Internal Revenue Bulletin 1996-8 (PDF rendition): IRS Announcements

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

SEQ 0001 JOB B09-001-006 PAGE-0003 COVER
REVISED 28MAY96 AT 11:25 BY LR DEPTH: 66.04 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-001
3
Bulletin No. 1996–8
February 27, 1996
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
PS–7–89, page 24.
Proposed regulations under section 1254 of the Code
relating to the treatment of gain from the disposition of
interest in certain natural resource recapture property
by S corporations and their shareholders.
T.D. 8645, page 4.
Final regulations under section 469 of the Code
providing rules for rental real estate activities of
taxpayers engaged in certain real property trades or
businesses.
T.D. 8646, page 10.
Final regulations under section 861 of the Code
provides guidance concerning the allocation and appor-
tionment of research and experimental expenditures for
purposes of determining taxable income from sources
inside and outside the U.S.
EMPLOYEE PLANS
Notice 96–11, page 19.
Guidelines are set forth for determining for February
1996, the weighted average interest rate and the
resulting permissible range of interest rates used to
calculate current liability for purposes of the full funding
limitation of section 412(c)(7) of the Code as amended
by the Omnibus Budget Reconciliation Act of 1987 and
by the Uruguay Round Agreements Act (GATT).
EXEMPT ORGANIZATIONS
Announcement 96–10, page 30.
A list is provided of organizations that no longer qualify
as organizations to which contributions are deductible
under section 170 of the Code.
EXCISE TAXES
Announcement 96–9, page 30.
Effective after December 31, 1995, the rates for fuel
taxes and the base amount not subject to the luxury tax
have changed. Also, excise taxes on transportation and
on the superfund expired December 31, 1995.
ADMINISTRATIVE
Rev. Proc. 96–25, page 19.
Automobile owners and lessees. This procedure provides
owners and lessees of passenger automobiles with
tables detailing the limitations on depreciation deduc-
tions for automobiles first placed in service during
calendar year 1996 and the amounts to be included in
income for automobiles first leased during calendar
year 1996.
Rev. Proc. 96–26, page 22.
Backup withholding; substitute Form W–9. The require-
ments for payors that want to use a substitute Form W–
9, Request for Taxpayer Identification Number and
Certification, are clarified.
Finding Lists begin on page 00.
Announcement of Disbarments and Suspensions begin on page 00.
Announcement of Declaratory Judgment Proceeding Under Section 7428 on page 00.

SEQ 0002 JOB B09-002-002 PAGE-0002 MISSION
REVISED 28MAY96 AT 11:25 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-002
2
Mission of the Service
The purpose of the Internal Revenue Service is to
collect the proper amount of tax revenue at the least
cost; serve the public by continually improving the
quality of our products and services; and perform in a
manner warranting the highest degree of public
confidence in our integrity, efficiency and fairness.
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to
administer the Internal Revenue Code. Tax policy
for raising revenue is determined by Congress.
With this in mind, it is the duty of the Service to
carry out that policy by correctly applying the laws
enacted by Congress; to determine the reasonable
meaning of various Code provisions in light of the
Congressional purpose in enacting them; and to
perform this work in a fair and impartial manner,
with neither a government nor a taxpayer point of
view.
At the heart of administration is interpretation of the
Code. It is the responsibility of each person in the
Service, charged with the duty of interpreting the
law, to try to find the true meaning of the statutory
provision and not to adopt a strained construction in
the belief that he or she is ‘‘protecting the revenue.’’
The revenue is properly protected only when we as-
certain and apply the true meaning of the statute.
The Service also has the responsibility of applying
and administering the law in a reasonable,
practical manner. Issues should only be raised by
examining officers when they have merit, never
arbitrarily or for trading purposes. At the same
time, the examining officer should never hesitate
to raise a meritorious issue. It is also important
that care be exercised not to raise an issue or to
ask a court to adopt a position inconsistent with
an established Service position.
Administration should be both reasonable and
vigorous. It should be conducted with as little
delay as possible and with great courtesy and
considerateness. It should never try to overreach,
and should be reasonable within the bounds of law
and sound administration. It should, however, be
vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax
devices and fraud.

SEQ 0003 JOB B09-002-002 PAGE-0003 MISSION
REVISED 28MAY96 AT 11:25 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-002
3
Introduction
The Internal Revenue Bulletin is the authoritative
instrument of the Commissioner of Internal Revenue for
announcing official rulings and procedures of the
Internal Revenue Service and for publishing Treasury
Decisions, Executive Orders, Tax Conventions, legisla-
tion, court decisions, and other items of general
interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscrip-
tion basis. Bulletin contents of a permanent nature are
consolidated semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin
all substantive rulings necessary to promote a uniform
application of the tax laws, including all rulings that
supersede, revoke, modify, or amend any of those
previously published in the Bulletin. All published
rulings apply retroactively unless otherwise indicated.
Procedures relating solely to matters of internal
management are not published; however, statements of
internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the
Service on the application of the law to the pivotal facts
stated in the revenue ruling. In those based on
positions taken in rulings to taxpayers or technical
advice to Service field offices, identifying details and
information of a confidential nature are deleted to
prevent unwarranted invasions of privacy and to comply
with statutory requirements.
Rulings and procedures reported in the Bulletin do not
have the force and effect of Treasury Department
Regulations, but they may be used as precedents.
Unpublished rulings will not be relied on, used, or cited
as precedents by Service personnel in the disposition of
other cases. In applying published rulings and proce-
dures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be
considered, and Service personnel and others con-
cerned are cautioned against reaching the same
conclusions in other cases unless the facts and
circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on
provisions of 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 Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellanous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and
Subparts. Also included in this part are Bank Secrecy
Act Administrative Rulings. Bank Secrecy Act Admin-
istrative Rulings are issued by the Department of the
Treasury’s Office of the Assistant Secretary
(Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemak-
ing and the disbarment and suspension list included in
this part, none of these announcements are consoli-
dated in the Cumulative Bulletins.
The first Bulletin for each month includes an index for
the matters published during the preceding month.
These monthly indexes are cumulated on a quarterly
and semiannual basis, and are published in the first
Bulletin of the succeeding quarterly and semi-annual
period, respectively.
The Bulletin Index-Digest System, a research and
reference service supplementing the Bulletin, may be
obtained from the Superintendent of Documents on a
subscription basis. It consists of four Services: Service
No. 1, Income Tax; Service No. 2, Estate and Gift
Taxes; Service No. 3, Employment Taxes; Service No.
4, Excise Taxes. Each Service consists of a basic
volume and a cumulative supplement that provides (1)
finding lists of items published in the Bulletin, (2)
digests of revenue rulings, revenue procedures, and
other published items, and (3) indexes of Public Laws,
Treasury Decisions, and Tax Conventions.
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, D.C. 20402.

SEQ 0004 JOB B09-003-004 PAGE-0004 PT 1 PGS 4-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-003
4
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 280F.—Limitation on
Depreciation for Luxury Automobiles;
Limitation where Certain Property
Used for Personal Purposes
26 CFR 280F–5T: Leased Property
(temporary).
This procedure provides owners and lessees of
passenger automobiles with tables detailing the
limitations on depreciation deductions for auto-
mobiles first placed in service during calendar
year 1996 and the amounts to be included in in-
come for automobiles first leased during calendar
year 1996. See Rev. Proc. 96–25, page 19.
26 CFR 280F–7: Property leased after December
31, 1986.
This procedure provides owners and lessees of
passenger automobiles with tables detailing the
limitations on depreciation deductions for auto-
mobiles first placed in service during calendar
year 1996 and the amounts to be included in in-
come for automobiles first leased during calendar
year 1996. See Rev. Proc. 96–25, page 19.
Section 469.—Passive Activity
Losses and Credits Limited
26 CFR 1.469–4: Definition of activity.
T.D. 8645
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Rules for Certain Rental Real Estate
Activities
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations providing rules for
rental real estate activities of taxpayers
engaged in certain real property trades
or businesses. The regulations reflect
changes to the law made by the Omni-
bus Budget Reconciliation Act of 1993,
and affect taxpayers subject to the
limitations on passive activity losses
and passive activity credits.
DATES: These regulations are effective
on January 1, 1995. See §1.469–11 for
applicability.
ADDRESSES: Send submissions to:
CC:DOM:CORP:T:R (TD 8645), Room
5228, Internal Revenue Service, POB
7604, Ben Franklin Station, Wash-
ington, DC 20044. In the alternative,
submissions may be hand delivered
between the hours of 8:00 a.m. and
5:00 p.m. to: CC:DOM:CORP:T:R (TD
8645), Courier’s Desk, Internal Reve-
nue Service, 1111 Constitution Avenue
NW, Washington, DC.
FOR FURTHER INFORMATION
CONTACT: William M. Kostak at
(202) 622-3080 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduc-
tion Act (44 U.S.C. 3504(h)) under
control number 1545–AS38. The esti-
mated annual burden per respondent
varies from 0.10 hours to 0.25 hours,
depending on individual circumstances,
with an estimated average of 0.15
hours.
Comments concerning the accuracy
of this burden estimate and suggestions
for reducing this burden should be sent
to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, IT:FP,
Washington, DC 20224, and to the
Office of Management and Budget,
Attn: Desk Officer for the Department
of the Treasury, Office of Information
and Regulatory Affairs, Washington,
DC 20503.
Background
This document amends 26 CFR part
1 to provide rules relating to the
treatment of rental real estate activities
of certain taxpayers under the passive
activity loss and credit limitations of
section 469. Section 469 disallows
losses from passive activities to the
extent they exceed income from pas-
sive activities and similarly disallows
credits from passive activities to the
extent they exceed tax liability alloca-
ble to passive activities. In general,
passive activities are activities in which
the taxpayer does not materially partici-
pate. In addition, until the enactment of
the Omnibus Budget Reconciliation Act
of 1993 (OBRA 1993), all rental
activities (including those in which a
taxpayer materially participated) were
passive.
OBRA 1993 added section 469(c)(7),
which provides that rental real estate
activities of qualifying taxpayers are
not subject to the rule that treats all
rental activities as passive. Thus, a
rental real estate activity of a qualify-
ing taxpayer is not passive if the
taxpayer materially participates in the
activity. Further, section 469(c)(7)
provides that each of a qualifying
taxpayer’s interests in rental real estate
is treated as a separate activity unless
the taxpayer elects to treat all interests
in rental real estate as a single activity.
On January 10, 1995, the IRS pub-
lished in the Federal Register a notice
of proposed rulemaking (60 FR 2557
[PS–80–93, 1995–1 C.B. 1015]) to
provide guidance regarding section
469(c)(7). A number of public com-
ments were received concerning the
proposed regulations, and a public
hearing was held on May 11, 1995.
After consideration of the comments
received, the proposed regulations are
adopted as revised by this Treasury
decision.
Explanation of provisions
I.General Background
The proposed regulations provide
rules for determining whether a tax-
payer qualifies for treatment under
section 469(c)(7). The proposed regula-
tions also provide rules for determining
the rental real estate activities of
qualifying taxpayers for purposes of
section 469. Except for modifications
in response to comments received on
the proposed regulations, the final
regulations generally adopt the rules
contained in the proposed regulations.
II.Public Comments
Several comments requested that the
Service reconsider the rule in the
p r o p o s e d r e g u l a t i o n s p r o h i b i t i n g
qualifying taxpayers from grouping
rental real estate activities with other
activities in determining whether the
taxpayers materially participate in the
rental real estate activities. After care-

SEQ 0005 JOB B09-003-004 PAGE-0005 PT 1 PGS 4-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-003
5
ful consideration, the final regulations
adopt the rule in the proposed regula-
tions because that position is consistent
with the statutory language and the
legislative history.
Several comments suggested that the
rule in the proposed regulations pro-
hibiting the grouping of rental real
estate activities with other activities be
modified to allow qualifying taxpayers
to group the activities of development
or construction of rental real estate
with rental real estate activities. The
final regulations do not adopt this
modification because in most cases
development and construction activities
are separate and distinct from rental
activities. In addition, this modification
would introduce significant administra-
tive difficulties in determining which
development activities or construction
activities qualify. However, the IRS
and Treasury Department invite com-
ments concerning whether the material
participation tests in §1.469–5T(a)
should be amended to include a look-
back material participation test for
taxpayers significantly involved in the
development or construction of their
rental real estate interests.
Several comments requested clar-
ification regarding whether a qualifying
taxpayer’s participation in a manage-
ment activity may count towards mate-
rial participation in a rental real estate
activity if the management activity
includes the management of rental real
estate owned by the taxpayer. The final
regulations clarify that a qualifying
taxpayer may participate in a rental real
estate activity through participation in a
management activity. In determining
whether the taxpayer materially partici-
pates in the rental real estate activity,
however, work the taxpayer performs
in the management activity is taken
into account only to the extent it is
performed in managing the taxpayer’s
own rental real estate. The final regula-
tions also clarify that a qualifying
taxpayer who owns rental real estate
through an entity, including a C corpo-
ration that is subject to section 469,
may count work performed by the tax-
payer in managing the rental real estate
of the entity in establishing material
participation in the taxpayer’s rental
real estate activities. Thus, if a qualify-
ing taxpayer owns some interests in
rental real estate through a closely held
C corporation and makes the election
to treat all interests in rental real estate
as a single activity, the aggregate rental
real estate activity will include those
interests held through the closely held
C corporation for purposes of material
participation.
One comment requested that the
regulations modify the definition of
trade or business to clarify that a
taxpayer’s real property trades or busi-
nesses are determined without regard to
the taxpayer’s grouping of activities
under §1.469–4. The final regulations
clarify that a taxpayer’s grouping of
activities under §1.469–4 does not
control the determination of the tax-
payer’s real property trades or busi-
nesses for purposes of this section.
Several comments requested that the
regulations provide a detailed definition
of real property trades or businesses
beyond the cross-reference to section
469(c)(7)(C). However, to avoid com-
plex and mechanical rules, the final
regulations do not adopt a detailed
definition of real property trades or
businesses. Instead, the regulations
provide that taxpayers may use any
reasonable method for determining
their real property trades or businesses.
Several comments requested that the
final regulations modify the rule in the
proposed regulations providing that
only employees who are five-percent
owners of their employer at all times
during the taxable year may treat
personal services performed as an
employee as services performed in a
real property trade or business. The
comments suggested that the regula-
tions should take into account personal
services performed by employees that
are five-percent owners for a signifi-
cant portion of a taxable year. In
response to these comments, the final
regulations are modified to provide that
an employee may count services per-
formed in a real property trade or
business during the portion of the
taxable year that the employee is a
five-percent owner in the employer.
Several comments requested clar-
ification concerning whether a qualify-
ing taxpayer that makes an election to
treat all interests in rental real estate as
a single activity will be treated as
having a single rental real estate
activity for purposes of the former
passive activity rule under section
469(f). In addition, comments requested
that the regulations be modified to
provide that qualifying taxpayers that
make the aggregation election will be
treated as having separate activities for
purposes of the disposition rules under
section 469(g) and §1.469–4(g). In re-
sponse to these comments, the final
regulations clarify that a qualifying
taxpayer that makes the election to
treat all interests in rental real estate as
a single rental real estate activity will
be treated as having a single activity
for all purposes of section 469, includ-
ing sections 469(f) and (g). The statu-
tory language and the legislative his-
tory do not support a rule allowing a
qualifying taxpayer to treat all interests
in rental real estate as a single activity
for purposes of material participation
and section 469(f), but as separate
activities for purposes of section
469(g).
In addition, in response to comments,
the final regulations provide an exam-
ple illustrating the operation of the
former passive activity rule for qualify-
ing taxpayers that make the election to
treat all interests in rental real estate as
a single activity. This example illus-
trates that qualifying taxpayers that
make the aggregation election may use
current net income from the aggregate
rental real estate activity to offset the
prior-year disallowed passive losses of
the aggregate rental real estate activity,
regardless of which rental real estate
interests within that activity produced
the income or prior-year losses.
Some comments requested that the
regulations permit qualifying taxpayers
to make or revoke the aggregation
election on an amended income tax
return. After careful consideration of
this issue, the final regulations adopt
the rule in the proposed regulations that
aggregation elections must be made or
revoked on an original return. The final
regulations provide, however, that the
election may be revoked in any year in
which the facts are materially changed
from those in the taxable year for
which the election was made.
In addition, one comment requested
clarification as to what constitutes a
material change in the facts and cir-
cumstances that would allow a taxpayer
to revoke an aggregation election.
However, the final regulations do not
provide an example or bright-line rule
for determining when a material change
in the facts and circumstances has
occurred, because this determination is
intended to be a broad factual inquiry.
Providing an example or bright-line
rule may inappropriately restrict the
scope of that inquiry.
One comment requested the modi-
fication of the rule in the proposed

SEQ 0006 JOB B09-003-004 PAGE-0006 PT 1 PGS 4-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-003
6
regulations that the aggregation election
has no effect in years the taxpayer is
not a qualifying taxpayer. Instead, the
comment suggested that, for ease of
administration and compliance, the ag-
gregation election should be binding
and irrevocable for all future years,
including years in which the taxpayer
is not a qualifying taxpayer. However,
the final regulations adopt the rule in
the proposed regulations because the
position advocated by the comment
would be unfavorable to many tax-
payers and would not significantly
improve administration.
Several comments requested that the
regulations modify the rule in the
proposed regulations treating each
rental real estate interest of a pass-
through entity as a separate interest of
a person owning a fifty-percent or
greater interest in the capital, gain,
loss, income, deduction, or credit of the
entity at any time during a taxable
year. A commentator stated that this
rule is burdensome on many pass-
through entities and should be elimi-
nated or modified. The final regulations
modify this rule so that it applies only
when a qualifying taxpayer owns a
fifty-percent or greater interest in the
capital, profits, or losses of a pass-
through entity for a taxable year.
Accordingly, this rule will not apply if
a qualifying taxpayer owns a fifty-
percent or greater interest in a single
item of income or deduction but does
not own a fifty-percent or greater
interest in the overall capital, profits, or
losses of the passthrough entity.
In response to one comment, the
final regulations also clarify the ap-
plication of the fifty-percent ownership
rule to tiered passthrough entities. The
final regulations provide that if a
passthrough entity owns a fifty-percent
or greater interest in the capital, profits,
or losses of another passthrough entity
for a taxable year, each interest in
rental real estate of the lower-tier entity
will be a separate interest in rental real
estate of the upper-tier entity.
In response to another comment, the
final regulations clarify that section
469(i) applies after the rules of section
469(c)(7) are applied. Accordingly, the
$25,000 offset will be applied only
against passive losses from rental real
estate activities, and not against losses
that are allowable as a result of section
469(c)(7). In addition, the final regula-
tions clarify that adjusted gross income
for purposes of section 469(i) is not
reduced by any losses from rental real
estate that are allowable as a result of
section 469(c)(7).
Several comments requested a modi-
fication to the effective date provision,
to provide that aggregation elections
made for taxable years beginning be-
fore January 1, 1995, are not binding
for future years. Because taxpayers had
sufficient notice of the rules of section
469(c)(7) and these regulations, this
modification is unnecessary and would
add administrative complexity. Accord-
ingly, the final regulations adopt the
effective date provision of the proposed
regulations.
Finally, in response to a comment,
the activity regrouping rule of §1.469–
4(e)(2) is clarified to provide that a
taxpayer may not regroup activities
unless the taxpayer’s original grouping
was clearly inappropriate or there has
been a material change in the facts and
circumstances that makes the original
grouping clearly inappropriate.
III.Effective Dates
In general, section 469(c)(7) applies
for taxable years beginning after De-
cember 31, 1993. These regulations are
effective for taxable years beginning on
or after January 1, 1995. These regula-
tions are also effective for elections
under section 469(c)(7)(A) and para-
graph (g) of these regulations that are
made with returns filed on or after
January 1, 1995.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It also has been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flex-
ibility Act (5 U.S.C. chapter 6) do not
apply to these regulations, and, there-
fore, a Regulatory Flexibility Analysis
is not required. Pursuant to section
7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking
preceding these regulations was submit-
ted to the Small Business Administra-
tion for comment on its impact on
small business.
Drafting Information
The principal author of these regula-
tions is William M. Kostak, Office of
Assistant Chief Counsel (Passthroughs
and Special Industries), IRS. However,
other personnel from the IRS and
Treasury Department participated in
their development.
******
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART I—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an
entry in numerical order to read as
follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.469–9 also issued under 26
U.S.C. 469(c)(6), (h)(2), and (l)(1).
Par. 2. Section 1.469–0 is amended
by:
1.Revising the entry for §1.469–
4(h).
2.Revising the heading for §1.469–9
and adding entries for paragraphs (a)
through (j) of §1.469–9.
3.Revising the entry for §1.469–11-
(b)(2) and removing the entries for
§1.469–11(b)(2)(i) and (ii).
4.Revising the entry for §1.469–11-
(b)(3).
5.Adding an entry for §1.469–11-
(b)(4).
6.The revisions and additions read
as follows:
§1.469–0 Table of contents.
******
§1.469–4 Definition of Activity.
******
(h)Rules for grouping rental real
estate activities for taxpayers qualifying
under section 469(c)(7).
******
§1.469–9 Rules for certain rental
real estate activities.
(a)Scope and purpose.
(b)Definitions.
(1)Trade or business.
(2)Real property trade or
business.
(3)Rental real estate.
(4)Personal services.

