Internal Revenue bulletinREG–105312–98, page 14. Proposed regulations under section 6045 of the...

INCOME TAX

Rev. Rul. 99–25, page 3.Federal rates; adjusted federal rates; adjusted federallong-term rate, and the long-term exempt rate. Forpurposes of sections 1274, 1288, 382, and other sectionsof the Code, tables set forth the rates for June 1999.

ADMINISTRATIVERev. Proc. 99–27, page 7.Insurance companies; modified endowment contracts;uniform closing agreement. This revenue procedure pro-vides procedures by which an issuer may remedy an inad-vertent non-egregious failure to comply with the modified en-dowment contract rules under section 7702A of the Code.

REG–105312–98, page 14.Proposed regulations under section 6045 of the Code relateto reporting payments of gross proceeds to attorneys. Apublic hearing is scheduled for September 22, 1999.

REG–113910–98, page 17.Proposed regulations under section 263A of the Code relateto accounting for costs incurred in producing property andacquiring property for resale. A public hearing is scheduledfor September 1, 1999.

Notice 99–31, page 6.The deadline for special reformations under section 664 ofthe Code will be extended from June 8, 1999, to June 30,2000.

Notice 99–32, page 6.Hope Scholarship credit; Lifetime Learning credit;election. Final regulations under section 25A of the Codewill permit taxpayers to elect to claim the Hope ScholarshipCredit and the Lifetime Learning Credit by attaching Form8863 to a timely filed original Federal income tax return orto an original or amended return filed after the due date ofthe return.

Internal Revenue

bbuulllleettiinnBulletin No. 1999–23

June 7, 1999

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

Department of the TreasuryInternal Revenue Service

Finding Lists begin on page 25.

The Internal Revenue Bulletin is the authoritative instrumentof the Commissioner of Internal Revenue for announcing offi-cial rulings and procedures of the Internal Revenue Serviceand for publishing Treasury Decisions, Executive Orders, TaxConventions, legislation, court decisions, and other items ofgeneral interest. It is published weekly and may be obtainedfrom the Superintendent of Documents on a subscriptionbasis. Bulletin contents are consolidated semiannually intoCumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform applicationof the tax laws, including all rulings that supersede, revoke,modify, or amend any of those previously published in theBulletin. All published rulings apply retroactively unless other-wise indicated. Procedures relating solely to matters of in-ternal management are not published; however, statementsof internal practices and procedures that affect the rightsand duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service onthe application of the law to the pivotal facts stated in therevenue ruling. In those based on positions taken in rulingsto taxpayers or technical advice to Service field offices,identifying details and information of a confidential natureare deleted to prevent unwarranted invasions of privacy andto comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not havethe force and effect of Treasury Department Regulations,but they may be used as precedents. Unpublished rulingswill not be relied on, used, or cited as precedents by Servicepersonnel in the disposition of other cases. In applying pub-lished rulings and procedures, the effect of subsequent leg-islation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and oth-ers concerned are cautioned against reaching the same con-clusions in other cases unless the facts and circumstancesare substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisionsof the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions, and Subpart B, Legislation and RelatedCommittee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts and Sub-parts. Also included in this part are Bank Secrecy Act Admin-istrative Rulings. Bank Secrecy Act Administrative Rulingsare issued by the Department of the Treasury’s Office of theAssistant Secretary (Enforcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative indexfor the matters published during the preceding months.These monthly indexes are cumulated on a semiannual basis,and are published in the first Bulletin of the succeeding semi-annual period, respectively.

Mission of the Service

Provide America’s taxpayers top quality service by help-ing them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness toall.

2

Introduction

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Section 42.—Low-IncomeHousing Credit

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof June 1999. See Rev. Rul. 99–25, on this page.

Section 280G.—GoldenParachute Payments

Federal short-term, mid-term, and long-termrates are set forth for the month of June 1999. SeeRev. Rul. 99–25, on this page.

Section 382.—Limitation on NetOperating Loss Carryforwardsand Certain Built-In LossesFollowing Ownership Change

The adjusted applicable federal long-term rate isset forth for the month of June 1999. See Rev. Rul.99–25, on this page.

Section 412.—MinimumFunding Standards


Section 467.—CertainPayments for the Use ofProperty or Services


Section 468.—Special Rules forMining and Solid WasteReclamation and Closing Costs


Section 482.—Allocation ofIncome and Deductions AmongTaxpayers


Section 483.—Interest onCertain Deferred Payments


Section 642.—Special Rules forCredits and Deductions


Section 807.—Rules for CertainReserves


Section 846.—DiscountedUnpaid Losses Defined


Section 1274.—Determinationof Issue Price in the Case ofCertain Debt Instruments Issuedfor Property

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

Rev. Rul. 99–25

Federal rates; adjusted federal rates;adjusted federal long-term rate, andthe long-term exempt rate.For purposesof sections 1274, 1288, 382, and othersections of the Code, tables set forth therates for June 1999.

This revenue ruling provides variousprescribed rates for federal income taxpurposes for June 1999 (the currentmonth.) Table 1 contains the short-term,mid-term, and long-term applicable fed-eral rates (AFR) for the current month forpurposes of section 1274(d) of the Inter-nal Revenue Code. Table 2 contains theshort-term, mid-term, and long-term ad-justed applicable federal rates (adjustedAFR) for the current month for purposesof section 1288(b). Table 3 sets forth theadjusted federal long-term rate and thelong-term tax-exempt rate described insection 382(f). Table 4 contains the ap-propriate percentages for determining thelow-income housing credit described insection 42(b)(2) for buildings placed inservice during the current month. Finally,Table 5 contains the federal rate for deter-mining the present value of an annuity, aninterest for life or for a term of years, or aremainder or a reversionary interest forpurposes of section 7520.

1999–23 I.R.B. 3 June 7, 1999

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

REV. RUL. 99–25 TABLE 2

Adjusted AFR for June 1999

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-termadjusted AFR 3.32% 3.29% 3.28% 3.27%

Mid-termadjusted AFR 3.91% 3.87% 3.85% 3.84%

Long-termadjusted AFR 4.85% 4.79% 4.76% 4.74%


Applicable Federal Rates (AFR) for June 1999

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-TermAFR 4.98% 4.92% 4.89% 4.87%

110% AFR 5.48% 5.41% 5.37% 5.35%120% AFR 5.99% 5.90% 5.86% 5.83%130% AFR 6.50% 6.40% 6.35% 6.32%

Mid-TermAFR 5.37% 5.30% 5.27% 5.24%

110% AFR 5.91% 5.83% 5.79% 5.76%120% AFR 6.46% 6.36% 6.31% 6.28%130% AFR 7.01% 6.89% 6.83% 6.79%150% AFR 8.11% 7.95% 7.87% 7.82%175% AFR 9.50% 9.28% 9.17% 9.11%

Long-TermAFR 5.79% 5.71% 5.67% 5.64%

110% AFR 6.38% 6.28% 6.23% 6.20%120% AFR 6.97% 6.85% 6.79% 6.75%130% AFR 7.56% 7.42% 7.35% 7.31%

June 7, 1999 4 1999–23 I.R.B.


Rates Under Section 382 for June 1999

Adjusted federal long-term rate for the current month 4.85%

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.) 4.85%

1999–23 I.R.B. 5 June 7, 1999


Appropriate Percentages Under Section 42(b)(2) for June 1999

Appropriate percentage for the 70% present value low-income housing credit 8.30%

Appropriate percentage for the 30% present value low-income housing credit 3.56%


Rate Under Section 7520 for June 1999

Applicable federal rate for determining the present value of an annuity, an interest for life or a termof years, or a remainder or reversionary interest 6.4%

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

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof June 1999. See Rev. Rul. 99–25, page 3.

Section 7520.—Valuation Tables


Section 7702A.—ModifiedEndowment Contract Defined

Procedures are provided by which an issuer mayremedy an inadvertent non-egregious failure to com-ply with the modified endowment contract rulesunder § 7702A. See Rev. Proc. 99–27, page 7.

Section 7872.—Treatment ofLoans With Below-MarketInterest Rates


June 7, 1999 6 1999–23 I.R.B.

Guidance Regarding Section664 Regulations

Notice 99–31

This notice informs taxpayers that thedeadline for special reformations of chari-table remainder unitrusts (CRUTs) pro-vided in § 1.664–3(a)(1)(i)(f )(3) of the In-come Tax Regulations will be extendedfrom June 8, 1999, until June 30, 2000.This notice also explains that the term“legal proceedings” in § 1.664–3(a)(1)-(i)(f )(3) includes certain non-judicial re-formations provided they are completedby June 30, 2000.

BACKGROUND

Section 1.664–3(a)(1)(i)(c) containsthe rules for CRUTs that use a combina-tion of methods to compute the unitrustamount. If certain requirements are satis-fied, the governing instrument of a CRUTmay provide that the unitrust amount iscomputed using one of the income excep-tion methods during an initial period andthereafter using the fixed percentagemethod (flip provision). The same fixedpercentage must be used throughout theterm of the CRUT.

Under § 1.664–3(a)(1)(i)(f )(1), the flipprovision is available for CRUTs createdon or after December 10, 1998. However,§ 1.664–3(a)(1)(i)(f )(3) permits reforma-tions of a CRUT whose governing instru-ment either contains an impermissible flipprovision or uses only one of the incomeexception methods. Such a CRUT maybe reformed to include a permitted flipprovision if the trustee begins legal pro-ceedings to reform by June 8, 1999.

DISCUSSION

Since the issuance of § 1.664–3(a)(1)-(i)(f )(3), a number of practitioners haverequested additional time to begin legalproceedings to reform a CRUT. TheTreasury Department and the Service alsounderstand that there may be state law im-pediments to meeting the June 8, 1999,deadline. In response, the Treasury De-partment and the Service intend to amend§ 1.664–3(a)(1)(i)(f )(3) to extend theJune 8, 1999, deadline to June 30, 2000.

Many practitioners have also inquiredwhether the term “legal proceedings” in § 1.664–3(a)(1)(i)(f )(3) requires a judicialreformation if non-judicial reformationsare permitted under state law. The Trea-sury Department and the Service willclarify that the term “legal proceedings”includes a non-judicial reformation that isvalid under state law, but that a non-judi-cial reformation must be completed byJune 30, 2000.

Taxpayers seeking a non-judicial refor-mation should ascertain what their statelaw requires for such a reformation to bevalid. For example, in some states, a non-judicial reformation requires the consentof all beneficiaries, including potentialbeneficiaries. In addition, in some states,the state’s Attorney General has jurisdic-tion over charitable remainder trusts andmust be notified of or consent to a refor-mation on behalf of the named or un-named charitable beneficiaries. In somecases, the state’s Attorney General maymore closely oversee charitable remain-der trusts in which the specific charitableorganization is not named in the govern-ing instrument or is subject to change bythe grantor or another person.

EFFECTIVE DATE

The amendments to § 1.664–3(a)(1)-(i)(f )(3) described in this notice will beeffective December 10, 1998.

DRAFTING INFORMATION

The principal author of this notice isMary Beth Collins of the Office of Assis-tant Chief Counsel (Passthroughs andSpecial Industries). For further informa-tion regarding this notice, contact Ms.Collins on (202) 622-3080 (not a toll-freecall).

Election to Claim Education Tax Credit

Notice 99–32

PURPOSE

This notice announces that the finalregulations under § 25A of the Internal

Revenue Code will permit taxpayers toelect to claim the Hope ScholarshipCredit and the Lifetime Learning Creditby attaching Form 8863, Education Cred-its (Hope and Lifetime Learning Credits),to a Federal income tax return (oramended return) for the taxable year inwhich the credit is claimed.

BACKGROUND

Section 25A provides two educationtax credits, the Hope Scholarship Creditand the Lifetime Learning Credit. In gen-eral, § 25A provides that, if certain re-quirements are met, a taxpayer may claiman education tax credit based on the quali-fied tuition and related expenses of thetaxpayer, the taxpayer’s spouse, and anydependent of the taxpayer for whom thetaxpayer properly claims a dependencydeduction under § 151. The education taxcredits are available for taxable years be-ginning after 1997. Section 25A(e)(1)provides that a taxpayer must elect toclaim an education tax credit.

DISCUSSION

On January 6, 1999, the Treasury De-partment and the Internal Revenue Ser-vice issued proposed regulations under § 25A. See64 Fed. Reg. 794 (1999).Section 1.25A–1(d) of the proposed regu-lations provides that no education taxcredit is allowed unless a taxpayer electsto claim the credit on the taxpayer’stimely filed (including extensions) Fed-eral income tax return for the taxable yearin which the credit is claimed. The pro-posed regulations provide that the elec-tion is made by attaching Form 8863 tothat Federal income tax return.

The Treasury Department and the Ser-vice have determined that taxpayersshould be able to make the election under§ 25A on an original or amended return.Thus, the regulations when finalized willprovide that a taxpayer claims an educa-tion tax credit by attaching Form 8863 toa Federal income tax return for the tax-able year in which the credit is claimed.The election procedure provided in thefinal regulations will apply to taxableyears beginning after 1997. Therefore,

Part III. Administrative, Procedural, and Miscellaneous

1999–23 I.R.B. 7 June 7, 1999

for taxable year 1998 and later years, ataxpayer may elect to claim an educationtax credit by attaching Form 8863 to atimely filed original Federal income taxreturn, or an original Federal income taxreturn or an amended return filed after thedue date of the return and before the expi-ration of the period of limitation for filinga claim for credit or refund for the taxableyear in which the credit is claimed.


The principal author of this notice isDonna Welch of the Office of the Assis-tant Chief Counsel (Income Tax and Ac-counting). For further information re-garding this notice contact her on (202)622-4910 (not a toll-free call).

26 CFR § 301.7121-1: Closing agreements.(Also Part I, section 7702A)

Rev. Proc. 99–27

SECTION 1. PURPOSE

This revenue procedure provides theprocedures by which an issuer may rem-edy an inadvertent non-egregious failureto comply with the modified endowmentcontract rules under § 7702A of the Inter-nal Revenue Code.

SECTION 2. BACKGROUND

.01 Definition of a modified endowmentcontract (“MEC”).

