock traded on established securities markets at the end of Year 1 is $700 and the amount of USP’s liabilities to unrelated persons at the end of Year 1 is $400. Neither CFC1 nor CFC2 has liabilities to unrelated persons at the end of Year

1. USP owns plant and equipment valued at $500, CFC1 owns plant and equipment valued at $400, and CFC2 owns plant and equipment valued at $250. The value of these assets has been determined using generally accepted valuation techniques, as required by §1.861–9T(h)(1)(ii). There is an outstanding loan from CFC2 to CFC1 in an amount of $100. There is also an outstanding loan from USP to CFC1 in an amount of $200.

(B) Valuation of group assets . Pursuant to §1.861–9T(h)(1)(i), the aggregate value of USP’s assets is $1100 (the $700 trading value of USP’s stock increased by $400 of USP’s liabilities to unrelated persons).

(C) Valuation of tangible assets . Pursuant to §1.861–9T(h)(1)(ii), the value of USP’s tangible assets and pro rata share of assets held by CFC1 and CFC2 is $1100 (the plant and equipment held directly by USP, valued at $500, plus USP’s 100% pro rata share of the plant and equipment held by CFC1 valued at $400 and USP’s 80% pro rata share of the plant and equipment held by CFC 2 valued at $200 (80% of $250)).

(D) Computation of intangible asset value . Pursuant to §1.861–9T(h)(1)(iii), the value of the intangible assets of USP, CFC1, and CFC2 is $0 (total aggregate group asset value ($1100) determined in paragraph (B) less total tangible asset value ($1100) determined in paragraph (C)). Because the intangible asset value is zero, the provisions of §1.861–9T(h)(2) and (3) relating to the apportionment and characterization of intangible assets do not apply.

(E) Valuing related party debt obligations . Pursuant to §1.861–9T(h)(4)(i), the value of the debt obligation of CFC1 held by CFC2 is equal to the amount of the liability, $100. The value of the debt obligation of CFC1 held by USP is equal to the amount of the liability, $200.

(F) Valuing the stock of CFC1 and CFC2 . Pursuant to §1.861–9T(h)(4)(ii), the value of the stock of CFC2 held by USP is $280 (USP’s 80% pro rata share of tangible assets of CFC2 included in paragraph (C) ($200) plus USP’s 80% pro rata share of the debt obligation of CFC1 held by CFC2 valued in paragraph (E) ($80). The value of the stock of CFC1 held by USP is $100 (USP’s 100% pro rata share of tangible assets of CFC1 included in paragraph (C) ($400) less USP’s 100% pro rata share of the liabilities of CFC1 to USP and CFC2 ($300)).

• • • • (k) - - - Paragraphs (e)(2) and (3) apply to taxable years beginning af

ter January 17, 2012. See 26 CFR §1.861–9T(e)(2) and (3) (revised as of April 1, 2011) for rules applicable to taxable years beginning on or before January 17, 2012. Paragraph (h)(4) applies to taxable years ending on or after January 17, 2012. See §1.861–9T(h)(4) (revised as of April 1, 2011) for rules applicable to taxable years ending before January 17, 2012.* * *

(l) Expiration date . The applicability date of paragraphs (e)(2), (e)(3), and (h)(4) expires on January 13, 2015.

Par. 4. Sec 1.861–11T is amended by revising paragraphs (d)(6)(ii) and (h) and adding paragraph (i) to read as follows:

§1.861–11T Special rules for allocating and apportioning interest expense of an affiliated group of corporations (temporary).

• • • • (6) - * (ii) Any foreign corporation if more than 50 percent of the gross income of such foreign corporation for the taxable year is effectively connected with the conduct of a trade or business within the United States and at least 80 percent of either the vote or value of all outstanding stock of such foreign corporation is owned directly or indirectly by members of the affiliated group (determined with regard to this sentence).
• • • • (h) Effective/applicability date . In general, the rules of this section apply for taxable years beginning after December 31,

1986. Paragraph (d)(6)(ii) applies to taxable years beginning after August 10,
1987. See 26 CFR §1.861–11T(d)(6)(ii) (revised as of April 1, 2010) for rules applicable to taxable years beginning on or before August 10, 2010.

(i) Expiration date . The applicability date of paragraph (d)(6)(ii) expires on January 13, 2015.

Steven T. Miller, Deputy Commissioner for Services and Enforcement.

Approved December 6, 2011.

Emily S. McMahon, Acting Assistant Secretary of the Treasury (Tax Policy).

2012–11 I.R.B. 471 March 12, 2012

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. 871(m) and 7805

• • Par. 2. Section 1.863–7 is amended by revising paragraph (a)(1) to read as follows:

§1.863–7 Allocation of income attributable to certain notional principal contracts under section 863(a) .

(a) Scope —(1) Introduction . [Reserved]. For further guidance, see §1.863–7T(a)(1).

• • • • Par. 3. Section 1.863–7T is added as follows:

§1.863–7T Allocation of income attributable to certain notional principal contracts under section 863(a) (temporary) .

(a) Scope —(1) Introduction . This section provides rules relating to the source and, in certain cases, the character of notional principal contract income. However, this section does not apply to income from a section 988 transaction within the meaning of section 988 and the regulations thereunder, relating to the treatment of certain nonfunctional currency transactions. Further, this section does not apply to a dividend equivalent as defined in section 871(m) or §1.871–15. Notional principal contract income is income attributable to a notional principal contract as defined in §1.446–3(c). An agreement between a taxpayer and a qualified business unit (as defined in section 989(a)) of the taxpayer, or among qualified business units of the same taxpayer, is not a notional principal contract, because a taxpayer cannot enter into a contract with itself.

(a)(2) through (e) [Reserved]. For further guidance, see §1.863–7(a)(2) through (e).

(f) Effective/applicability date . This section applies to payments made on or after January 23, 2012.

in section 541 of the Hiring Incentives to Restore Employment Act (HIRE Act), Public Law 111–147 (124 Stat. 71).