SEQ 0007 JOB B09-003-004 PAGE-0007 PT 1 PGS 4-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-003
7
(5)Material participation.
(6)Qualifying taxpayer.
(c)Requirements for qualifying
taxpayers.
(1)In general.
(2)Closely held C
corporations.
(3)Requirement of material
participation in the real
property trades or busi-
nesses.
(4)Treatment of spouses.
(5)Employees in real prop-
erty trades or businesses.
(d)General rule for determining
real property trades or
businesses.
(1)Facts and circumstances.
(2)Consistency requirement.
(e)Treatment of rental real estate
activities of a qualifying
taxpayer.
(1)In general.
(2)Treatment as a former
passive activity.
(3)Grouping rental real estate
activities with other
activities.
(i)In general.
(ii)Special rule for certain
management activities.
(4)Example.
(f)Limited partnership interests in
rental real estate activities.
(1)In general.
(2)De minimis exception.
(g)Election to treat all interests
in rental real estate as a single
rental real estate activity.
(1)In general.
(2)Certain changes not mate-
rial.
(3)Filing a statement to
make or revoke the
election.
(h)Interests in rental real estate
held by certain passthrough
entities.
(1)General rule.
(2)Special rule if a qualify-
ing taxpayer holds a fifty-
percent or greater interest
in a passthrough entity.
(3)Special rule for interests
held in tiered passthrough
entities.
(i)[Reserved].
(j)$25,000 offset for rental real
estate activities of qualifying
taxpayers.
(1)In general.
(2)Example.
******
§1.469–11 Effective date and
transition rules.
******
(b)* * *
(2) Additional transition rule for
1992 amendments.
(3)Fresh starts under consistency
rules.
(i)Regrouping when tax liability is
first determined under Project PS–1–
89.
(ii)Regrouping when tax liability is
first determined under §1.469–4.
(iii)Regrouping when taxpayer is
first subject to section 469(c)(7).
( 4 ) C e r t a i n i n v e s t m e n t c r e d i t
property.
******
Par. 3. Section 1.469–4 is amended
by revising paragraphs (e)(1) and (2)
and (h). The revisions read as follows:
§1.469–4 Definition of Activity.
******
(e)* * *
(1)Original groupings. Except as
provided in paragraph (e)(2) of this
section and §1.469–11, once a taxpayer
has grouped activities under this sec-
tion, the taxpayer may not regroup
those activities in subsequent taxable
years. Taxpayers must comply with
disclosure requirements that the Com-
missioner may prescribe with respect to
both their original groupings and the
addition and disposition of specific
activities within those chosen groupings
in subsequent taxable years.
(2)Regroupings. If it is determined
that a taxpayer’s original grouping was
clearly inappropriate or a material
change in the facts and circumstances
has occurred that makes the original
grouping clearly inappropriate, the tax-
payer must regroup the activities and
must comply with disclosure require-
ments that the Commissioner may
prescribe.
******
(h)Rules for grouping rental real
estate activities for taxpayers qualify-
ing under section 469(c)(7). See
§1.469–9 for rules for certain rental
real estate activities.
Par. 4. Section 1.469-9 is revised to
read as follows:
§1.469–9 Rules for certain rental
real estate activities.
(a)Scope and purpose. This section
provides guidance to taxpayers engaged
in certain real property trades or busi-
nesses on applying section 469(c)(7) to
their rental real estate activities.
(b)Definitions. The following defi-
nitions apply for purposes of this
section:
(1)Trade or business. A trade or
business is any trade or business
determined by treating the types of
activities in §1.469–4(b)(1) as if they
involved the conduct of a trade or
business, and any interest in rental real
estate, including any interest in rental
real estate that gives rise to deductions
under section 212.
(2)Real property trade or business.
Real property trade or business is
defined in section 469(c)(7)(C).
(3)Rental real estate. Rental real
estate is any real property used by
customers or held for use by customers
in a rental activity within the meaning
of §1.469–1T(e)(3). However, any
rental real estate that the taxpayer
grouped with a trade or business
activity under §1.469–4(d)(1)(i)(A) or
(C) is not an interest in rental real
estate for purposes of this section.
(4)Personal services. Personal serv-
ices means any work performed by an
individual in connection with a trade or
business. However, personal services
do not include any work performed by
an individual in the individual’s capac-
ity as an investor as described in
§1.469–5T(f)(2)(ii).
(5)Material participation. Material
participation has the same meaning as
under §1.469–5T. Paragraph (f) of this
section contains rules applicable to
limited partnership interests in rental
real estate that a qualifying taxpayer
elects to aggregate with other interests
in rental real estate of that taxpayer.
(6)Qualifying taxpayer. A qualify-
ing taxpayer is a taxpayer that owns at
least one interest in rental real estate
and meets the requirements of para-
graph (c) of this section.
(c)Requirements for qualifying tax-
payers—(1) In general. A qualifying
taxpayer must meet the requirements of
section 469(c)(7)(B).
(2)Closely held C corporations. A
closely held C corporation meets the
requirements of paragraph (c)(1) of this
section by satisfying the requirements

SEQ 0008 JOB B09-003-004 PAGE-0008 PT 1 PGS 4-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-003
8
of section 469(c)(7)(D)(i). For purposes
of section 469(c)(7)(D)(i), gross re-
ceipts do not include items of portfolio
income within the meaning of §1.469–
2T(c)(3).
(3)Requirement of material par-
ticipation in the real property trades or
businesses. A taxpayer must materially
participate in a real property trade or
business in order for the personal
services provided by the taxpayer in
that real property trade or business to
count towards meeting the requirements
of paragraph (c)(1) of this section.
(4)Treatment of spouses. Spouses
filing a joint return are qualifying
taxpayers only if one spouse separately
satisfies both requirements of section
469(c)(7)(B). In determining the real
property trades or businesses in which
a married taxpayer materially partici-
pates (but not for any other purpose
under this paragraph (c)), work per-
formed by the taxpayer’s spouse in a
trade or business is treated as work
performed by the taxpayer under
§1.469–5T(f)(3), regardless of whether
the spouses file a joint return for the
year.
(5)Employees in real property
trades or businesses. For purposes of
paragraph (c)(1) of this section, per-
sonal services performed during a
taxable year as an employee generally
will be treated as performed in a trade
or business but will not be treated as
performed in a real property trade or
business, unless the taxpayer is a five-
percent owner (within the meaning of
section 416(i)(1)(B)) in the employer.
If an employee is not a five-percent
owner in the employer at all times
during the taxable year, only the
personal services performed by the
employee during the period the
employee is a five-percent owner in the
employer will be treated as performed
in a real property trade or business.
(d)General rule for determining
real property trades or businesses—(1)
Facts and circumstances. The deter-
mination of a taxpayer’s real property
trades or businesses for purposes of
paragraph (c) of this section is based
on all of the relevant facts and
circumstances. A taxpayer may use any
reasonable method of applying the facts
and circumstances in determining the
real property trades or businesses in
which the taxpayer provides personal
services. Depending on the facts and
circumstances, a real property trade or
business consists either of one or more
than one trade or business specifically
described in section 469(c)(7)(C). A
taxpayer’s grouping of activities under
§1.469–4 does not control the deter-
mination of the taxpayer’s real property
trades or businesses under this para-
graph (d).
(2)Consistency requirement. Once a
taxpayer determines the real property
trades or businesses in which personal
services are provided for purposes of
paragraph (c) of this section, the
taxpayer may not redetermine those
real property trades or businesses in
subsequent taxable years unless the
original determination was clearly inap-
propriate or there has been a material
change in the facts and circumstances
that makes the original determination
clearly inappropriate.
(e)Treatment of rental real estate
activities of a qualifying taxpayer—(1)
In general. Section 469(c)(2) does not
apply to any rental real estate activity
of a taxpayer for a taxable year in
which the taxpayer is a qualifying
taxpayer under paragraph (c) of this
section. Instead, a rental real estate
activity of a qualifying taxpayer is a
passive activity under section 469 for
the taxable year unless the taxpayer
materially participates in the activity.
Each interest in rental real estate of a
qualifying taxpayer will be treated as a
separate rental real estate activity,
unless the taxpayer makes an election
under paragraph (g) of this section to
treat all interests in rental real estate as
a single rental real estate activity. Each
separate rental real estate activity, or
the single combined rental real estate
activity if the taxpayer makes an
election under paragraph (g), will be an
activity of the taxpayer for all purposes
of section 469, including the former
passive activity rules under section
469(f) and the disposition rules under
section 469(g). However, section 469
will continue to be applied separately
with respect to each publicly traded
partnership, as required under section
469(k), notwithstanding the rules of
this section.
(2)Treatment as a former passive
activity. For any taxable year in which
a qualifying taxpayer materially partici-
pates in a rental real estate activity,
that rental real estate activity will be
treated as a former passive activity
under section 469(f) if disallowed
deductions or credits are allocated to
the activity under §1.469–1(f)(4).
(3)Grouping rental real estate ac-
tivities with other activities—(i) In
general. For purposes of this section, a
qualifying taxpayer may not group a
rental real estate activity with any other
activity of the taxpayer. For example, if
a qualifying taxpayer develops real
property, constructs buildings, and
owns an interest in rental real estate,
the taxpayer’s interest in rental real
estate may not be grouped with the
taxpayer’s development activity or con-
struction activity. Thus, only the par-
ticipation of the taxpayer with respect
to the rental real estate may be used to
determine if the taxpayer materially
participates in the rental real estate
activity under §1.469–5T.
(ii)Special rule for certain manage-
ment activities. A qualifying taxpayer
may participate in a rental real estate
activity through participation, within
the meaning of §§1.469–5(f) and 5T(f),
in an activity involving the manage-
ment of rental real estate (even if this
management activity is conducted
through a separate entity). In determin-
ing whether the taxpayer materially
participates in the rental real estate
activity, however, work the taxpayer
performs in the management activity is
taken into account only to the extent it
is performed in managing the tax-
payer’s own rental real estate interests.
(4)Example. The following example
illustrates the application of this para-
graph (e).
Example. (i) Taxpayer B owns interests in
three rental buildings, U, V and W. In 1995, B
has $30,000 of disallowed passive losses alloca-
ble to Building U and $10,000 of disallowed
passive losses allocable to Building V under
§1.469–1(f)(4). In 1996, B has $5,000 of net
income from building U, $5,000 of net losses
from building V, and $10,000 of net income from
building W. Also in 1996, B is a qualifying
taxpayer within the meaning of paragraph (c) of
this section. Each building is treated as a
separate activity of B under paragraph (e)(1) of
this section, unless B makes the election under
paragraph (g) to treat the three buildings as a
single rental real estate activity. If the buildings
are treated as separate activities, material par-
ticipation is determined separately with respect
to each building. If B makes the election under
paragraph (g) to treat the buildings as a single
activity, all participation relating to the buildings
is aggregated in determining whether B mate-
rially participates in the combined activity.
(ii)Effective beginning in 1996, B makes the
election under paragraph (g) to treat the three
buildings as a single rental real estate activity. B
works full-time managing the three buildings and
thus materially participates in the combined
activity in 1996 (even if B conducts this
management function through a separate entity,
including a closely held C corporation). Accord-
ingly, the combined activity is not a passive
activity of B in 1996. Moreover, as a result of
the election under paragraph (g), disallowed

SEQ 0009 JOB B09-003-004 PAGE-0009 PT 1 PGS 4-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-003
9
passive losses of $40,000 ($30,000 + $10,000)
are allocated to the combined activity. B’s net
income from the activity for 1996 is $10,000
($5,000 – $5,000 + $10,000). This net income is
nonpassive income for purposes of section 469.
However, under section 469(f), the net income
from a former passive activity may be offset
with the disallowed passive losses from the same
activity. Because Buildings U, V and W are
treated as one activity for all purposes of section
469 due to the election under paragraph (g), and
this activity is a former passive activity under
section 469(f), B may offset the $10,000 of net
income from the buildings with an equal amount
of disallowed passive losses allocable to the
buildings, regardless of which buildings pro-
duced the income or losses. As a result, B has
$30,000 ($40,000 – $10,000) of disallowed pas-
sive losses remaining from the buildings after
1996.
(f)Limited partnership interests in
rental real estate activities—(1) In
general. If a taxpayer elects under
paragraph (g) of this section to treat all
interests in rental real estate as a single
rental real estate activity, and at least
one interest in rental real estate is held
by the taxpayer as a limited partnership
interest (within the meaning of §1.469–
5T(e)(3)), the combined rental real
estate activity will be treated as a
limited partnership interest of the tax-
payer for purposes of determining
material participation. Accordingly, the
taxpayer will not be treated under this
section as materially participating in
the combined rental real estate activity
unless the taxpayer materially partici-
pates in the activity under the tests
listed in §1.469–5T(e)(2) (dealing with
the tests for determining the material
participation of a limited partner).
(2)De minimis exception. If a
qualifying taxpayer elects under para-
graph (g) of this section to treat all
interests in rental real estate as a single
rental real estate activity, and the
taxpayer’s share of gross rental income
from all of the taxpayer’s limited
partnership interests in rental real estate
is less than ten percent of the tax-
payer’s share of gross rental income
from all of the taxpayer’s interests in
rental real estate for the taxable year,
paragraph (f)(1) of this section does not
apply. Thus the taxpayer may deter-
mine material participation under any
of the tests listed in §1.469–5T(a) that
apply to rental real estate activities.
(g)Election to treat all interests in
rental real estate as a single rental
real estate activity—(1) In general. A
qualifying taxpayer may make an elec-
tion to treat all of the taxpayer’s
interests in rental real estate as a single
rental real estate activity. This election
is binding for the taxable year in which
it is made and for all future years in
which the taxpayer is a qualifying
taxpayer under paragraph (c) of this
section, even if there are intervening
years in which the taxpayer is not a
qualifying taxpayer. The election may
be made in any year in which the tax-
payer is a qualifying taxpayer, and the
failure to make the election in one year
does not preclude the taxpayer from
making the election in a subsequent
year. In years in which the taxpayer is
not a qualifying taxpayer, the election
will not have effect and the taxpayer’s
activities will be those determined
under §1.469–4. If there is a material
change in the taxpayer’s facts and
circumstances, the taxpayer may revoke
the election using the procedure de-
scribed in paragraph (g)(3) of this
section.
(2)Certain changes not material.
The fact that an election is less
advantageous to the taxpayer in a
particular taxable year is not, of itself,
a material change in the taxpayer’s
facts and circumstances. Similarly, a
break in the taxpayer’s status as a
qualifying taxpayer is not, of itself, a
material change in the taxpayer’s facts
and circumstances.
(3)Filing a statement to make or
revoke the election. A qualifying tax-
payer makes the election to treat all
interests in rental real estate as a single
rental real estate activity by filing a
statement with the taxpayer’s original
income tax return for the taxable year.
This statement must contain a declara-
tion that the taxpayer is a qualifying
taxpayer for the taxable year and is
making the election pursuant to section
469(c)(7)(A). The taxpayer may make
this election for any taxable year in
which section 469(c)(7) is applicable.
A taxpayer may revoke the election
only in the taxable year in which a
material change in the taxpayer’s facts
and circumstances occurs or in a
subsequent year in which the facts and
c i r c u m s t a n c e s r e m a i n m a t e r i a l l y
changed from those in the taxable year
for which the election was made. To
revoke the election, the taxpayer must
file a statement with the taxpayer’s
original income tax return for the year
of revocation. This statement must
contain a declaration that the taxpayer
is revoking the election under section
469(c)(7)(A) and an explanation of the
nature of the material change.
(h)Interests in rental real estate
held by certain passthrough entities—
(1) General rule. Except as provided in
paragraph (h)(2) of this section, a
qualifying taxpayer’s interest in rental
real estate held by a partnership or an
S corporation (passthrough entity) is
treated as a single interest in rental real
estate if the passthrough entity grouped
its rental real estate as one rental
activity under §1.469–4(d)(5). If the
passthrough entity grouped its rental
real estate into separate rental activities
under §1.469–4(d)(5), each rental real
estate activity of the passthrough entity
will be treated as a separate interest in
rental real estate of the qualifying
taxpayer. However, the qualifying tax-
payer may elect under paragraph (g) of
this section to treat all interests in
rental real estate, including the rental
real estate interests held through pass-
through entities, as a single rental real
estate activity.
(2)Special rule if a qualifying tax-
payer holds a fifty-percent or greater
interest in a passthrough entity. If a
qualifying taxpayer owns, directly or
indirectly, a fifty-percent or greater
interest in the capital, profits, or losses
of a passthrough entity for a taxable
year, each interest in rental real estate
held by the passthrough entity will be
treated as a separate interest in rental
real estate of the qualifying taxpayer,
regardless of the passthrough entity’s
grouping of activities under §1.469–
4(d)(5). However, the qualifying tax-
payer may elect under paragraph (g) of
this section to treat all interests in
rental real estate, including the rental
real estate interests held through pass-
through entities, as a single rental real
estate activity.
(3)Special rule for interests held in
tiered passthrough entities. If a pass-
through entity owns a fifty-percent or
greater interest in the capital, profits, or
losses of another passthrough entity for
a taxable year, each interest in rental
real estate held by the lower-tier entity
will be treated as a separate interest in
rental real estate of the upper-tier
entity, regardless of the lower-tier
entity’s grouping of activities under
§1.469–4(d)(5).
(i)[Reserved].
(j)$25,000 offset for rental real
estate activities of qualifying tax-
payers—(1) In general. A qualifying
taxpayer’s passive losses and credits
from rental real estate activities (in-
cluding prior-year disallowed passive
activity losses and credits from rental
real estate activities in which the

SEQ 0010 JOB B09-004-003 PAGE-0010 PT 1 PGS 10-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-004
10
taxpayer materially participates) are
allowed to the extent permitted under
section 469(i). The amount of losses or
credits allowable under section 469(i)
is determined after the rules of this
section are applied. However, losses
allowable by reason of this section are
not taken into account in determining
adjusted gross income for purposes of
section 469(i)(3).
(2)Example. The following example
illustrates the application of this para-
graph (j).
Example. (i) Taxpayer A owns building X and
building Y, both interests in rental real estate. In
1995, A is a qualifying taxpayer within the
meaning of paragraph (c) of this section. A does
not elect to treat X and Y as one activity under
section 469(c)(7)(A) and paragraph (g) of this
section. As a result, X and Y are treated as
separate activities pursuant to section 469(c)(7)-
(A)(ii). A materially participates in X which has
$100,000 of passive losses disallowed from prior
years and produces $20,000 of losses in 1995. A
does not materially participate in Y which
produces $40,000 of income in 1995. A also has
$50,000 of income from other nonpassive
sources in 1995. A otherwise meets the require-
ments of section 469(i).
(ii)Because X is not a passive activity in
1995, the $20,000 of losses produced by X in
1995 are nonpassive losses that may be used by
A to offset part of the $50,000 of nonpassive
income. Accordingly, A is left with $30,000
($50,000 – $20,000) of nonpassive income. In
addition, A may use the prior year disallowed
passive losses of X to offset any income from X
and passive income from other sources. There-
fore, A may offset the $40,000 of passive income
from Y with $40,000 of passive losses from X.
(iii)Because A has $60,000 ($100,000 –
$40,000) of passive losses remaining from X and
meets all of the requirements of section 469(i), A
may offset up to $25,000 of nonpassive income
with passive losses from X pursuant to section
469(i). As a result, A has $5,000 ($30,000 –
$25,000) of nonpassive income remaining and
disallowed passive losses from X of $35,000
($60,000 – $25,000) in 1995.
Par. 5. Section 1.469–11 is amended
as follows:
1.Paragraph (a)(2) is amended by
removing ‘‘; and’’ and adding ‘‘;’’ in
its place.
2.Paragraph (a)(3) is redesignated
as paragraph (a)(4) and a new para-
graph (a)(3) is added.
3.Paragraph (b)(1) is revised.
4.The heading for paragraph (b)(2)
is revised; the headings for paragraphs
(b)(2)(i) and (b)(2)(ii) are removed;
paragraph (b)(2)(ii) is removed, and
paragraph (b)(2)(i) is redesignated as
paragraph (b)(2).
5.Paragraph (b)(3) is redesignated
as paragraph (b)(4).
6.A new paragraph (b)(3) is added.
The added and revised provisions
read as follows:
§1.469–11 Effective date and
transition rules.
(a)* * *
(3)The rules contained in §1.469–9
apply for taxable years beginning on or
after January 1, 1995, and to elections
made under §1.469–9(g) with returns
filed on or after January 1, 1995; and
******
(b)* * * (1) Application of 1992
amendments for taxable years begin-
ning before October 4, 1994. Except as
provided in paragraph (b)(2) of this
section, for taxable years that end after
May 10, 1992, and begin before
October 4, 1994, a taxpayer may
determine tax liability in accordance
with Project PS–1–89 published at
1992–1 C.B. 1219 (see §601.601(d)(2)-
(ii)(b) of this chapter).
(2)Additional transition rule for
1992 amendments. * * *
(3)Fresh starts under consistency
rules—(i) Regrouping when tax lia-
bility is first determined under Project
PS–1–89. For the first taxable year in
which a taxpayer determines its tax
liability under Project PS–1–89, the
taxpayer may regroup its activities
without regard to the manner in which
the activities were grouped in the
preceding taxable year and must re-
group its activities if the grouping in
the preceding taxable year is inconsist-
ent with the rules of Project PS–1–89.
(ii)Regrouping when tax liability is
first determined under §1.469–4. For
the first taxable year in which a
taxpayer determines its tax liability
under §1.469–4, rather than under the
rules of Project PS–1–89, the taxpayer
may regroup its activities without re-
gard to the manner in which the
activities were grouped in the preced-
ing taxable year and must regroup its
activities if the grouping in the preced-
ing taxable year is inconsistent with the
rules of §1.469–4.
(iii)Regrouping when taxpayer is
first subject to section 469(c)(7). For
the first taxable year beginning after
December 31, 1993, a taxpayer may re-
group its activities to the extent neces-
sary or appropriate to avail itself of the
provisions of section 469(c)(7) and
without regard to the manner in which
the activities were grouped in the
preceding taxable year.
******
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
Approved December 12, 1995.
Leslie Samuels,
Assistant Secretary of
the Treasury (Tax Policy).
(Filed by the Office of the Federal Register on
December 21, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 22, 1995, 60 F.R. 66496)
Section 861.—Income From Sources
Within the United States
26 CFR 1.861–8: Computation of taxable
income from sources within the United States
and from other sources and activities.
T.D. 8646
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Allocation and Apportionment of
Research and Experimental
Expenditures
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document provides
guidance concerning the allocation and
apportionment of research and experi-
mental expenditures for purposes of
determining taxable income from
sources within and without the United
States. This document affects taxpayers
that have income from United States
and foreign sources and that have made
expenditures for research and experi-
mentation that the taxpayer deducts
under section 174 of the Internal
Revenue Code of 1986.
EFFECTIVE DATE: January 1, 1996.
FOR FURTHER INFORMATION
CONTACT: Carl Cooper at (202)
622-3840 (not a toll-free number).

