Internal Revenue Bulletin 2021-5 (PDF rendition): IRS Revenue Procedures

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.

Bulletin No. 2021–5
February 1, 2021
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.
ADMINISTRATIVE
REG-115057-20, page 714.
These proposed regulations amend regulations under sec-
tions 165 and 7508A, interpreting new section 7508A(d)
relating to mandatory postponements of time to perform
time-sensitive tax acts by reason of a federally declared di-
saster, and clarifying the definition of federally declared di-
saster under section 165(i)(5). Under section 7508A(a), the
Secretary has discretion to determine which taxpayers are
affected by a federally declared disaster and to specify both
the time-sensitive acts that are postponed and a period of
time that may be disregarded, up to one year, in determin-
ing whether such acts are timely performed. The proposed
regulations clarify that the phrase “in the same manner
as a period specified under [section 7508A(a)]” in section
7508A(d)(1) means that the time-sensitive acts postponed
for the mandatory 60-day period are those determined by the
Secretary under section 7508A(a). The proposed regulations
further provide that the mandatory 60-day period will only
apply if the Secretary bases his discretionary determination
on a disaster declaration that specifies an incident date. The
proposed regulations also clarify that the mandatory 60-day
period cannot exceed the one-year limitation provided under
section 7508A(a).
EMPLOYEE PLANS
Notice 2021-9, page 678.
This notice sets forth updates on the corporate bond month-
ly yield curve, the corresponding spot segment rates for Jan-
uary 2021 used under § 417(e)(3)(D), the 24-month average
segment rates applicable for January 2021, and the 30-year
Treasury rates, as reflected by the application of § 430(h)(2)
(C)(iv).
Rev. Rul. 2021-3, page 674.
This revenue ruling provides tables of covered compensation
under § 401(l)(5)(E) of the Internal Revenue Code and the In-
come Tax Regulations thereunder, effective January 1, 2021.
INCOME TAX
REG-111950-20, page 683.
These proposed regulations provide guidance under sections
1297 and 1298, including rules regarding the treatment of
certain income received or accrued by a foreign corporation
and assets held by a foreign corporation for purposes of
section 1297 and rules on whether a foreign corporation is
engaged in the active conduct of an insurance business for
purposes of section 1297(b)(2)(B). The proposed regulations
also include rules addressing the treatment of qualified im-
provement property under the alternative depreciation sys-
tem for purposes of the global intangible low-taxed income
and the foreign-derived intangible income provisions.
Rev. Proc. 2021-12, page 681.
This revenue procedure extends to September 30, 2021,
the expiration dates relevant to the application of the safe
harbors in Rev. Proc. 2020-26, 2020-18 I.R.B. 753, and Rev.
Proc. 2020-34, 2020-26 I.R.B. 990.
T.D. 9936, page 508.
These final regulations provide guidance under sections
1291, 1297, and 1298, regarding the determination of
ownership in a passive foreign investment company and the
treatment of certain income received or accrued by a for-
eign corporation and assets held by a foreign corporation for
purposes of section 1297. The final regulations also provide
guidance regarding the exclusion from passive income un-
der section 1297(b)(2)(B) for income derived by a qualifying
insurance corporation in the active conduct of an insurance
business.
Finding Lists begin on page ii.

T.D. 9943, page 577.
This document contains final regulations that provide addi-
tional guidance regarding the limitation on the business in-
terest expense deduction limitation to reflect changes made
by the Tax Cuts and Jobs Act and the Coronavirus Aid, Re-
lief, and Economic Security Act. The final regulations provide
guidance regarding which taxpayers and trades or business-
es are subject to the limitation, and how the limitation applies
in consolidated group, partnership, international, and other
contexts.
T.D. 9945, page 627.
Section 1061 recharacterizes certain net long-term capital
gains of a partner that holds one or more applicable part-
nership interests as short-term capital gains. An applicable
partnership interest is an interest in a partnership that is
transferred to or held by a taxpayer in connection with the
performance of substantial services by the taxpayer, or any
other related person, in any applicable trade or business.
The final regulations also amend existing regulations on hold-
ing periods to clarify the holding period of a partner’s interest
in a partnership that includes an applicable partnership inter-
est and/or a profits interest.