Section 871(m) applies to securities loans, sale-repurchase transactions (repos), certain NPCs defined as “specified notional principal contracts” (specified NPCs), and any similar transactions that provide for a payment contingent upon or determined by reference to a U.S. source dividend (dividend equivalent). Section 871(m) treats a dividend equivalent as a dividend from sources within the United States for purposes of sections 871(a), 881, and 4948(a), and chapters 3 and 4 of subtitle A of the Code. Section 871(m) generally applies to any dividend equivalent made after September 14, 2010. With respect to payments made after March 18, 2012, section 871(m)(3)(B) provides that any NPC will be a specified NPC unless the Secretary determines that such contract is of a type which does not have the potential for tax avoidance.

Notice 2010–46, 2010–24 I.R.B. 757, outlined a proposed framework for limiting withholding in the case of a series of securities lending or sale-repurchase transactions. While the Treasury Department and the IRS anticipate issuing proposed regulations addressing the issues raised in Notice 2010–46, these regulations do not address these concerns. See §601.601(d)(2).

Explanation of Provisions

Section 1.871–16T(b) of these temporary regulations incorporates the definition of a specified NPC as provided in section 871(m)(3)(A). These temporary regulations extend the applicability of the section 871(m)(3)(A) statutory definition of a specified NPC through December 31, 2012. Proposed regulations set forth in the notice of proposed rulemaking in this issue of the Bulletin outline the proposed treatment of dividend equivalents under section 871(m) beginning January 1, 2013. The Treasury Department and the IRS believe that an extension of the statutory definition of the term specified NPC is necessary to allow taxpayers and withholding agents to modify their systems and other operating procedures to comply with the rules described in the notice of proposed rulemaking.

These temporary regulations also amend several regulations to clarify the application of section 871(m). For example, temporary regulations modify §1.863–7 to provide that that section does not apply to a dividend equivalent under section 871(m). Section 1.881–2T(b)(3) provides that section 871(m) and §1.871–16T apply to dividend equivalents received by foreign corporations. Certain regulations under section 1441 have been amended to require a withholding agent to withhold tax owed with respect to a dividend equivalent.

Notwithstanding these temporary regulations, the Commissioner may challenge transactions that are designed to avoid the application of these rules under applicable judicial doctrines. Nothing in these rules precludes the Commissioner from asserting that a contract labeled as an NPC or other equity derivative is in fact an ownership interest in the equity referenced in the contract.

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) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the special analyses section of the preamble to the cross-reference notice of proposed rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Code, these temporary regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on the impact on small businesses.

Drafting Information

The principal author of these regulations is D. Peter Merkel, the Office of Associate Chief Counsel (International). Other personnel from the Treasury Department and the IRS participated in their development.

- - - -

March 12, 2012 472 2012–11 I.R.B.

(g) Expiration date . This section expires January 16, 2015.

Par. 4. Section 1.871–15T is added and reserved to read as follows:

§1.871–15T Treatment of dividend equivalents (temporary) . [Reserved]

Par. 5. Section 1.871–16T is added to read as follows:

§1.871–16T Specified notional principal contracts (temporary) .

(a) [Reserved]. (b) Specified notional principal con- tracts between March 18, 2012 and Jan- uary 1, 2013 . With respect to payments made after March 18, 2012 and before January 1, 2013, the term specified notional principal contract means any notional principal contract (as defined in §1.446–3) if—

(1) In connection with entering into such contract, any long party to the contract transfers the underlying security to any short party to the contract;

(2) In connection with the termination of such contract, any short party to the contract transfers the underlying security to any long party to the contract;

(3) The underlying security is not readily tradable on an established securities market; or

(4) In connection with entering into such contract, the underlying security is posted as collateral by any short party to the contract with any long party to the contract.

(c) through (f) [Reserved]. (g) Effective/applicability date . This section applies to payments made on or after January 23, 2012.

(h) Expiration date . This section expires on January 16, 2015.

Par. 6. Section 1.881–2 is amended by adding paragraph (b)(3) to read as follows:

§1.881–2 Taxation of foreign corporations not engaged in U.S. business .

• • • • (b) - - (3) [Reserved]. For further guidance, see §1.881–2T(b)(3).
• • • • Par. 7. Section 1.881–2T is added as follows:

§1.881–2T Taxation of foreign corporations not engaged in U.S. business (temporary) .

(a) through (b)(2) [Reserved]. For further guidance, see §1.881–2(a) through (b)(2).

(3) Dividend Equivalents . For rules applicable to a foreign corporation’s receipt of a dividend equivalent, see section 871(m) and §1.871–16T. (c) through (e) [Reserved]. For further guidance, see §1.881–2(c) through (e).

(f) Effective/applicability date . This section applies on or after January 23, 2012. (g) Expiration date . The applicability of this section expires on January 16, 2015.

Par. 8. Section 1.1441–2 is amended by adding paragraphs (b)(6) and (e)(7) to read as follows:

§1.1441–2 Amounts subject to withholding.

• • • • (b) - - (6) [Reserved]. For further guidance, see §1.1441–2T(b)(6).
• • • • (e) - - (7) [Reserved]. For further guidance, see §1.1441–2T(e)(7).
• • • • Par. 9. Section 1.1441–2T is added to read as follows:

§1.1441–2T Amounts subject to withholding (temporary).

(a) through (b)(5) [Reserved]. For further guidance, see §1.1441–2(a) through (b)(5).

(6) Dividend equivalents . Amounts subject to withholding include the payment of a dividend equivalent described in section 871(m). For this purpose, the term payment includes any gross amount that is used in computing any net amount that is transferred to or from the taxpayer under the terms of the contract.

(c) through (e)(6) [Reserved]. For further guidance, see §1.1441–2(c) through (e)(6).