SEQ 0011 JOB B09-004-003 PAGE-0011 PT 1 PGS 10-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-004
11
SUPPLEMENTARY INFORMATION:
Background and Explanation of
Provisions
On May 24, 1995, the IRS published
a notice of proposed rulemaking and
notice of public hearing in the Federal
Register (60 FR 27453 [INTL–23–95,
1995–1 C.B. 987]) proposing amend-
ments to the Income Tax Regulations
(26 CFR part 1) under section 861 of
the Internal Revenue Code of 1986.
Section 1.861–8(e)(3) of the Income
Tax Regulations provides rules regard-
ing the allocation and apportionment of
research and experimental expenditures
for purposes of determining taxable
income from sources inside and outside
the United States.
The notice of proposed rulemaking
proposed three principal changes to the
existing regulations. First, allocation of
research and experimental expenditures
to three digit SIC code product catego-
ries of gross income would be permit-
ted. Second, the percentage of research
and experimental expenditures that may
be exclusively apportioned to United
States source income under the sales
m e t h o d o f a p p o r t i o n m e n t u n d e r
§1.861–8(e)(3)(ii) would be increased
from 30 percent to 50 percent. Third,
use of the optional gross income
methods of apportionment would con-
stitute a binding election to use such
methods in subsequent years. The
election would not be revocable with-
out the prior consent of the Commis-
sioner. The three changes were pro-
posed in part on the basis of an
economic study performed by the
Treasury Department pursuant to Rev.
Proc. 92–56 (1992–2 C.B. 409), ‘‘The
Relationship between U.S. Research
and Development and Foreign In-
come,’’ which was published by the
Treasury Department simultaneously
with the proposed regulations.
Written comments responding to the
notice were received, and a public
hearing was held on September 8,
1995.
Regarding the determination of prod-
uct categories under §1.861–8(e)-
(3)(i)(B) of the proposed regulations,
commenters suggested that the rule
requiring a taxpayer to determine rele-
vant product categories by reference to
the three digit classification of the
Standard Industrial Classification Man-
ual should be modified to allow deter-
minations by reference to the five digit
classifications of the Manual. This
suggestion was not adopted, because
such a rule would too narrowly restrict
the necessarily broad scope of the
deduction. The IRS continues to be-
lieve that research and experimentation
is an inherently speculative activity,
that findings may contribute unex-
pected benefits, and that gross income
derived from successful research and
experimentation must bear the cost of
unsuccessful research and experi-
mentation.
Commenters suggested that the reg-
ulations permit taxpayers to determine
product categories by reference to two
or three digit categories at the annual
election of the taxpayer. This sugges-
tion was not adopted. The regulations
provide that a taxpayer may determine
product categories by reference to two
or three digit categories. A taxpayer
may aggregate, disaggregate or change
a previously selected SIC code cate-
gory if the taxpayer establishes to the
satisfaction of the Commissioner that,
due to changes in the relevant facts, a
change in product category is appropri-
ate. This rule provides a simple and
workable format for balancing the need
for consistency with the desire for
flexibility.
Referring to current §1.861–8(g) Ex-
ample 6 (which has been redesignated
§1.861–17(h) Example 4), commenters
suggested that the regulations allow the
use of the Wholesale Trade SIC code
category with respect to sales from any
other category. The current §1.861–8(g)
Example 6 was not correct on this point
and does not override the rule stated
parenthetically in the list of two digit
SIC code categories in present §1.861–
8(e)(3)(i)(A) that wholesale trade may
not be combined with other product
categories. The final regulations in-
clude this rule along with Example 6
corrected to conform to the rule.
Regarding the exclusive place of
performance apportionment rule under
§1.861–8(e)(3)(ii)(A) of the proposed
regulations, commenters suggested
adding a rule providing that if the ratio
of foreign research and experimental
expenditures in a three digit SIC code
category of all foreign affiliates of a
United States consolidated group over
foreign affiliate sales in that SIC code
category exceed fifty percent of the
ratio of United States consolidated
group research and experimental expen-
ditures in that SIC code category over
United States consolidated group sales
in that SIC code category, then the
United States consolidated group re-
search and experimental expenditures
should be exclusively apportioned to
United States source gross income.
This suggestion has not been adopted.
Although a foreign affiliate may incur
substantial research and experimental
expenditures in a given product cate-
gory, the foreign affiliate may still
benefit from the research and experi-
mental expenditures of the United
States consolidated group. See Perkin-
Elmer Corporation v. Commissioner,
103 T.C. 464 (1994).
Regarding the optional gross income
methods of apportionment under
§1.861–8(e)(3)(iii) of the proposed reg-
ulations, commenters suggested that the
final regulations include a fifty percent
exclusive place of performance appor-
tionment under the optional gross in-
come methods to be parallel with
§1.861–8(e)(3)(ii)(A). This suggestion
has been adopted in part. Section
(b)(1)(ii) of the final regulations in-
cludes a twenty-five percent exclusive
place of performance apportionment
under the optional gross income
methods. This twenty-five percent ex-
clusive apportionment ensures that tax-
payers electing to use one of the
optional gross income methods also
obtain results comparable to those
obtained by taxpayers electing to use
the sales method, i.e., an overall
allocation that is twenty-five percent
lower on average than the allocation to
foreign source income resulting from
the current regulations. The Treasury
Department study does not support a
greater exclusive apportionment.
Commenters suggested that the pro-
posed regulations should be modified
to reduce the floor on the amount of
research and experimental expenditures
that must be apportioned to foreign
source income under the optional gross
income methods from fifty percent to
thirty percent of the amount that would
have been apportioned under the sales
method. This suggestion has not been
adopted. The adoption of this suggested
rule in addition to the twenty-five
percent exclusive apportionment rule is
not supported by the Treasury Depart-
ment study.
Commenters suggested the elimina-
tion of the binding election to use the
optional gross income methods under
§1.861–8(e)(3)(iii)(C) of the proposed
regulations. Commenters also suggested
that the binding election rule should be
modified to provide for a change of
method without the prior consent of the

SEQ 0012 JOB B09-004-003 PAGE-0012 PT 1 PGS 10-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-004
12
Commissioner after five years’ use of
one method. This suggestion, which
recognizes the need for consistency
while reducing the administrative bur-
den on taxpayers, has been adopted.
Commenters suggested that the effec-
tive date election under §1.861–8(e)-
(3)(vi) of the proposed regulations
permit election by fiscal year taxpayers
whose taxable years begin after August
1, 1994, but before January 1, 1995.
This suggestion has been adopted.
Finally, these provisions, which were
previously published as §1.861–8(e)(3),
have been renumbered and will now be
published as §1.861–17. This change
has been made solely for the purpose
of achieving greater clarity in format-
ting and is not intended to result in any
additional substantive changes.
Special Analyses
It has been determined that these
final regulations are not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It also has been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flex-
ibility Act (5 U.S.C. chapter 6) do not
apply to these regulations, and there-
fore a Regulatory Flexibility Analysis
is not required. Pursuant to section
7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking
preceding these final regulations has
been submitted to the Chief Counsel
for Advocacy of the Small Business
Administration for comment on its
impact on small business.
Drafting Information
The principal author of these regula-
tions is Carl Cooper, Office of the
Associate Chief Counsel (Interna-
tional). However, other personnel from
IRS and Treasury participated in their
development.
******
Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
continues to read as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.861–8 is amended
by:
1.Revising paragraph (e)(3) to
read as set forth below.
2.Removing and reserving para-
graph (g), Examples 3 through 16 and
23.
§1.861–8 Computation of taxable
income from sources within the
United States and from other sources
and activities.
******
(e)* * *
(3)Research and experimental ex-
penditures. For rules regarding the
allocation and apportionment of re-
search and experimental expenditures,
see §1.861–17.
******
Par. 3. Section 1.861–17 is added to
read as follows:
§1.861–17 Allocation and apportion-
ment of research and experimental
expenditures.
(a)Allocation—(1) In general. The
methods of allocation and apportion-
ment of research and experimental
expenditures set forth in this section
recognize that research and experimen-
tation is an inherently speculative ac-
tivity, that findings may contribute
unexpected benefits, and that the gross
income derived from successful re-
search and experimentation must bear
the cost of unsuccessful research and
experimentation. Expenditures for re-
search and experimentation that a tax-
payer deducts under section 174 or-
dinarily shall be considered deductions
that are definitely related to all income
reasonably connected with the relevant
broad product category (or categories)
of the taxpayer and therefore allocable
to all items of gross income as a class
(including income from sales, royalties,
and dividends) related to such product
category (or categories). For purposes
of this allocation, the product category
(or categories) that a taxpayer may be
considered to have shall be determined
in accordance with the provisions of
paragraph (a)(2) of this section.
(2)Product categories—(i) Alloca-
tion based on product categories. Or-
dinarily, a taxpayer’s research and
experimental expenditures may be di-
vided between the relevant product
categories. Where research and experi-
mentation is conducted with respect to
more than one product category, the
taxpayer may aggregate the categories
for purposes of allocation and appor-
tionment; however, the taxpayer may
not subdivide the categories. Where
research and experimentation is not
clearly identified with any product
category (or categories), it will be
considered conducted with respect to
all the taxpayer’s product categories.
(ii)Use of three digit standard
industrial classification codes. A tax-
payer shall determine the relevant
product categories by reference to the
three digit classification of the Standard
Industrial Classification Manual (SIC
code). A copy may be purchased from
the Superintendent of Documents,
United States Government Printing Of-
fice, Washington, DC 20402. The
individual products included within
each category are enumerated in Ex-
ecutive Office of the President, Office
of Management and Budget, Standard
Industrial Classification Manual, 1987
(or later edition, as available).
(iii)Consistency. Once a taxpayer
selects a product category for the first
taxable year for which this section is
effective with respect to the taxpayer, it
must continue to use that product
category in following years, unless the
taxpayer establishes to the satisfaction
of the Commissioner that, due to
changes in the relevant facts, a change
in the product category is appropriate.
For this purpose, a change in the
taxpayer’s selection of a product cate-
gory shall include a change from a
three digit SIC code category to a two
digit SIC code category, a change from
a two digit SIC code category to a
three digit SIC code category, or any
other aggregation, disaggregation or
change of a previously selected SIC
code category.
(iv)Wholesale trade category. The
two digit SIC code category ‘‘Whole-
sale trade’’ is not applicable with
respect to sales by the taxpayer of
goods and services from any other of
the taxpayer’s product categories and is
not applicable with respect to a domes-
tic international sales corporation
(DISC) or foreign sales corporation
(FSC) for which the taxpayer is a
related supplier of goods and services
from any of the taxpayer’s product
categories.
(v)Retail trade category. The two
digit SIC code category ‘‘Retail trade’’
is not applicable with respect to sales

SEQ 0013 JOB B09-004-003 PAGE-0013 PT 1 PGS 10-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-004
13
by the taxpayer of goods and services
from any other of the taxpayer’s
product categories, except wholesale
trade, and is not applicable with respect
to a DISC or FSC for which the tax-
payer is a related supplier of goods and
services from any other of the tax-
payer’s product categories, except
wholesale trade.
(3)Affiliated Groups—(i) In gen-
eral. Except as provided in paragraph
(a)(3)(ii) of this section, the allocation
and apportionment required by this
section shall be determined as if all
members of the affiliated group (as
defined in §1.861–14T(d)) were a
single corporation. See §1.861–14T.
(ii)Possessions corporations. (A)
For purposes of the allocation and
apportionment required by this section,
sales and gross income from products
produced in whole or in part in a
possession by an electing corporation
(within the meaning of section 936(h)-
(5)(E)), and dividends from an electing
corporation, shall not be taken into
account, except that this paragraph
(a)(3)(ii) shall not apply to sales of
(and gross income and dividends at-
tributable to sales of) products with
respect to which an election under
section 936(h)(5)(F) is not in effect.
(B)The research and experimental
expenditures taken into account for
purposes of this section shall be
reduced by the amount of such expen-
ditures included in computing the cost-
sharing amount (determined under sec-
tion 936(h)(5)(C)(i)).
(4)Legally mandated research and
experimentation. Where research and
experimentation is undertaken solely to
meet legal requirements imposed by a
political entity with respect to improve-
ment or marketing of specific products
or processes, and the results cannot
reasonably be expected to generate
amounts of gross income (beyond de
minimis amounts) outside a single
geographic source, the deduction for
such research and experimentation shall
be considered definitely related and
therefore allocable only to the grouping
(or groupings) of gross income within
that geographic source as a class (and
apportioned, if necessary, between such
groupings as set forth in paragraphs (c)
and (d) of this section). For example,
where a taxpayer performs tests on a
product in response to a requirement
imposed by the U.S. Food and Drug
Administration, and the test results
cannot reasonably be expected to gen-
erate amounts of gross income (beyond
de minimis amounts) outside the United
States, the costs of testing shall be
allocated solely to gross income from
sources within the United States.
(b)Exclusive apportionment—(1) In
general. An exclusive apportionment
shall be made under this paragraph (b),
where an apportionment based upon
geographic sources of income of a
deduction for research and experimen-
tation is necessary (after applying the
exception in paragraph (a)(4) of this
section).
(i)Exclusive apportionment under
the sales method. If the taxpayer
apportions on the sales method under
paragraph (c) of this section, an amount
equal to fifty percent of such deduction
for research and experimentation shall
be apportioned exclusively to the statu-
tory grouping of gross income or the
residual grouping of gross income, as
the case may be, arising from the
geographic source where the research
and experimental activities which ac-
count for more than fifty percent of the
amount of such deduction were
performed.
(ii)Exclusive apportionment under
the optional gross income methods. If
the taxpayer apportions on the optional
gross income methods under paragraph
(d) of this section, an amount equal to
twenty-five percent of such deduction
for research and experimentation shall
be apportioned exclusively to the statu-
tory grouping or the residual grouping
of gross income, as the case may be,
arising from the geographic source
where the research and experimental
activities which account for more than
fifty percent of the amount of such
deduction were performed.
(iii)Exception. If the applicable fifty
percent geographic source test of the
preceding paragraph (b)(1)(i) or (ii) is
not met, then no part of the deduction
shall be apportioned under this para-
graph (b)(1).
(2)Facts and circumstances sup-
porting an increased exclusive ap-
portionment—(i) In general. The exclu-
sive apportionment provided for in
paragraph (b)(1) of this section reflects
the view that research and experimenta-
tion is often most valuable in the
country where it is performed, for two
reasons. First, research and experimen-
tation often benefits a broad product
category, consisting of many individual
products, all of which may be sold in
the nearest market but only some of
which may be sold in foreign markets.
Second, research and experimentation
often is utilized in the nearest market
before it is used in other markets, and
in such cases, has a lower value per
unit of sales when used in foreign
markets. The taxpayer may establish to
the satisfaction of the Commissioner
that, in its case, one or both of the
conditions mentioned in the preceding
sentences warrant a significantly
greater exclusive allocation percentage
than allowed by paragraph (b)(1) of
this section because the research and
experimentation is reasonably expected
to have very limited or long delayed
application outside the geographic
source where it was performed. Past
experience with research and experi-
mentation may be considered in deter-
mining reasonable expectations.
(ii)Not all products sold in foreign
markets. For purposes of establishing
that only some products within the
product category (or categories) are
sold in foreign markets, the taxpayer
shall compare the commercial produc-
tion of individual products in domestic
and foreign markets made by itself, by
uncontrolled parties (as defined under
paragraph (c)(2)(i) of this section) of
products involving intangible property
which was licensed or sold by the
taxpayer, and by those controlled cor-
porations (as defined under paragraph
(c)(3)(ii) of this section) that can
reasonably be expected to benefit di-
rectly or indirectly from any of the
taxpayer’s research expense connected
with the product category (or catego-
ries). The individual products compared
for this purpose shall be limited, for
nonmanufactured categories, solely to
those enumerated in Executive Office
of the President, Office of Management
and Budget Standard Industrial Classi-
fication Manual, 1987 (or later edition,
as available), and, for manufactured
categories, solely to those enumerated
at a 7-digit level in the U.S. Bureau of
the Census, Census of Manufacturers:
1992, Numerical List of Manufactured
Products, 1993, (or later edition, as
available). Copies of both of these
documents may be purchased from the
Superintendent of Documents, United
States Government Printing Office,
Washington, DC 20402.
(iii)Delayed application of research
findings abroad. For purposes of
establishing the delayed application of
research findings abroad, the taxpayer
shall compare the commercial introduc-
tion of its own particular products and

SEQ 0014 JOB B09-004-003 PAGE-0014 PT 1 PGS 10-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-004
14
processes (not limited by those listed in
the Standard Industrial Classification
Manual or the Numerical List of Manu-
factured Products) in the United States
and foreign markets, made by itself, by
uncontrolled parties (as defined under
paragraph (c)(2)(i) of this section) of
products involving intangible property
that was licensed or sold by the
taxpayer, and by those controlled cor-
porations (as defined under paragraph
(c)(3)(i) of this section) that can
reasonably be expected to benefit,
directly or indirectly, from the tax-
payer’s research expense. For purposes
of evaluating the delay in the applica-
tion of research findings in foreign
markets, the taxpayer shall use a safe
haven discount rate of 10 percent per
year of delay unless he is able to
establish to the satisfaction of the
Commissioner, by reference to the cost
of money and the number of years
during which economic benefit can be
directly attributable to the results of the
taxpayer’s research, that another dis-
count rate is more appropriate.
(c)Sales method—(1) In general.
The amount equal to the remaining
portion of such deduction for research
and experimentation, not apportioned
under paragraph (a)(4) or (b)(1)(i) of
this section, shall be apportioned be-
tween the statutory grouping (or among
the statutory groupings) within the
class of gross income and the residual
grouping within such class in the same
proportions that the amount of sales
from the product category (or catego-
ries) that resulted in such gross income
within the statutory grouping (or statu-
tory groupings) and in the residual
grouping bear, respectively, to the total
amount of sales from the product
category (or categories).
(i)Apportionment in excess of gross
income. Amounts apportioned under
this section may exceed the amount of
gross income related to the product
category within the statutory grouping.
In such case, the excess shall be
applied against other gross income
within the statutory grouping. See
§1.861–8(d)(1) for instances where the
apportionment leads to an excess of
deductions over gross income within
the statutory grouping.
(ii)Leased property. For purposes of
this paragraph (c), amounts received
from the lease of equipment during a
taxable year shall be regarded as sales
receipts for such taxable year.
(2)Sales of uncontrolled parties. For
purposes of the apportionment under
paragraph (c)(1) of this section, the
sales from the product category (or
categories) by each party uncontrolled
by the taxpayer, of particular products
involving intangible property that was
licensed or sold by the taxpayer to such
uncontrolled party shall be taken fully
into account both for determining the
taxpayer’s apportionment and for deter-
mining the apportionment of any other
member of a controlled group of
corporations to which the taxpayer
belongs if the uncontrolled party can
reasonably be expected to benefit di-
rectly or indirectly (through any mem-
ber of the controlled group of corpora-
tions to which the taxpayer belongs)
from the research expense connected
with the product category (or catego-
ries) of such other member. An uncon-
trolled party can reasonably be ex-
pected to benefit from the research
expense of a member of a controlled
group of corporations to which the
taxpayer belongs if such member can
reasonably be expected to license, sell,
or transfer intangible property to that
uncontrolled party or transfer secret
processes to that uncontrolled party,
directly or indirectly through a member
of the controlled group of corporations
to which the taxpayer belongs. Past
experience with research and experi-
mentation shall be considered in deter-
mining reasonable expectations.
(i)Definition of uncontrolled party.
For purposes of this paragraph (c)(2)
the term uncontrolled party means a
party that is not a person with a
relationship to the taxpayer specified in
section 267(b), or is not a member of a
controlled group of corporations to
which the taxpayer belongs (within the
meaning of section 993(a)(3) or
927(d)(4)).
(ii)Licensed products. In the case of
licensed products, if the amount of
sales of such products is unknown (for
example, where the licensed product is
a component of a large machine), a
reasonable estimate based on the prin-
ciples of section 482 should be made.
(iii)Sales of intangible property. In
the case of sales of intangible property,
regardless of whether the consideration
received in exchange for the intangible
is a fixed amount or is contingent on
the productivity, use, or disposition of
the intangible, if the amount of sales of
products utilizing the intangible prop-
erty is unknown, a reasonable estimate
of sales shall be made annually. If
necessary, appropriate economic analy-
ses shall be used to estimate sales.
(3)Sales of controlled parties. For
purposes of the apportionment under
paragraph (c)(1) of this section, the
sales from the product category (or
categories) of the taxpayer shall be
taken fully into account and the sales
from the product category (or catego-
ries) of a corporation controlled by the
taxpayer shall be taken into account to
the extent provided in this paragraph
(c)(3) for determining the taxpayer’s
apportionment, if such corporation can
reasonably be expected to benefit di-
rectly or indirectly (through another
member of the controlled group of
corporations to which the taxpayer
belongs) from the taxpayer’s research
expense connected with the product
category (or categories). A corporation
controlled by the taxpayer can reason-
ably be expected to benefit from the
taxpayer’s research expense if the
taxpayer can be expected to license,
sell, or transfer intangible property to
that corporation or transfer secret proc-
esses to that corporation, either directly
or indirectly through a member of the
controlled group of corporations to
which the taxpayer belongs. Past ex-
perience with research and experimen-
tation shall be considered in determin-
ing reasonable expectations.
(i)Definition of a corporation con-
trolled by the taxpayer. For purposes of
this paragraph (c)(3), the term a
corporation controlled by the taxpayer
means any corporation that has a
relationship to the taxpayer specified in
section 267(b) or is a member of a
controlled group of corporations to
which the taxpayer belongs (within the
meaning of section 993(a)(3) or
927(d)(4).
(ii)Sales to be taken into account.
The sales from the product category (or
categories) of a corporation controlled
by the taxpayer taken into account shall
be equal to the amount of sales that
bear the same proportion to the total
sales of the controlled corporation as
the total value of all classes of the
stock of such corporation owned di-
rectly or indirectly by the taxpayer,
within the meaning of section 1563,
bears to the total value of all classes of
stock of such corporation.
(iii)Sales not to be taken into
account more than once. Sales from the
product category (or categories) be-
tween or among such controlled corpo-
rations or the taxpayer shall not be
taken into account more than once; in
such a situation, the amount sold by the
selling corporation to the buying corpo-