(1) Section 7702A(a) provides that alife insurance contract is a MEC if thecontract—

(a) is entered into on or after June21, 1988, and fails to meet the “7-paytest” of § 7702A(b), or

(b) is received in exchange for acontract described in paragraph (a) of thissection 2.01(1).

(2) A contract fails to meet the 7-paytest if the accumulated amount paid underthe contract at any time during the first 7contract years exceeds the sum of the netlevel premiums which would have to bepaid on or before such time if the contractwere to provide for paid-up “future bene-fits” (as defined in §§ 7702A(e)(3) and7702(f)(4)) after the payment of 7 levelannual premiums.

(3) Section 72(e)(11) provides that,for purposes of determining amounts in-cludible in gross income, all MECs issued

by the same company to the same contractholder during any calendar year aretreated as one MEC.

.02 Tax treatment of amounts receivedunder a MEC.Section 72(e)(10) providesthat a MEC is subject to the rules of § 72(e)(2)(B), which tax non-annuity dis-tributions on an income-out-first basis,and the rules of § 72(e)(4)(A) (as modi-fied by §§ 72(e)(10)(A)(ii) and 72(e)-(10)(B)), which generally deem loans andassignments or pledges of any portion ofthe value of a MEC to be non-annuity dis-tributions. Moreover, under § 72(v), theportion of any annuity or non-annuity dis-tribution received under a MEC that is in-cludible in gross income is subject to a10% additional tax unless the distributionis made on or after the date on which thetaxpayer attains age 591⁄2, is attributable tothe taxpayer’s becoming disabled (withinthe meaning of § 72(m)(7)), or is part of aseries of substantially equal periodic pay-ments (not less frequently than annually)made for the life (or life expectancy) ofthe taxpayer or the joint lives (or joint lifeexpectancies) of such taxpayer and thetaxpayer’s beneficiary.

.03 Need for a correction mechanism.The Internal Revenue Service (“Service”)has become aware of situations in which,as a result of inadvertent non-egregiousfailures to comply with the MEC rules,life insurance premiums have been col-lected which exceed the 7-pay limit pro-vided by § 7702A(b). This may producesignificant unforeseen tax consequencesfor the contract holders. To allow issuersto remedy such situations, the Serviceunder the circumstances described belowwill enter into closing agreements whichwill provide that contracts identified inthe closing agreements will not be treatedas MECs.

SECTION 3. DEFINITIONS

The following definitions and rulesapply solely for purposes of this revenueprocedure.

.01 Testing period. The 7-year perioddescribed in § 7702A(b) or such addi-tional period as may be required under § 7702A(c)(3) if a contract undergoes amaterial change.

.02 Amount paid. The amount paidunder a contract in any “contract year” (asdefined in § 7702A(e)(2)) equals the pre-miums paid for the contract during the

year, reduced by amounts to which § 72(e) applies (determined without re-gard to § 72(e)(4)(A)) but not includingamounts includible in gross income. Forthis purpose, premiums paid do not in-clude—

(1) any portion of any premium paidduring the contract year that is returned(with interest) to the contract holderwithin 60 days after the end of the con-tract year in order to comply with the 7-pay test, or

(2) the “cash surrender value” (as de-fined in § 7702(f)(2)(A)) of another lifeinsurance contract (other than a contractthat fails the 7-pay test) exchanged for thecontract.

.03 7-pay premium.(1) In general. Ex-cept as otherwise provided in section3.03(2) of this revenue procedure, the 7-pay premium for a contract is the net levelpremium (computed in accordance withthe rules in § 7702A(c)) that would have tobe paid for the contract if the contract wereto provide for paid up future benefits afterthe payment of 7 level annual premiums.

(2) 7-pay premium for a contractthat undergoes a material change.If acontract (other than a contract that failsthe 7- pay test) is materially changed, thecontract is treated as newly issued on thedate of the material change and the 7-paypremium for the changed contract is anamount equal to the excess, if any, of—

(a) the net level premium (com-puted in accordance with the rules in § 7702A(c)) that would have to be paid forthe changed contract if the contract were toprovide for paid up future benefits after thepayment of 7 level annual premiums, over

(b) a “proportionate share of thecash surrender value” (as defined in sec-tion 3.04 of this revenue procedure) underthe contract.

(3) Assumed 7-pay premium.The 7-pay premium assumed by the issuer whenthe contract was issued.

.04 Proportionate share of cash surren-der value. The proportionate share of thecash surrender value of a contract is theamount obtained by multiplying—

(1) the “cash surrender value” (as de-fined in § 7702(f)(2)(A)) of the contract,by

(2) a fraction, the numerator ofwhich is the net level premium (computedin accordance with the rules in § 7702A(c)) that would have to be paid

for the changed or new contract if suchcontract were to provide for paid up fu-ture benefits after the payment of 7 levelannual premiums, and the denominator ofwhich is the net single premium (deter-mined using the rules in § 7702) for suchcontract at that time.

.05 Overage. A contract’s overage isthe amount of the excess, if any, of—

(1) the sum of amounts paid underthe contract during the testing period forthe contract year and all prior contractyears, over

(2) the sum of the 7-pay premiumsfor the contract year and all prior contractyears of the testing period.

.06 Overage earnings.The overageearnings for a contract year is the amountobtained by multiplyingó

(1) the sum of a contract’s overagefor the contract year and its cumulativeoverage earnings for all prior contractyears, by—

(2) the earnings rate set forth in sec-tion 3.07 of this revenue procedure.

.07 Earnings rates. (1) Contracts otherthan variable contracts. Except as other-wise provided in sections 3.07(3) and3.07(8) of this revenue procedure, theearnings rate applicable to a contract yearis the “general account total return” (asdefined in section 3.07(2) of this revenueprocedure) for the calendar year in whichthe contract year begins.

(2) General account total return.The general account total return is the cal-endar year arithmetic average of themonthly interest rates described asMoody’s Corporate Bond Yield Average -Monthly Average Corporates as publishedby Moody’s Investors Service Inc., or anysuccessor thereto.

(3) Variable contracts described in § 817(d). (a) Pre-1999 contract years.The earnings rate applicable to a contractyear that begins before January 1, 1999, isthe rate set forth in the following table forthe calendar year in which the contractyear begins.

(b) Post-1998 contract years.Ex-cept as otherwise provided in section3.07(8), the earnings rate applicable to acontract year that begins after December31, 1998, is equal to the sum of—

(i) 10 percent of the general ac-count total return (as defined in section3.07(2) of this revenue procedure), and

(ii) 90 percent of the “separateaccount total return” (as defined in sec-tion 3.07(4) of this revenue procedure),for the calendar year in which the contractyear begins.

(4) Separate account total return.Except as otherwise provided in section3.07(8), the separate account total returnequals—

(a) 75 percent of the “equity fundtotal return” (as defined in section 3.07(5)of this revenue procedure), plus

(b) 25 percent of the “bond fundtotal return” (as defined in section 3.07(6)of this revenue procedure), less

(c) 1.1 percentage point.(5) Equity fund total return.The eq-

uity fund total return equals—(a) the “calendar year percentage

return” (as defined in section 3.07(7) ofthis revenue procedure) represented bythe end-of-year values of the Standardand Poor’s (S&P) 500 Total Return Index,with daily dividend reinvestment, as pub-lished by The McGraw-Hill Companies,Inc., or any successor thereto, less

(b) 1.5 percentage point.(6) Bond Fund Total Return.The

bond fund total return equals—(a) the “calendar year percentage

return” (as defined in section 3.07(7) ofthis revenue procedure) represented bythe end-of-year values of the MerrillLynch Corporate Bond Master BondIndex, Total Return, as published by Mer-rill Lynch & Company, Inc., or any suc-cessor thereto, less

(b) 1.0 percentage point.(7) Calendar year percentage return.

The calendar year percentage return foran index described in section 3.07(5) orsection 3.07(6) of this revenue procedureis calculated by–

(a) dividing the end-of-year valueof the index for the calendar year by theend-of-year value of the index for the im-mediately preceding calendar year, and

(b) subtracting 1 from the resultobtained under paragraph (a) of this sec-tion 3.07(7).

(8) If the general account total returnor the separate account total return for acalendar year cannot be determined be-cause the calendar year in which the con-tract year begins has not ended, then theearnings rate for the contract year (or por-tion thereof) is determined using the gen-eral account total return and, if applicable,the average separate account total return,for the 3 calendar years immediately pre-ceding the calendar year in which the con-tract year begins.

.08 Proportionate share of overageearnings allocable to taxable distribu-tions. The proportionate share of overageearnings allocable to taxable distributionsunder a contract is the amount obtainedby multiplying—

(1) the total amount of the taxabledistributions under the contract, by

(2) a fraction, the numerator ofwhich is the contract’s cumulative over-age earnings and the denominator ofwhich is the total income on the contract.

.09 Total income on a contract.Thetotal income on a contract as of any dateis an amount equal to the excess, if any,of—

(1) the contract’s cash surrendervalue (as defined in § 7702(f)(2)(A)) onsuch date, over

(2) the premiums paid under the con-tract before such date, reduced byamounts to which § 72(e) applies (deter-mined without regard to § 72(e)(4)(A))but not including amounts includible inthe contract holder’s gross income.

.10 Distribution frequency factor.Thedistribution frequency factor for a con-tract is—

(1) .8, if—(a) the interest rate with respect to

any portion of a policy loan that could bemade under the contract at any time (in-cluding policy loans that could be madeafter a contractually specified date in thefuture) is guaranteed not to exceed thesum of:

(i) 1 percentage point, plus (ii) the rate at which earnings

are credited to the portion of the con-

June 7, 1999 8 1999–23 I.R.B.

Calendar Year Earnings Rate

1988 13.5%1989 17.4%1990 1.4%1991 25.4%1992 5.9%1993 13.9%

Calendar Year Earnings Rate

1994 –1.0%1995 23.0%1996 14.3%1997 17.8%1998 19.7%

tract’s cash surrender value (as defined in § 7702(f)(2)(A)) that is allocable to suchportion of the policy loan; or

(b) the contract holder has an op-tion to make a partial withdrawal of thecontract’s cash surrender value that re-duces the “death benefit” (as defined in § 7702(f)(3)) under the contract by lessthan an amount determined by multiply-ing—

(i) the death benefit under thecontract immediately before the with-drawal, by

(ii) the percentage obtained bydividing the withdrawn amount by thecontract’s cash surrender value (as de-fined in § 7702(f)(2)(A)) immediately be-fore the withdrawal; and

(2) .5 for all other contracts..11 Applicable percentage.The applic-

able percentage for a contract is-(1) 15%, if the death benefit under

the contract is less than $50,000,(2) 28% if the death benefit under

the contract is equal to or exceeds$50,000 but is less than $180,000, and

(3) 36%, if the death benefit underthe contract is equal to or exceeds$180,000.

.12 Reported amount.The reportedamount for a contract is the amount that—

(1) the issuer reports on a timelyfiled information return as includible inthe contract holder’s gross income, or

(2) the contract holder includes ingross income on a timely filed income taxreturn.

.13 Aggregation of contracts.AllMECs issued by the same issuer to thesame contract holder during any calendaryear are treated as one MEC.

SECTION 4. SCOPE

.01 Applicability. Except as providedin sections 4.02 and 4.03 of this revenueprocedure, the issuer of a contract can usethis revenue procedure to remedy the fail-ure of the contract to comply with the re-quirements of § 7702A. See section 8 ofthis revenue procedure, below, for its dateof expiration.

.02 Inapplicability. This revenue pro-cedure does not apply to a MEC if—

(1) the contract insures the life ofany individual (other than a “key person”as defined in § 264(e)(3)) who is or was-

(a) an officer, director, or em-ployee of, or

(b) financially interested in, anytrade or business carried on by the con-tract holder;

(2) the contract’s status as a MEC re-sulted from a failure to comply with therequirements of § 7702A that—

(a) are attributable to one or moredefective interpretations or positions thatthe Service determines to be a significantfeature of a program to sell investmentoriented contracts, or

(b) arises where the controllingstatutory provision, as supplemented byany legislative history or guidance pub-lished by the Service, is clear on its faceand the Service determines that failure tofollow the provision results in a signifi-cant increase in the investment orientationof a contract; or

(3) except as provided in this section4.02(3), the issuer previously entered intoa closing agreement to remedy a failure ofany contract to comply with the require-ments of § 7702A. Upon an applicationby the issuer setting forth unusual or spe-cial facts and circumstances, the Servicein its sole discretion may waive the limi-tation imposed by this section 4.02(3).However, the Service will not waive thelimitation if the issuer requests to enterinto a closing agreement to cure the sameor similar failures to comply with the re-quirements of § 7702A that were identi-fied in a previous closing agreement. Ex-amples of unusual or special facts andcircumstances include:

(a) The issuer analyzed each of itscontracts as of the date of its first submis-sion under this revenue procedure, usingall of the legal and factual assumptionsdescribed in its first submission, and re-quested a closing agreement for all of itscontracts eligible for relief under this rev-enue procedure to remedy the contracts’failure comply with the requirements of§ 7702A. The issuer subsequently ac-quired a company that had inadvertentlyissued contracts that failed to comply withthe requirements of § 7702A, which hadnot previously requested a closing agree-ment to remedy the failure of any of itscontracts to comply with the requirementsof § 7702A. In this situation, the issuermay request a closing agreement with re-spect to all of the acquired company’scontracts that otherwise are eligible forrelief under this revenue procedure.

(b) The issuer analyzed each of itscontracts as of the date of its first submis-

sion under this revenue procedure, usingall legal and factual assumptions de-scribed in its first submission, and re-quested a closing agreement for each con-tract eligible for relief under this revenueprocedure. The issuer subsequently dis-covers that it inadvertently failed to iden-tify other legal and factual assumptionsnot described in its first submission,which would cause the same and addi-tional contracts to fail to comply with therequirements of § 7702A. In this situa-tion, the issuer may request a closingagreement for all of its contracts other-wise eligible for relief under this revenueprocedure to remedy the contracts’ failureto comply with the requirements of §7702A based on the combination of itspreviously and its newly identified legaland factual assumptions.