(7) Rules for dividend equivalents . With respect to a dividend equivalent described in section 871(m), a payment is considered made to a person when any

gross amount is used in computing any net amount that is transferred to or from the person under the terms of the contract pursuant to a transaction described in section 871(m)(2). When a dividend equivalent is used to determine a net payment, the person entitled to the gross dividend equivalent is considered to have received a payment even if that person receives no payment because the net payment equals zero or that person makes a net payment.

(f) [Reserved]. For further guidance, see §1.1441–2(f).

(g) Effective/applicability date . This section applies on or after January 23, 2012. (h) Expiration date . The applicability of this section expires on January 16, 2015.

Par. 10. Section 1.1441–3 is amended by redesignating paragraph (h) as paragraph (j) and adding new paragraphs (h) and (i) to read as follows:

§1.1441–3 Determination of amounts to be withheld .

• • • • (h) [Reserved]. For further guidance, see §1.1441–3T(h).

(i) [Reserved]. For further guidance, see §1.1441–3T(i).

• • • • Par. 11. Section 1.1441–3T is added to read as follows:

§1.1441–3T Determination of amounts to be withheld (temporary) .

(a) through (g) [Reserved]. For further guidance, see §1.1441–3(a) through (g).

(h) Dividend equivalents —(1) In gen- eral . The gross amount of a dividend equivalent described in section 871(m) is subject to withholding in an amount equal to the gross amount of the dividend equivalent used in computing any net amount that is transferred to or from the taxpayer.

(2) Procedures for withholding with re- spect to a dividend equivalent paid prior to a notional principal contract (NPC) be- coming a specified NPC . [Reserved].

(i) Estimate or other determination of the portion of a distribution attributable to a dividend equivalent —(1) In general . In determining the amount subject to withholding as a dividend equivalent, a withholding agent may use a distributing corporation’s estimate or other determination

2012–11 I.R.B. 473 March 12, 2012

(2) [Reserved]. For further guidance, see §1.1441–7T(a)(2).

(3) Examples . The following examples illustrate the rules of paragraph (a) of this section:

• • • • Example 6 . [Reserved]. For further guidance, see §1.1441–7T(a)(3) Example 6 .
• • • • Par. 15. Section 1.1441–7T is added to read as follows:

§1.1441–7T General provisions relating to withholding agents (temporary) .

(a)(1) [Reserved]. For further guidance, see §1.1441–7(a)(1).

(2) Withholding agent with respect to dividend equivalents . Each person that is a party to any contract or arrangement that provides for the payment of a dividend equivalent, as defined in section 871(m), shall be treated as having control and custody of such payment.

(3) Examples . The following examples illustrate the rules of paragraphs (a)(1) and (a)(2) of this section:

Example 1 through Example 5 [Reserved]. For further guidance, see §1.1441–7(a)(3), Example 1 through Ex- ample 5 .

Example 6 . FC, a foreign corporation, enters into a notional principal contract (NPC) with Bank X, a bank organized in the United States. The NPC is a specified NPC for purposes of section 871(m). FC is the long party to the contract and Bank X is the short party. The NPC references a specified number of shares of dividend-paying common stock issued by a domestic corporation. As the long party, FC receives payments from Bank X based on any appreciation in the value of the common stock and dividends paid with respect to the common stock. As the short party, Bank X receives payment from FC based on any depreciation in the value of the common stock and a payment based on LIBOR. Bank X is a withholding agent because Bank X is deemed to have control and custody of a dividend equivalent as a party to the NPC. If FC’s tax liability under section 881 has not been satisfied in full by Bank X as withholding agent, FC is required to file a return on Form 1120–F ( U.S. Income Tax Return of a Foreign Corpo- ration ).

(b)(1) through (g) [Reserved]. For further guidance, see §1.1441–7(b)(1) through (g).

(h) Effective/applicability date . This section applies on or after January 23, 2012. (i) Expiration date . The applicability of this section expires on January 16, 2015.

with respect to the underlying security (as defined in section 871(m)(4)(C)) in applying the provisions of paragraphs (c)(2) through (c)(4) of this section. However, a withholding agent that elects to use any such estimate will be liable for the amount by which the actual amount required to be withheld exceeds the amount actually withheld and applicable penalties and interest resulting from its reliance on such estimate or determination. Failure of the withholding agent to withhold the required amount shall not be attributed to the distributing corporation.

(2) [Reserved] (j) [Reserved]. For further guidance, see §1.1441–3(j).

(k) Effective/applicability date . This section applies on or after January 23, 2012. (l) Expiration date . The applicability of this section expires on January 16, 2015.

Par. 12. Section 1.1441–4 is amended by revising paragraph (a)(3)(i) and adding paragraph (a)(3)(iii) to read as follows:

§1.1441–4 Exemptions from withholding for certain effectively connected income and other amounts .

(a)* - (3) - * (i) [Reserved]. For further guidance, see §1.1441–4T(a)(3)(i).

• • • • (iii) [Reserved]. For further guidance, see §1.1441–4T(a)(3)(iii).
• • • • Par. 13. Section 1.1441–4T is added to read as follows:

§1.1441–4T Exemptions from withholding for certain effectively connected income and other amounts (temporary) .

(a)(1) through (a)(2) [Reserved]. For further guidance, see §1.1441–4(a)(1) through (a)(2).

(3) Income on notional principal con- tracts —(i) General rule . Except as otherwise provided in paragraph (a)(3)(iii) of this section, a withholding agent that pays amounts attributable to a notional principal contract described in §1.863–7T(a) or §1.988–2(e) shall have no obligation to withhold on the amounts paid under the

terms of the notional principal contract regardless of whether a withholding certificate is provided. However, a withholding agent must file returns under §1.1461–1(b) and (c) reporting the income that it must treat as effectively connected with the conduct of a trade or business in the United States under the provisions of this paragraph (a)(3). Except as otherwise provided in paragraph (a)(3)(ii) of this section, a withholding agent must treat the income as effectively connected with the conduct of a U.S. trade or business if the income is paid to, or to the account of, a qualified business unit of a foreign person located in the United States or, if the payment is paid to, or to the account of, a qualified business unit of a foreign person located outside the United States, the withholding agent knows, or has reason to know, the payment is effectively connected with the conduct of a trade or business within the United States. Income on a notional principal contract does not include the amount characterized as interest under the provisions of §1.446–3(g)(4).