SEQ 0015 JOB B09-004-003 PAGE-0015 PT 1 PGS 10-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-004
15
ration shall be subtracted from the sales
of the buying corporation.
(iv)Effect of cost-sharing arrange-
ments. If the corporation controlled by
the taxpayer has entered into a bona
fide cost-sharing arrangement, in ac-
cordance with the provisions of
§1.482–7, with the taxpayer for the
purpose of developing intangible prop-
erty, then that corporation shall not
reasonably be expected to benefit from
the taxpayer’s share of the research
expense.
(d)Gross income methods—(1)(i) In
general. In lieu of applying the sales
method of paragraph (c) of this section,
the remaining amount of the deduction
for research and experimentation, not
apportioned under paragraph (a)(4) or
(b)(1)(ii) of this section, shall be
apportioned as prescribed in paragraphs
(d)(2) and (3) of this section, between
the statutory grouping (or among the
statutory groupings) of gross income
and the residual grouping of gross
income.
(ii)Optional methods to be applied
to all research and experimental expen-
ditures. These optional methods must
be applied to the taxpayer’s entire
deduction for research and experimen-
tal expense remaining after applying
the exception in paragraph (a)(4) of
this section, and may not be applied on
a product category basis. Thus, after
the allocation of the taxpayer’s entire
deduction for research and experimen-
tal expense under paragraph (a)(2) of
this section (by attribution to SIC code
categories), the taxpayer must then
apportion as necessary the entire de-
duction as allocated by separate
amounts to various product categories,
using only the sales method under
paragraph (c) of this section or only the
optional gross income methods under
this paragraph (d). The taxpayer may
not use the sales method for a portion
of the deduction and optional gross
income methods for the remainder of
the deduction separately allocated.
(2)Option one. The taxpayer may
apportion its research and experimental
expenditures ratably on the basis of
gross income between the statutory
grouping (or among the statutory
groupings) of gross income and the
residual grouping of gross income in
the same proportions that the amount
of gross income in the statutory group-
ing (or groupings) and the amount of
gross income in the residual grouping
bear, respectively, to the total amount
of gross income, if the conditions
described in paragraph (d)(2)(i) and (ii)
of this section are both met.
(i)The amount of research and
experimental expense ratably appor-
tioned to the statutory grouping (or
groupings in the aggregate) is not less
than fifty percent of the amount that
would have been so apportioned if the
taxpayer had used the method de-
scribed in paragraph (c) of this section;
and
(ii)The amount of research and
experimental expense ratably appor-
tioned to the residual grouping is not
less than fifty percent of the amount
that would have been so apportioned if
the taxpayer had used the method
described in paragraph (c) of this
section.
(3)Option two. If, when the amount
of research and experimental expense is
apportioned ratably on the basis of
gross income, either of the conditions
described in paragraph (d)(2)(i) or (ii)
of this section is not met, the taxpayer
may either—
(i)Where the condition of paragraph
(d)(2)(i) of this section is not met,
apportion fifty percent of the amount of
research and experimental expense that
would have been apportioned to the
statutory grouping (or groupings in the
aggregate) under paragraph (c) of this
section to such statutory grouping (or
to such statutory groupings in the
aggregate and then among such group-
ings on the basis of gross income
within each grouping), and apportion
the balance of the amount of research
and experimental expenses to the re-
sidual grouping; or
(ii)Where the condition of para-
graph (d)(2)(ii) of this section is not
met, apportion fifty percent of the
amount of research and experimental
expense that would have been appor-
tioned to the residual grouping under
paragraph (c) of this section to such
residual grouping, and apportion the
balance of the amount of research and
experimental expenses to the statutory
grouping (or to the statutory groupings
in the aggregate and then among such
groupings ratably on the basis of gross
income within each grouping).
(e)Binding election—(1) In general.
A taxpayer may choose to use either
the sales method under paragraph (c) of
this section or the optional gross
income methods under paragraph (d) of
this section for its original return for its
first taxable year to which this section
applies. The taxpayer’s use of either
the sales method or the optional gross
income methods for its return filed for
its first taxable year to which this
section applies shall constitute a bind-
ing election to use the method chosen
for that year and for four taxable years
thereafter.
(2)Change of method. The tax-
payer’s election of a method may not
be revoked during the period referred
to in paragraph (e)(1) of this section
without the prior consent of the Com-
missioner. After the expiration of that
period, the taxpayer may change
methods without the prior consent of
the Commissioner. However, the tax-
payer’s use of the new method shall
constitute a binding election to use the
new method for its return filed for the
first year for which the taxpayer uses
the new method and for four taxable
years thereafter. The taxpayer’s elec-
tion of the new method may not be
revoked during that period without the
prior consent of the Commissioner.
(i)Short taxable years. For purposes
of this paragraph (e), the term taxable
year includes a taxable year of less
than twelve months.
(ii)Affiliated groups. In the case of
an affiliated group, the period referred
to in paragraph (e)(1) of this section
shall commence as of the latest taxable
year in which any member of the group
has changed methods.
(f)Special rules for partnerships—
(1) Research and experimental expendi-
tures. For purposes of applying this
section, if research and experimental
expenditures are incurred by a part-
nership in which the taxpayer is a
partner, the taxpayer’s research and
experimental expenditures shall include
the taxpayer’s distributive share of the
partnership’s research and experimental
expenditures.
(2)Purpose and location of expendi-
tures. In applying the exception for
expenditures undertaken to meet legal
requirements under paragraph (a)(4) of
this section and the exclusive appor-
tionment for the sales method and the
optional gross income methods under
paragraph (b) of this section, a part-
ner’s distributive share of research and
experimental expenditures incurred by
a partnership shall be treated as in-
curred by the partner for the same
purpose and in the same location as
incurred by the partnership.
(3)Apportionment under the sales
method. In applying the remaining

SEQ 0016 JOB B09-005-004 PAGE-0016 PT 1 PGS 16-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-005
16
apportionment for the sales method
under paragraph (c) of this section, a
taxpayer’s sales from a product cate-
gory shall include the taxpayer’s share
of any sales from the product category
of any partnership in which the tax-
payer is a partner. For purposes of the
preceding sentence, a taxpayer’s share
of sales shall be proportionate to the
taxpayer’s distributive share of the
partnership’s gross income in the prod-
uct category.
(g)Effective date. This section ap-
plies to taxable years beginning after
December 31, 1995. However, a tax-
payer may at its option, apply this
section in its entirety to all taxable
years beginning after August 1, 1994.
(h)Examples. The following exam-
ples illustrate the application of this
section:
Example 1—(i) Facts. X, a domestic corpora-
tion, is a manufacturer and distributor of small
gasoline engines for lawn mowers. Gasoline
engines are a product within the category,
Engines and Turbines (SIC Industry Group 351).
Y, a wholly owned foreign subsidiary of X, also
manufactures and sells these engines abroad.
During 1996, X incurred expenditures of $60,000
on research and experimentation, which it
deducts as a current expense, to invent and
patent a new and improved gasoline engine. All
of the research and experimentation was per-
formed in the United States. In 1996, the
domestic sales by X of the new engine total
$500,000 and foreign sales by Y total $300,000.
X provides technology for the manufacture of
engines to Y via a license that requires the
payment of an arm’s length royalty. In 1996, X’s
gross income is $160,000, of which $140,000 is
U.S. source income from domestic sales of
gasoline engines and $10,000 is foreign source
royalties from Y, and $10,000 is U.S. source
interest income.
(ii)Allocation. The research and experimental
expenditures were incurred in connection with
small gasoline engines and they are definitely
related to the items of gross income to which the
research gives rise, namely gross income from
the sale of small gasoline engines in the United
States and royalties received from subsidiary Y,
a foreign manufacturer of gasoline engines.
Accordingly, the expenses are allocable to this
class of gross income. The U.S. source interest
income is not within this class of gross income
and, therefore, is not taken into account.
(iii)Apportionment. (A) For purposes of ap-
plying the foreign tax credit limitation, the
statutory grouping is general limitation gross
income from sources without the United States
and the residual grouping is gross income from
sources within the United States. Since the
related class of gross income derived from the
use of engine technology consists of both gross
income from sources without the United States
(royalties from Y) and gross income from
sources within the United States (gross income
from engine sales), X’s deduction of $60,000 for
its research and experimental expenditure must
be apportioned between the statutory and residual
grouping before the foreign tax credit limitation
may be determined. Because more than 50
percent of X’s research and experimental activity
was performed in the United States, 50 percent
of that deduction can be apportioned exclusively
to the residual grouping of gross income, gross
income from sources within the United States.
The remaining 50 percent of the deduction can
then be apportioned between the residual and
statutory groupings on the basis of sales of small
gasoline engines by X and Y. Alternatively, X’s
deduction for research and experimentation can
be apportioned under the optional gross income
method. The apportionment for 1996 is as
follows:
(1)Tentative Apportionment on the Basis of
Sales.
(i) Research and experimental ex-
pense to be apportioned between re-
sidual and statutory groupings of gross
income:$60,000
(ii) Less: Exclusive apportionment
of research and experimental expense
to the residual grouping of gross
income ($60,000 3 50 percent):$30,000
(iii) Research and experimental ex-
pense to be apportioned between re-
sidual and statutory groupings of gross
income on the basis of sales:$30,000
(iv) Apportionment of research and
experimental expense to the residual
grouping of gross income ($30,000 3
$500,000/($500,000 + $300,000)):$18,750
(v) Apportionment of research and
experimental expense to the statutory
grouping of gross income ($30,000 3
$300,000/($500,000 + $300,000)):$11,250
(vi) Total apportioned deduction for
research and experimentation:$60,000
(vii) Amount apportioned to the
residual grouping ($30,000 + $18,750):$48,750
(viii) Amount apportioned to the
statutory grouping:$11,250
(2) Tentative Apportionment on the Basis of
Gross Income.
(i) Exclusive apportionment of re-
search and experimental expense to the
residual grouping of gross income
($60,000 3 25 percent):$15,000
(ii) Research and experimental ex-
pense apportioned to sources within
the United States (residual grouping)
($45,000 3 $140,000/($140,000 +
$10,000)):$42,000
(iii) Research and experimental ex-
pense apportioned to sources within
c o u n t r y Y ( s t a t u t o r y g r o u p i n g )
($45,000 3 $10,000/($140,000 +
$10,000)):$3,000
(iv) Amount apportioned to the
residual grouping:$57,000
(v) Amount apportioned to the statu-
tory grouping:$3,000
(B)The total research and experimental ex-
pense apportioned to the statutory grouping
($3,000) under the gross income method is
approximately 26 percent of the amount appor-
tioned to the statutory grouping under the sales
method. Thus, X may use option two of the
gross income method (paragraph (d)(3) of this
section) and apportion to the statutory grouping
fifty percent (50%) of the $11,250 apportioned to
that grouping under the sales method. Thus, X
apportions $5,625 of research and experimental
expense to the statutory grouping. X’s use of the
optional gross income methods will constitute a
binding election to use the optional gross income
methods for 1996 and four taxable years
thereafter.
Example 2—(i) Facts. Assume the same facts
as in Example 1 except that X also spends
$30,000 in 1996 for research on steam turbines,
all of which is performed in the United States,
and X has steam turbine sales in the United
States of $400,000. X’s foreign subsidiary Y
neither manufactures nor sells steam turbines.
The steam turbine research is in addition to the
$60,000 in research which X does on gasoline
engines for lawnmowers. X thus has a deduction
of $90,000 for its research activity. X’s gross
income is $200,000, of which $140,000 is U.S.
source income from domestic sales of gasoline
engines, $50,000 is U.S. source income from
domestic sales of steam turbines, and $10,000 is
foreign source royalties from Y.
(ii)Allocation. X’s research expenses generate
income from sales of small gasoline engines and
steam turbines. Both of these products are in the
same three digit SIC code category, Engines and
Turbines (SIC Industry Group 351). Therefore,
the deduction is definitely related to this product
category and allocable to all items of income
attributable to it. These items of X’s income are
gross income from the sale of small gasoline
engines and steam turbines in the United States
and royalties from foreign subsidiary Y, a
foreign manufacturer and seller of small gasoline
engines.
(iii)Apportionment. (A) For purposes of ap-
plying the foreign tax credit limitation, the
statutory grouping is general limitation gross
income from sources outside the United States
and the residual grouping is gross income from
sources within the United States. X’s deduction
of $90,000 must be apportioned between the
statutory and residual groupings. Because more
than 50 percent of X’s research and experimental
activity was performed in the United States, 50
percent of that deduction can be apportioned
exclusively to the residual grouping, gross
income from sources within the United States.
The remaining 50 percent of the deduction can
then be apportioned between the residual and
statutory groupings on the basis of total sales of
small gasoline engines and steam turbines by X
and Y. Alternatively, X’s deduction for research
and experimentation can be apportioned under
the optional gross income methods. The appor-
tionment for 1996 is as follows:
(1)Tentative Apportionment on the Basis of
Sales.
(i) Research and experimental ex-
pense to be apportioned between re-
sidual and statutory groupings of gross
income:$90,000
(ii) Less: Exclusive apportionment
of the research and experimental ex-
pense to the residual grouping of gross
income ($90,000 3 50 percent):$45,000
(iii) Research and experimental ex-
pense to be apportioned between the
residual and statutory groupings of
gross income on the basis of sales:$45,000
(iv) Apportionment of research and
experimental expense to the residual
grouping of gross income ($45,000 3
($500,000 + $400,000)/($500,000 +
$400,000 + $300,000)):$33,750

SEQ 0017 JOB B09-005-004 PAGE-0017 PT 1 PGS 16-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-005
17
(v) Apportionment of research and
experimental expense to the statutory
grouping of gross income ($45,000 3
$300,000/($500,000 + $400,000 +
$300,000)):$11,250
(vi) Total apportioned deduction for
research and experimentation:$90,000
(vii) Amount apportioned to the
residual grouping ($45,000 + $33,750):$78,750
(viii) Amount apportioned to the
statutory
grouping:$11,250
(2) Tentative Apportionment on the Basis of
Gross Income.
(i) Exclusive apportionment of re-
search and experimental expense to the
residual grouping of gross income
($90,000 3 25 percent):$22,500
(ii) Research and experimental ex-
pense apportioned to sources within
the United States (residual grouping)
($67,500 3 $190,000/($140,000 +
$50,000 + $10,000)):$64,125
(iii) Research and experimental ex-
pense apportioned to sources within
c o u n t r y Y ( s t a t u t o r y g r o u p i n g )
($67,500 3 $10,000/($140,000 +
$50,000 + $10,000)):$3,375
(iv) Amount apportioned to the
residual grouping:$86,625
(v) Amount apportioned to the statu-
tory grouping:$3,375
(B)The total research and experimental ex-
pense apportioned to the statutory grouping
($3,375) under the gross income method is 30
percent of the amount apportioned to the
statutory grouping under the sales method. Thus,
X may use option two of the gross income
method (paragraph (d)(3) of this section) and
apportion to the statutory grouping fifty percent
(50%) of the $11,250 apportioned to that
grouping under the sales method. Thus, X
apportions $5,625 of research and experimental
expense to the statutory grouping. X’s use of the
optional gross income methods will constitute a
binding election to use the optional gross income
methods for 1996 and four taxable years
thereafter.
Example 3—(i) Facts. Assume the same facts
as in Example 1 except that in 1997 X continues
its sales of the new engines, with sales of
$600,000 in the United States and $400,000
abroad by subsidiary Y. X also acquires a 60
percent (by value) ownership interest in foreign
corporation Z and a 100 percent ownership
interest in foreign corporation C. X transfers its
engine technology to Z for a royalty equal to 5
percent of sales, and X enters into an arm’s
length cost-sharing arrangement with C to share
the funding of all of X’s research activity. In
1997, corporation Z has sales in country Z equal
to $1,000,000. X incurs expense of $80,000 on
research and experimentation in 1997, and in
addition, X performs $15,000 of research on
gasoline engines which was funded by the cost-
sharing arrangement with C. All of Z’s sales are
from the product category, Engines and Turbines
(SIC Industry Group 351). X performs all of its
research in the United States and $20,000 of its
expenditure of $80,000 is made solely to meet
pollution standards mandated by law. X
establishes, to the satisfaction of the Commis-
sioner, that the expenditure in response to
pollution standards is not expected to generate
gross income (beyond de minimis amounts)
outside the United States.
(ii)Allocation. The $20,000 of research ex-
pense which X incurred in connection with
pollution standards is definitely related and thus
allocable to the residual grouping, gross income
from sources within the United States. The
remaining $60,000 in research and experimental
expenditure incurred by X is definitely related to
all gasoline engines and is therefore allocable to
the class of gross income to which the engines
give rise, gross income from sales of gasoline
engines in the United States, royalties from
country Y, and royalties from country Z. No part
of the $60,000 research expense is allocable to
dividends from country C, because corporation C
has already paid, through its cost-sharing ar-
rangement, for research activity performed by X
which may benefit C.
(iii)Apportionment. For purposes of applying
the foreign tax credit limitation, the statutory
grouping is general limitation gross income from
sources without the United States, and the
residual grouping is gross income from sources
within the United States. X’s deduction of
$60,000 for its research and experimental expen-
diture must be apportioned between these group-
ings. Because more than 50 percent of the
research and experimentation was performed in
the United States, 50 percent of the $60,000
deduction can be apportioned exclusively to the
residual grouping. The remaining 50 percent of
the deduction can then be apportioned between
the residual and the statutory grouping on the
basis of sales of gasoline engines by X, Y, and
Z. (If X utilized the optional gross income
methods in 1996, then its use of such methods
constituted a binding election to use the optional
gross income methods in 1996 and for four
taxable years thereafter. If X utilized the sales
method in 1996, then its use of such method
constituted a binding election to use the sales
method in 1996 and for four taxable years
thereafter.) The optional gross income methods
are not illustrated in this Example 3 (see instead
Examples 1 and 2). Since X has only a 60
percent ownership interest in corporation Z, only
60 percent of Z’s sales (60% of $1,000,000, or
$600,000) are included for purposes of appor-
tionment. The allocation and apportionment for
1997 is as follows:
(A) X’s total research expense:$80,000
(B) Less: Legally mandated research
directly allocated to the residual
grouping of gross income:$20,000
(C) Tentative apportionment on the
basis of sales.
(1) Research and experimental ex-
pense to be apportioned between re-
sidual and statutory groupings of gross
income:$60,000
(2) Less: Exclusive apportionment
of research and experimental expense
to the residual grouping of gross
income ($60,000 3 50 percent):$30,000
(3) Research and experimental expense
to be apportioned between the residual
and the statutory groupings on the
basis of sales:$30,000
(4) Apportionment of research and
experimental expense to gross income
from sources within the United States
(residual grouping) ($30,000 3
$600,000 / ($600,000 + $400,000 +
$600,000)):$11,250
(5) Apportionment of research and
experimental expense to general lim-
itation gross income from countries Y
and Z (statutory grouping) ($30,000 3
$400,000 + $600,000/($600,000 +
$400,000 +$600,000)):$18,750
(6) Total apportioned deduction for
research and experimentation ($30,000
+ $30,000):$60,000
(7) Amount apportioned to the re-
sidual grouping ($30,000 + $11,250):$41,250
(8) Amount apportioned to the statu-
tory grouping of gross income from
sources within countries Y and Z:$18,750
Example 4—Research and Experimentation—
(i) Facts. X, a domestic corporation, manufac-
tures and sells forklift trucks and other types of
materials handling equipment in the United
States. The manufacture and sale of forklift
trucks and other materials handling equipment
belongs to the product category, Construction,
Mining, and Materials Handling Machinery and
Equipment (SIC Industry Group 353). X also
sells its forklift trucks to a wholesaling subsidi-
ary located in foreign country Y (but title passes
in the United States), and X manufactures
forklift trucks in foreign country Z. The whole-
saling of forklift trucks to country Y also
belongs to X’s product category Transportation
equipment and, therefore, may not belong to the
product category, Wholesale trade (SIC Major
Group 50 and 51). In 1997, X sold $7,000,000 of
forklift trucks to purchasers in the United States,
$3,000,000 of forklift trucks to the wholesaling
subsidiary in Y, and transferred forklift truck
components with an FOB export value of
$2,000,000 to its branch in Z. The branch’s sales
of finished forklift trucks were $5,000,000. In
response to legally mandated emission control
requirements, X’s United States research depart-
ment has been engaged in a research project to
improve the performance and quality of engine
exhaust systems used on its products in the
United States. It incurs expenses of $100,000 for
this purpose in 1997. In the past, X has
customarily adapted the product improvements
developed originally for the domestic market to
its forklift trucks manufactured abroad. During
the taxable year 1997, development of an
improved engine exhaust system is completed
and X begins installing the new system during
the latter part of the taxable year in products
manufactured and sold in the United States. X
continues to manufacture and sell forklift trucks
in foreign countries without the improved engine
exhaust systems.
(ii)Allocation. X’s deduction for its research
expense is definitely related to the income to
which it gives rise, namely income from the
manufacture and sale of forklift trucks within the
United States and in country Z. Although the
research is undertaken in response to a legal
mandate, it can reasonably be expected to
generate gross income from the manufacture and
sale of trucks by the branch in Z. Therefore, the
deduction is not allocable solely to income from
X’s domestic sales of forklift trucks. It is
allocable to income from such sales and income
from the sales of X’s branch in Z.
(iii)Apportionment. For the method of appor-
tionment on the basis of either sales or gross
income, see Example 3. However, in determining
the amount of research apportioned to income
from foreign and domestic sources, the net sales
of the branch in Z are $3,000,000 ($5,000,000
less $2,000,000) and the sales within the United