.03 Examples. Pursuant to section4.02(2) of this revenue procedure, thisrevenue procedure does not apply to aMEC if—

(1) the contract provides for paid-upfuture benefits after the payment of lessthan 7 level annual premiums,

(2) the amount paid under the con-tract in any contract year of the testing pe-riod exceeds 300 percent of the 7-pay pre-mium for the contract year, or

(3) the cash surrender value of thecontract (within the meaning of § 7702(f)-(2)(A)) exceeded (or was illustrated orprojected to exceed) the contract holder’sinvestment in the contract (as defined in §72(e)(6)) within 3 years after the issuanceof the contract and the assumed 7-paypremium for the contract was more than150 percent of the correct 7-pay premiumfor the contract.

SECTION 5. PROCEDURE

.01 Request for a ruling. An issuer thatseeks relief under this revenue proceduremust submit a request for a ruling thatmeets the requirements of Rev. Proc. 99–1, 1999–1 I.R.B. at 6 (or any successor).Additionally, the submission must containthe following information:

(1) a specimen copy of each contractform;

(2) the policy number for each con-tract;

(3) the taxpayer identification num-ber of each contract holder;

(4) the original issue date of eachcontract;

1999–23 I.R.B. 9 June 7, 1999

(5) the death benefit (as defined insection 7702(f)(3)) under each contract;

(6) the 7-pay premium assumed bythe issuer when the contract was issued;

(7) the cash surrender value (withinthe meaning of § 7702(f)(2)(A)) of eachcontract at the end of each contract year;

(8) a description of the defect[s] thatcaused the contract[s] to fail to complywith the 7-pay test, including an explana-tion of how and why the defect[s] arose;

(9) a description of the administrativeprocedures the issuer has implemented toensure that none of its contracts will inad-vertently fail the 7-pay test in the future;

(10) a description of any materialchange[s] in the benefits under (or in theother terms of) any contract together withthe date[s] on which the materialchange[s] occurred;

(11) for any contract with regard towhich a contract holder directly or indi-rectly received (or was deemed to have re-ceived) any distribution to which § 72 ap-plies—

(a) the date and amount of eachdistribution,

(b) the amount of the distributionincludible in the contract holder’s grossincome,

(c) the amount of gross income re-ported to the contract holder and to theService on a timely filed information re-turn as a result of the distribution,

(d) the date on which the contractholder attained [or will attain] age 591⁄2,

(e) whether the distribution is at-tributable to the contract holder becomingdisabled (within the meaning of § 72(m)(7)), and,

(f) whether the distribution is partof a series of substantially equal periodicpayments (not less frequently than annu-ally) made for the life (or life expectancy)of the contract holder or the joint lives (orjoint life expectancies) of the contractholder and his or her beneficiary;

(12) a template (see, for example,section 5.04(3) of this revenue procedure)setting forth the following information foreach contract:

(a) the cumulative amounts paidunder the contract within each contractyear of the testing period;

(b) the contract’s cumulative 7-paypremium;

(c) the overage, if any, for eachcontract year;

(d) the earnings rate applicable foreach contract year;

(e) the overage earnings for eachcontract year; and

(13) representations, signed underpenalties of perjury by a representative ofthe issuer with authority to sign tax re-turns on behalf of the issuer, that—

(a) no contract identified in the rul-ing request insures the life of any individ-ual (other than a “key person” as definedin § 264(e)(3)) who is or was an officer,director, or employee of, or financially in-terested in, any trade or business carriedon by the contract holder;

(b) no contract identified in theruling request provides for paid-up futurebenefits after the payment of less than 7level annual premiums;

(c) no contract identified in theruling request had an amount paid in anycontract year of the testing period that ex-ceeded 300 percent of the 7-pay premiumfor such contract year;

(d) none of the contracts identifiedin the ruling request meet both of the fol-lowing conditions:

(i) the assumed 7-pay premiumfor the contract exceeded 150 percent ofthe correct 7-pay premium for such con-tract; and

(ii) the cash surrender value ofthe contract (within the meaning of § 7702(f)(2)(A)) exceeded the contractholder’s investment in the contract (as de-fined in § 72(e)(6)) within three yearsafter the issuance of the contract; and

(e) set forth the details of any pre-vious request by the issuer to cure anyfailure of any contract to comply with therequirements of § 7702A.

.02 Time for filing request. The requestfor a ruling must be filed on or beforeMay 31, 2001.

.03 Closing agreement.The issuer alsomust submit a proposed closing agree-ment, executed by the issuer, in substan-tially the same form as the model closingagreement in section 6 of this revenueprocedure. The amount shown in section1(A) of the closing agreement is the sumof the amounts required to be paid (deter-mined under section 5.04 of this revenueprocedure) for all of the contracts coveredby the agreement.

.04 Determination of amount requiredto be paid with regard to a contract.

(1) Except as provided in section5.04(2) of this revenue procedure, the

amount required to be paid with regard toa contract is the sum of—

(a) the income tax (determinedusing the applicable percentage for thecontract under section 3.11 of this revenueprocedure) and the additional tax undersection 72(v) with regard to amounts(other than reported amounts (as definedin section 3.12 of this revenue procedure))received (or deemed received) under thecontract during the period commencingwith the date 2 years before the date onwhich the contract first failed to satisfy theMEC rules and ending on the effectivedate of the closing agreement;

(b) any interest computed under § 6621(a)(2) as if the amounts determinedunder section 5.04(1)(a) of this revenueprocedure are underpayments by the con-tract holder[s] for the tax year[s] in whichthe amounts are received (or deemed re-ceived); and

(c) an amount, not less than $0,obtained by multiplying—

(i) the excess, if any, of the con-tract’s cumulative overage earnings overthe proportionate share of overage earn-ings allocable to taxable distributionsunder the contract, by

(ii) the applicable percentagefor the contract, and by

(iii) the distribution frequencyfactor for the contract under section 3.10of this revenue procedure.

(2) Special rule for pre-1999 con-tracts with de minimis overage earnings.If the overage earnings of a contract is-sued before January 1, 1999, at all timesduring the testing period do not exceed$75, then the amount required to be paidwith regard to the contract is determinedwithout regard to paragraphs (a) and (b)of section 5.04(1) of this revenue proce-dure.

(3) Examples of the determination ofthe amount required to be paid with re-gard to a contract.

(a) Example 1. A, an individual,purchases a life insurance contract otherthan a contract described in sections3.07(3), 4.02(1), or 4.02(2) of this rev-enue procedure. The death benefit of thecontract exceeds $180,000. The net levelpremium (assuming paid-up future bene-fits after 7 annual premium payments) forthe contract is $10,490. The contract pro-vides that, within 60 days after the end ofa contract year, the issuer will return (with

June 7, 1999 10 1999–23 I.R.B.

interest) the amount of any excess pre-mium that would cause the contract to bea MEC under § 7702A.

The interest rate on all portions of anypolicy loans will always exceed the rate atwhich interest is credited to the contract’sassociated cash value by more than 1 per-centage point. A partial withdrawal of thecash surrender value (within the meaningof § 7702(f)(2)(A)) always reduces thedeath benefit by an amount not less thanthe amount determined by multiplying the

death benefit immediately before thewithdrawal by the percentage obtained bydividing the withdrawn amount by thecash surrender value immediately beforethe withdrawal.

A pays a premium of $10,000 whenthe contract is issued on January 1, 1991.At the beginning of each of the next 6contract years, A pays additional premi-ums of $10,750, $10,800, $10,700,$11,500, $11,000, and $10,000, respec-tively. Due to an inadvertent error, the

issuer fails to return any of the excesspremiums.

The issuer desires to enter into a clos-ing agreement to remedy the failure tocomply with § 7702A. The issuer has notpreviously used this revenue procedure toremedy the failure of any contract to com-ply with the MEC rules.

Pursuant to section 5.01(12) of thisrevenue procedure, the issuer preparesthe following template with regard to thecontract.

1999–23 I.R.B. 11 June 7, 1999

Cumulative CumulativeContract Premiums 7-Pay Earnings OverageYear Paid Premiums Overage Rate Earnings

1 (1991) 10,000 10,490 0 9.2% 02 (1992) 20,750 20,980 0 8.6% 03 (1993) 31,550 31,470 80 7.5% 6.004 (1994) 42,250 41,960 290 8.3% 24.575 (1995) 53,750 52,450 1,300 7.8% 103.786 (1996) 64,750 62,940 1,810 7.7% 149.717 (1997) 74,750 73,430 1,320 7.5% 120.30

Prior to A’s payment of the $10,800premium at the beginning of contract year3, the cumulative premiums paid for thecontract do not exceed the contract’s cu-mulative 7-pay premiums. Therefore,there are no overage earnings in contractyears 1 and 2.

Upon payment of the $10,800 premiumat the beginning of contract year 3, how-ever, the cumulative amount paid for thecontract ($31,550) exceeds the contract’scumulative 7-pay premiums ($31,470) by$80. As the earnings rate for the calendaryear in which contract year 3 begins is7.5%, the contract’s overage earnings forcontract year 3 equal $6 ($80 3 7.5%).

For contract year 4, the overage is $290($42,250 – $41,960). The cumulativeoverage earnings for all prior contractyears equal $6.00. The earnings rate is8.3%. The overage earnings for contractyear 4 equal $24.57 (($290 + $6) 38.3%).

For contract year 5, the overage is$1,300 ($53,750 – $52,450). The cumu-lative overage earnings for all prior con-tract years equal $30.57 ($6 + $24.57).The earnings rate is 7.8%. The overageearnings for contract year 5 equal $103.78(($1,300 + $30.57) 3 7.8%).

For contract year 6, the overage is$1,810 ($64,750 – $62,940). The cumu-lative overage earnings for all prior con-tract years equal $134.35 ($6 + $24.57 +$103.78). The earnings rate is 7.7%. Theoverage earnings for contract year 6 equal$149.71 ($1,810 + $134.35) 3 7.7%).

For contract year 7, the overage is$1,320 ($74,750 – $73,430). The cumu-lative overage earnings for all prior con-tract years equal $284.06 ($6 + $24.57 +$103.78 + $149.71). The earnings rate is7.5%. The overage earnings for contractyear 7 equal $120.30 (($1,320 + $284.06)3 7.5%).

The cumulative overage earnings forthe contract equal $404.36 ($6 + $24.57 +$103.78 + $149.71 + $120.30). Undersections 3.10 and 3.11 of this revenueprocedure, the distribution frequency fac-tor is .5 and the applicable percentage is36%. Accordingly, the amount requiredto be paid with regard to the contractunder section 5.04 of this revenue proce-dure is $72.78 ($404.36 3 .5 3 36%).

(b) Example 2.The facts are the sameas in example 1 except that, at the begin-ning of contract year 5, A receives $3,000as a policy loan. The contract’s cashvalue (within the meaning of§ 72(e)-

(3)(A)(i)) immediately prior to the loan is$58,500, which exceeds A’s investment inthe contract ($53,750) by $4,750. Eachyear A pays the interest on the policyloan. The issuer does not file a timely in-formation return with regard to thedeemed distribution resulting from thepolicy loan and A does not include thedistribution in gross income reported onthe income tax return for the taxable yearsin which the deemed distribution is re-ceived. The total income on the contract(as defined in section 3.09 of this revenueprocedure) is $14,500.

The amount required to be paid with re-gard to the contract under section 5.04 ofthis revenue procedure is the sum of–

(1) an amount equal to the incometax (determined using a 36% tax rate) andthe additional tax under section 72(v)with regard to the $3,000 deemed distrib-ution in contract year 5;

(2) interest computed under section6621(a)(2) as if the amounts determinedunder (1) were underpayments for the tax-able year in which the distributions aredeemed to have occurred; and

(3) 36% of $160.35, which is the ex-cess of the contract’s cumulative overageearnings over the proportionate share of

the overage earnings allocable to taxabledistributions ($404.36 – $83.66), multi-plied by the distribution frequency factor(.5).

The proportionate share of overageearnings allocable to taxable distributionsis obtained by multiplying the totalamount of the taxable distribution underthe contract ($3,000), by a fraction, thenumerator of which is the contract’s cu-mulative overage earnings ($404.36) andthe denominator of which is the total in-come on the contract ($14,500).

.05 Payment of amount.The issuer isrequired to pay the amount determinedunder section 5.04 of this revenue proce-dure within thirty (30) days of the date ofexecution of the closing agreement by theService. Payment shall be made by checkpayable to the “United States Treasury”delivered, together with a fully executedcopy of the closing agreement, to InternalRevenue Service, Philadelphia ServiceCenter, 11601 Roosevelt Boulevard,Philadelphia, Pennsylvania 19154, Atten-tion: Chief, Receipt and Control Branch,DP319.

.06 Correction of contracts.The issueralso must bring each contract into compli-ance with § 7702A, either by an increasein death benefit[s] or the return of excesspremiums and earnings thereon, withinninety (90) days of the date of executionof the closing agreement by the Service.

SECTION 6. MODEL CLOSINGAGREEMENT

Effective as of the date executed by In-ternal Revenue Service ____________

CLOSING AGREEMENT AS TOFINAL DETERMINATION COVERINGSPECIFIC MATTERS

THIS CLOSING AGREEMENT(“Agreement”), made pursuant to section7121 of the Internal Revenue Code (the“Code”) by and between [taxpayer ’sname, address, and identifying number](“Taxpayer”), and the Commissioner ofInternal Revenue (the “Service”).

WHEREAS,

A. Taxpayer is the issuer of one ormore modified endowment contracts, asdefined in section 7702A of the Code;

B. On___________, Taxpayer pursuantto Rev. Proc. 99–27, 1999-23 I.R.B., sub-

mitted to the Service a request for a rulingthat one or more modified endowmentcontracts (the “Contract[s]”), which areidentified on Exhibit A to this Agreement,be treated as contracts that are not modi-fied endowment contracts.

C. Taxpayer represents that the Con-tract[s] is [are] not described in section4.02 or 4.03 of Rev. Proc. 99–27.

D. Taxpayer represents that the cumu-lative “overage earnings,” within themeaning of section 3.06 of Rev. Proc. 99–27, for the Contract[s] equal $_____.

E. Taxpayer represents that the total ofthe amounts determined under section5.04(1)(a), (b), and (c) of Rev. Proc. 99–27, after taking the special rule in section5.04(2) of the revenue procedure into ac-count, with regard to the Contract[s] are$______, $______, and $______, respec-tively.