(ii) [Reserved]. For further guidance, see §1.1441–4(a)(3)(ii).

(iii) Exception for specified notional principal contracts . A withholding agent that makes a payment attributable to a specified notional principal contract described in section 871(m), or §1.871–16T that is not treated as effectively connected with the conduct of a trade or business within the United States shall have an obligation to withhold on the amount of such payment that is a dividend equivalent.

(b) through (g) [Reserved]. For further guidance, see §1.1441–4(b) through (g).

(h) Effective/applicability date . This section applies on or after January 23, 2012. (i) Expiration date . The applicability of this section expires on January 16, 2015.

Par. 14. Section 1.1441–7 is amended by:

1. Redesignating paragraph (a)(2) as paragraph (a)(3) and revising newly designated paragraph (a)(3).

2. Adding a new paragraph (a)(2). The revision and addition reads as follows:

§1.1441–7 General provisions relating to withholding agents .

(a) - -

March 12, 2012 474 2012–11 I.R.B.

Rev. Rul. 2012–9

This revenue ruling provides various prescribed rates for federal income tax purposes for March 2012 (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%. Finally, 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.

Par. 16. Section 1.1461–1 is amended by:

1. Redesignating paragraphs (c)(2)(i)(L) and (c)(2)(i)(M) as (c)(2)(i)(M) and (c)(2)(i)(N), respectively.

2. Adding a new paragraph (c)(2)(i)(L). The addition reads as follows:

§1.1461–1 Payment and returns of tax withheld .

• • • • (c) - - (2) - - (i) - - (L) [Reserved]. For further guidance, see §1.1461–1T(c)(2)(L).
• • • • Par. 17. Section 1.1461–1T is added as follows:

§1.1461–1T Payment and returns of tax withheld (temporary) .

(a) through (c)(2)(i)(K) [Reserved]. For further guidance, see §1.1461–1(a) through (c)(2)(i)(K).

(L) Dividend equivalents as defined in section 871(m) and the regulations thereunder;

(c)(2)(i)(M) through (i) [Reserved]. For further guidance, see §1.1461–1(c)(2)(i)(M) through (i).

(j) Effective/applicability date . This section applies on or after January 23, 2012. (k) Expiration date . The applicability of this section expires on January 16, 2015.

Steven T. Miller, Deputy Commissioner for Services and Enforcement .

Approved January 3, 2012.

Emily S. McMahon, Acting Assistant Secretary of the Treasury (Tax Policy) .

(Filed by the Office of the Federal Register on January 19, 2012, 11:15 a.m., and published in the issue of the Federal Register for January 23, 2012, 77 F.R. 3108)

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 March 2012.

2012–11 I.R.B. 475 March 12, 2012

REV. RUL. 2012–9 TABLE 1

Applicable Federal Rates (AFR) for March 2012

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term

AFR .19% .19% .19% .19% 110% AFR .21% .21% .21% .21% 120% AFR .23% .23% .23% .23% 130% AFR .25% .25% .25% .25%

Mid-term

AFR 1.08% 1.08% 1.08% 1.08% 110% AFR 1.19% 1.19% 1.19% 1.19% 120% AFR 1.30% 1.30% 1.30% 1.30% 130% AFR 1.40% 1.40% 1.40% 1.40% 150% AFR 1.63% 1.62% 1.62% 1.61% 175% AFR 1.90% 1.89% 1.89% 1.88%

Long-term

AFR 2.65% 2.63% 2.62% 2.62% 110% AFR 2.91% 2.89% 2.88% 2.87% 120% AFR 3.18% 3.16% 3.15% 3.14% 130% AFR 3.45% 3.42% 3.41% 3.40%

REV. RUL. 2012–9 TABLE 2

Adjusted AFR for March 2012

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted .26% .26% .26% .26% AFR

Mid-term adjusted AFR 1.05% 1.05% 1.05% 1.05%

Long-term adjusted 3.47% 2.95% 2.94% 2.93% AFR

REV. RUL. 2012–9 TABLE 3

Rates Under Section 382 for March 2012

Adjusted federal long-term rate for the current month 2.97%

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. 2012–9 TABLE 4

Appropriate Percentages Under Section 42(b)(1) for March 2012

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 7.43%

Appropriate percentage for the 30% present value low-income housing credit 3.18%

March 12, 2012 476 2012–11 I.R.B.

REV. RUL. 2012–9 TABLE 5

Rate Under Section 7520 for March 2012

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 1.4%

cision. The revisions to the regulations are discussed in this preamble.

Summary of Comments and Explanation of Revisions

The IRS received nine written comments in response to the NPRM, and this section addresses those public comments. This section also describes the significant differences between the rules proposed in the NPRM and those adopted in the final regulations.

1. 2011 Amendment to Section 6695(g)

On October 21, 2011, section 501 of the United States-Korea Free Trade Agreement Implementation Act, Public Law 112–41, 125 Stat 428, amended section 6695(g) of the Code by increasing the amount of the penalty from $100 to $500. To account for this change in the law, §1.6695–2(a) of the final regulations has been conformed to the statutory language of section 6695(g), as amended.

2. Necessity of These Regulations

Two commenters stated that the proposed amendments to the due diligence standards in the NPRM were unnecessary in light of recent regulatory changes requiring tax return preparers to register with the IRS and comply with the ethical standards governing practice before the IRS (Circular 230), as well as the tax return preparer penalties under section 6694. They suggested that the IRS can apply these existing provisions to address misconduct by tax return preparers, including improper determination of eligibility for, and amount of, EIC by both individual tax return preparers and firms.