SEQ 0018 JOB B09-005-004 PAGE-0018 PT 1 PGS 16-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-005
18
States are $12,000,000 ($7,000,000 plus
$3,000,000 plus $2,000,000). See §1.861–17(c)-
(3)(iii).
Example 5—(i) Facts. X, a domestic corpora-
tion, is a drug company that manufactures a wide
variety of pharmaceutical products for sale in the
United States. Pharmaceutical products belong to
the product category, Drugs (SIC Industry Group
283). X exports its pharmaceutical products
through a foreign sales corporation (FSC). X’s
wholly owned foreign subsidiary Y also man-
ufactures pharmaceutical products. In 1997, X
has domestic sales of pharmaceutical products of
$10,000,000, the FSC has sales of pharmaceuti-
cal products of $3,000,000, and Y has sales of
pharmaceutical products of $5,000,000. In that
same year, 1997, X incurs expense of $200,000
on research to test a product in response to
requirements imposed by the United States Food
and Drug Administration (FDA). X is able to
show that, even though country Y imposes
certain testing requirements on pharmaceutical
products, the research performed in the United
States is not accepted by country Y for purposes
of its own licensing requirements, and the
research has minimal use abroad. X is further
able to show that FSC sells goods to countries
that do not accept or do not require research
performed in the United States for purposes of
their own licensing standards.
(ii)Allocation. Since X’s research expense of
$200,000 is undertaken to meet the requirements
of the United States Food and Drug Administra-
tion, and since it is reasonable to expect that the
expenditure will not generate gross income
(beyond de minimis amounts) outside the United
States, the deduction is definitely related and
thus allocable to the residual grouping.
(iii)Apportionment. No apportionment is nec-
essary since the entire expense is allocated to the
residual grouping, gross income from sales
within the United States.
Example 6—(i) Facts. X, a domestic corpora-
tion, is engaged in continuous research and
experimentation to improve the quality of the
products that it manufactures and sells, which are
floodlights, flashlights, fuse boxes, and solderless
connectors. X incurs and deducts $100,000 of
expenditure for research and experimentation in
1997 that was performed exclusively in the
United States. As a result of this research
activity, X acquires patents that it uses in its own
manufacturing activity. X licenses its floodlight
patent to Y and Z, uncontrolled foreign corpora-
tions, for use in their own territories, countries Y
and Z, respectively. Corporation Y pays X an
arm’s length royalty of $3,000 plus $0.20 for
each floodlight sold. Sales of floodlights by Y
for the taxable year are $135,000 (at $4.50 per
unit) or 30,000 units, and the royalty is $9,000
($3,000 + $0.20 3 30,000). Y has sales of other
products of $500,000. Z pays X an arm’s length
royalty of $3,000 plus $0.30 for each unit sold. Z
manufactures 30,000 floodlights in the taxable
year, and the royalty is $12,000 ($3,000 + $0.30
3 30,000). The dollar value of Z’s floodlight
sales is not known and cannot be reasonably
estimated because, in this case, the floodlights
are not sold separately by Z but are instead used
as a component in Z’s manufacture of lighting
equipment for theaters. The sales of all Z’s
products, including the lighting equipment for
theaters, are $1,000,000. Y and Z each sell the
floodlights exclusively within their respective
countries. X’s sales of floodlights for the taxable
year are $500,000 and its sales of its other pro-
ducts, flashlights, fuse boxes, and solderless
connectors, are $400,000. X has gross income of
$500,000, consisting of gross income from do-
mestic sources from sales of floodlights, flash-
lights, fuse boxes, and solderless connectors of
$479,000, and royalty income of $9,000 and
$12,000 from foreign corporations Y and Z re-
spectively. X utilized the optional gross income
methods of apportionment for its return filed for
its first taxable year to which this section applies.
(ii)Allocation. X’s research and experimental
expenses are definitely related to all of the
products that it produces, which are floodlights,
flashlights, fuse boxes, and solderless connectors.
All of these products are in the same three digit
SIC Code category, Electric Lighting and Wiring
Equipment (SIC Industry Group 364). Thus, X’s
research and experimental expenses are allocable
to all items of income attributable to this product
category, domestic sales income and royalty
income from the foreign countries in which
corporations Y and Z operate.
(iii)Apportionment. (A) The statutory group-
ing of gross income is general limitation income
from sources without the United States. The
residual grouping is gross income from sources
within the United States. X’s deduction of
$100,000 for its research expenditures must be
apportioned between the groupings. For appor-
tionment on the basis of sales in accordance with
paragraph (c) of this section, X is entitled to an
exclusive apportionment of 50 percent of its
research and experimental expense to the residual
grouping, gross income from sources within the
United States, since more than 50 percent of the
research activity was performed in the United
States. The remaining 50 percent of the deduc-
tion can then be apportioned between the
residual and statutory groupings on the basis of
sales. Since Y and Z are unrelated licensees of
X, only their sales of the licensed product,
floodlights, are included for purposes of appor-
tionment. Floodlight sales of Z are unknown, but
are estimated at ten times royalties from Z, or
$120,000. All of X’s sales from the entire
product category are included for purposes of
apportionment on the basis of sales. Alter-
natively, X may apportion its deduction on the
basis of gross income, in accordance with
paragraph (d) of this section. The apportionment
is as follows:
(1) Tentative Apportionment on the basis of
sales.
(i) Research and experimental ex-
pense to be apportioned between statu-
tory and residual groupings of gross
income:$100,000
(ii) Less: Exclusive apportionment
of research and experimental expense
to the residual groupings of gross
income ($100,000 3 50 percent):$50,000
(iii) Research and experimental ex-
pense to be apportioned between the
statutory and residual groupings of
gross income on the basis of sales:$50,000
(iv) Apportionment of research and
experimental expense to the residual
groupings of gross income ($50,000 3
$900,000/($900,000 + $135,000 +
$120,000)):$38,961
(v) Apportionment of research and
experimental expense to the statutory
grouping, royalty income from coun-
tries Y and Z ($50,000 3 $135,000 +
$120,000/($900,000 + $135,000 +
$120,000)):$11,039
(vi) Total apportioned deduction for
research and experimentation:$100,000
(vii) Amount apportioned to the
residual grouping ($50,000 + $38,961):$88,961
(viii) Amount apportioned to the
statutory grouping of sources within
countries Y and Z:$11,039
(2) Tentative apportionment on gross income
basis.
(i) Exclusive apportionment of re-
search and experimental expense to the
residual grouping of gross income
($100,000 3 25 percent):$25,000
(ii) Apportionment of research and
experimental expense to the residual
grouping of gross income ($75,000 3
$479,000/$500,000):$71,850
(iii) Apportionment of research and
experimental expense to the statutory
grouping of gross income ($75,000 3
$9,000 + $12,000/$500,000):$3,150
(iv) Amount apportioned to the
residual grouping:$96,850
(v) Amount apportioned to the stat-
utory grouping of general limitation
income from sources without the
United States:$3,150
(B)Since X has elected to use the optional
gross income methods of apportionment and its
apportionment on the basis of gross income to
the statutory grouping, $3,150, is less than 50
percent of its apportionment on the basis of sales
to the statutory grouping, $11,039, it must use
Option two of paragraph (d)(3) of this section
and apportion $5,520 (50 percent of $11,039) to
the statutory grouping.
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
Approved December 13, 1995.
Leslie Samuels,
Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 21, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 22, 1995, 60 F.R. 66502)
Section 3406.—Backup Withholding
26 CFR 31.3406(h)–3: Certificates.
When does a substitute Form W–9 that
contains a single signature line both for the
certifications under section 3406 of the Internal
Revenue Code and for unrelated account opening
provisions satisfy the requirement that the
certifications be clearly set forth? See Rev. Proc.
96–26, page 22.

SEQ 0019 JOB B09-006-008 PAGE-0019 PT 3 PGS 19-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-006
19
Part III.Administrative, Procedural, and Miscellaneous
Weighted Average Interest Rate Update
Notice 96–11
Notice 88–73 provides guidelines for
determining the weighted average inter-
est rate and the resulting permissible
range of interest rates used to calculate
current liability for the purpose of
t h e f u l l f u n d i n g l i m i t a t i o n o f
§ 412(c)(7) of the Internal Revenue
Code as amended by the Omnibus
Budget Reconciliation Act of 1987 and
as further amended by the Uruguay
Round Agreements Act, Pub. L. 103–
465 (GATT).
The average yield on the 30-year
Treasury Constant Maturities for Janu-
ary 1996 is 6.05 percent.
The following rates were determined
for the plan years beginning in the
month shown below.
MonthYear
Weighted
Average
90% to 108%
Permissible
Range
90% to 110%
Permissible
Range
February19967.016.31 to 7.576.31 to 7.71
Drafting Information
The principal author of this notice is
Donna Prestia of the Employee Plans
Division. For further information re-
garding this notice, call (202) 622-6076
between 2:30 and 4:00 p.m. Eastern
time (not a toll-free number). Ms.
Prestia’s number is (202) 622-7377
(also not a toll-free number).
26 CFR 601.105: Examination of returns and
claims for refund, credit, or abatement;
determination of correct tax liability.
(Also Part I, §280F; 1.280F–7, 1.280F–5T.)
Rev. Proc. 96–25
SECTION 1. PURPOSE
This revenue procedure provides lim-
itations on depreciation deductions for
owners of passenger automobiles first
placed in service during calendar year
1996, and the amounts to be included
in income by lessees of passenger
automobiles first leased during calendar
year 1996. The tables detailing these
amounts reflect the automobile price
inflation adjustments required by
§ 280F(d)(7) of the Internal Revenue
Code.
SECTION 2. BACKGROUND
F o r o w n e r s o f a u t o m o b i l e s ,
§ 280F(a) imposes dollar limitations on
the depreciation deduction for both the
year that the automobile is placed in
service and each succeeding year.
Section 280F(d)(7) requires the
amounts allowable as depreciation de-
ductions to be increased by a price
inflation adjustment amount for pas-
senger automobiles placed in service
after calendar year 1988.
For leased automobiles, §280F(c)
requires a reduction in the deduction
allowed to the lessee of the automobile.
The reduction must be substantially
equivalent to the limitations on the
depreciation deductions imposed on
o w n e r s o f a u t o m o b i l e s . U n d e r
§ 1.280F–7(a) of the Income Tax Reg-
ulations, this reduction requires the
lessees to include in gross income an
inclusion amount determined by apply-
ing a formula to the amount obtained
from a table. The table shows inclusion
amounts for a range of fair market
values for each tax year after the
automobile is first leased.
SECTION 3. SCOPE AND
OBJECTIVE
01.The limitations on depreciation
deductions in section 4.02 of this
revenue procedure apply to automobiles
(other than leased automobiles) that are
placed in service in calendar year 1996
and continue to apply for each tax year
that the automobile remains in service.
02.The table in section 4.03 of this
revenue procedure applies to leased
automobiles for which the lease term
begins in calendar year 1996. Lessees
of such automobiles must use this table
to determine the inclusion amount for
each tax year during which the auto-
mobile is leased. See §§ 1.280F–5T(d)
and 1.280F–5T(e) of the temporary
Income Tax Regulations, §1.280F–
7(a), Rev. Proc. 89–64, 1989–2 C.B.
783, Rev. Proc. 90–22, 1990–1 C.B.
504, Rev. Proc. 91–30, 1991–1 C.B.
563, Rev. Proc. 92–43, 1992–1 C.B.
873, Rev. Proc 93–35, 1993–2 C.B.
472, Rev. Proc 94–53, 1994–2 C.B.
712, and Rev. Proc. 95–9, 1995–1 C.B.
498, to determine inclusion amounts for
automobiles first leased before January
1, 1996.
SECTION 4. APPLICATION
01.A taxpayer placing an auto-
mobile in service for the first time
during calendar year 1996 is limited to
the depreciation deduction shown in
Table 1 of section 4.02(2). A taxpayer
first leasing an automobile in calendar
year 1996 must use Table 2 in section
4.03 to determine the inclusion amount
that is added to gross income. Other-
wise, the procedures of § 1.280F–7(a)
must be followed.
02.Limitations on Depreciation De-
ductions for Certain Automobiles.
(1)Amount of the Inflation Adjust-
ment. Under §280F(d)(7)(B)(i), the
automobile price inflation adjustment
for any calendar year is the percentage
(if any) by which the CPI automobile
component for October of the preced-
ing calendar year exceeds the CPI
automobile component for October
1987. The term ‘‘CPI automobile com-
ponent’’ is defined in §280F(d)(7)(B)-
(ii) as the ‘‘automobile component’’ of
the Consumer Price Index for all Urban

SEQ 0020 JOB B09-006-008 PAGE-0020 PT 3 PGS 19-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-006
20
Consumers published by the Depart-
ment of Labor (the CPI). The new car
component of the CPI was 115.2 for
October 1987 and 138.6 for October
1995. The October 1995 index ex-
ceeded the October 1987 index by 23.4.
The Internal Revenue Service has,
therefore, determined that the auto-
mobile price inflation adjustment for
1996 is 20.31 percent (23.4/115.2 3
100%). This adjustment is applicable to
all automobiles that are first placed in
service in calendar year 1996. The
dollar limitations in §280F(a) must
therefore be multiplied by a factor of
0.2031, and the resulting increases,
after rounding to the nearest $100, are
added to the 1988 limitations to give
the depreciation limitations for 1996.
(2)Amount of the Limitation. For
automobiles placed in service in calen-
dar year 1996, Table 1 contains the
dollar amount of the depreciation lim-
itations for each tax year.
REV. PROC. 96–25 TABLE 1
DEPRECIATION LIMITATIONS FOR AUTOMOBILES
FIRST PLACED IN SERVICE IN CALENDAR YEAR 1996
Tax YearAmount
1st Tax Year$3,060
2nd Tax Year$4,900
3rd Tax Year$2,950
Each Succeeding Year$1,775
03.Inclusions in Income of Lessees of Automobiles.
The inclusion amounts for automobiles first leased in calendar year 1996 are calculated under the procedures described in
§ 1.280F–7(a). Table 2 of this revenue procedure is the applicable table to be used in applying those procedures.
REV. PROC. 96–25 TABLE 2
DOLLAR AMOUNTS FOR AUTOMOBILES
WITH A LEASE TERM BEGINNING IN CALENDAR YEAR 1996
Fair Market Value
of Automobile
OverNot Over
Tax Year During Lease
1st2nd3rd4th
5th and
Later
$15,500$15,8003681010
15,80016,100511161921
16,10016,400716242732
16,40016,7001021313742
16,70017,0001226394653
17,00017,5001533495867
17,50018,0001942617384
18,00018,50023507488102
18,50019,000275986104119
19,00019,500316799119136
19,50020,0003575112134154
20,00020,5003884125149171
20,50021,0004293137164189
21,00021,50046101150179207
21,50022,00050110162194225
22,00023,00056122182217250
23,00024,00064139207247286
24,00025,00071157232277320
25,00026,00079174257308355
26,00027,00087191282338390
27,00028,00095207308369425
28,00029,000103224333399460

SEQ 0021 JOB B09-006-008 PAGE-0021 PT 3 PGS 19-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-006
21
REV. PROC. 96–25 TABLE 2
DOLLAR AMOUNTS FOR AUTOMOBILES
WITH A LEASE TERM BEGINNING IN CALENDAR YEAR 1996
Fair Market Value
of Automobile
OverNot Over
Tax Year During Lease
1st2nd3rd4th
5th and
Later
29,00030,000110242358429495
30,00031,000118259383459531
31,00032,000126276408490565
32,00033,000134293433520600
33,00034,000141310459550635
34,00035,000149327484581670
35,00036,000157344509611705
36,00037,000165361535641740
37,00038,000172378560672775
38,00039,000180395585702810
39,00040,000188412611732844
40,00041,000196429636762880
41,00042,000203446661793915
42,00043,000211463687822950
43,00044,000219480712853985
44,00045,0002274977378831,020
45,00046,0002355147629141,054
46,00047,0002425317889441,089
47,00048,0002505488139741,125
48,00049,0002585658381,0051,159
49,00050,0002665828631,0351,195
50,00051,0002735998891,0651,230
51,00052,0002816169141,0961,264
52,00053,0002896339391,1261,299
53,00054,0002976509641,1571,334
54,00055,0003046689891,1861,370
55,00056,0003126841,0151,2171,404
56,00057,0003207011,0401,2471,440
57,00058,0003287181,0661,2771,474
58,00059,0003367351,0911,3071,509
59,00060,0003437531,1151,3381,544
60,00062,0003557781,1541,3831,597
62,00064,0003708121,2051,4431,667
64,00066,0003868461,2551,5041,737
66,00068,0004028801,3051,5651,807
68,00070,0004179141,3561,6261,876
70,00072,0004339481,4061,6861,947
72,00074,0004489821,4571,7472,016
74,00076,0004641,0161,5081,8072,086
76,00078,0004791,0501,5581,8682,156
78,00080,0004951,0841,6091,9282,226
80,00085,0005221,1441,6972,0342,349
85,00090,0005611,2291,8232,1862,523
90,00095,0006001,3141,9502,3372,698
95,000100,0006381,4002,0752,4892,873
100,000110,0006971,5272,2652,7163,135
110,000120,0007741,6972,5183,0193,485
120,000130,0008521,8682,7703,3223,834
130,000140,0009302,0383,0233,6244,185
140,000150,0001,0072,2083,2763,9274,534
150,000160,0001,0852,3783,5294,2304,884

SEQ 0022 JOB B09-006-008 PAGE-0022 PT 3 PGS 19-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-006
22
REV. PROC. 96–25 TABLE 2
DOLLAR AMOUNTS FOR AUTOMOBILES
WITH A LEASE TERM BEGINNING IN CALENDAR YEAR 1996
Fair Market Value
of Automobile
OverNot Over
Tax Year During Lease
1st2nd3rd4th
5th and
Later
160,000170,0001,1632,5483,7814,5335,234
170,000180,0001,2402,7194,0334,8375,583
180,000190,0001,3182,8894,2865,1395,933
190,000200,0001,3963,0594,5395,4426,282
200,000210,0001,4733,2304,7915,7456,632
210,000220,0001,5513,4005,0446,0476,982
220,000230,0001,6293,5705,2966,3517,332
230,000240,0001,7063,7405,5506,6537,681
240,000250,0001,7843,9115,8016,9568,032
SECTION 5. EFFECTIVE DATE
This revenue procedure is effective
for automobiles (other than leased
automobiles) that are first placed in
service during calendar year 1996 and
to leased automobiles that are first
leased during calendar year 1996.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Bernard P. Harvey of the
Office of Assistant Chief Counsel
Passthroughs and Special Industries).
For further information regarding this
revenue procedure contact Mr. Harvey
on (202) 622-3110 (not a toll-free call).
26 CFR 601.602: Forms and instructions.
(Also Part I, Section 3406; 31.3406(h)–3)
Rev. Proc. 96–26
SECTION 1. PURPOSE
This revenue procedure clarifies the
certification requirements for a sub-
stitute Form W–9, Request for Tax-
payer Identification Number and Cer-
tification, and amplifies Rev. Proc. 83–
89, 1983–2 C.B. 613, which provides
guidelines for payors of interest, divi-
dends, and patronage dividends and
brokers that want to design and provide
their own substitute Forms W–9.
SECTION 2. BACKGROUND
. 0 1 U n d e r § § 6 1 0 9 ( a ) ( 2 ) a n d
3406(a)(1)(A) of the Internal Revenue
Code, a payee of a reportable payment
must provide its Taxpayer Identifica-
tion Number (TIN) to a person who is
required to file an information return
with respect to the payment. In addi-
tion, under §3406(a)(1)(A) the payee
of a reportable interest or dividend
payment generally must certify that its
TIN is correct and that it is not subject
to backup withholding under §3406(a)-
(1)(C) for failure to include interest and
dividend income on its tax return
( r e q u i r e d c e r t i f i c a t i o n s ) . S e c t i o n
3406(a)(1)(A) and (D) requires the
imposition of backup withholding on a
reportable interest or dividend payment
to a payee if the payee does not
provide its TIN or make the required
certifications.
.02The Internal Revenue Service
provides an official Form W–9 for a
payee to provide the required certifica-
tions to the payor. A payor may use a
substitute Form W–9 to obtain the TIN
and the required certifications provided
the certification requirements in the
substitute Form W–9 comply with
section 4 of Rev. Proc. 83–89. A payor
may incorporate the required certifica-
tions into other business forms
customarily used, such as account
signature cards, provided the required
certifications are clearly set forth. See
section 5.01 of Rev. Proc. 83–89.
SECTION 3. SCOPE
This revenue procedure applies to
payors that choose to obtain the re-
quired certifications by using a sub-
stitute Form W–9 incorporated into
business forms the payor customarily
uses, as set forth in section 2.02 of this
revenue procedure.
SECTION 4. FORMAT FOR
MAKING THE REQUIRED
CERTIFICATIONS
.01Required certifications clearly
set forth. For a payor to be treated as
having provided a taxpayer with a valid
substitute Form W–9, the required
certifications must be clearly set forth.
The Service will treat the required
certifications as being clearly set forth
only if they meet the provisions of
section 4.02 or 4.03 of this revenue
procedure.
.02Separate signature for required
certifications. A substitute Form W–9
is valid if a separate signature line is
p r o v i d e d j u s t f o r t h e r e q u i r e d
certifications.
.03Single signature for required
certifications and other provisions. A
substitute Form W–9 is valid if:
(1)a single signature line is pro-
vided for the required certifications as
well as other provisions unrelated to
the required certifications;
(2)the language of the required
certifications is highlighted, boxed,
printed in bold-face type, or presented
in some other manner that distinguishes
and causes the language to stand out
from all other information contained on
the substitute Form W–9; and
(3)the following statement is pro-
vided in the same manner prescribed in
section 4.03(2) and appears imme-
diately above the single signature line
on the substitute Form W–9: ‘‘The