F. To ensure that the Contracts are nottreated as modified endowment contracts,Taxpayer and the Service have enteredinto this Agreement.

NOW THEREFORE, IT IS HEREBYFURTHER DETERMINED ANDAGREED BETWEEN TAXPAYER ANDTHE SERVICE AS FOLLOWS:

1. In consideration for the agreement ofthe Service as set forth in Section 2below, Taxpayer agrees as follows:

(A) To pay to the Service the sum of_________ dollars and _________ cents($_______) at the time and in the mannerdescribed in Section 3 below;

(B) The amount paid pursuant toSection 1(A) above is not deductible byTaxpayer, nor is such amount refundable,subject to credit or offset, or otherwise re-coverable by Taxpayer from the Service;

(C) For purposes of its informationreporting and withholding obligationsunder the Code, no holder’s investment inany Contract may be increased by anyportion of—

(i) the sum set forth in Section1(A) above, or

(ii) the excess of the cumulativeoverage earnings over the proportionateshare of overage earnings included ingross income reported to the Service on atimely filed information return or incometax return with regard to amounts re-ceived under any Contract; and

(D) To bring the Contract[s] intocompliance with § 7702A, either by an in-

crease in death benefit[s] or the return ofexcess premiums and earnings thereon.

2. In consideration of the agreement ofTaxpayer set forth in Section 1 above, theService and Taxpayer agree as follows:

(A) To treat each Contract as havingsatisfied the requirements of section7702A during the period from the date ofissuance of the Contract through and in-cluding the later of—

(i) date of the execution of thisAgreement, and

(ii) the date of the corrective ac-tions described in Section 1(D) above;

(B) To treat the corrective action de-scribed in 1(D) above as having no effecton the date the Contract was issued or en-tered into;

(C) To waive civil penalties for fail-ure of Taxpayer to satisfy the reporting,withholding, and/or deposit requirementsfor income subject to tax under § 72(e)-(10) that was received or deemed receivedby a contract holder under a Contract in acalendar year ending prior to the date ofexecution of this Agreement; and

(D) To treat no portion of the sum de-scribed in Section 1(A) above as incometo the holders of the Contracts.

3. The actions required of Taxpayer inSection 1(D) above shall be taken by Tax-payer within ninety (90) days of the dateof execution of this Agreement by the Ser-vice. Payment of the amount described inSection 1(A) above shall be made withinthirty (30) days of the date of execution ofthis Agreement by the Service by checkpayable to the “United States Treasury,”delivered together with a fully executedcopy of this Agreement, to Internal Rev-enue Service, Philadelphia Service Center,11601 Roosevelt Boulevard, Philadelphia,Pennsylvania 19154, Attention: Chief, Re-ceipt and Control Branch, DP319.

4. This Agreement is, and shall be con-strued as being, for the benefit of Tax-payer. The holder[s] of Contract[s] cov-ered by this Agreement are intendedbeneficiaries of this Agreement. ThisAgreement shall not be construed as creat-ing any liability of an issuer to the holdersof the Contract[s].

5. Neither the Service nor Taxpayershall endeavor by litigation or other meansto attack the validity of this Agreement.

6. This Agreement may not be cited orrelied upon as precedent in the dispositionof any other matter.

June 7, 1999 12 1999–23 I.R.B.

NOW THIS CLOSING AGREEMENTFURTHER WITNESSETH, that Tax-payer and the Service mutually agree thatthe matters so determined shall be finaland conclusive, except as follows:

1. The matter to which this Agreementrelates may be reopened in the event of

fraud, malfeasance, or misrepresentationof material facts set forth herein.

2. This Agreement is subject to sectionsof the Code that expressly provide that ef-fect be given to their provisions notwith-standing any other law or rule of law ex-cept § 7122 of the Code.

3. This Agreement is subject to any leg-islation enacted subsequent to the date ofexecution hereof if the legislation pro-vides that it is effective with respect toclosing agreements.

1999–23 I.R.B. 13 June 7, 1999

SECTION 7. EFFECTIVE DATE

This revenue procedure is effectiveMay 18,1999, the date this revenue proce-dure was made available to the public.

SECTION 8. EXPIRATION DATE

This revenue procedure is availableonly for requests for relief that are re-ceived on or before May 31, 2001.

SECTION 9. PAPERWORKREDUCTION ACT

The collection of information con-tained in this revenue procedure havebeen reviewed and approved by the Of-fice of Management and Budget in accor-dance with the Paperwork Reduction Act(44 U.S.C. 3507) under control number1545-1625.

The collection of information and re-porting burden are in section 5 of this rev-enue procedure. This information will beused to determine whether an issuer mayremedy failures to comply with the re-quirements of § 7702A. The likely re-spondents are insurance companies.

The estimated total annual reportingburden is 20,000 hours.

The estimated annual burden per re-spondent varies from 50 hour to 150hours with an average of 100 hours. Theestimated number of respondents is 200.

The estimated annual frequency of theresponses is one time.

An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-lection of information displays a validOMB control number.

Books and records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.


The principal author of this revenueprocedure is Katherine Hossofsky of theOffice of Assistant Chief Counsel (Finan-cial Institutions and Products). For fur-ther information regarding this revenueprocedure, contact Ms. Hossofsky on(202) 622-3477 (not a toll-free call).

IN WITNESS WHEREOF, the parties have subscribed their names in triplicate.

Taxpayer

Date Signed: ________________________________ By: ______________________________________

Title/Office

Commissioner of Internal Revenue

By: ______________________________________

______________________________________Title/Office

Notice of Proposed Rulemakingand Notice of Public Hearing

Reporting of Gross ProceedsPayments to Attorneys

REG–105312–98

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemak-ing and notice of public hearing.

SUMMARY: This document containsproposed regulations relating to the report-ing of payments of gross proceeds to attor-neys. The regulations reflect changes tothe law made by the Taxpayer Relief Actof 1997. The regulations will affect attor-neys who receive payments of gross pro-ceeds on behalf of their clients, and certainpayors (defendants in lawsuits and theirinsurance companies and agents) that inthe course of their trades or businessesmake payments to these attorneys. Thisdocument also provides notice of a publichearing on these proposed regulations.

DATES: Written and electronic com-ments must be received by August 19,1999. Outlines of topics to be discussedat the public hearing scheduled for Sep-tember 22, 1999, at 10 a.m., must be re-ceived by September 1, 1999.

ADDRESSES: Send submissions to:CC:DOM:CORP:R (REG–105312–98),Room 5226, Internal Revenue Service,POB 7604, Ben Franklin Station, Wash-ington, DC 20044. Submissions may behand delivered Monday through Fridaybetween the hours of 8 a.m. and 5 p.m. to:CC:DOM:CORP:R (REG–105312–98),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, taxpayersmay submit comments electronically viathe Internet by selecting the “Tax Regs”option on the IRS Home Page, or by sub-mitting comments directly to the IRS In-ternet site at http://www.irs.ustreas.gov/tax_regs/regslist.html. The public hear-ing will be held in the IRS Auditorium,7th Floor, Internal Revenue Building,1111 Constitution Avenue, NW, Washing-ton, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the proposed regula-tions, A. Katharine Jacob Kiss at (202)622-4920; concerning submissions ofcomments, the hearing, and/or to beplaced on the building access list to attendthe hearing, Michael Slaughter at (202)622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information con-tained in this notice of proposed rulemak-ing has been submitted to the Office ofManagement and Budget for review in ac-cordance with the Paperwork ReductionAct of 1995 (44 U.S.C. 3507(d)). Com-ments on the collection of informationshould be sent to the Office of Manage-ment and Budget,Attn: Desk Officer forthe Department of the Treasury, Office ofInformation and Regulatory Affairs,Washington, DC 20503, with copies tothe Internal Revenue Service,Attn: IRSReports Clearance Officer, OP:FS:FP,Washington, DC 20224. Comments onthe collection of information should be re-ceived by July 20, 1999. Comments arespecifically requested concerning:

Whether the proposed collection of in-formation is necessary for the proper per-formance of the functions of the InternalRevenue Service,including whether theinformation will have practical utility;

The accuracy of the estimated burdenassociated with the proposed collection ofinformation (see below);

How the quality, utility, and clarity ofthe information to be collected may be en-hanced;

How the burden of complying with theproposed collection of information maybe minimized, including through the ap-plication of automated collection tech-niques or other forms of information tech-nology; and

Estimates of capital or start-up costsand costs of operation, maintenance, andpurchase of services to provide informa-tion.

The collection of information in thisproposed regulation is in §1.6045–5(a).This information is required by the IRS toimplement section 1021 of the Taxpayer

Relief Act of 1997. This information willbe used to verify compliance with section6045 and to determine that the taxableamount of these payments has been com-puted correctly. The collection of infor-mation is mandatory. The likely respon-dents are businesses and other for profitinstitutions.

Respondent taxpayers (payors) providethe information by completing one Form1099-MISC, Miscellaneous Income, foreach attorney who has received one ormore payments of gross proceeds fromthe payor during the calendar year. Theburden for this requirement is reflected inthe burden estimate for Form 1099-MISC. The estimated burden of informa-tion collection for the 1999 Form 1099-MISC is 14 minutes per return.

An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-lection of information displays a validOMB control number assigned by the Of-fice of Management and Budget.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally, tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.

Background

This document contains proposedamendments to the Income Tax Regula-tions (26 CFR Part 1) under section 6045of the Internal Revenue Code. A new re-porting requirement, section 6045(f), wasadded to the Code by section 1021 of theTaxpayer Relief Act of 1997 (1997 Act)(Public Law 105–34, 111 Stat. 922).Section 6045(f) provides for informationreporting for payments of gross proceedsmade in the course of a trade or businessto attorneys in connection with legal ser-vices (whether or not the services are per-formed for the payor). No information re-turn is required under section 6045(f) forthe portion of any payment that is re-quired to be reported under section6041(a) (or that would be required exceptfor the $600 limitation) or under section6051 (employee compensation). The1997 Act also provides that the general

June 7, 1999 14 1999–23 I.R.B.

Part IV. Items of General Interest

1999–23 I.R.B. 15 June 7, 1999

exception for reporting to corporations in§1.6041–3(c) does not apply to corpora-tions providing legal services.

Explanation of Provisions

The proposed regulations take into ac-count comments made by, among others,insurance companies and other payors,the American Bar Association, and themembers of the Commissioner’s Informa-tion Reporting Program Advisory Com-mittee (IRPAC). The operation of section6045(f) was the subject of a paper pre-sented at the IRPAC meeting held inWashington, DC., on October 28 and 29,1997, and comments were also receivedat that meeting.

The proposed regulations clarify thatthere is no threshold amount below whichreporting under section 6045(f) is not re-quired. Additionally, payments made tocorporations engaged in providing legalservices are reportable.

Several commentators asked whetherreporting under section 6045(f) relievesthe payor of all other reporting obliga-tions by shifting the reporting obligationsto the attorney. The proposed regulationsdo not adopt this approach. Section 6045imposes an additional reporting require-ment on payors and does not relieve themof any other pre-existing or concurrentlyexisting reporting requirement. The ex-ception in section 6045(f)(2)(B) is limitedto situations in which the amount of theattorney fee is already reportable to the at-torney as income or wages. The legisla-tive history clearly supports this determi-nation. See, H.R. Conf. Rep. No. 220,105th Cong., 1st Sess. 546 (1997) andJoint Committee on Taxation Staff, Gen-eral Explanation of Tax Legislation En-acted in 1997,105th Cong., 1st Sess. 214-15 (1997).

Several commentators stated that incertain situations, a gross proceeds pay-ment is delivered to the attorney, but theattorney is not listed as a payee on thecheck. In some instances this results fromthe operation of local law; in other in-stances, attorneys request that their namesnot appear on the check. The proposedregulations provide that when a paymentis delivered to an attorney, even if that at-torney is not listed as a payee, the payor isrequired to file an information returnunder section 6045(f).

Wherever possible, however, the pro-posed regulations provide exceptions tothe reporting requirement. For example,the proposed regulations provide for arule of administrative convenience if mul-tiple attorneys are listed as payees. Gen-erally, in those situations, the payor isonly required to report on the attorneywho receives the payment. The IRS andTreasury Department continue to wel-come comments on whether additionalexceptions to the reporting requirementare appropriate.

Many commentators suggested thatForm 1099-B is not the best form for re-porting under section 6045(f). The pro-posed regulations provide that the infor-mation return is made on Form1099-MISC.

Several commentators asked the IRS todefine legal services. Some commenta-tors requested a narrow definition thatwould exclude any services that did notrequire that the provider be an attorney,e.g., property or financial managementservices. However, those commentatorsalso stated that the attorney would mostlikely be collecting a fee for renderingthose services. The IRS and Treasury De-partment have proposed a broad defini-tion of legal services that includes anyservices performed by or under the super-vision of an attorney.

One commentator asked whether theattorney’s TIN must be certified. Theproposed regulations provide that, consis-tent with the general rule under sections6045 and 6041, the attorney’s TIN neednot be certified.

The proposed regulations clarify thatpayments of gross proceeds are subject tobackup withholding if the attorney doesnot provide a TIN. This is consistent withthe legislative history that provides:

Third, attorneys are required to promptly supplytheir TINS to persons required to file these infor-mation reports, pursuant to section 6109. Failureto do so could result in the attorney being subjectto penalty under section 6723 and the paymentsbeing subject to backup withholding under sec-tion 3406.

H.R. Conf. Rep. No. 220, at 546 (1997).Finally, all of the examples in the pro-

posed regulations follow the generallywell-established principle of tax law thatthe income portion of a plaintiff’s settle-ment is not reportable net of the attorneys

fees. But, cf., Rev. Rul. 80–364, 1980–2C.B. 294 (Situation 3 holding that the at-torney’s fees portion of the settlement is areimbursement for expenses incurred bythe union to enforce the collective bar-gaining agreement and not includible inthe gross income of the individual em-ployees), and Davis v. Commissioner,T.C.M. 1998–248 (following Cotnam v.Commissioner,263 F.2d 119 (5th Cir.1959) for determinations under Alabamalaw).

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in Execu-tive Order 12866. Therefore, a regulatoryassessment is not required. It has also beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C.Chapter 5) does not apply to these regula-tions.