As reflected in section 6695(g), Congress has determined that noncompliance with the EIC rules poses a sufficiently significant problem to merit imposing unique due diligence requirements on tax return preparers involved in determining eligibility for, or amount of, the EIC. By recently quintupling the amount of the penalty for

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 March 2012. See Rev. Rul. 2012-9, page 475.

Section 6695.—Other Assessable Penalties With Respect to the Preparation of Tax Returns for Other Persons

26 CFR 1.6695–2: Tax return preparer due diligence requirements for determining earned income credit eligibility.

T.D. 9570

Tax Return Preparer Penalties Under Section 6695

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations that modify existing regulations related to the tax return preparer penalties under section 6695 of the Internal Revenue Code (Code). The final regulations are necessary to monitor and to improve compliance with the tax return preparer due diligence requirements of section 6695(g). The final regulations affect paid tax return preparers.

DATES: Effective Date: The final regulations are effective on December 20, 2011.

Applicability Date: For date of applicability, see §1.6695–2(e).

FOR FURTHER INFORMATION CONTACT: Spence Hanemann, (202) 622–4940 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in the final regulations was previously reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545–1570. The collection of information is in §1.6695–2(b)(1) and (b)(4) of the final regulations, and is an increase in the total annual burden from the burden in the prior regulations. The collection of this information will improve the IRS’ ability to enforce compliance with the due diligence requirements under section 6695(g) with respect to determining eligibility for, or the amount of, the earned income credit (EIC) under section 32.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law.

Background

This document contains amendments to the Income Tax Regulations (26 CFR part

1. under section 6695 of the Code. The Treasury Department and the IRS published a notice of proposed rulemaking (REG–140280–09, 2011–45 I.R.B. 709) in the Federal Register, 76 FR 62689, on October 11, 2011 (the NPRM). A public hearing was scheduled for November 7,

2011. The IRS did not receive any requests to testify at the public hearing, and the public hearing was cancelled. Written comments responding to the NPRM were received and are available for public inspection at http://www.regulations.gov or upon request. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury de

2012–11 I.R.B. 477 March 12, 2012

taxpayer (or other tax return preparer who determines eligibility for, or amount of, the EIC) as long as the tax return preparer does not know, or have reason to know, that the information is incorrect, inconsistent, or incomplete. A signing tax return preparer who satisfies the knowledge requirement in §1.6695–2(b)(3), therefore, will ordinarily be able to rely on the information furnished to the signing tax return preparer by a taxpayer or nonsigning tax return preparer regarding the EIC. The additional requirements in proposed §1.6695–2(b)(1)(i) and (b)(4)(i)(C) are not unduly burdensome and will improve the IRS’ ability to determine whether a tax return preparer has complied with the EIC due diligence requirements that already exist. No modification is made in the final regulations in response to these comments.

5. Nonsigning Tax Return Preparers

Two commenters expressed concern that expanding the due diligence requirements and penalty to nonsigning tax return preparers would subject individuals to the section 6695(g) penalty who are beyond the intended scope of these rules. The commenters provided the example of individuals hired by tax preparation software companies to answer discrete questions for taxpayers who are using tax preparation software to prepare their own tax return or claim for refund. These individuals provide general resource information for the taxpayers who are preparing their own tax return or claim for refund, and they do not know all of the specific facts relating to the taxpayer’s tax return or claim for refund. The commenters reasoned that these individuals might be nonsigning tax return preparers and would arguably be subject to these due diligence requirements and related penalty.

The term “nonsigning tax return preparer” is specifically defined in §301.7701–15(b)(2) and is limited to those who prepare all or a substantial portion of a tax return or claim for refund within the meaning of §301.7701–15(b)(3). Under §301.7701–15(b)(3), a person who renders tax advice on a position that is directly relevant to the existence or amount of an entry on a tax return or claim for refund is regarded as having prepared that entry. Section 301.7701–15(b)(3) further provides that whether a schedule, entry, or

failure to comply with these requirements, Congress reaffirmed the need for specific rules to reduce EIC noncompliance. In order to address noncompliance with the EIC rules, the final regulations modify the due diligence requirements under section 6695(g) that have been in place for over a decade. Treasury and the IRS concluded that these regulations are consistent with section 6695(g), and no modification is made in the final regulations in response to these comments.

3. Submission of Form 8867

Section 1.6695–2(b)(1)(i) of the proposed regulations required that the Form 8867, “ Paid Preparer’s Earned Income Credit Checklist,” be submitted to the IRS in the manner required by forms, instructions, or other appropriate guidance. One commenter noted, in part, that tax return preparers sometimes provide a paper copy of the completed tax return or claim for refund to the taxpayer for submission by the taxpayer. A tax return preparer’s ability to provide a paper copy, as opposed to filing the tax return electronically, is subject to the rules and limitations in §301.6011–7 and related guidance. Another commenter stated that the proposed regulations were unclear in how they apply to nonsigning tax return preparers. The due diligence requirements and the penalty for failure to comply with them apply to any tax return preparer, including a nonsigning tax return preparer, who determines eligibility for, or amount of, the EIC.

After consideration of these comments, Treasury and the IRS have concluded that the rules in the regulations should be clarified to provide how tax return preparers who prepare a tax return or claim for refund but do not submit it directly to the IRS can satisfy the requirement under proposed §1.6695–2(b)(1)(i) to submit the completed Form 8867 to the IRS. In response to these comments, §1.6695–2(b)(1)(i) of the final regulations provides that tax return preparers who prepare a tax return or claim for refund but do not submit it directly to the IRS may satisfy this aspect of their due diligence obligation by providing the form to the taxpayer or the signing tax return preparer, as appropriate, for submission with the tax return or claim for refund.