SEQ 0023 JOB B09-006-008 PAGE-0023 PT 3 PGS 19-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-006
23
Internal Revenue Service does not
require your consent to any provision
of this document other than the cer-
tifications required to avoid backup
withholding.’’
SECTION 5. IMPERMISSIBLE USE
OF THE CERTIFICATIONS
.01A payor may not (1) require a
payee to agree to provisions included
on a substitute Form W–9 other than
the required certifications in order to
avoid backup withholding, or (2)
threaten backup withholding in order to
secure a payee’s acceptance of provi-
sions included on a substitute Form W–
9 that are unrelated to the required
certifications.
.02If a payor contravenes the provi-
sions of section 5.01 of this revenue
procedure, the payor may be subject to
civil or criminal penalties under 31
U.S.C. §333. That section generally
prohibits the use of any words, titles,
abbreviations, etc. in connection with a
business solicitation or activity in a
manner that could reasonably be inter-
preted to convey a false impression that
such activity is approved, endorsed,
sponsored, or authorized by the Service.
SECTION 6. EFFECT ON OTHER
DOCUMENTS
This revenue procedure amplifies
Rev. Proc. 83–89.
SECTION 7. EFFECTIVE DATE
Except for section 5, the provisions
of this revenue procedure apply to
substitute Forms W–9 completed by
payees after December 31, 1996. The
provisions of section 5.02 of this
revenue procedure apply to violations
occurring after March 31, 1995, the
effective date of 31 U.S.C. §333.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Renay France of the
Office of Assistant Chief Counsel
(Income Tax and Accounting). For
further information regarding this reve-
nue procedure, contact Renay France
on (202) 622-4910 (not a toll-free call).

SEQ 0025 JOB B09-007-004 PAGE-0024 PT 4 PGS 24-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-007
241996 –23 I.R.B.
Part IV. Items of General Interest
Notice of Proposed Rulemaking
Treatment of Gain From the
Disposition of Interest in Certain
Natural Resource Recapture Property
by S Corporations and Their
Shareholders
PS–7–89
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rule-
making.
SUMMARY: This document contains
proposed regulations under section
1254 of the Internal Revenue Code
relating to the tax treatment by S
corporations and their shareholders of
gain from the disposition by an S
corporation (and a former S corpora-
tion) of certain natural resource recap-
ture property (section 1254 property
after enactment of the Tax Reform Act
of 1986 and oil, gas, or geothermal
property before enactment of the Tax
Reform Act of 1986), and also rules
relating to the disposition of stock in
an S corporation that holds certain
natural resource recapture property.
Changes to the applicable tax law were
made by the Tax Reform Act of 1986,
and the Subchapter S Revision Act of
1982. The regulations provide the
public with guidance in complying with
the changed tax laws.
DATES: Written comments and re-
quests for a public hearing must be
received by February 20, 1996.
ADDRESSES: Send comments and re-
quests for a public hearing to:
CC:DOM:CORP:R (PS–7–89), Room
5228, Internal Revenue Service, P.O.
Box 7604, Ben Franklin Station, Wash-
ington, DC 20044. In the alternative,
submissions may be hand-delivered to
CC:DOM:CORP:R (PS–7–89), Room
5228, Internal Revenue Service Build-
ing, 1111 Constitution Avenue, NW.,
Washington, DC 20224.
FOR FURTHER INFORMATION
C O N T A C T : J a m e s A . Q u i n n ,
202-622-3060 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in this notice of proposed
rulemaking has been submitted to the
Office of Management and Budget
(OMB) for review in accordance with
the Paperwork Reduction Act of 1995
(44 U.S.C 3507).
Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk
Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503, with copies to the Internal
Revenue Service, Attn: IRS Reports
Clearance Officer IT:FP, Washington,
DC 20224. Comments on the collection
of information should be received by
January 22, 1996.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number.
The collection of information is
contained in §1.1254–4(c) of the pro-
posed regulations. This information is
required by the Internal Revenue Serv-
ice to verify that taxpayers have re-
ported the appropriate amount of gain
as ordinary income under section 1254
when a shareholder sells stock in an S
corporation that holds natural resource
recapture property. The likely respond-
ents are individuals and businesses and
other for-profit institutions.
Books or records relating to a col-
lection of information must be retained
as long as their contents may become
material in the administration of any
internal revenue law. Generally, tax
returns and tax return information are
confidential, as required by 26 U.S.C.
6103.
Estimated total annual reporting bur-
den: 1,000 hours.
The estimated annual burden per re-
spondent varies from .5 hours to 1.5
hours, depending on individual circum-
stances, with an estimated average of 1
hour.
Estimated number of respondents:
1,000.
Estimated annual frequency of re-
sponses: On occasion.
Background
On June 11, 1980, proposed amend-
ments to the Income Tax Regulations,
26 CFR part 1, under sections 170,
301, 312, 341, 453, 751, 1254, and
1502 of the Internal Revenue Code of
1954 (Code) were published in the
Federal Register (45 FR 39512). These
amendments were proposed to conform
the regulations to section 205(a), (b),
(c)(1) and (2) of the Tax Reform Act
of 1976, Public Law 94–455, 90 Stat.
1533, and section 402(c) of the Energy
Tax Act of 1978, Public Law 95–618,
92 Stat. 3202, and to make certain
other technical amendments to the
regulations to conform them to section
1(c) of the Act of September 12, 1966,
Public Law 89–570, 80 Stat. 762,
section 211(b)(6) of the Tax Reform
Act of 1969, Public Law 91–172, 83
Stat. 570, and sections 1042(c)(2),
1101(d)(2), 1901(a)(93), and 2110(a) of
the Tax Reform Act of 1976, 90 Stat.
1637, 1658, 1780, 1905. Section
1.1254–3 of the proposed regulations
provided rules relating to the sale or
exchange of stock in an electing small
business corporation (hereinafter re-
ferred to as an S corporation). Because
of the substantial changes in the tax
treatment of S corporations since the
proposed regulations were issued, the
proposed regulations contained in
§1.1254–3 needed to be completely
revised.
This document revises and re-
proposes §1.1254–3 of the above-
referenced notice of proposed rulemak-
ing as amendments to the Income Tax
Regulations, 26 CFR part 1, under
section 1254 of the Code, relating to S
corporations (redesignated as §1.1254–
4). These amendments are proposed to
conform the regulations to section
5(a)(37) of the Subchapter S Revision
Act of 1982, Public Law 97–354, 96
Stat. 1669, and sections 411 and 413 of
the Tax Reform Act of 1986, Public
Law 99–514, 100 Stat. 2225, 2227. The
amendments are to be issued under the
authority contained in sections 1254(b)
and 7805 of the Code.
Explanation of Provisions
These proposed regulations contain
rules for applying the provisions of
section 1254 to the disposition of

SEQ 0026 JOB B09-007-004 PAGE-0025 PT 4 PGS 24-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-007
251996 –23 I.R.B.
natural resource recapture property by
an S corporation (and a former S
corporation) and the disposition of S
corporation stock.
The proposed regulations provide
that the recognition of ordinary income
under section 1254 upon the disposition
of natural resource recapture property
by an S corporation is generally com-
puted at the shareholder level. Deter-
mining the amount of ordinary income
to be recognized under section 1254 at
the shareholder level is appropriate
because the determination of section
1254 costs can be affected by share-
holder elections and characteristics.
See, for example, sections 59(e) and
1363(c)(2)(A). Similarly, in the case of
oil and gas properties, gain on the
disposition of the property and deple-
tion with respect to the property are
computed at the shareholder level. See
section 613A(c)(11).
The proposed regulations also con-
tain rules relating to the recognition of
ordinary income under section 1254
upon a sale or exchange of S corpora-
tion stock. Under section 1254(b)(2),
rules similar to the rules of section 751
are to be applied to that portion of the
excess of the amount realized over the
adjusted basis of the stock that is
attributable to section 1254 costs. Pur-
suant to section 1254(b)(2), the pro-
posed regulations provide that, as a
general rule, a shareholder must treat
any gain recognized on a sale or
exchange of S corporation stock as
ordinary income to the extent of the
shareholder’s section 1254 costs with
respect to the shares sold or exchanged.
The proposed regulations provide
two exceptions to the general rule for
determining the amount treated as
ordinary income under section 1254
upon a sale or exchange of stock. The
first exception is that the general rule
does not apply to the extent that the
shareholder establishes that the gain is
not attributable to the section 1254
costs. The portion of the gain recog-
nized that is not attributable to section
1254 costs is that portion of the gain
recognized that exceeds the amount of
ordinary income that the shareholder
would have recognized under section
1254 (with respect to the shares sold or
exchanged) if, immediately prior to the
sale or exchange of the stock, the
corporation had sold at fair market
value all of the corporation’s property
the disposition of which would result in
the recognition by the shareholder of
ordinary income under section 1254.
To establish that a portion of the gain
recognized is not attributable to a
shareholder’s section 1254 costs, the
shareholder must attach to the share-
holder’s tax return a statement detailing
the shareholder’s share of the fair
market value and basis, and the share-
holder’s section 1254 costs, for each of
the S corporation’s natural resource
recapture properties held immediately
before the sale or exchange of stock.
The second exception to the general
rule for sales or exchanges of stock is
that, in the case of a contribution of
property to the S corporation prior to a
stock sale or exchange pursuant to a
plan a principal purpose of which is to
avoid the recognition of ordinary in-
come under section 1254, the selling or
exchanging shareholder must recognize
as ordinary income under section 1254
the amount of ordinary income the
shareholder would have recognized un-
der section 1254 (with respect to the
shares sold or exchanged) had the S
corporation sold all of its natural
resource recapture property the disposi-
tion of which would result in ordinary
income under section 1254. Section
1.1254–4(c)(3) Example 3 of the pro-
posed regulations illustrates this
exception.
The proposed regulations also
provide rules for determining an S
corporation shareholder’s section 1254
costs. Generally, an S corporation
shareholder’s section 1254 costs with
respect to any natural resource recap-
ture property held by the corporation
include all of the shareholder’s section
1254 costs with respect to the property
while in the hands of the S corporation.
In the case of a person (acquiring
shareholder) who acquires stock from
another shareholder, the proposed reg-
ulations provide that the acquiring
shareholder’s section 1254 costs are
zero if the acquiring shareholder’s basis
for the stock transferred is determined
by reference to its cost (within the
meaning of section 1012) or by refer-
ence to the fair market value of the
stock on the date of the decedent’s
death or on the applicable date pro-
vided in section 2032 (relating to
alternate valuation date). However, an
acquiring shareholder’s section 1254
costs include any section 1254 costs
paid or incurred before the decedent’s
death, to the extent that the basis of the
stock is reduced under section
1014(b)(9) (relating to adjustments to
basis if the property is acquired from a
decedent prior to death). For stock that
is acquired in a transfer that is a gift,
in a transfer that is part sale or
exchange and part gift, or a transfer
described in section 1041, the acquiring
shareholder generally acquires the sec-
tion 1254 costs of the transferor but
reduces the section 1254 costs by the
amount of any gain treated as ordinary
income under section 1254 by the
transferor on the transfer.
The proposed regulations provide
rules for applying section 1254 to the
shareholders of an S corporation that
incurred section 1254 costs while it
was a C corporation (former C corpora-
tion). In the case of a C corporation
that holds natural resource recapture
property and that elects to be an S
corporation, each shareholder’s section
1254 costs as of the beginning of the
corporation’s first taxable year as an S
corporation include a pro rata share of
the section 1254 costs of the corpora-
tion as of the close of the last taxable
year that the corporation was a C
corporation.
The proposed regulations also pro-
vide rules for applying section 1254 to
a corporation that holds natural re-
source recapture property after the
termination of its S corporation election
(former S corporation). In the case of
an S corporation that becomes a C
corporation, the C corporation’s section
1254 costs with respect to any natural
resource recapture property held by the
corporation as of the beginning of the
corporation’s first taxable year as a C
corporation include the sum of its
shareholders’ section 1254 costs with
respect to the property as of the close
of the last taxable year for which the
corporation was an S corporation. In
the case of an S termination year as
defined in section 1362(e)(4), the
shareholders’ section 1254 costs are
determined as of the close of the S
short year as defined in section
1362(e)(1)(A).
Because certain transactions will
change the allocation to the share-
holders of gain or amount realized
from the natural resource recapture
property if the S corporation disposes
of it subsequent to these transactions,
the proposed regulations require that
section 1254 costs be reallocated to
reflect the effects of these transactions.
Transactions requiring reallocation of
the section 1254 costs are transactions
involving the issuance of stock by an S

SEQ 0027 JOB B09-007-004 PAGE-0026 PT 4 PGS 24-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-007
261996 –23 I.R.B.
corporation in a reorganization or oth-
erwise, and transfers of natural re-
source recapture property to the S
corporation in exchange for stock of
the S corporation (for example, in a
section 351 transaction or in a
reorganization).
The rules for former S corporations
and the rules for allocating section
1254 costs upon certain transfers re-
quire the S corporation to determine
the aggregate of its shareholders’ sec-
tion 1254 costs. The proposed regula-
tions provide rules for the S corpo-
ration to apply in determining a
shareholder’s section 1254 costs with
respect to natural resource recapture
property held by the S corporation. In
general, the S corporation may deter-
mine a shareholder’s section 1254 costs
by using written data provided by the
shareholder or by applying certain
assumptions.
These regulations are proposed to
apply to dispositions of natural re-
source recapture property by an S
corporation (and a former S corpora-
tion) and dispositions of S corporation
stock occurring after publication of
these regulations as final regulations in
the Federal Register.
Comments and Requests for a Public
Hearing
Before the adoption of these pro-
posed regulations, consideration will be
given to any written comments that are
timely submitted (preferably an original
and eight copies) to the IRS. All com-
ments will be available for public
inspection and copying. A public hear-
ing will be held upon written request to
the Internal Revenue Service by any
person who also submits written com-
ments. If a public hearing is held,
notice of the time and place will be
published in the Federal Register.
Special Analyses
It has been determined that this pro-
posed regulation is not a significant
regulatory action as defined in Execu-
tive Order 12866. Therefore, a regula-
tory assessment is not required. It also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and,
therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, this notice of proposed rulemak-
ing will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business.
Drafting Information
The principal author of these regula-
tions is James A. Quinn of the Office
of Assistant Chief Counsel (Pass-
throughs and Special Industries), IRS.
However, other personnel from the IRS
and Treasury Department participated
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
for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.1254–4 also issued under 26
U.S.C. 1254(b). * * *
Par. 2. Section 1.1254–0 is amended
by revising the entry for §1.1254–4 to
read as follows:
§1.1254–0 Table of contents for
section 1254 recapture
rules. * * *
******
§1.1254–4 Special rules for S
corporations and their shareholders.
(a)In general.
(b)Determination of gain treated
as ordinary income under sec-
tion 1254 upon a disposition
of natural resource recapture
property by an S corporation.
(1)General rule.
(2)Examples.
(c)Character of gain recognized
by a shareholder upon a sale
or exchange of S corporation
stock.
(1)General rule.
(2)Exceptions.
(3)Examples.
(d)Section 1254 costs of a share-
holder.
(e)Section 1254 costs of an ac-
quiring shareholder after cer-
tain acquisitions.
(1)Basis determined under sec-
tion 1012.
(2)Basis determined by reason
of the application of section
1014(a).
(3)Basis determined by reason
of the application of section
1014(b)(9).
(4) Gifts and section 1041
transfers.
(f)Special rules for former S cor-
porations and former C corpo-
rations.
(1)Section 1254 costs of an S
corporation that was for-
merly a C corporation.
(2)Examples.
(3)Section 1254 costs of a C
corporation that was for-
merly an S corporation.
(g)Determination of a share-
holder’s section 1254 costs
upon certain stock transactions
(1)Issuance of stock.
(2)Natural resource recapture
property acquired in ex-
change for stock.
(3) Treatment of nonvested
stock.
(4)Exception.
(5)Aggregate of S corporation
shareholders’ section 1254
costs with respect to natural
resource recapture property
held by the S corporation
(6)Examples.
(h)Effective date.
******
Par. 3. Section 1.1254–4 is amended
by adding text to read as follows:
§1.1254–4 Special rules for S
corporations and their shareholders.
(a)In general. This section provides
rules for applying the provisions of
section 1254 to S corporations and
their shareholders upon the disposition
by an S corporation (or a former S
corporation) of natural resource recap-
ture property and upon the disposition
by a shareholder of stock of an S
corporation that holds natural resource
recapture property.
(b)Determination of gain treated as
ordinary income under section 1254
upon a disposition of natural resource
recapture property by an S corpora-
tion—(1) General rule. Upon a disposi-