It is hereby certified that the collectionof information in these regulations willnot have a significant economic impact ona substantial number of small entities.This certification is based on the factsthat: (1) the time required to prepare andfile a Form 1099-MISC is minimal (cur-rently estimated at 14 minutes per form);and (2) it is not anticipated that, as a resultof these regulations, small entities willhave to prepare and file more than a few,at most, forms per year. Therefore, aRegulatory Flexibility Analysis under theRegulatory Flexibility Act (5 U.S.C.chapter 6) is not required. Pursuant tosection 7805(f) of the Internal RevenueCode, this notice of proposed rulemakingwill be submitted to the Chief Counsel forAdvocacy of the Small Business Admin-istration for comment on its impact onsmall business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considera-tion will be given to any electronic orwritten comments (a signed original andeight (8) copies) that are submitted timelyto the IRS. The IRS and Treasury Depart-ment request comments on the clarity ofthe proposed rules and how they can bemade easier to understand. All commentswill be available for public inspection andcopying.

June 7, 1999 16 1999–23 I.R.B.

A public hearing has been scheduledfor September 22, 1999, beginning at 10a.m. in the IRS Auditorium of the InternalRevenue Building, 1111 Constitution Av-enue, NW., Washington, DC. Due tobuilding security procedures, visitorsmust enter at the 10th Street entrance, lo-cated between Constitution and Pennsyl-vania Avenues, NW. In addition, all visi-tors must present photo identification toenter the building. Because of access re-strictions, visitors will not be admitted be-yond the immediate entrance area morethan 15 minutes before the hearing starts.For information about having your nameplaced on the building access list to attendthe hearing, see the “FOR FURTHER IN-FORMATION CONTACT” section ofthis preamble.

The rules of 26 CFR 601.601(a)(3)apply to the hearing.

Persons who wish to present oral com-ments at the hearing must submit writtencomments and an outline of the topics tobe discussed and the time to be devoted toeach topic (signed original and 8 copies)by September 1, 1999. A period of 10minutes will be allotted to each person formaking comments. An agenda showingthe scheduling of the speakers will be pre-pared after the deadline for receiving out-lines has passed. Copies of the agendawill be available free of charge at thehearing.

Drafting Information

The principal author of these proposedregulations is A. Katharine Jacob Kiss,Office of Assistant Chief Counsel (In-come Tax and Accounting). However,other personnel from the IRS and Trea-sury Department participated in their de-velopment.

* * * * *

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is pro-posed to be amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.6041–3, effective on

January 1, 2000, is amended by revising

the first sentence of paragraph (q)(1) toread as follows:

§1.6041–3 Payments for which no returnof information is required under section6041.

* * * * *

(q) * * *(1) A corporation described in

§1.6049–4(c)(1)(ii)(A), except a corpora-tion engaged in providing legal services,and except a corporation engaged in pro-viding medical and health care services orengaged in the billing and collecting ofpayments in respect to the providing ofmedical and health care services. * * *

* * * * *

Par. 3. Section 1.6041–3, currently ineffect as of May 21, 1999, is amended byrevising the introductory text of para-graph (c) to read as follows:

§1.6041–3 Payments for which no returnof information is required under section6041.

* * * * *

(c) Payments to a corporation, exceptpayments made after December 31, 1997,to a corporation engaged in providinglegal services, and except payments madeafter December 31, 1970, to a corporationengaged in providing medical and healthcare services or engaged in the billing andcollecting of payments in respect to theproviding of medical and health care ser-vices, other than payments to—

* * * * *

Par. 4. Section 1.6045–5 is added toread as follows:

§1.6045–5 Information reporting onpayments to attorneys.

(a) Requirement of reporting—(1) Ingeneral. A person engaged in a trade orbusiness that makes a payment in thecourse of that trade or business to an at-torney in connection with legal services(whether or not the services were per-formed for the payor) must, except as pro-vided in paragraph (c) of this section, filean information return on Form 1099-MISC, “Miscellaneous Income”, with theInternal Revenue Service for the calendar

year in which the payment is made. Forthe time and place of filing Form 1099-MISC, see §1.6041–6. The requirementsof this paragraph (a)(1) apply whether ornot—

(i) Payments to the attorney aggregateless than $600 for the calendar year;

(ii) A portion of a payment is kept bythe attorney as compensation for legalservices rendered; or

(iii) Other information returns are re-quired with respect to some or all of apayment under other applicable provi-sions of the Internal Revenue Code andthe regulations thereunder.

(2) Information required. The infor-mation return required under paragraph(a)(1) of this section must include the fol-lowing information:

(i) The name, address, and taxpayeridentification number (TIN) (as defined insection 7701(a)) of the person making thepayment.

(ii) The name, address, and TIN of theattorney to whom the payment was made.

(iii) The aggregate amount of pay-ments for the calendar year.

(iv) Any other information required byForm 1099-MISC and its instructions.

(3) Requirement to furnish statement.A person required to file an informationreturn under paragraph (a)(1) of this sec-tion must furnish to the attorney a writtenstatement of the information required tobe shown on the return. This requirementmay be met by furnishing a copy of thereturn to the attorney. The written state-ment must be furnished to the attorney onor before January 31 of the year followingthe year in which the payment was made.

(b) Special rules—(1) Check deliveredto non-payee attorney. If a check is deliv-ered to an attorney who is not a payee, aninformation return must be filed underparagraph (a)(1) of this section with re-spect to the attorney if, under the circum-stances, it is reasonable for the payor tobelieve that the attorney is receiving thecheck in connection with legal services.

(2) Joint or multiple payees—(i)Check delivered to attorney.If more thanone attorney is listed as a payee on acheck, an information return must be filedunder paragraph (a)(1) of this section withrespect to the attorney who received thecheck.

1999–23 I.R.B. 17 June 7, 1999

(ii) Check delivered to non-attorney.Ifa check has attorney and non-attorneypayees and the check is delivered to a non-attorney, an information return must befiled under paragraph (a)(1) of this sectionwith respect to the first listed attorney.

(3) Attorney required to report pay-ments made to the other attorneys.An at-torney with respect to whom an informa-tion return is filed under paragraph (b)(1)or (2) of this section must file informationreturns, as required under this section, forpayments the attorney makes to any otherattorneys.

(c) Exceptions. A return of informa-tion is not required under paragraph (a)(1)of this section with respect to the follow-ing payments:

(1) Payments of wages or other com-pensation paid to an attorney by the attor-ney’s employer.

(2) Payments of compensation or prof-its paid or distributed to its individualpartner by a partnership engaged in pro-viding legal services.

(3) Payments of dividends or corporateearnings and profits paid to its share-holder by a corporation engaged in pro-viding legal services.

(4) Payments of income to an attorneyof a fixed or determinable amount re-quired to be reported (or payments thatwould be required to be reported were itnot for failing to meet the dollar amountlimitation contained in section 6041(a))pursuant to section 6041(a) and §1.6041–1(a).

(5) Payments of the balance of thegross proceeds made to an attorney if apayment described in paragraph (c)(4) ofthis section is made.

(6) Payments made to a foreign attor-ney, if the foreign attorney can clearlydemonstrate that the attorney is not sub-ject to U.S. tax.

(d) Definitions. The following defini-tions apply for purposes of this section:

(1) Attorneymeans a person engagedin the practice of law, whether as a soleproprietor, partnership, corporation, orjoint venture.

(2) Legal servicesmeans all servicesperformed by, or under the supervision of,an attorney.

(e) Attorney to furnish TIN.A payorthat is required to make an information re-turn under this section must solicit a TIN

from the attorney at or before the time thepayor pays gross proceeds to the attorney.Any attorney whose TIN is solicited mustfurnish the TIN to the payor, but is not re-quired to certify that the TIN is correct.Except as otherwise provided under sec-tion 3406, if the attorney does not furnishthe attorney’s TIN, the payment is subjectto backup withholding.

(f) Examples. The provisions of thissection are illustrated by the following ex-amples:

Example 1.A, a plaintiff in a suit for lost wagesagainst T, is represented by attorney B. A settles hersuit for $300,000. Payment is made by a checkpayable jointly to A and B. T does not know theamount of the attorney fee. B retains $100,000 anddisburses the remaining $200,000 net proceeds to A.

T must file a Form W-2 for $300,000 with respectto A under section 6051. T must also file a Form1099-MISC with respect to B for $300,000 (seeparagraph (a)(1)(iii) of this section).

Example 2. The facts are the same as in Example1, except that T knows that the attorney fee is one-third of the settlement amount, or $100,000. T mustfile a Form W-2 for $300,000 with respect to Aunder section 6051. T must also file a Form 1099-MISC with respect to B for $100,000 under section6041. T is not required to file an information returnwith respect to B for $200,000 (the balance of thegross proceeds) because of the exception providedin paragraph (c)(5) of this section.

Example 3. C, a plaintiff in a suit for physicalpersonal injury against V, is represented by attorneyD. C settles his suit for damages that are excludablefrom C’s gross income under section 104(a)(2). Thesettlement check is payable jointly to C and D. Vdoes not know the amount of the attorney fee. Vmust file a return of information with respect to Dunder paragraph (a)(1) of this section. V is not re-quired to file a return of information with respect toC under section 6041 because the settlement amountis excludable from C’s income under section104(a)(2).

Example 4.W, a defendant in a suit for wrongfulinjury, knows that D, the plaintiff, has been repre-sented by attorney E throughout the proceeding.State O, where the suit is brought, mandates that cer-tain benefits and settlement awards be made payableto the claimant only. W makes a check payablesolely to D and delivers the payment to E’s office.W has made a payment to an attorney (see paragraph(b)(1) of this section) and must file a return of infor-mation under paragraph (a) of this section.

Example 5. X, a defendant in a suit for lostwages, reasonably believes that F, the plaintiff, hasbeen represented by attorney G throughout the pro-ceeding as evidenced by filings and correspondencesigned by G. X makes a check for damages payablesolely to F and delivers it to G’s office. X has madea payment to an attorney (see paragraph (b)(1) ofthis section) and must file a return of informationunder paragraph (a) of this section.

Example 6.Y, a defendant in a suit, makes a pay-ment of the gross proceeds of the amount awardedunder the suit to the plaintiff’s attorneys, H, I, and J.

H, I, and J are not related parties. The payment isdelivered to J’s office. J deposits the monies into hertrust account and pays H and I their respectiveshares. Y must file a return of information with re-spect to J (see paragraph (b)(2)(i) of this section). Jmust file a return of information with respect to Hand I (see paragraph (b)(3) of this section).

(g) Cross reference to penalties.Seethe following sections regarding penaltiesfor failure to comply with the require-ments of section 6045(f) and this section:

(1) Section 6721 for failure to file acorrect information return.

(2) Section 6722 for failure to furnish acorrect payee statement.

(3) Section 6723 for failure to complywith other information reporting require-ments (including the requirement to fur-nish a TIN).

(4) Section 7203 for willful failure tosupply information (including a taxpayeridentification number).

(h) Effective date.The rules in thissection apply to payments made after De-cember 31, 1999.

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on May20, 1999, 8:45 a.m., and published in the issue of theFederal Register for May 21, 1999, 64 F.R. 27730)

Notice of Proposed Rulemakingand Notice of Public Hearing

Special Rules Regarding theSimplified Production andResale Methods With HistoricAbsorption Ratio Election

REG–113910–98

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemakingand notice of public hearing.

SUMMARY: This document containsproposed regulations under section 263Athat relate to accounting for costs incurredin producing property and acquiring prop-erty for resale. The proposed regulationsare necessary to address specific prob-lems in the current section 263A regula-tions and affect persons who elect to usethe simplified production or resale meth-

June 7, 1999 18 1999–23 I.R.B.

ods with historic absorption ratio election.This document also provides notice of apublic hearing on these proposed regula-tions.

DATES: Written and electronic com-ments must be received by August 23,1999. Outlines of topics to be discussedat the public hearing scheduled for Sep-tember 1, 1999, at 10 a.m., must be re-ceived by August 11, 1999.

ADDRESSES: Send submissions to:CC:DOM:CORP:R (REG–113910–98),room 5226, Internal Revenue Service,POB 7604, Ben Franklin Station, Wash-ington, DC 20044. Submissions may behand delivered Monday through Fridaybetween the hours of 8 a.m. and 5 p.m. to:CC:DOM:CORP:R (REG–113910–98),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC. Alternatively, taxpayersmay submit comments electronically viathe Internet by selecting the “Tax Regs”option on the IRS Home Page, or by sub-mitting comments directly to the IRS In-ternet site at http://www.irs.ustreas.gov/tax_regs/regslist.html. The public hear-ing will be held in room 2615, InternalRevenue Building, 1111 Constitution Av-enue, NW, Washington, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the regulations, Jen-nifer Nuding, (202)622-4970; concerningsubmissions of comments, the hearing,and/or to be placed on the building accesslist to attend the hearing, LaNita VanDyke at (202) 622-7180 (not toll-freecalls).

SUPPLEMENTARY INFORMATION:

Background

Section 263A provides uniform rulesfor capitalization of certain expenses.Section 263A requires the capitalizationof the direct, and an allocable portion ofthe indirect, costs of real or tangible per-sonal property produced by a taxpayer orreal and personal property described insection 1221(1) that is acquired by thetaxpayer for resale. The rules under sec-tion 263A, which were added by the TaxReform Act of 1986, Public Law 99-514,section 803, 100 Stat. 2085, 2350, weredesigned, in part, to properly match in-

come with related expenses and, thus,more accurately reflect income. Theyalso were intended to make the tax systemmore neutral by eliminating the differ-ences in capitalization rules that createddistortions in the allocation of economicresources and the manner in which certaineconomic activity was organized. See S.Rep. No. 313, 99th Cong., 2d Sess. 140(1986), 1986–3 C.B. Vol. 3 140. How-ever, the legislative history provides au-thority to the Secretary to prescribe sim-plifying methods and assumptions wherethe costs and other burdens of literal com-pliance with section 263A may outweighthe benefits of the provision (e.g., match-ing and neutrality). S. Rep. No. 313, 99thCong., 2d Sess. 142 (1986).