One commenter suggested that the Form 8867 be a stand-alone form that the taxpayer signs and submits as an affidavit of EIC eligibility. After consideration of this comment, Treasury and the IRS have concluded that imposing such an obligation on taxpayers, rather than on tax return preparers, would be contrary to the purpose of section 6695(g), which is to discourage tax return preparers from preparing EIC tax returns or claims for refund without performing basic due diligence. No modification is made in the final regulations in response to this comment.

4. Requirement to Verify Taxpayer Information

Section 1.6695–2(b)(1)(i) of the proposed regulations required submission of Form 8867 to the IRS, and §1.6695–2(b)(4)(i)(C) of the proposed regulations required retention of a copy of any document that was provided by the taxpayer and on which the tax return preparer relied to complete Form 8867 or the Earned Income Credit Worksheet. Two commenters suggested that these additional requirements increased a tax return preparer’s burden under the knowledge requirement of existing §1.6695–2(b)(3) because a tax return preparer would now be obligated to verify taxpayers’ responses to the eligibility questions and also to verify nonsigning tax return preparers’ (if any) completion of the Form 8867. The proposed regulations, however, do not expand tax return preparers’ obligation to verify information provided by taxpayers and other tax return preparers under existing §1.6695–2(b)(3).

Under §1.6695–2(b)(3) of the current regulations, tax return preparers are already required to complete Form 8867, prohibited from ignoring the implications of information provided, obligated to make reasonable inquiries if the information provided appears incorrect, inconsistent, or incomplete, and required to contemporaneously document their reasonable inquiries and the taxpayer’s responses. For purposes of §1.6695–2(b)(3), tax return preparers would not be held to a higher standard under the proposed regulations than they are under the existing regulations. A tax return preparer can generally rely on the information furnished by a

March 12, 2012 478 2012–11 I.R.B.

prior to the date the tax return or claim for refund is filed, the only acceptable remedial action would be to satisfy the due diligence requirements prior to filing, in which case there would be no penalty. If, on the other hand, management does not know of the failure to comply until after the tax return or claim for refund is filed, the appropriate analysis is whether the firm had reasonable and appropriate compliance procedures and disregarded those procedures through willfulness, recklessness, or gross indifference, as described in §1.6695–2(c)(3), and management’s knowledge is relevant only insofar as it is a factor in that analysis. In response to this comment, the final regulations provide that a firm is only subject to a penalty under §1.6695–2(c)(1) if the manager knew of an employee’s failure to comply with the due diligence requirements prior to the date the tax return or claim for refund was filed.

The other commenter suggested that the IRS might determine under proposed §1.6695–2(c)(3) that a single failure to submit Form 8867 with a tax return by an otherwise compliant firm qualifies as disregard of reasonable and appropriate compliance procedures through gross indifference. Section 1.6695–2(c)(3) of the proposed regulations established a heightened standard, in part, by imposing liability for the penalty against a firm that disregarded its reasonable and appropriate compliance procedures through willfulness, recklessness, or gross indifference. A single, accidental failure to submit Form 8867 with a tax return by an otherwise compliant firm would not constitute disregard of compliance procedures through willfulness, recklessness, or gross indifference, and the firm would not be subject to the penalty in that situation. After consideration of this comment, Treasury and the IRS have concluded that the heightened standards in proposed §1.6695–2(c)(3) would adequately protect firms against isolated and inadvertent instances of disregard of their compliance procedures. No modification is made to the final regulations in response to this comment.

8. Retention of Records

Proposed §1.6695–2(b)(4)(ii) required that a tax return preparer must retain the records described in §1.6695–2(b)(4)(i)

other portion of a tax return or claim for refund is a substantial portion is determined based upon whether the person knows or reasonably should know that the tax attributable to the schedule, entry, or other portion of a tax return or claim for refund is a substantial portion of the tax required to be shown on the tax return or claim for refund. Also, §301.7701–15(f)(1)(viii) provides an exception from the definition of tax return preparer for any individual providing only typing, reproduction, or other mechanical assistance in the preparation of a tax return or claim for refund.

Treasury and the IRS have concluded that, in the routine situation described by these commenters, the individuals employed at the tax preparation software companies as described in the comments are not nonsigning tax return preparers as long as they either (i) fall within the mechanical exception because they are not exercising independent judgment on the taxpayer’s underlying tax positions, or (ii) do not know (and reasonably should not know) that any generic advice provided relating to the EIC is a substantial portion of the tax required to be shown. On the other hand, in rare instances when any such individual is both exercising independent judgment and knows or reasonably should know that specific advice provided to a taxpayer relating to EIC is a substantial portion of the tax return or claim for refund within the meaning of §301.7701–15(b)(3), the individual is a nonsigning tax return preparer subject to the due diligence rules. No modification is made to the final regulations in response to this comment.

6. Penalizing Firms

By replacing “signing tax return preparer” with “tax return preparer,” §1.6695–2(a) of the proposed regulations effectively provided that a firm that employs a person to prepare for compensation a tax return or claim for refund may be subject to the penalty for its employee’s failure to comply with the due diligence requirements. Two commenters questioned the proposed application of the due diligence requirements and penalty to firms. Section 6695(g) imposes a penalty on “[a]ny person who is a tax return preparer” that fails to comply with the due diligence requirements “with respect to

determining eligibility for, or the amount of, the credit allowable by section 32.” Under section 7701(a)(36), a “tax return preparer” is “any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed by title or any claim for refund of tax imposed by this title.” After consideration of these comments, Treasury and the IRS have concluded that it is appropriate to apply the due diligence requirements to firms as provided in the proposed regulations. This position is consistent with the long-standing application of the section 6694 tax return preparer penalties to firms under the rules provided in §§1.6694–2(a)(2) and 1.6694–3(a)(2). No modification is made to the final regulations in response to these comments.