SEQ 0028 JOB B09-007-004 PAGE-0027 PT 4 PGS 24-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-007
271996 –23 I.R.B.
tion of natural resource recapture prop-
erty by an S corporation, the amount of
gain treated as ordinary income under
section 1254 is determined at the share-
holder level. Each shareholder must
recognize as ordinary income under
section 1254 the lesser of—
(i)The shareholder’s section 1254
costs with respect to the property
disposed of; or
(ii)The shareholder’s share of the
amount, if any, by which the amount
realized on the sale, exchange, or
involuntary conversion, or the fair
market value of the property upon any
other disposition (including a distribu-
tion), exceeds the adjusted basis of the
property.
(2)Examples. The following exam-
ples illustrate the provisions of para-
graph (b)(1) of this section:
Example 1. Disposition of natural resource
recapture property other than oil and gas
property. A and B are equal shareholders in X,
an S corporation. On January 1, 1995, X acquires
for $90,000 an undeveloped mineral property, its
sole property. During 1995, X expends and
deducts $100,000 in developing the property. On
January 15, 1996, X sells the property for
$250,000 when X’s basis in the property is
$90,000. Thus, X recognizes gain of $160,000 on
the sale. A and B’s share of the $160,000 gain
recognized is $80,000 each. Each shareholder has
$50,000 of section 1254 costs with respect to the
property. Under these circumstances, A and B
each are required to recognize $50,000 of the
$80,000 of gain on the sale of the property as
ordinary income under section 1254.
Example 2. Disposition of oil and gas property
the adjusted basis of which is allocated to the
shareholders under section 613A(c)(11). C and D
are equal shareholders in Y, an S corporation.
On January 1, 1995, Y acquires for $150,000 an
undeveloped oil and gas property, its sole
property. During 1995, Y expends in developing
the property $40,000 in intangible drilling costs
which it elects to expense under section 263(c).
On January 15, 1996, Y sells the property for
$200,000. C and D’s share of the $200,000
amount realized on the sale is $100,000 each. C
and D each have a basis of $75,000 in the
property and $20,000 of section 1254 costs with
respect to the property. Under these circum-
stances, C and D each are required to recognize
$20,000 of the $25,000 gain on the sale of the
property as ordinary income under section 1254.
(c)Character of gain recognized by
a shareholder upon a sale or exchange
of S corporation stock—(1) General
rule. Except as provided in paragraph
(c)(2) of this section, if an S corpora-
tion shareholder recognizes gain upon a
sale or exchange of stock in the S
corporation (determined without regard
to section 1254), the gain is treated as
ordinary income under section 1254 to
the extent of the shareholder’s section
1254 costs (with respect to the shares
sold or exchanged).
(2)Exceptions—(i) Gain not attribu-
table to section 1254 costs—(A) Gen-
eral rule. Paragraph (c)(1) of this
section does not apply to any portion
of the gain recognized on the sale or
exchange of the stock that the taxpayer
establishes is not attributable to section
1254 costs. The portion of the gain
recognized that is not attributable to
section 1254 costs is that portion of the
gain recognized that exceeds the
amount of ordinary income that the
shareholder would have recognized un-
der section 1254 (with respect to the
shares sold or exchanged) if, imme-
diately prior to the sale or exchange of
the stock, the corporation had sold at
fair market value all of the corpora-
tion’s property the disposition of which
would result in the recognition by the
shareholder of ordinary income under
section 1254.
(B)Substantiation. To establish that
a portion of the gain recognized is not
attributable to a shareholder’s section
1254 costs so as to qualify for the
exception contained in paragraph (c)-
(2)(i)(A) of this section, the share-
holder must attach to the shareholder’s
tax return a statement detailing the
shareholder’s share of the fair market
value and basis, and the shareholder’s
section 1254 costs, for each of the S
corporation’s natural resource recapture
properties held immediately before the
sale or exchange of stock.
(ii)Transactions entered into as part
of a plan to avoid recognition of
ordinary income under section 1254. In
the case of a contribution of property
prior to a sale or exchange of stock
pursuant to a plan a principal purpose
of which is to avoid recognition of
ordinary income under section 1254,
paragraph (c)(1) of this section does
not apply. Instead, the amount recog-
nized as ordinary income under section
1254 is the amount of ordinary income
the selling or exchanging shareholder
would have recognized under section
1254 (with respect to the shares sold or
exchanged) had the S corporation sold
its natural resource recapture property
the disposition of which would have
resulted in the recognition of ordinary
income under section 1254. The
amount recognized as ordinary income
under the preceding sentence reduces
the amount realized on the sale or
exchange of the stock. This reduced
amount realized is used in determining
any gain or loss on the sale or
exchange.
(3)Examples. The following exam-
ples illustrate the provisions of this
paragraph (c):
Example 1. Application of general rule upon a
sale of S corporation stock. C and D are equal
shareholders in Y, an S corporation. As of
January 1, 1995, Y holds two mining properties:
Blackacre, with an adjusted basis of $5,000 and
a fair market value of $35,000, and Whiteacre,
with an adjusted basis of $20,000 and a fair
market value of $15,000. Y also holds securities
with a basis of $5,000 and a fair market value of
$10,000. On January 1, 1995, D sells 50 percent
of D’s Y stock to E for $15,000. As of the date
of the sale, D’s adjusted basis in the Y stock
sold is $7,500, and D has $18,000 of section
1254 costs with respect to Blackacre and $12,000
of section 1254 costs with respect to Whiteacre.
Under this paragraph (c), the gain recognized by
D upon the sale of Y stock is treated as ordinary
income to the extent of D’s section 1254 costs
with respect to the stock sold, unless D
establishes that a portion of such excess is not
attributable to D’s section 1254 costs. However,
because D would recognize $7,500 in ordinary
income under section 1254 with respect to the
stock sold if Y sold Blackacre (the only asset the
disposition of which would result in ordinary
income to D under section 1254), the $7,500 of
gain recognized by D upon the sale of D’s Y
stock is attributable to D’s section 1254 costs.
Therefore, upon the sale of stock to E, D
recognizes $7,500 of ordinary income under this
paragraph (c).
Example 2. Sale of S corporation stock where
gain is not entirely attributable to section 1254
costs. Assume the same facts as in Example 1,
except that Blackacre has a fair market value of
$25,000, and the securities have a fair market
value of $20,000. Immediately prior to the sale
of stock to E, if Y had sold Blackacre (its only
asset the disposition of which would result in the
recognition of ordinary income to D under
section 1254), D would recognize $5,000 in
ordinary income with respect to the stock sold
under section 1254. D attaches a statement to
D’s tax return for 1995 detailing D’s share of the
fair market values and bases, and D’s section
1254 costs with respect to Blackacre and
Whiteacre. Therefore, upon the sale of stock to
E, of the $7,500 gain recognized by D, $5,000 is
ordinary income under this paragraph (c).
Example 3. Contribution of property prior to
sale of S corporation stock as part of a plan to
avoid recognition of ordinary income under
section 1254. H owns all of the stock of Z, an S
corporation. As of January 1, 1995, H has $3,000
of section 1254 costs with respect to property P,
which is natural resource recapture property and
Z’s only asset. Property P has an adjusted basis
of $5,000 and a fair market value of $8,000. H
has a basis of $5,000 in Z stock, which has a fair
market value of $8,000. On January 1, 1995, H
contributes securities to Z which have a basis of
$7,000 and a fair market value of $4,000. On
April 15, 1995, H sells all of the Z stock to J for
$12,000. On that date, H’s adjusted basis in the
Z stock is also $12,000. Based on all the facts
and circumstances, the sale of stock is part of a
plan (along with the contribution by H of the
securities to Z) that has a principal purpose to
avoid recognition of ordinary income under
section 1254. Consequently, under paragraph

SEQ 0029 JOB B09-007-004 PAGE-0028 PT 4 PGS 24-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-007
281996 –23 I.R.B.
(c)(2)(ii) of this section, H must recognize
$3,000 as ordinary income under section 1254,
the amount of ordinary income that H would
recognize as ordinary income under section 1254
if property P were sold at fair market value. In
addition, H reduces the amount realized on the
sale of the stock ($12,000) by $3,000. As a
result, H also recognizes a $3,000 capital loss on
the sale of the stock ($9,000 amount realized less
$12,000 adjusted basis).
(d)Section 1254 costs of a share-
holder. An S corporation shareholder’s
section 1254 costs with respect to any
natural resource recapture property held
by the corporation include all of the
shareholder’s section 1254 costs with
respect to the property in the hands of
the S corporation. See §1.1254–1(b)(1)
for the definition of section 1254 costs.
(e)Section 1254 costs of an acquir-
i n g s h a r e h o l d e r a f t e r c e r t a i n
acquisitions—(1) Basis determined un-
der section 1012. If stock in an S
corporation that holds natural resource
recapture property is acquired and the
acquiring shareholder’s basis for the
stock is determined solely by reference
to its cost (within the meaning of
section 1012), the amount of section
1254 costs with respect to the property
held by the corporation in the acquiring
shareholder’s hands is zero on the
acquisition date.
(2)Basis determined by reason of
the application of section 1014(a). If
stock in an S corporation that holds
natural resource recapture property is
acquired from a decedent and the
acquiring shareholder’s basis is deter-
mined, by reason of the application of
section 1014(a), solely by reference to
the fair market value of the stock on
the date of the decedent’s death or on
the applicable date provided in section
2032 (relating to alternate valuation
date), the amount of section 1254 costs
with respect to the property held by the
corporation in the acquiring share-
holder’s hands is zero on the acquisi-
tion date.
(3)Basis determined by reason of
the application of section 1014(b)(9). If
stock in an S corporation that holds
natural resource recapture property is
acquired before the death of the dece-
dent, the amount of section 1254 costs
with respect to the property held by the
corporation in the acquiring share-
holder’s hands includes the amount, if
any, of the section 1254 costs deducted
by the acquiring shareholder before the
decedent’s death, to the extent that the
basis of the stock (determined under
section 1014(a)) is required to be
reduced under section 1014(b)(9) (relat-
ing to adjustments to basis when the
property is acquired before the death of
the decedent).
(4)Gifts and section 1041 transfers.
If stock is acquired in a transfer that is
a gift, in a transfer that is a part sale or
exchange and part gift, or in a transfer
that is described in section 1041(a), the
amount of section 1254 costs with re-
spect to the property held by the
corporation in the acquiring share-
holder’s hands immediately after the
transfer is an amount equal to—
(i)The amount of section 1254 costs
with respect to the property held by the
corporation in the hands of the trans-
feror immediately before the transfer;
minus
(ii)The amount of any gain recog-
nized as ordinary income under section
1254 by the transferor upon the
transfer.
(f)Special rules for former S corpo-
rations and former C corporations—(1)
Section 1254 costs of an S corporation
that was formerly a C corporation. In
the case of a C corporation that holds
natural resource recapture property and
that elects to be an S corporation, each
shareholder’s section 1254 costs as of
the beginning of the corporation’s first
taxable year as an S corporation in-
clude a pro rata share of the section
1254 costs of the corporation as of the
close of the last taxable year that the
corporation was a C corporation.
(2)Examples. The following exam-
ples illustrate the application of the
provisions of paragraph (f)(1) of this
section:
Example 1. Sale of natural resource recapture
property held by an S corporation that was
formerly a C corporation—(i) Y is a C
corporation that elects to be an S corporation
effective January 1, 1996. On that date, Y owns
Oil Well, which is natural resource recapture
property and a capital asset. Y has section 1254
costs of $20,000 as of the close of the last
taxable year that it was a C corporation. On
January 1, 1996, Oil Well has a value of
$200,000 and a basis of $100,000. Thus, under
section 1374, Y’s net unrealized built-in gain is
$100,000. Also on that date, Y’s basis in Oil
Well is allocated to A, Y’s sole shareholder,
under section 613A(c)(11) and the section 1254
costs are allocated to A under §1.1254–4(f)(1).
In addition, A has a basis in A’s Y stock of
$100,000.
(ii)On November 1, 1996, Y sells Oil Well
for $250,000. During 1996, Y has taxable
income greater than $100,000, and no other
transactions or items treated as recognized built-
in gain or loss. Under section 1374, Y has net
recognized built-in gain of $100,000. Assuming a
tax rate of 35 percent on capital gain, Y has a
tax of $35,000 under section 1374. The tax of
$35,000 is treated as a capital loss under section
1366(f)(2). A has a realized gain on the sale of
$150,000 ($250,000 minus $100,000) of which
$20,000 is recognized as ordinary income under
section 1254, and $130,000 is recognized as
capital gain. Consequently, A recognizes ordi-
nary income of $20,000 and net capital gain of
$95,000 ($130,000 minus $35,000) on the sale.
Example 2. Sale of stock followed by sale of
natural resource recapture property held by an S
corporation that was formerly a C corporation—
(i) Assume the same facts as in Example 1(i). On
November 1, 1996, A sells all of A’s Y stock to
P for $250,000. A has a realized gain on the sale
of $150,000 ($250,000 minus $100,000) of
which $20,000 is recognized as ordinary income
under section 1254, and $130,000 is recognized
as capital gain.
(ii)On November 2, 1996, Y sells Oil Well
for $250,000. During 1996, Y has taxable
income greater than $100,000, and no other
transactions or items treated as recognized built-
in gain or loss. Under section 1374, Y has net
recognized built-in gain of $100,000. Assuming a
tax rate of 35 percent on capital gain, Y has a
tax of $35,000 under section 1374. The tax of
$35,000 is treated as a capital loss under section
1366(f)(2). P has a realized gain on the sale of
$150,000 ($250,000 minus $100,000), which is
recognized as capital gain. Consequently, P
recognizes net capital gain of $115,000
($150,000 minus $35,000) on the sale.
(3)Section 1254 costs of a C
corporation that was formerly an S
corporation. In the case of an S
corporation that becomes a C corpora-
tion, the C corporation’s section 1254
costs with respect to any natural
resource recapture property held by the
corporation as of the beginning of the
corporation’s first taxable year as a C
corporation include the sum of its
shareholders’ section 1254 costs with
respect to the property as of the close
of the last taxable year that the
corporation was an S corporation. In
the case of an S termination year as
defined in section 1362(e)(4), the
shareholders’ section 1254 costs are
determined as of the close of the S
short year as defined in section
1362(e)(1)(A). See paragraph (g)(5) of
this section for rules on determining
the aggregate amount of the share-
holders’ section 1254 costs.
(g)Determination of a shareholder’s
section 1254 costs upon certain stock
transactions—(1) Issuance of stock.
Upon an issuance of stock (whether
such stock is newly-issued or had been
held as treasury stock) by an S
corporation in a reorganization or
otherwise—
(i)Each recipient of shares must be
allocated a pro rata share (determined
solely with respect to the shares issued
in the transaction) of the aggregate of

SEQ 0030 JOB B09-007-004 PAGE-0029 PT 4 PGS 24-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-007
291996 –23 I.R.B.
the S corporation shareholders’ section
1254 costs with respect to natural
resource recapture property held by the
S corporation immediately before the
issuance (as determined pursuant to
paragraph (g)(5) of this section); and
(ii) Each pre-existing shareholder
must reduce his or her section 1254
costs with respect to natural resource
recapture property held by the S
corporation immediately before the is-
suance by an amount equal to the pre-
existing shareholder’s section 1254
costs immediately before the issuance
multiplied by the percentage of stock
of the corporation issued in the
transaction.
(2)Natural resource recapture prop-
erty acquired in exchange for stock. If
natural resource recapture property is
transferred to an S corporation in
exchange for stock of the S corporation
(for example, in a section 351 transac-
tion, or in a reorganization described in
section 368), the S corporation must
allocate to its shareholders a pro rata
share of the S corporation’s section
1254 costs with respect to the property
immediately after the transaction (as
determined under §1.1254–3(b)(1)).
(3)Treatment of nonvested stock.
Stock issued in connection with the
performance of services that is substan-
tially nonvested (within the meaning of
§1.83–3(b)) is treated as issued for pur-
poses of this section at the first time it is
treated as outstanding stock of the S
corporation for purposes of section 1361.
(4)Exception. Paragraph (g)(1) of
this section does not apply to stock
issued in exchange for stock of the
same S corporation (as for example, in
a recapitalization described in section
368(a)(1)(E)).
(5)Aggregate of S corporation
shareholders’ section 1254 costs with
respect to natural resource recapture
property held by the S corporation—(i)
In general. The aggregate of S corpora-
tion shareholders’ section 1254 costs is
equal to the sum of each shareholder’s
section 1254 costs. The S corporation
must determine each shareholder’s sec-
tion 1254 costs under either paragraph
(g)(5)(i)(A) (written data) or paragraph
(g)(5)(i)(B) (assumptions) of this sec-
tion. The S corporation may determine
the section 1254 costs of some share-
holders under paragraph (g)(5)(i)(A) of
this section and of others under para-
graph (g)(5)(i)(B) of this section.
(A)Written data. An S corporation
may determine a shareholder’s section
1254 costs by using written data
provided by a shareholder showing the
shareholder’s section 1254 costs with
respect to natural resource recapture
property held by the S corporation
unless the S corporation knows or has
reason to know that the written data is
inaccurate. If an S corporation does not
receive written data upon which it may
rely, the S corporation must use the
assumptions provided in paragraph
(g)(5)(i)(B) of this section in determin-
ing a shareholder’s section 1254 costs.
(B)Assumptions. An S corporation
that does not use written data pursuant
to paragraph (g)(5)(i)(A) of this section
to determine a shareholder’s section
1254 costs must use the following
assumptions to determine the share-
holder’s section 1254 costs.
(1) The shareholder deducted his or
her share of the amount of deductions
under sections 263(c), 616, and 617 in
the first year in which the shareholder
could claim a deduction for such
amounts, unless in the case of expendi-
tures under sections 263(c) or 616 the S
corporation elected to capitalize such
amounts;
(2) The shareholder was not subject
to the following limitations with re-
spect to the shareholder’s depletion
allowance under section 611, except to
the extent a limitation applied at the
corporate level: the taxable income
limitation of section 613(a); the deple-
table quantity limitations of section
613A(c); or the limitations of sections
613A(d)(2), (3), and (4) (exclusion of
retailers and refiners).
(6)Examples. The following exam-
ples illustrate the provisions of this
paragraph (g):
Example 1. Transfer of natural resource
recapture property to an S corporation in a
section 351 transaction. As of January 1, 1996,
A owns all the stock (20 shares) in X, an S
corporation. X holds property that is not natural
resource recapture property that has a fair market
value of $2,000 and an adjusted basis of $2,000.
On January 1, 1996, B transfers natural resource
recapture property, Property P, to X in exchange
for 80 shares of X stock in a transaction that
qualifies under section 351. Property P has a fair
market value of $8,000 and an adjusted basis of
$5,000. Pursuant to section 351, B does not
recognize gain on the transaction. Immediately
prior to the transaction, B’s section 1254 costs
with respect to Property P equaled $6,000. Under
§1.1254–2(c)(1), B does not recognize any gain
under section 1254 on the section 351 transaction
and, under §1.1254–3(b)(1), X’s section 1254
costs with respect to Property P immediately
after the contribution equal $6,000. Under
paragraph (g)(2) of this section, each shareholder
is allocated a pro rata share of X’s section 1254
costs. The pro rata share of X’s section 1254
costs that is allocated to A equals $1,200 (20
percent interest in X multiplied by X’s $6,000 of
section 1254 costs). The pro rata share of X’s
section 1254 costs that is allocated to B equals
$4,800 (80 percent interest in X multiplied by
X’s $6,000 of section 1254 costs).
Example 2. Contribution of money in exchange
for stock of an S corporation holding natural
resource recapture property. As of January 1,
1996, A and B each own 50 percent of the stock
(50 shares each) in X, an S corporation. X holds
natural resource recapture property, Property P,
which has a fair market value of $20,000 and an
adjusted basis of $14,000. A’s and B’s section
1254 costs with respect to Property P are $4,000
and $1,500, respectively. On January 1, 1996, C
contributes $20,000 to X in exchange for 100
shares of X’s stock. Under paragraph (g)(1)(i) of
this section, X must allocate to C a pro rata
share of its shareholders’ section 1254 costs.
Using the assumptions set forth in paragraph
(g)(5)(i)(B) of this section, X determines that A’s
section 1254 costs with respect to natural
resource recapture property held by X equal
$4,500. Using written data provided by B, X
determines that B’s section 1254 costs with
respect to Property P equal $1,500. Thus, the
aggregate of X’s shareholders’ section 1254 costs
equals $6,000. C’s pro rata share of the $6,000
of section 1254 costs equals $3,000 (C’s 50
percent interest in X multiplied by $6,000).
Under paragraph (g)(1)(ii) of this section, A’s
section 1254 costs are reduced by $2,000 (A’s
actual section 1254 costs ($4,000) multiplied by
50 percent). B’s section 1254 costs are reduced
by $750 (B’s actual section 1254 costs ($1,500)
multiplied by 50 percent).
Example 3. Merger involving an S corporation
that holds natural resource recapture property.
X, an S corporation with one shareholder, A,
holds as its sole asset natural resource recapture
property that has a fair market value of $120,000
and an adjusted basis of $40,000. A has section
1254 costs with respect to the property of
$60,000. For valid business reasons, X merges
into Y, an S corporation with one shareholder, B,
in a reorganization described in section
368(a)(1)(A). Y holds property that is not natural
resource recapture property that has a fair market
value of $120,000 and basis of $120,000. Under
paragraph (c) of this section, A does not
recognize ordinary income under section 1254
upon the exchange of stock in the merger
because A did not otherwise recognize gain on
the merger. Under paragraph (g)(2) of this
section, Y must allocate to A and B a pro rata
share of its $60,000 of section 1254 costs. Thus,
A and B are each allocated $30,000 of section
1254 costs (50 percent interest in X, each,
multiplied by $60,000).
(h)Effective date. This section ap-
plies to dispositions of natural resource
recapture property by an S corporation
(and a former S corporation) and
dispositions of S corporation stock
occurring after [publication of these
regulations as final regulations in the
Federal Register].
Margaret Milner Richardson,
Commissioner of
Internal Revenue.