Section 263A costs are the costs that ataxpayer must capitalize under section263A and equal the sum of a taxpayer’ssection 471 costs, its additional section263A costs, and interest capitalizableunder section 263A(f). Additional section263A costs are the costs, other than inter-est, that were not capitalized under thetaxpayer’s method of accounting immedi-ately prior to the effective date of section263A, but that are required to be capital-ized under section 263A.

Sections 1.263A–1 through 1.263A–3of the final regulations (T.D. 8482,1993–2 C.B. 77) were published in theFederal Registerfor August 9, 1993 (58F.R. 42207) and amended by T.D. 8559(59 F.R. 39958), T.D. 8584 (59 F.R.67187), T.D. 8597 (60 F.R. 36671), T.D.8728 (62 F.R. 42051) and T.D. 8729 (62F.R. 44542). The final regulations pro-vide simplified methods for determiningthe additional section 263A costs properlyallocable to eligible property on hand atthe end of the taxable year, including end-ing inventories of property produced andproperty acquired for resale. The finalregulations include the simplified produc-tion method contained in the temporaryregulations issued under 263A,§1.263A–1T(b)(5), T.D. 8131 (58 F.R.151), and the simplified resale method, aredesignation of the modified resalemethod set forth in Notice 89-67, 1989–1C.B. 723. A taxpayer using either thesimplified production method or the sim-plified resale method determines the addi-tional section 263A costs properly alloca-ble to eligible property on hand at the end

of the taxable year by multiplying its ab-sorption ratio by the section 471 costs onhand at year-end. Under both the simpli-fied production method and the simplifiedresale method, an absorption ratio is cal-culated annually and applied to determinethe additional section 263A costs allo-cated to ending inventory.

In response to requests for additionalsimplification, the final regulations pro-vide an election to use an historic absorp-tion ratio to determine additional section263A costs allocable to eligible propertyon hand at year-end that may be used inconnection with either the simplified pro-duction method or the simplified resalemethod.

The final regulations permit a taxpayerthat properly elects to use the historic ab-sorption ratio to determine the additionalsection 263A costs allocable to eligibleproperty on hand at the end of the taxableyear by using an historic absorption ratioin lieu of an actual absorption ratio, i.e.,by multiplying the historic absorptionratio by section 471 costs on hand at year-end. The historic absorption ratio isbased on costs capitalized by a taxpayerduring its test period, generally the threetaxable-year period immediately prior tothe taxable year that the taxpayer electsthe historic absorption ratio. The historicabsorption ratio equals the taxpayer’s ad-ditional section 263A costs incurred dur-ing the test period divided by the section471 costs incurred by the taxpayer duringthe test period. Under the final regula-tions, taxpayers are required to test the ac-curacy of the historic absorption ratioevery six years. If the test of the ratio in-dicates more than one-half of one percent-age point difference (plus or minus) fromthe historic absorption ratio, the taxpayermust redetermine its historic absorptionratio using a new updated test period.The final regulations provide that, ifelected, the historic absorption ratio mustbe used for each taxable year within thequalifying period. Generally, the qualify-ing period includes each of the first fivetaxable years beginning with the first tax-able year after a test period (or an updatedtest period).

Explanation of Provisions

This document contains proposedamendments to the Income Tax Regula-

1999–23 I.R.B. 19 June 7, 1999

tions (26 CFR part 1) that relate to thecapitalization of certain costs under sec-tion 263A. More specifically, this docu-ment contains proposed amendments withrespect to the historic absorption ratioelection that are necessary to carry out thepurpose of section 263A. The rules undersection 263A were designed to properlymatch income with related expenses byrequiring all of the costs relating to anitem produced or acquired for resale to beincluded in the basis or inventoriable costof that item. The simplified productionmethod and the simplified resale methodwere included in the regulations to pro-vide taxpayers with a simplified methodfor determining the additional section263A costs allocable to items on hand atyear end. The historic absorption ratioelection was provided in response to com-mentators’ concerns that computationsunder the simplified production methodand the simplified resale method arecostly and time consuming because tax-payers must determine absorption ratiosannually, even though there may havebeen little or no change in the taxpayers’business operations that would cause theabsorption ratios to vary from year toyear.

The historic absorption ratio election inthe final regulations is intended to permittaxpayers to determine additional section263A costs allocable to items on hand atyear-end without calculating actual ab-sorption ratios while still capitalizing thecosts properly allocable to property pro-duced or acquired for resale. The historicabsorption ratio was selected in lieu of anindustry-based ratio because the IRS andTreasury Department believed that a ratiobased on taxpayer specific historical datawould more reasonably approximate thetaxpayer’s annual absorption ratio than anindustry-based ratio.

The IRS and Treasury Department havebecome aware that the historic absorptionratio may become materially inaccurategenerally as the result of a significantchange in a taxpayer’s circumstances dur-ing the qualifying period, thus resulting ina failure to allocate the proper amount ofadditional section 263A costs to items onhand at year-end. Although the regula-tions provide that a taxpayer must test itshistoric absorption ratio every six years, asignificant deviation from the taxpayer’s

actual absorption ratio could result in asubstantial mismatching of the taxpayer’sincome and related expenses during thequalifying period.

The IRS and Treasury Department con-sidered many alternate approaches to re-vising the historic absorption ratio regula-tions in order to prevent a substantialmismatching of income and related ex-penses. Among the approaches consid-ered and rejected were the following: (1)eliminate the historic absorption ratioelection entirely; (2) limit use of the his-toric absorption ratio election to smalltaxpayers; (3) require taxpayers to retesttheir historic absorption ratio more fre-quently, e.g., every three years; and (4)provide a general anti-abuse rule.

These proposed regulations provide forearly termination of the qualifying periodif the taxpayer’s historic absorption ratiois materially inaccurate. In such a case,the taxpayer must calculate a new historicabsorption ratio beginning with the yearin which the taxpayer’s historic absorp-tion ratio became materially inaccurate.

Generally, a taxpayer’s historic absorp-tion ratio may become materially inaccu-rate when the taxpayer experiences a sig-nificant change in the taxpayer’s normalbusiness operations and that change hasan effect on the taxpayer’s section 263Aabsorption ratio. For example, the fol-lowing changes may cause a taxpayer’shistoric absorption ratio to become mate-rially inaccurate: a significant change inthe taxpayer’s manufacturing process, e.g.implementation of a new inventory man-agement system; a significant change inthe taxpayer’s product offering; a signifi-cant addition or retirement of equipmentused for manufacturing; a significantchange in the taxpayer’s components ofcost, e.g., a manufacturing operation thatbecomes significantly more or less laborintensive; a significant change in the tax-payer’s overhead costs, e.g. a new plant,building or building addition; and a sig-nificant change in the taxpayer’s trade orbusiness, e.g., the sale or acquisition of adivision.

The proposed regulations establish ahigh threshold for when the historic ab-sorption ratio will be regarded as materi-ally inaccurate. The regulations provide adefinition of materially inaccurate that in-corporates both a percentage test and a

specific dollar amount test. The regula-tions provide that the historic absorptionratio is materially inaccurate if: (1) thetaxpayer’s actual absorption ratio deviatesby more than 50% and by more than one-half of one percentage point from the tax-payer’s historic absorption ratio; and (2)the amount of additional section 263Acosts capitalizable to items on hand atyear-end using the actual absorption ratiodeviates by more than $100,000 from theamount of additional section 263A costscapitalizable to items on hand at year-endusing the historic absorption ratio. Thishigh threshold is provided so that annualactual absorption ratio computations willbe unnecessary in the overwhelming ma-jority of situations. For example, theplacement in service of a significantamount of property may have a signifi-cant effect on a taxpayer’s actual absorp-tion ratio. However, it may not be neces-sary for a taxpayer to compute its actualabsorption ratio for a year that the tax-payer placed property in service if, basedon the taxpayer’s knowledge of the differ-ence between its tax depreciation andbook depreciation, and its inventoryturnover, the taxpayer knows that it wouldbe impossible for the amount of addi-tional section 263A costs allocable toitems on hand at year-end to increase by$100,000 if the taxpayer used the simpli-fied production method without the his-toric absorption ratio election. Therefore,the taxpayer would not need to calculatean actual absorption ratio for that year.

Proposed Effective Date

The provisions of these regulations areproposed to be effective for taxable yearsbeginning after May 24, 1999.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in EO12866. Therefore, a regulatory assess-ment is not required. It also has been de-termined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions, and because the regulations do notimpose a collection of information onsmall entities, the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Pursuant to section 7805(f) of the Internal

June 7, 1999 20 1999–23 I.R.B.

Revenue Code, this notice of proposedrulemaking will be submitted to the ChiefCounsel for Advocacy of the Small Busi-ness Administration for comment on itsimpact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considera-tion will be given to any written com-ments (a signed original and eight (8)copies) and electronic comments that aresubmitted timely to the IRS. The IRS andTreasury Department request commentson the clarity of the proposed rules andhow they can be made easier to under-stand. All comments will be available forpublic inspection and copying.

A public hearing has been scheduledfor Wednesday, September 1, 1999, inroom 2615, Internal Revenue Building,1111 Constitution Avenue, NW, Washing-ton, DC. Due to building security proce-dures, visitors must enter at the 10thStreet entrance, located between Consti-tution and Pennsylvania Avenues, NW. Inaddition, all visitors must present photoidentification to enter the building. Be-cause of access restrictions, visitors willnot be admitted beyond the immediate en-trance area more than 15 minutes beforethe hearing starts. For information abouthaving your name placed on the buildingaccess list to attend the hearing, see the“FOR FURTHER INFORMATIONCONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3)apply to the hearing.

Persons who wish to present oral com-ments at the hearing must submit writtenor electronic comments by August 23,1999 and submit an outline of the topicsto be discussed and the time to be devotedto each topic (a signed original and eight(8) copies) by August 11, 1999.

A period of 10 minutes will be allo-cated to each person for making com-ments.

An agenda showing the scheduling ofthe speakers will be prepared after thedeadline for receiving outlines haspassed. Copies of the agenda will beavailable free of charge at the hearing.

Drafting Information

The principal author of these regula-tions is Jennifer Nuding of the Office of

Assistant Chief Counsel (Income Tax andAccounting). However, other personnelfrom the IRS and Treasury Departmentparticipated in their development.

* * * * *

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is pro-posed to be amended as follows:

Part 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.263A–2 is amended

as follows:1. Paragraphs (b)(4)(ii)(C)(1) and (2)

are revised;2. New paragraphs (b)(4)(ii)(C)(3) and

(4) are added;3. Paragraph (b)(4)(vi) is amended by:

a. Revising the paragraph headingand introductory text;

b. Redesignating the Exampleas Ex-ample 1;

c. Adding new Example 2and Ex-ample 3.

The revisions and additions read as fol-lows:

§1.263A–2 Rules relating to propertyproduced by the taxpayer.

* * * * *

(b) * * *(4) * * *(ii) * * *(C) Qualifying period—(1) In general.

A qualifying period generally includeseach of the first five taxable years begin-ning with the first taxable year after a testperiod (or an updated test period). How-ever, a qualifying period may be extendedunder the provisions of paragraph(b)(4)(ii)(C)(2) of this section or may ter-minate early under the provisions of para-graph (b)(4)(ii)(C)(3) of this section.

(2) Extension of qualifying period.Inthe first taxable year following the closeof each qualifying period, (e.g., the sixthtaxable year following the test period),the taxpayer must compute the actual ab-sorption ratio under the simplified pro-duction method. If the actual absorptionratio computed for this taxable year (therecomputation year) is within one-half ofone percentage point (plus or minus) of

the historic absorption ratio used in deter-mining capitalizable costs for the qualify-ing period (e.g., the previous five taxableyears), the qualifying period is extendedto include the recomputation year and thefollowing five taxable years (or a shorterperiod if the qualifying period is termi-nated early under the provisions of para-graph (b)(4)(ii)(C)(3) of this section), andthe taxpayer must continue to use the his-toric absorption ratio throughout the ex-tended qualifying period. If, however, theactual absorption ratio computed for therecomputation year is not within one-halfof one percentage point (plus or minus) ofthe historic absorption ratio, the taxpayermust use actual absorption ratios begin-ning with the recomputation year underthe simplified production method andthroughout the updated test period. Thetaxpayer must resume using the historicabsorption ratio (determined with refer-ence to the updated test period) in thethird taxable year following the recompu-tation year.

(3) Earlier termination of the qualify-ing period.For taxable years beginningafterMay 24, 1999, a qualifying periodcloses immediately prior to a taxable yearin which the taxpayer’s historic absorp-tion ratio becomes materially inaccurate(early recomputation year). If the tax-payer’s historic absorption ratio is materi-ally inaccurate, as defined in paragraph(b)(4)(ii)(C)(4) of this section, the tax-payer must use its actual absorption ratioscomputed using the simplified productionmethod beginning with the early recom-putation year and throughout the updatedtest period. The taxpayer must resumeusing the historic absorption ratio (deter-mined with reference to the updated testperiod) in the third taxable year followingthe early recomputation year.

(4) Materially inaccurate.For purposesof this paragraph (b)(4), an historic ab-sorption ratio becomes materially inaccu-rate in a taxable year that—

(i) The taxpayer’s actual absorptionratio computed using the simplified pro-duction method deviates by more than 50percent and by more than one-half of onepercentage point from the taxpayer’s his-toric absorption ratio for that year; and

(ii ) The amount of additional section263A costs capitalizable to eligible prop-erty remaining on hand at the close of thatyear under the simplified production

(iii) In 1998, K incurs $90,000,000 of section 471costs of which $15,000,000 remain in inventory atthe end of the year. In addition, K places$50,000,000 of plant and equipment into service.K’s book depreciation on the new plant and equip-ment is $5,000,000, while K’s tax depreciation on

the new plant and equipment is $10,000,000. K’sbook depreciation is a section 471 cost as describedin §1.263A–1(d)(2) and the excess of K’s tax depre-ciation over K’s book depreciation, $5,000,000, isan additional section 263A cost. K also has$4,500,000 in other additional section 263A costs.

(iv) K must determine whether K’s historic ab-sorption ratio is materially inaccurate in 1998.Under the simplified production method without thehistoric absorption ratio election, K determines itsactual absorption ratio for 1998 as follows:

1999–23 I.R.B. 21 June 7, 1999

method (using the taxpayer’s actual ab-sorption ratio) deviates by more than$100,000 from the amount of additionalsection 263A costs capitalizable to thatproperty under the simplified productionmethod with historic absorption ratioelection for that year.