7. Conditions Required for Imposing a Penalty on a Firm

Proposed §1.6695–2(c) provided generally that a firm cannot be subject to a penalty under section 6695(g) unless one of the following three conditions is satisfied: (1) a member of the principal management of the firm knew of the failure to comply with the due diligence requirements; (2) the firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements; or (3) the firm failed to comply with its reasonable and appropriate compliance procedures through willfulness, recklessness, or gross indifference. Two commenters expressed concern with the conditions required for application of the penalty to a firm, as set forth in proposed §1.6695–2(c).

One of these commenters noted that, if management became aware through the firm’s reasonable and appropriate compliance procedures that an employee failed to comply with the due diligence requirements, then the firm would be subject to a penalty under proposed §1.6695–2(c)(1) because management knew of the failure. The commenter suggested that the final regulations provide that the penalty not apply to the firm if management knew and took reasonable action to resolve the problem before the penalty is assessed. After consideration of this comment, Treasury and the IRS have concluded that, if management knows of the failure to comply

2012–11 I.R.B. 479 March 12, 2012

When an agency issues a rulemaking, the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), requires the agency to “prepare and make available for public comment an initial regulatory flexibility analysis” that will “describe the impact of the proposed rule on small entities.” (5 U.S.C. 603(a)). Section 605 of the RFA provides an exception to this requirement if the agency certifies that the rulemaking will not have a significant economic impact on a substantial number of small entities.

The final rules affect tax return preparers who determine the eligibility for, or the amount of, EIC. The NAICS code that relates to tax preparation services (NAICS code 541213) is the appropriate code for tax return preparers subject to the final regulations. Entities identified as tax preparation services are considered small under the Small Business Administration size standards (13 CFR 121.201) if their annual revenue is less than $7 million. The IRS estimates that approximately 75 to 85 percent of the 550,000 persons who work at firms or are self-employed tax return preparers are operating as or employed by small entities. The IRS has determined that the final rules will have an impact on a substantial number of small entities.

The IRS has determined, however, that the economic impact on entities affected by the final rules will not be significant. The prior regulations under section 6695(g) required tax return preparers to complete the Form 8867 or otherwise record in their files the information necessary to complete the form. Tax return preparers were also required to maintain records of the checklists and EIC computations, as well as a record of how and when the information used to compute the EIC was obtained by the tax return preparer. The amount of time necessary to submit, record, and retain the additional information required in the final regulations, therefore, should be minimal for these tax return preparers.

Based on these facts, the IRS hereby certifies that the collection of information contained in the final regulations will not have a significant economic impact on a substantial number of small entities. Accordingly, a Regulatory Flexibility Analysis is not required.

Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preced

for the period ending three years after the later of the date the tax return or claim for refund was due or the date it was filed. One commenter stated that the record retention date should not be tied to the date the tax return or claim for refund was filed because, if the tax return preparer who prepares the tax return or claim for refund is not the individual who files it, that tax return preparer might not know when it is filed and when the retention period expires. In response to the comment, the final regulations require a tax return preparer to retain the records described in §1.6695–2(b)(4)(i) for the period ending three years after the later of the date the tax return or claim for refund was due or the date it was transferred in final form by the tax return preparer to the next person in the course of the filing process. In the case of a signing tax return preparer who electronically files the tax return or claim for refund, the next step in the filing process will be to electronically file the tax return or claim for refund, so the relevant date is the date the tax return or claim for refund is filed. In the case of a signing tax return preparer who does not electronically file the tax return or claim for refund, the next person in the course of the filing process will be the taxpayer, so the relevant date is the date the tax return or claim for refund is presented to the taxpayer for signature. In the case of a nonsigning tax return preparer, the next person in the course of the filing process will be the signing tax return preparer, so the relevant date is the date the nonsigning tax return preparer submitted to the signing tax return preparer that portion of the tax return or claim for refund for which the nonsigning tax return preparer was responsible.

The record retention date under the final regulations will be the same for nonsigning tax return preparers supervised by a signing tax return preparer in the same firm and nonsigning tax return preparers who are employed by a different firm than the signing tax return preparer. In both cases, the records must be retained until three years from the later of the due date of the tax return or the date the tax return or claim for refund is submitted in final form to the signing tax return preparer. As a practical matter, however, a supervised nonsigning tax return preparer and the supervising signing tax return preparer can satisfy both of their record retention obligations un

der the final regulations by retaining a single paper or electronic copy of the records described in §1.6695–2(b)(4)(i). The supervised nonsigning tax return preparer’s record retention period may, nevertheless, expire before the signing tax return preparer’s record retention period. In such cases, the supervising signing tax return preparer is required to retain the records until the expiration of his or her record retention period under §1.6695–2(b)(4)(ii), regardless of when the supervised nonsigning tax return preparer’s record retention period expires.

9. Comment Period and Effective Date

One commenter stated that the 30-day comment period provided under the proposed regulations was inadequate. Numerous substantive comments were, in fact, received addressing the proposed regulations. Treasury and the IRS have concluded that the duration of the comment period provided in the proposed regulations was in compliance with all of the applicable procedural rules and requirements governing regulations.

Three commenters stated that the proposed effective date of the regulations would not provide tax return preparers and computer software providers sufficient time to adjust their procedures and products to reflect the proposed amendments. The proposed regulations provided that they will apply to tax returns and claims for refund for tax years ending on or after December 31, 2011. The IRS publicly announced in Spring 2011 that the IRS was exploring the implementation of a new requirement for tax return preparers to submit the Form 8867 with a taxpayer’s tax return or claim for refund. Treasury and the IRS have concluded that implementation of these rules for the upcoming filing season is consistent with the best interests of tax administration.

Special Analyses

It has been determined that this final rule is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to the final regulations.

March 12, 2012 480 2012–11 I.R.B.

parer, including the identity of any person furnishing the information, as well as a copy of any document that was provided by the taxpayer and on which the tax return preparer relied to complete Form 8867 (or successor form) or the Earned Income Credit Worksheet (or other record of the tax return preparer’s EIC computation permitted under paragraph (b)(2)(i)(B) of this section).