SEQ 0031 JOB B09-008-007 PAGE-0030 PT 4 PGS 30-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-008
301996 –23 I.R.B.
(Filed by the Office of the Federal Register on
December 20, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 21, 1995, 60 F.R. 66238)
Changes to Excise Tax Rates
Announcement 96–9
The changes listed below are effec-
tive after December 31, 1995, and will
be reflected on Form 720 for the first
quarter of 1996, as well as on the next
revisions of Forms 4136 and 8849. If
these rates are modified by legislation,
the IRS will issue another announce-
ment and will revise all forms
accordingly.
I. FUEL TAXES
These changes to the fuel taxes
reflect the expiration of the Leaking
Underground Storage Tank Trust Fund
Tax (LUST) and a reduction in certain
aviation-related fuel taxes.
The rates listed below are effective
January 1, 1996.
Tax rate
IRSper gallon
No.Type of fuel(in cents)
60Diesel fuel24.3
71Dyed diesel fuel for use in trains5.55
78Dyed diesel fuel for use in buses7.3
61Special motor fuel (including LPG)18.3
62Gasoline18.3
58Gasoline sold for gasohol production, 10% alcohol14.333
73Gasoline sold for gasohol production, 7.7% alcohol15.321
74Gasoline sold for gasohol production, 5.7% alcohol16.142
59Gasohol, 10% alcohol12.9
75Gasohol, 7.7% alcohol14.142
76Gasohol, 5.7% alcohol15.222
69Aviation fuel (other than gasoline)4.3
14Gasoline used in noncommercial aviation (expired)0.0
77Aviation fuel (other than gasoline) for use in commercial aviation4.3
64Inland waterways fuel use tax24.3
101Compressed natural gas taxed at 48.54 cents per thousand cubic feet remains
unchanged
The rates of tax for the ‘‘other
alcohol fuels’’ have decreased and will
be listed in the Instructions for Form
720.
II. LUXURY TAX
The base amount not subject to the
luxury tax for passenger vehicles has
increased from $32,000 to $34,000
effective for sales or uses occurring
after December 31, 1995. Get Form
8807, Certain Manufacturers and Re-
tailers Excise Taxes, from the IRS to
compute the luxury tax.
III. TRANSPORTATION TAXES
The excise tax on transportation of
persons and property by air and use of
international air travel facilities (IRS
Nos. 26, 28, and 27) expired December
31, 1995. Travelers that paid for tickets
in 1995 for travel in 1996 may be
entitled to refunds of the tax. Some
airlines are refunding the tax to the
traveler. Therefore, contact the airline
to discuss its refund policy or get Form
8849, Claim for Refund of Excise
Taxes, from the IRS to obtain a refund.
All refund claims submitted to IRS re-
quire an original passenger receipt.
IV. SUPERFUND TAX
The excise tax on domestic and
imported petroleum, chemicals, and
imported chemical substances (IRS
Nos. 53, 16, 54, and 17) expired
December 31, 1995.
V. HOW TO GET FORMS
Forms can be obtained by calling
1-800-829-3676 or downloaded off the
IRS home page on Internet at http://
www.irs.ustreas.gov.
Deletions from Cumulative List of
Organizations Contributions to Which
Are Deductible Under Section 170 of
the Code
Announcement 96–10
The name of an organization that no
longer qualifies as an organization
described in section 170(c)(2) of the
Internal Revenue Code of 1986 is listed
below.
Generally, the Service will not dis-
allow deductions for contributions
made to a listed organization on or
before the date of announcement in the
Internal Revenue Bulletin that an orga-
nization no longer qualifies. However,
the Service is not precluded from
disallowing a deduction for any contri-
butions made after an organization
ceases to qualify under section
170(c)(2) if the organization has not
timely filed a suit for declaratory
judgment under section 7428 and if the
contributor (1) had knowledge of the
revocation of the ruling or determina-
tion letter, (2) was aware that such
revocation was imminent, or (3) was in
part responsible for or was aware of
the activities or omissions of the
organization that brought about this
revocation.
If on the other hand a suit for
declaratory judgment has been timely
filed, contributions from individuals
and organizations described in section

SEQ 0032 JOB B09-008-007 PAGE-0031 PT 4 PGS 30-
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 66.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-008
311996 –23 I.R.B.
170(c)(2) that are otherwise allowable
will continue to be deductible. Protec-
tion under section 7428(c) would begin
on (DATE) 1996, and would end on
the date the court first determines that
the organization is not described in
section 170(c)(2) as more particularly
set forth in section 7428(c)(1). For
individual contributors, the maximum
deduction protected is $1,000, with a
husband and wife treated as one
contributor. This benefit is not ex-
tended to any individual who was
responsible, in whole or in part, for the
acts or omissions of the organization
that were the basis for revocation.
Christian Job Center of Colorado, Inc.
Denver, CO
Foundation for Airborne Relief
Long Beach, CA
Southern Legal Defense Foundation
Raleigh, NC
Section 7428(c) Validation of Certain
Contributions Made During Pendency
of Declaratory Judgment Proceedings
This announcement serves notice to
potential donors that the organization
listed below has recently filed a timely
declaratory judgment suit under section
7428 of the Code, challenging revoca-
tion of its status as an eligible donee
under section 170(c)(2).
Protection under section 7428(c) of
the Code begins on the date that the
notice of revocation is published in the
Internal Revenue Bulletin and ends on
the date on which a court first deter-
mines that an organization is not
described in section 170(c)(2), as more
particularly set forth in section
7428(c)(1). In the case of individual
contributors, the maximum amount of
contributions protected during this
period is limited to $1,000.00, with a
husband and wife being treated as one
contributor. This protection is not
extended to any individual who was
responsible, in whole or in part, for the
acts or omissions of the organization
that were the basis for the revocation.
This protection also applies (but with-
out limitation as to amount) to organi-
zations described in section 170(c)(2)
which are exempt from tax under
section 501(a). If the organization
ultimately prevails in its declaratory
judgment suit, deductibility of contribu-
tions would be subject to the normal
limitations set forth under section 170.
Southern Legal Defense Foundation
Raleigh, NC

SEQ 0033 JOB B09-050-002 PAGE-0032 ANN DISBARMENT
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-050
32
Announcement of the Disbarment, Suspension, or Consent to Voluntary
Suspension of Attorneys, Certified Public Accountants, Enrolled Agents and
Enrolled Actuaries From Practice Before the Internal Revenue Service
Under 31 Code of Federal Regula-
tions, Part 10, an attorney, certified
public accountant, enrolled agent or en-
rolled actuary, in order to avoid the in-
stitution or conclusion of a proceeding
for his disbarment or suspension from
practice before the Internal Revenue
Service, may offer his consent to
suspension from such practice. The
Director of Practice, in his discretion,
may suspend an attorney, certified
public accountant, enrolled agent or
enrolled actuary in accordance with the
consent offered.
Attorneys, certified public account-
ants, enrolled agents and enrolled actu-
aries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting
assistance from, being employed by,
or sharing fees with, any practi-
tioner disbarred or suspended from
practice before the Internal Revenue
Service.
To enable attorneys, certified public
accountants, enrolled agents and en-
rolled actuaries to identify practitioners
under consent suspension from practice
before the Internal Revenue Service,
the Director of Practice will announce
in the Internal Revenue Bulletin the
names and addresses of practitioners
who have been suspended from such
practice, their designation as attor-
ney, certified public accountant, en-
rolled agent or enrolled actuary and
date or period of suspension. This an-
nouncement will appear in the weekly
Bulletin at the earliest practicable date
after such action and will continue to
appear in the weekly Bulletins for five
successive weeks or for as many weeks
as is practicable for each attorney,
certified public accountant, enrolled
agent or enrolled actuary so suspended
and will be consolidated and published
in the Cumulative Bulletin.
The following individuals have been
placed under consent suspension from
practice before the Internal Revenue
Service:
NameAddressDesignationDate of Suspension
Isdaner, Thomas M.Crofton, MDCPAOctober 31, 1995 to October 30, 1996
Cacciola, MarlenePittsburg, CAEnrolled
Agent
November 9, 1995 to May 8, 1996
Goldman, William D.Hot Springs, ARAttorneyNovember 9, 1995 to November 8, 1996
Armstrong, David L.Norman, OKCPAIndefinite from November 10, 1995
Heckathorn, BenRed Oak, TXCPA/
Attorney
Indefinite from November 28, 1995
Tisdel, LindaSeattle, WAEnrolled
Agent
November 28, 1995 to May 27, 1997
Webb, Herbert M.Gainsville, FLAttorneyDecember 21, 1995 to June 20, 1997
Hipp, Robert J.Evanston, ILCPADecember 28, 1995 to April 27, 1996
Ruff, James M.Willmar, MNCPAJanuary 1, 1996 to March 31, 1996
Mulkerin, John J.Wheaton, ILCPAJanuary 5, 1996 to April 4, 1996
Redwitz, RobertIrvine, CACPAFebruary 15, 1996 to May 14, 1996
Lind, Stanley L.Milwaukee, WIAttorneyMarch 1, 1996 to February 28, 1997
Dais, Robert E.Plano, TXCPAMarch 1, 1996 to February 28, 1997
Under Section 330, Title 31 of the
United States Code, the Secretary of
the Treasury, after due notice and
opportunity for hearing, is authorized
to suspend or disbar from practice
before the Internal Revenue Service
any person who has violated the rules
and regulations governing the recogni-
tion of attorneys, certified public ac-
countants, enrolled agents or enrolled
actuaries to practice before the Internal
Revenue Service.
Attorneys, certified public account-
ants, enrolled agents, and enrolled
actuaries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting as-
sistance from, being employed by or
sharing fees with, any practitioner
disbarred or under suspension from
practice before the Internal Revenue
Service.
To enable attorneys, certified public
accountants, enrolled agents and
enrolled actuaries to identify such
disbarred or suspended practitioners,
the Director of Practice will announce
in the Internal Revenue Bulletin the
names and addresses of practitioners
who have been suspended from such
practice, their designation as attorney,
certified public accountant, enrolled
agent or enrolled actuary, and the date
of disbarment or period of suspension.
This announcement will appear in the
weekly Bulletin for five successive
weeks or as long as it is practicable for
each attorney, certified public account-
ant, enrolled agent or enrolled actuary
so suspended or disbarred and will be
consolidated and published in the
Cumulative Bulletin.
After due notice and opportunity
for hearing before an administrative
law judge, the following individuals
have been disbarred from further prac-
tice before the Internal Revenue
Service:

SEQ 0034 JOB B09-050-002 PAGE-0033 ANN DISBARMENT
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-050
33
NameAddressDesignationEffective Date
Muraskin, DavidNew York, NYAttorneyNovember 6, 1995
Kelsey, PatrickPoolesville, MDCPANovember 13, 1995
Announcement of the Expedited Suspension of Attorneys, Certified Public
Accountants, Enrolled Agents, and Enrolled Actuaries From Practice Before the
Internal Revenue Service
Under title 31 of the Code of Federal
Regulations, section 10.76, the Director
of Practice is authorized to immediately
suspend from practice before the Inter-
nal Revenue Service any practitioner
who, within five years, from the date
the expedited proceeding is instituted,
(1) has had a license to practice as an
attorney, certified public accountant, or
actuary suspended or revoked for
cause; or (2) has been convicted of any
crime under title 26 of the United
States Code or, of a felony under title
18 of the United States Code involving
dishonesty or breach of trust.
Attorneys, certified public account-
ants, enrolled agents, and enrolled ac-
tuaries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting as-
sistance from, being employed by, or
sharing fees with, any practitioner
disbarred or suspended from practice
before the Internal Revenue Service.
To enable attorneys, certified public
accountants, enrolled agents, and en-
rolled actuaries to identify practitioners
under expedited suspension from prac-
tice before the Internal Revenue Serv-
ice, the Director of Practice will an-
nounce in the Internal Revenue Bulletin
the names and addresses of practition-
ers who have been suspended from such
practice, their designation as attorney,
certified public accountant, enrolled
agent, or enrolled actuary, and date or
period of suspension. This announce-
ment will appear in the weekly Bulletin
at the earliest practicable date after
such action and will continue to appear
in the weekly Bulletins for five succes-
sive weeks or for as many weeks as is
practicable for each attorney, certified
public accountant, enrolled agent, or
enrolled actuary so suspended and will
be consolidated and published in the
Cumulative Bulletin.
The following individuals have been
placed under suspension from practice
before the Internal Revenue Service by
virtue of the expedited proceeding
provisions of the applicable regulations:
NameAddressDesignationDate of Suspension
Trebatch, Henry T.Great Neck, NYCPAIndefinite from November 6, 1995
Roomberg, AlanMinersville, PACPAIndefinite from November 10, 1995
Elfenbein, Emanuel B.Miami, FLEnrolled
Agent
Indefinite from November 27, 1995
Cerullo, Louis, J.Boca Raton, FLCPAIndefinite from November 27, 1995
Fogel, HaroldSt. Paul, MNCPAIndefinite from December 13, 1995
Glover, Paul L.Downers Grove, ILAttorneyIndefinite from December 13, 1995
Miller, John R.Akron, OHAttorneyIndefinite from December 13, 1995
Pofahl, CharlesDallas, TXAttorneyIndefinite from December 18, 1995
Walburg, DouglasMahtomedi, MNCPAIndefinite from December 18, 1995
Hibler, Thomas M.Plymouth, MICPA/
Attorney
Indefinite from December 18, 1995
Oringer, RonaldFlanders, NJCPAIndefinite from December 29, 1995
Butcher, FrederickStillwater, NJCPAIndefinite from December 29, 1995
Tokars, FredericAtlanta, GAAttorneyIndefinite from December 29, 1995
Atkins, Sanford I.Moreland Hills, OHAttorneyIndefinite from December 29, 1995

SEQ 0035 JOB B09-051-002 PAGE-0034 TERMS
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS
COMPOSITE COLOR
778/20048/28MAY96/B09-051
34
Definition of Terms
Revenue rulings and revenue proce-
dures (hereinafter referred to as ‘‘rul-
ings’’) that have an effect on previous
rulings use the following defined terms
to describe the effect:
Amplified describes a situation where
no change is being made in a prior
published position, but the prior posi-
tion is being extended to apply to a
variation of the fact situation set forth
therein. Thus, if an earlier ruling held
that a principle applied to A, and the
new ruling holds that the same princi-
ple also applies to B, the earlier ruling
is amplified. (Compare with modified,
below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in
a prior ruling is being changed.
Distinguished describes a situation
where a ruling mentions a previously
published ruling and points out an
essential difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but
not to B, and the new ruling holds that
it applies to both A and B, the prior
ruling is modified because it corrects a
published position. (Compare with am-
plified and clarified, above).
Obsoleted describes a previously
published ruling that is not considered
determinative with respect to future
transactions. This term is most com-
monly used in a ruling that lists
previously published rulings that are
obsoleted because of changes in law or
regulations. A ruling may also be
obsoleted because the substance has
been included in regulations subse-
quently adopted.
Revoked describes situations where
the position in the previously published
ruling is not correct and the correct
position is being stated in the new
ruling.
Superseded describes a situation
where the new ruling does nothing
more than restate the substance and
situation of a previously published
ruling (or rulings). Thus, the term is
used to republish under the 1986 Code
and regulations the same position pub-
lished under the 1939 Code and regula-
tions. The term is also used when it is
desired to republish in a single ruling a
series of situations, names, etc., that
were previously published over a
period of time in separate rulings. If
If the new ruling does more than
restate the substance of a prior ruling, a
combination of terms is used. For
example, modified and superseded de-
scribes a situation where the substance
of a previously published ruling is
being changed in part and is continued
without change in part and it is desired
to restate the valid portion of the
previously published ruling in a new
ruling that is self contained. In this
case the previously published ruling is
first modified and then, as modified, is
superseded.
Supplemented is used in situations in
which a list, such as a list of the names
of countries, is published in a ruling
and that list is expanded by adding
further names in subsequent rulings.
After the original ruling has been
supplemented several times, a new
ruling may be published that includes
the list in the original ruling and the
additions, and supersedes all prior
rulings in the series.
Suspended is used in rare situations
to show that the previous published
rulings will not be applied pending
some future action such as the issuance
of new or amended regulations, the
outcome of cases in litigation, or the
outcome of a Service study.
Abbreviations
The following abbreviations in current use and
formerly used will appear in material published
in the Bulletin.
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 Procedural 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.

SEQ 0036 JOB B09-052-003 PAGE-0035 FINDING LIST
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 32.08 PICAS
COMPOSITE COLOR
778/20047/28MAY96/B09-052
35
Numerical Finding List
1
Bulletins 1996–1 through 1996–7
Announcements:
96–1, 1996–2 I.R.B. 57
96–2, 1996–2 I.R.B. 57
96–3, 1996–2 I.R.B. 57
96–4, 1996–3 I.R.B. 50
96–5, 1996–4 I.R.B. 99
96–6, 1996–5 I.R.B. 43
96–7, 1996–5 I.R.B. 44
96–8, 1996–7 I.R.B. 56
Delegations Orders:
232 (Rev. 2), 1996–7 I.R.B. 49
239 (Rev. 1), 1996–7 I.R.B. 49
Notices:
96–2, 1996–2 I.R.B. 15
96–1, 1996–3 I.R.B. 30
96–4, 1996–4 I.R.B. 69
96–5, 1996–6 I.R.B. 22
96–6, 1996–5 I.R.B. 27
96–7, 1996–6 I.R.B. 22
96–8, 1996–6 I.R.B. 23
96–9, 1996–6 I.R.B. 26
96–10, 1996–7 I.R.B. 47
Proposed Regulations:
DL–1–95, 1996–6 I.R.B. 28
EE–20–95, 1996–5 I.R.B. 15
EE–34–95, 1996–3 I.R.B. 49
EE–35–95, 1996–5 I.R.B. 19
EE–53–95, 1996–5 I.R.B. 23
IA–33–95, 1996–4 I.R.B. 99
INTL–3–95, 1996–6 I.R.B. 29
INTL–9–95, 1996–5 I.R.B. 25
PS–2–95, 1996–7 I.R.B. 50
Revenue Procedures:
96–1, 1996–1 I.R.B. 8
96–2, 1996–1 I.R.B. 60
96–3, 1996–1 I.R.B. 82
96–4, 1996–1 I.R.B. 94
96–5, 1996–1 I.R.B. 129
96–6, 1996–1 I.R.B. 151
96–7, 1996–1 I.R.B. 185
96–8, 1996–1 I.R.B. 187
96–9, 1996–2 I.R.B. 15
96–10, 1996–2 I.R.B. 17
96–11, 1996–2 I.R.B. 18
96–12, 1996–3 I.R.B. 30
96–13, 1996–3 I.R.B. 31
96–14, 1996–3 I.R.B. 41
96–15, 1996–3 I.R.B. 41
96–16, 1996–3 I.R.B. 45
1
A cumulative list of all Revenue Rulings,
Revenue Procedures, Treasury Decisions, etc.,
published in Internal Revenue Bulletins 1995–27
through 1995–52 will be found in Internal
Revenue Bulletin 1996–1, dated January 2, 1996.
Revenue Procedures—Continued
96–17, 1996–4 I.R.B. 69
96–18, 1996–4 I.R.B. 73
96–19, 1996–4 I.R.B. 80
96–20, 1996–4 I.R.B. 88
96–21, 1996–4 I.R.B. 96
96–22, 1996–5 I.R.B. 27
96–23, 1996–5 I.R.B. 27
96–24, 1996–5 I.R.B. 28
Revenue Rulings:
96–1, 1996–1 I.R.B. 7
96–2, 1996–2 I.R.B. 5
96–3, 1996–2 I.R.B. 14
96–6, 1996–2 I.R.B. 8
96–4, 1996–3 I.R.B. 16
96–5, 1996–3 I.R.B. 29
96–7, 1996–3 I.R.B. 12
96–8, 1996–4 I.R.B. 62
96–9, 1996–4 I.R.B. 5
96–10, 1996–4 I.R.B. 27
96–11, 1996–4 I.R.B. 28
96–14, 1996–6 I.R.B. 20
Treasury Decisions:
8630, 1996–3 I.R.B. 19
8631, 1996–3 I.R.B. 7
8632, 1996–4 I.R.B. 6
8633, 1996–4 I.R.B. 20
8634, 1996–3 I.R.B. 17
8635, 1996–3 I.R.B. 5
8636, 1996–4 I.R.B. 64
8637, 1996–4 I.R.B. 29
8638, 1996–5 I.R.B. 5
8639, 1996–5 I.R.B. 12
8640, 1996–2 I.R.B. 10
8641, 1996–6 I.R.B. 4
8642, 1996–7 I.R.B. 4
8644, 1996–7 I.R.B. 16

SEQ 0037 JOB B09-052-003 PAGE-0036 FINDING LIST
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 41.11 PICAS
COMPOSITE COLOR
778/20047/28MAY96/B09-052
36
Finding List of Current Action on
Previously Published Items
1
Bulletins 1996–1 through 1996–7
*Denotes entry since last publication
Delegation Orders:
232 (Rev. 1)
Superseded by
232 (Rev. 2), 1996–7 I.R.B. 49
239
Amended by
239 (Rev. 1), 1996–7 I.R.B. 49
Revenue Procedures:
65–17
Modified by
96–14, 1996–3 I.R.B. 41
66–49
Modified by
96–15, 1996–3 I.R.B. 41
88–32
Obsoleted by
96–15, 1996–3 I.R.B. 41
88–33
Obsoleted by
96–15, 1996–3 I.R.B. 41
89–19
Superseded by
96–17, 1996–4 I.R.B. 69
89–48
Superseded in part by
96–17, 1996–4 I.R.B. 69
91–22
Modified by
96–1, 1996–1 I.R.B. 8
91–22
Amplified by
96–13, 1996–3 I.R.B. 31
91–23
Superseded by
96–13, 1996–3 I.R.B. 31
91–24
Superseded by
96–14, 1996–3 I.R.B. 41
91–26
Superseded by
96–13, 1996–3 I.R.B. 31
92–20
Modified by
96–1, 1996–1 I.R.B. 8
1
A cumulative finding list for previously
published items mentioned in Internal Revenue
Bulletins 1995–27 through 1995–52 will be
found in Internal Revenue Bulletin 1996–1, dated
January 2, 1996.
Revenue Procedures—Continued
92–85
Modified by
96–1, 1996–1 I.R.B. 8
93–16
Superseded by
96–11, 1996–2 I.R.B. 18
93–46
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
94–18
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
94–59
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
95–1
Superseded by
96–1, 1996–1 I.R.B. 8
95–2
Superseded by
96–2, 1996–1 I.R.B. 60
95–3
Superseded by
96–3, 1996–1 I.R.B. 82
95–4
Superseded by
96–4, 1996–1 I.R.B. 94
95–5
Superseded by
96–5, 1996–1 I.R.B. 129
95–6
Superseded by
96–6, 1996–1 I.R.B. 151
95–7
Superseded by
96–7, 1996–1 I.R.B. 185
95–8
Superseded by
96–8, 1996–1 I.R.B. 187
95–13
Superseded by
96–20, 1996–4 I.R.B. 88
Revenue Procedures—Continued
95–20
Superseded by
96–24, 1996–5 I.R.B. 28
95–50
Superseded by
96–3, 1996–1 I.R.B. 82
96–3
Amplified by
96–12, 1996–3 I.R.B. 30
Revenue Rulings:
66–307
Obsoleted by
96–3, 1996–2 I.R.B. 14
72–437
Modified by
96–13, 1996–3 I.R.B. 31
80–80
Obsoleted by
96–3, 1996–2 I.R.B. 14
82–80
Modified by
96–14, 1996–3 I.R.B. 41
92–19
Supplemented in part
96–2, 1996–2 I.R.B. 5
92–75
Clarified by
96–13, 1996–3 I.R.B. 31
95–10
Supplemented and superseded by
96–4, 1996–3 I.R.B. 16
95–11
Supplemented and superseded by
96–5, 1996–3 I.R.B. 29

SEQ 0038 JOB B09-052-003 PAGE-0037 FINDING LIST
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 32.10 PICAS
COMPOSITE COLOR
778/20047/28MAY96/B09-052
37
NOTES

SEQ 0039 JOB B09-052-003 PAGE-0038 FINDING LIST
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 32.10 PICAS
COMPOSITE COLOR
778/20047/28MAY96/B09-052
38
NOTES

SEQ 0040 JOB B09-052-003 PAGE-0039 FINDING LIST
REVISED 28MAY96 AT 11:26 BY LR DEPTH: 65.01 PICAS WIDTH 32.10 PICAS
COMPOSITE COLOR
778/20047/28MAY96/B09-052
39
NOTES