* * * * *

(vi) Examples.The provisions of thisparagraph (b)(4) are illustrated by the fol-lowing examples:

Example 1.* * *

Example 2.(i) Taxpayer K uses the FIFO method

of accounting for inventories and properly elects to

use the historic absorption ratio with the simplified

production method for 1998. K identifies the fol-

lowing costs incurred during the test period:

1995:Add’l section 263A costs — $3,500,000 Section 471costs — $75,000,0001996:Add’l section 263A costs — $4,000,000 Section 471costs — $80,000,0001997:Add’l section 263A costs — $4,500,000 Section 471costs — $85,000,000

(ii) Therefore, K computes a 5% historic absorp-tion ratio as follows:

Historic absorption ratio =$3,500,000 + 4,000,000 + 4,500,000

= 5%$75,000,000 + 80,000,000 + 85,000,000

Actual absorption Ratio =$4,500,000 + $5,000,000

= 10%$90,000,000 + $5,000,000

(v) The difference between K’s actual absorptionratio (10%) under the simplified production methodfor 1998 and K’s historic absorption ratio (5%) is5%, which is greater than 50 percent of K’s historicabsorption ratio for that year (5% x 50% = 2.5%).Under the simplified production method without thehistoric absorption ratio election, K determines theadditional section 263A costs allocable to its endinginventory by multiplying its actual absorption ratio(10%) by the section 471 costs remaining in its end-ing inventory as follows:

Add’l section 263A costs = 10% 3 $15,000,000= $1,500,000

(vi) Under the simplified production methodusing the historic absorption ratio, K determines theadditional section 263A costs allocable to its endinginventory by multiplying its historic absorption ratio(5%) by the section 471 costs remaining in its end-ing inventory as follows:

Add’l section 263A costs = 5% 3 $15,000,000 =$750,000

(vii) The difference between the amount of addi-tional section 263A costs allocable to eligible prop-erty remaining on hand at the close of 1998 underthe simplified production method using the tax-payer’s actual absorption ratio and the amount of ad-ditional section 263A costs allocable to that propertyunder the simplified production method with his-toric absorption ratio election ($1,500,000 –$750,000 = $750,000) exceeds $100,000. Accord-ingly, K’s historic absorption ratio is materially inac-curate for 1998.

(viii) Since K’s historic absorption ratio is mate-rially inaccurate in 1998, K’s qualifying periodcloses immediately prior to the beginning of K’s1998 taxable year. Therefore, K must update its testperiod beginning in 1998. K must use actual absorp-tion ratios under the simplified production methodbeginning in 1998 and throughout the updated testperiod (1999 and 2000). K must resume using thehistoric absorption ratio (determined with referenceto the updated test period) in 2001, the third taxableyear following 1998.

Example 3. (i) Taxpayer L properly elects to usethe historic absorption ratio with the simplified pro-

duction method for 1999. L computes a 10% his-toric absorption ratio. On average, L’s inventoryturns over approximately fifteen times a year.

(ii) In 1999, L incurs $8,000,000 of section 471costs of which $500,000 remain in inventory at theend of the year. In addition, L places $5,000,000 ofplant and equipment into service. The difference be-tween L’s tax depreciation on the new plant andequipment and L’s book depreciation on that plantand equipment for 1999 is $500,000, which is an ad-ditional section 263A cost. There were no otherchanges in L’s additional 263A costs.

(iii) L can determine, without calculating an actualabsorption ratio, that its historic absorption ratio is notmaterially inaccurate for 1999. The difference be-tween the amount of additional section 263A costs al-located to its ending inventory using its actual absorp-tion ratio and the amount of additional section 263Acosts allocated to its ending inventory using its his-toric absorption ratio will not exceed $100,000 and,therefore, L does not fall within the specific dollaramount test of paragraph (b)(4)(ii)(C)(4)(ii ) of thissection. Although L’s additional section 263A costsincreased by over $100,000 in 1999 (they increasedby $500,000) as a result of placing the plant andequipment into service, only a portion of that amountwill be allocated to ending inventory. L’s inventoryturns over approximately fifteen times a year. Of the$500,000 of additional section 263A costs incurred asthe result of placing the plant and equipment into ser-vice in 1999, only about $33,000 ($500,000 4 15)will be allocated to ending inventory. Since $33,000is well below the $100,000 threshold, L can deter-mine without calculating an actual absorption ratiofor 1999 that its historic absorption ratio is not materi-ally inaccurate. Since L’s historic absorption ratio isnot materially inaccurate in 1999, L’s qualifying pe-riod does not terminate early.

* * * * *

Par. 3. Section 1.263A-3 is amended asfollows:

1. Paragraphs (d)(4)(ii)(C)(1) and (2)are revised;

2. New paragraphs (d)(4)(ii)(C)(3) and(4) are added;

3. Paragraph (d)(4)(vi) is amended by:a. Revising the paragraph heading

and introductory text;b. Redesignating the Example as Ex-

ample 1;c. Adding new Example 2.

The revisions and additions read as fol-lows:

§1.263A–3 Rules relating to propertyacquired for resale.

* * * * *

(d) * * *(4) * * *(ii) * * *(C) Qualifying period—(1) In general.

A qualifying period generally includeseach of the first five taxable years begin-ning with the first taxable year after a testperiod (or an updated test period). How-ever, a qualifying period may be extendedunder the provisions of paragraph(d)(4)(ii)(C)(2) of this section or may ter-minate early under the provisions of para-graph (d)(4)(ii)(C)(3) of this section.

(2) Extension of qualifying period.Inthe first taxable year following the closeof each qualifying period, (e.g., the sixthtaxable year following the test period),the taxpayer must compute the actualcombined absorption ratio under the sim-plified resale method. If the actual com-bined absorption ratio computed for thistaxable year (the recomputation year) iswithin one-half of one percentage point

(iii) In 1999, W decides to automate part of itsrepackaging activities. Accordingly, W places newrepackaging equipment into service. The repackag-ing equipment has a basis of $15,000,000 for taxpurposes. W’s tax depreciation on the new equip-ment for 1999 is $3,000,000. This depreciation al-lowance is an additional section 263A cost and is ahandling cost as defined in paragraph (c)(4) of thissection. As a result of the new equipment, W’s di-rect labor costs with respect to its repackaging activ-ities decrease by $500,000 during 1999. In 1999, Wincurs $60,000,000 of section 471 costs, of which$6,000,000 remain on hand at the end of the year. Widentifies $6,000,000 of storage and handling costs,including W’s tax depreciation on the new equip-ment and taking into account the reduction in directlabor costs, and $450,000 of purchasing costs in-curred in 1999.

(iv) W must determine whether W’s historic ab-sorption ratio is materially inaccurate in 1999. Inorder to do so, W calculates W’s actual combinedabsorption ratio for 1999 as follows:

Storage & handling costs=

$6,000,000= 10%

absorption ratio $60,000,000Purchasing costs

=$450,000

= 0.75%absorption ratio $60,000,000

Combined absorption ratio = 10% + 0.75% =10.75%

(v) The difference between W’s actualcombined absorption ratio (10.75%)under the simplified resale method for1999 and W’s historic absorption ratio(5%) is 5.75%, which is greater than 50percent of W’s historic absorption ratiofor that year (5% 3 50% = 2.5%). Underthe simplified resale method without thehistoric absorption ratio election, W de-termines the additional section 263A costsallocable to its ending inventory by multi-plying its actual combined absorptionratio (10.75%) by the section 471 costsremaining in its ending inventory as fol-lows:

Add’l section 263A costs = 10.75% 3$6,000,000 = $645,000

(vi) Under the simplified resale methodusing the historic absorption ratio, W de-termines the additional section 263A costs

allocable to its ending inventory by multi-plying its historic absorption ratio (5%) bythe section 471 costs remaining in its end-ing inventory as follows:

Add’l section 263A costs = 5% 3$6,000,000 = $300,000

(vii) The difference between theamount of additional section 263A costsallocable to eligible property remainingon hand at the close of 1999 under thesimplified resale method using the tax-payer’s actual combined absorption ratioand the amount of additional section263A costs allocable to that propertyunder the simplified resale method withhistoric absorption ratio election($645,000 – $300,000 = $345,000) ex-ceeds $100,000. Accordingly, W’s his-toric absorption ratio is materially inaccu-rate for 1999.

(viii) Since W’s historic absorptionratio was materially inaccurate in 1999,

June 7, 1999 22 1999–23 I.R.B.

(plus or minus) of the historic absorptionratio used in determining capitalizablecosts for the qualifying period (e.g., theprevious five taxable years), the qualify-ing period is extended to include the re-computation year and the following fivetaxable years (or a shorter period if thequalifying period is terminated earlyunder the provisions of paragraph(d)(4)(ii)(C)(3) of this section), and thetaxpayer must continue to use the historicabsorption ratio throughout the extendedqualifying period. If, however, the actualcombined absorption ratio computed forthe recomputation year is not within one-half of one percentage point (plus orminus) of the historic absorption ratio, thetaxpayer must use actual combined ab-sorption ratios beginning with the recom-putation year under the simplified resalemethod and throughout the updated testperiod. The taxpayer must resume usingthe historic absorption ratio (determinedwith reference to the updated test period)in the third taxable year following the re-computation year.

(3) Earlier termination of the qualify-ing period. For taxable years beginningafter [INSERT DATE OF PUBLICA-TION OF THIS DOCUMENT IN THEFEDERAL REGISTER], a qualifying pe-riod closes immediately prior to a taxable

year in which the taxpayer’s historic ab-sorption ratio becomes materially inaccu-rate (early recomputation year). If the tax-payer ’s historic absorption ratio ismaterially inaccurate, as defined in para-graph (d)(4)(ii)(C)(4) of this section, thetaxpayer must use its actual combined ab-sorption ratios computed using the simpli-fied resale method beginning with theearly recomputation year and throughoutthe updated test period. The taxpayermust resume using the historic absorptionratio (determined with reference to theupdated test period) in the third taxableyear following the early recomputationyear.

(4) Materially inaccurate.For purposesof this paragraph (d)(4), an historic ab-sorption ratio becomes materially inaccu-rate in a taxable year that—

(i) The taxpayer’s actual combined ab-sorption ratio computed using the simpli-fied resale method deviates by more than50 percent and by more than one-half ofone percentage point from the taxpayer’shistoric absorption ratio for that year; and

(ii ) The amount of additional section263A costs capitalizable to eligible prop-erty remaining on hand at the close of thatyear under the simplified resale method(using the taxpayer’s actual combined ab-sorption ratio) deviates by more than

$100,000 from the amount of additionalsection 263A costs capitalizable to thatproperty under the simplified resalemethod with historic absorption ratioelection for that year.

* * * * *

(vi) Examples. The provisions of thisparagraph (d)(4) are illustrated by the fol-lowing examples:

Example 1.* * *

Example 2.(i) Taxpayer W operates a mail-orderretail business and uses the FIFO method of ac-counting for inventories. In 1996, 1997 and 1998,W used the simplified resale method without the his-toric absorption ratio election with the variation per-mitted in paragraph (d)(3)(iii)(A) of this section, ex-clusion of beginning inventories from thedenominator in the storage and handling costs ab-sorption ratio formula. Taxpayer W elects to use thehistoric absorption ratio with the simplified resalemethod for 1999. W identifies the following costsincurred during the test period:

1996:Add’l section 263A costs — $2,000,000 Section 471costs — $45,000,0001997:Add’l section 263A costs — $2,500,000 Section 471costs — $50,000,0001998:Add’l section 263A costs — $3,000,000 Section 471costs — $55,000,000

(ii) Therefore, W computes a 5% historic absorp-tion ratio as follows:

Historic absorption ratio =$2,000,000 + 2,500,000 + 3,000,000

= 5%$45,000,000 + 50,000,000 + 55,000,000

1999–23 I.R.B. 23 June 7, 1999

W’s qualifying period closes immediatelyprior to the beginning of W’s 1999 tax-able year. Therefore, W must update itstest period beginning in 1999. W mustuse actual combined absorption ratiosunder the simplified resale method begin-ning in 1999 and throughout the updatedtest period (2000 and 2001). W must re-

sume using the historic absorption ratio(determined with reference to the updatedtest period) in 2002, the third taxable yearfollowing 1999.

* * * * *

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on May21, 1999, 8:45 a.m., and published in the issue of theFederal Register for May 24, 1999, 64 F.R. 27936)

June 7, 1999 24 1999–23 I.R.B.

Revenue rulings and revenue procedures(hereinafter referred to as “rulings”)that have an effect on previous rulingsuse the following defined terms to de-scribe the effect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus,if an earlier ruling held that a principleapplied to A, and the new ruling holdsthat the same principle also applies to B,the earlier ruling is amplified. (Comparewith modified, below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.

Distinguisheddescribes a situationwhere a ruling mentions a previouslypublished ruling and points out an essen-tial difference between them.

Modified is used where the substanceof a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A but notto B, and the new ruling holds that it ap-

plies to both A and B, the prior ruling ismodified because it corrects a publishedposition. (Compare with amplified andclarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly usedin a ruling that lists previously publishedrulings that are obsoleted because ofchanges in law or regulations. A rulingmay also be obsoleted because the sub-stance has been included in regulationssubsequently adopted.

Revoked describes situations where theposition in the previously published rul-ing is not correct and the correct positionis being stated in the new ruling.

Superseded describes a situation wherethe new ruling does nothing more thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over a pe-riod of time in separate rulings. If the

new ruling does more than restate thesubstance of a prior ruling, a combinationof terms is used. For example, modifiedand superseded describes a situationwhere the substance of a previously pub-lished ruling is being changed in part andis continued without change in part and itis desired to restate the valid portion ofthe previously published ruling in a newruling that is self contained. In this casethe previously published ruling is firstmodified and then, as modified, is super-seded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling andthat list is expanded by adding furthernames in subsequent rulings. After theoriginal ruling has been supplementedseveral times, a new ruling may be pub-lished that includes the list in the originalruling and the additions, and supersedesall prior rulings in the series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current use and for-merly used will appear in material published in theBulletin.

A—Individual.

Acq.—Acquiescence.

B—Individual.