(ii) The items in paragraph (b)(4)(i) of this section must be retained for three years from the latest of the following dates, as applicable:

(A) The due date of the tax return (determined without regard to any extension of time for filing);

(B) In the case of a signing tax return preparer electronically filing the tax return or claim for refund, the date the tax return or claim for refund was filed;

(C) In the case of a signing tax return preparer not electronically filing the tax return or claim for refund, the date the tax return or claim for refund was presented to the taxpayer for signature; or

(D) In the case of a nonsigning tax return preparer, the date the nonsigning tax return preparer submitted to the signing tax return preparer that portion of the tax return or claim for refund for which the nonsigning tax return preparer was responsible.

(iii) The items in paragraph (b)(4)(i) of this section may be retained on paper or electronically in the manner prescribed in applicable regulations, revenue rulings, revenue procedures, or other appropriate guidance (see §601.601(d)(2) of this chapter).

(c) Special rule for firms . A firm that employs a tax return preparer subject to a penalty under section 6695(g) is also subject to penalty if, and only if—

(1) One or more members of the principal management (or principal officers) of the firm or a branch office participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements of this section;

(2) The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements of this section; or

(3) The firm disregarded its reasonable and appropriate compliance procedures through willfulness, recklessness, or gross indifference (including ignoring facts that

ing the final regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business and no comments were received.

Drafting Information

The principal author of the final regulations is Spence Hanemann, Office of the Associate Chief Counsel (Procedure and Administration).

- - - -

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 * * * Section 1.6695–2 also issued under 26 U.S.C. 6695(g). - * * Par. 2. In §1.6695–2, paragraphs (a), (b)(1), (b)(2), (b)(4), (c), and (d) are revised and new paragraph (e) is added to read as follows:

§1.6695–2 Tax return preparer due diligence requirements for determining earned income credit eligibility .

(a) Penalty for failure to meet due dili- gence requirements . A person who is a tax return preparer of a tax return or claim for refund under the Internal Revenue Code with respect to determining the eligibility for, or the amount of, the earned income credit (EIC) under section 32 and who fails to satisfy the due diligence requirements of paragraph (b) of this section will be subject to a penalty of $500 for each such failure.

(b) - - (1) Completion and submission of Form 8867 —(i) The tax return preparer must complete Form 8867, “ Paid Preparer’s Earned Income Credit Checklist,” or such other form and such other information as may be prescribed by the Internal Revenue Service (IRS), and—

(A) In the case of a signing tax return preparer electronically filing the tax return or claim for refund, must electronically file the completed Form 8867 (or successor form) with the tax return or claim for refund;

(B) In the case of a signing tax return preparer not electronically filing the tax return or claim for refund, must provide the taxpayer with the completed Form 8867 (or successor form) for inclusion with the filed tax return or claim for refund; or

(C) In the case of a nonsigning tax return preparer, must provide the signing tax return preparer with the completed Form 8867 (or successor form), in either electronic or non-electronic format, for inclusion with the filed tax return or claim for refund.

(ii) The tax return preparer’s completion of Form 8867 (or successor form) must be based on information provided by the taxpayer to the tax return preparer or otherwise reasonably obtained by the tax return preparer.

(2) Computation of credit —(i) The tax return preparer must either—

(A) Complete the Earned Income Credit Worksheet in the Form 1040 instructions or such other form and such other information as may be prescribed by the IRS; or

(B) Otherwise record in one or more documents in the tax return preparer’s paper or electronic files the tax return preparer’s EIC computation, including the method and information used to make the computation.

(ii) The tax return preparer’s completion of the Earned Income Credit Worksheet (or other record of the tax return preparer’s EIC computation permitted under paragraph (b)(2)(i)(B) of this section) must be based on information provided by the taxpayer to the tax return preparer or otherwise reasonably obtained by the tax return preparer.

• • • • (4) Retention of records —(i) The tax return preparer must retain—

(A) A copy of the completed Form 8867 (or successor form);

(B) A copy of the completed Earned Income Credit Worksheet (or other record of the tax return preparer’s EIC computation permitted under paragraph (b)(2)(i)(B) of this section); and

(C) A record of how and when the information used to complete Form 8867 (or successor form) and the Earned Income Credit Worksheet (or other record of the tax return preparer’s EIC computation permitted under paragraph (b)(2)(i)(B) of this section) was obtained by the tax return pre

2012–11 I.R.B. 481 March 12, 2012

(Filed by the Office of the Federal Register on December 19, 2011, 8:45 a.m., and published in the issue of the Federal Register for December 20, 2011, 76 F.R. 78816)

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of March 2012. See Rev. Rul. 2012-9, page 475.

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 March 2012. See Rev. Rul. 2012-9, page 475.

would lead a person of reasonable prudence and competence to investigate or ascertain) in the preparation of the tax return or claim for refund with respect to which the penalty is imposed.

(d) Exception to penalty . The section 6695(g) penalty will not be applied with respect to a particular tax return or claim for refund if the tax return preparer can demonstrate to the satisfaction of the IRS that, considering all the facts and circumstances, the tax return preparer’s normal office procedures are reasonably designed and routinely followed to ensure compliance with the due diligence requirements of paragraph (b) of this section, and the failure to meet the due diligence requirements of paragraph (b) of this section with respect to the particular tax return or claim

for refund was isolated and inadvertent. The preceding sentence does not apply to a firm that is subject to the penalty as a result of paragraph (c) of this section.

(e) Effective/applicability date . This section applies to tax returns and claims for refund for tax years ending on or after December 31, 2011.

Steven T. Miller, Deputy Commissioner for Services and Enforcement.

Approved December 14, 2011.

Emily S. McMahon, Acting Assistant Secretary

of the Treasury.

March 12, 2012 482 2012–11 I.R.B.