BE—Beneficiary.

BK—Bank.

B.T.A.—Board of Tax Appeals.

C.—Individual.

C.B.—Cumulative Bulletin.

CFR—Code of Federal Regulations.

CI—City.

COOP—Cooperative.

Ct.D.—Court Decision.

CY—County.

D—Decedent.

DC—Dummy Corporation.

DE—Donee.

Del. Order—Delegation Order.

DISC—Domestic International Sales Corporation.

DR—Donor.

E—Estate.

EE—Employee.

E.O.—Executive Order.

ER—Employer.

ERISA—Employee Retirement Income Security Act.

EX—Executor.

F—Fiduciary.

FC—Foreign Country.

FICA—Federal Insurance Contribution Act.

FISC—Foreign International Sales Company.

FPH—Foreign Personal Holding Company.

F.R.—Federal Register.

FUTA—Federal Unemployment Tax Act.

FX—Foreign Corporation.

G.C.M.—Chief Counsel’s Memorandum.

GE—Grantee.

GP—General Partner.

GR—Grantor.

IC—Insurance Company.

I.R.B.—Internal Revenue Bulletin.

LE—Lessee.

LP—Limited Partner.

LR—Lessor.

M—Minor.

Nonacq.—Nonacquiescence.

O—Organization.

P—Parent Corporation.

PHC—Personal Holding Company.

PO—Possession of the U.S.

PR—Partner.

PRS—Partnership.

PTE—Prohibited Transaction Exemption.

Pub. L.—Public Law.

REIT—Real Estate Investment Trust.

Rev. Proc.—Revenue Procedure.

Rev. Rul.—Revenue Ruling.

S—Subsidiary.

S.P.R.—Statements of Procedral Rules.

Stat.—Statutes at Large.

T—Target Corporation.

T.C.—Tax Court.

T.D.—Treasury Decision.

TFE—Transferee.

TFR—Transferor.

T.I.R.—Technical Information Release.

TP—Taxpayer.

TR—Trust.

TT—Trustee.

U.S.C.—United States Code.

X—Corporation.

Y—Corporation.

Z—Corporation.

Definition of Terms

1999–23 I.R.B. 25 June 7, 1999

1 See footnote at end of list.

Numerical Finding List1

Bulletins 1999–1 through 1999–22

Announcements:

99–1, 1999–2 I.R.B. 4199–2, 1999–2 I.R.B. 4499–3, 1999–3 I.R.B. 1599–4, 1999–3 I.R.B. 1599–5, 1999–3 I.R.B. 1699–6, 1999–4 I.R.B.2499–7, 1999–2 I.R.B. 4599–8, 1999–4 I.R.B.2499–9, 1999–4 I.R.B. 2499–10, 1999–5 I.R.B. 6399–11, 1999–5 I.R.B. 6499–12, 1999–5 I.R.B. 6599–13, 1999–6 I.R.B. 1899–14, 1999–7 I.R.B.6099–15, 1999–8 I.R.B.7899–16, 1999–8 I.R.B. 8099–17, 1999–9 I.R.B. 5999–18, 1999–13 I.R.B. 2199–19, 1999–10 I.R.B. 6399–20, 1999–11 I.R.B.5399–21, 1999–11 I.R.B.5599–22, 1999–12 I.R.B. 3299–23, 1999–15 I.R.B. 799–24, 1999–14 I.R.B. 1299–25, 1999–12 I.R.B. 3599–26, 1999–14 I.R.B. 2099–27, 1999–13 I.R.B. 2299–28, 1999–13 I.R.B. 2599–29, 1999–13 I.R.B. 2599–30, 1999–13 I.R.B. 2699–31, 1999–13 I.R.B. 2699–32, 1999–14 I.R.B.2099–33, 1999–14 I.R.B. 2199–34, 1999–15 I.R.B. 899–35, 1999–14 I.R.B. 2299–36, 1999–16 I.R.B. 1099–37, 1999–15 I.R.B. 999–38, 1999–15 I.R.B. 999–39, 1999–15 I.R.B. 1099–40, 1999–16 I.R.B. 1099–41, 1999–16 I.R.B. 1099–42, 1999–16 I.R.B. 1199–43, 1999–16 I.R.B. 1199–44, 1999–16 I.R.B. 1299–45, 1999–16 I.R.B. 1299–46, 1999–16 I.R.B. 1399–48, 1999–17 I.R.B.2099–49, 1999–18 I.R.B.799–50, 1999–19 I.R.B. 699–51, 1999–19 I.R.B. 699–52, 1999–19 I.R.B. 999–53, 1999–20 I.R.B. 9599–54, 1999–21 I.R.B.3299–55, 1999–22 I.R.B.3499–56, 1999–22 I.R.B. 37

Notices:

99–1, 1999–2 I.R.B. 899–2, 1999–2 I.R.B. 899–3, 1999–2 I.R.B. 1099–4, 1999–3 I.R.B. 999–5, 1999–3 I.R.B. 1099–6, 1999–3 I.R.B. 1299–7, 1999–4 I.R.B.2399–8, 1999–5 I.R.B. 2699–9, 1999–4 I.R.B. 2399–10, 1999–6 I.R.B. 14

Notices—Continued

99–11, 1999–8 I.R.B.5699–12, 1999–9 I.R.B. 4499–13, 1999–10 I.R.B. 2699–14, 1999–11 I.R.B.799–15, 1999–12 I.R.B.2099–16, 1999–13 I.R.B.1099–17, 1999–14 I.R.B.699–18, 1999–16 I.R.B. 499–19, 1999–16 I.R.B. 499–20, 1999–17 I.R.B.1699–21, 1999–17 I.R.B. 1999–22, 1999–19 I.R.B.599–23, 1999–20 I.R.B.7399–24, 1999–20 I.R.B.7499–25, 1999–20 I.R.B.7599–26, 1999–21 I.R.B.399–27, 1999–21 I.R.B.499–28, 1999–21 I.R.B.899–29, 1999–21 I.R.B.899–30, 1999–22 I.R.B.5

Proposed Regulations:

REG–209103–89, 1999–11 I.R.B. 10REG–208156–91, 1999–22 I.R.B. 11REG–209619–93, 1999–10 I.R.B. 28REG–245562–96, 1999–9 I.R.B. 45REG–100905–97, 1999–22 I.R.B. 10REG–104072–97, 1999–11 I.R.B. 12REG–114663–97, 1999–6 I.R.B. 15REG–114664–97, 1999–11 I.R.B. 21REG–116826–97, 1999–10 I.R.B. 40REG–118620–97, 1999–9 I.R.B. 46REG–120168–97, 1999–12 I.R.B. 21REG–121806–97, 1999–10 I.R.B. 46REG–100729–98, 1999–14 I.R.B. 9REG–104924–98, 1999–10 I.R.B.47REG–105964–98, 1999–12 I.R.B. 22REG–106004–98, 1999–20 I.R.B. 77REG–106177–98, 1999–12 I.R.B. 25REG–106219–98, 1999–9 I.R.B. 51REG–106386–98, 1999–12 I.R.B. 31REG–106388–98, 1999–11 I.R.B. 27REG–106564–98, 1999–10 I.R.B.53REG–106902–98, 1999–8 I.R.B. 57REG–106905–98, 1999–11 I.R.B. 39REG–110524–98, 1999–10 I.R.B. 55REG–111435–98, 1999–7 I.R.B. 55REG–113694–98, 1999–7 I.R.B. 56REG–111435–98, 1999–7 I.R.B. 55REG–113744–98, 1999–10 I.R.B. 59REG–114841–98, 1999–11 I.R.B. 41REG–115433–98, 1999–9 I.R.B. 54REG–116099–98, 1999–12 I.R.B. 34REG–116824–98, 1999–7 I.R.B.57REG–117620–98, 1999–7 I.R.B. 59REG–118662–98, 1999–13 I.R.B. 13REG–119192–98, 1999–11 I.R.B. 45REG–121865–98, 1999–8 I.R.B.63REG–103851–99, 1999–20 I.R.B. 93

Railroad Retirement Quarterly Rate:

1999–22 I.R.B. 3

Revenue Procedures:

99–1, 1999–1 I.R.B. 699–2, 1999–1 I.R.B. 7399–3, 1999–1 I.R.B. 10399–4, 1999–1 I.R.B. 11599–5, 1999–1 I.R.B. 15899–6, 1999–1 I.R.B. 18799–7, 1999–1 I.R.B. 226

Revenue Procedures—Continued

99–8, 1999–1 I.R.B. 22999–9, 1999–2 I.R.B. 1799–10, 1999–2 I.R.B. 1199–11, 1999–2 I.R.B. 1499–12, 1999–3 I.R.B. 1399–13, 1999–5 I.R.B. 5299–14, 1999–5 I.R.B. 5699–15, 1999–7 I.R.B. 4299–16, 1999–7 I.R.B. 5099–17, 1999–7 I.R.B. 5299–18, 1999–11 I.R.B.799–19, 1999–13 I.R.B.1099–20, 1999–14 I.R.B.799–21, 1999–17 I.R.B. 1899–22, 1999–15 I.R.B.599–23, 1999–16 I.R.B.599–24, 1999–21 I.R.B.899–25, 1999–21 I.R.B.24

Revenue Rulings:

99–1, 1999–2 I.R.B. 499–2, 1999–2 I.R.B. 599–3, 1999–3 I.R.B. 499–4, 1999–4 I.R.B.1999–5, 1999–6 I.R.B.899–6, 1999–6 I.R.B. 699–7, 1999–5 I.R.B. 499–8, 1999–6 I.R.B.899–9, 1999–7 I.R.B.1499–10, 1999–10 I.R.B. 1099–11, 1999–10 I.R.B. 1899–12, 1999–11 I.R.B. 699–13, 1999–10 I.R.B. 499–14, 1999–13 I.R.B. 399–15, 1999–12 I.R.B.499–16, 1999–13 I.R.B.599–17, 1999–14 I.R.B. 499–18, 1999–14 I.R.B. 399–19, 1999–15 I.R.B. 399–20, 1999–18 I.R.B.599–21, 1999–18 I.R.B. 399–22, 1999–19 I.R.B.399–23, 1999–20 I.R.B.399–24, 1999–21 I.R.B.3

Tax Convention:

1999–22 I.R.B. 4

Treasury Decisions:

8789, 1999–3 I.R.B. 58791, 1999–5 I.R.B. 78792, 1999–7 I.R.B.368793, 1999–7 I.R.B.158794, 1999–7 I.R.B.48795, 1999–7 I.R.B.88796, 1999–4 I.R.B. 168797, 1999–5 I.R.B. 58798, 1999–12 I.R.B. 168799, 1999–6 I.R.B. 108800, 1999–4 I.R.B. 208801, 1999–4 I.R.B. 58802, 1999–4 I.R.B. 108803, 1999–12 I.R.B. 158804, 1999–12 I.R.B. 58805, 1999–5 I.R.B. 148806, 1999–6 I.R.B.48807, 1999–9 I.R.B. 338808, 1999–10 I.R.B. 218809, 1999–7 I.R.B.278810, 1999–7 I.R.B.198811, 1999–10 I.R.B. 19

June 7, 1999 26 1999–23 I.R.B.

Numerical Finding List–Continued


Treasury Decisions—Continued

8812, 1999–8 I.R.B. 198813, 1999–9 I.R.B. 348814, 1999–9 I.R.B. 48815, 1999–9 I.R.B. 318816, 1999–8 I.R.B. 48817, 1999–8 I.R.B. 518818, 1999–17 I.R.B.38819, 1999–20 I.R.B.5

1 A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., published inInternal Revenue Bulletins 1998–1 through 1998–52will be found in Internal Revenue Bulletin 1999–1,dated January 4, 1999.

1999–23 I.R.B. 27 June 7, 1999

Finding List of Current Action onPreviously Published Items1


Notices:

92–36Modified by Rev. Proc. 99–23, 1999–16 I.R.B. 5

94–16Obsoleted by Notice 99–22, 1999–19 I.R.B. 5




98–61Modified by99–29, 1999–21 I.R.B. 8


Revenue Procedures:

78–10Obsoleted by99–12, 1999–3 I.R.B. 13

89–9Modified by99–23, 1999–16 I.R.B. 5

89–13Modified by99–23, 1999–16 I.R.B. 5

93–39, section 13Modified by99–23, 1999–16 I.R.B. 5

94–56Superseded by99–9, 1999–2 I.R.B. 17

95–12Modified by99–23, 1999–16 I.R.B. 5


97–41Modified by99–23, 1999–16 I.R.B. 5




Revenue Procedures—Continued






98–14Modified by99–23, 1999–16 I.R.B. 5

98–22Modified and amplified by99–13, 1999–5 I.R.B. 52

98–28Obsoleted by (except as provided in section 5.02 of)99–22, 1999–15 I.R.B. 5




98–63Modified by announcement99–7, 1999–2 I.R.B. 45

Revenue Rulings:

92–19Supplemented in part by99–10, 1999–10 I.R.B. 10

1 A cumulative finding list for previously publisheditems mentioned in Internal Revenue Bulletins1998–1 through 1998–52 will be found in InternalRevenue Bulletin 1999–1, dated January 4, 1999.

Notes

June 7, 1999 28 1999–23 I.R.B.

1999–23 I.R.B. 29 June 7, 1999

Notes

June 7, 1999 30 1999–23 I.R.B.

Notes

INTERNAL REVENUE BULLETINThe Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold

on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superintendent ofDocuments when their subscriptions must be renewed.

CUMULATIVE BULLETINSThe contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are

sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of printand are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from theSuperintendent of Documents.

HOW TO ORDERCheck the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,

detach entire page, and mail to the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. Pleaseallow two to six weeks, plus mailing time, for delivery.

WE WELCOME COMMENTS ABOUT THEINTERNAL REVENUE BULLETIN

If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, wewould be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page(www.irs.ustreas.gov) or write to the IRS Bulletin Unit, OP:FS:FP:P:1, Room 5617, 1111 Constitution Avenue NW, Washington, DC 20224.

Internal Revenue bulletinREG–105312–98, page 14. Proposed regulations under section 6045 of the...

Documents

Transcript of Internal Revenue bulletinREG–105312–98, page 14. Proposed regulations under section 6045 of the...