The IRS Mission
Provide America’s taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing of-
ficial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly.
It is the policy of the Service to publish in the Bulletin all sub-
stantive 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 other-
wise indicated. Procedures relating solely to matters of inter-
nal 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 rul-
ings 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
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned 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 Other Related Items, and Subpart B,
Legislation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
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 Administrative Rulings are issued
by the Department of the Treasury’s Office of the Assistant
Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.
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.
February 1, 2021 Bulletin No. 2021–5

Part I
26 CFR 1.1291-1; 1.1297-1; 1.1297-2; 1.1297-4;
1.1297-6; 1.1297-6; 1.1298-2; 1.1298-4
T.D. 9936
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Guidance on Passive
Foreign Investment
Companies
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations regarding the determi-
nation of whether a foreign corporation
is treated as a passive foreign invest-
ment company (“PFIC”) for purposes
of the Internal Revenue Code (“Code”),
and the application and scope of certain
rules that determine whether a United
States person that indirectly holds stock
in a PFIC is treated as a shareholder of
the PFIC. The regulations affect Unit-
ed States persons with direct or indirect
ownership interests in certain foreign
corporations.
DATES: Effective date: These regulations
are effective on January 14, 2021.
Applicability dates: For dates of appli-
cability see §§1.1291-1(j), 1.1297-1(g),
1.1297-2(h), 1.1297-4(g), 1.1297-6(f),
1.1298-2(g), and 1.1298-4(f).
FOR FURTHER INFORMATION
CONTACT: Concerning the regula-
tions §§1.1291-0 and 1.1291-1, 1.1297-0
through 1.1297-2, 1.1298-0, 1.1298-2,
and 1.1298-4, Christina G. Daniels at
(202) 317-6934; concerning the regula-
tions §§1.1297-4 and 1.1297-6, Josephine
Firehock at (202) 317-4932 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
On July 11, 2019, the Department of
the Treasury (“Treasury Department”)
and the IRS published proposed regula-
tions (REG-105474-18) under sections
1291, 1297, and 1298 in the Federal
Register (84 FR 33120) (the “proposed
regulations” or “2019 proposed regula-
tions”). All written comments received in
response to the proposed regulations are
available at www.regulations.gov or upon
request. A public hearing on the proposed
regulations was scheduled for December
9, 2019, but it was not held because there
were no requests to speak. Terms used
but not defined in this preamble have the
meaning provided in these final regula-
tions.
In addition, on October 2, 2019,
the Treasury Department and the IRS
published proposed regulations (REG-
104223-18) relating to the repeal of sec-
tion 958(b)(4) by the Tax Cuts and Jobs
Act, Pub. L. 115-97, 131 Stat. 2054 (2017)
(the “Act”) in the Federal Register (84
FR 52398) (the “section 958 proposed
regulations”). As in effect before its re-
peal, section 958(b)(4) provided that sec-
tion 318(a)(3)(A), (B), and (C) (providing
for downward attribution) was not to be
applied so as to consider a United States
person (as defined in section 7701(a)(30))
as owning stock owned by a person who
is not a United States person (a “foreign
person”). After the Act repealed section
958(b)(4), stock of a foreign corporation
owned by a foreign person could be at-
tributed to a United States person under
section 318(a)(3) for various purposes,
including for purposes of determining
whether the foreign corporation is a con-
trolled foreign corporation within the
meaning of section 957 (“CFC”). The sec-
tion 958 proposed regulations generally
made modifications to ensure that the op-
eration of certain rules outside of subpart
F of part III of subchapter N of chapter 1
of subtitle A of the Code (“subpart F”) are
consistent with their application before the
Act’s repeal of section 958(b)(4). A public
hearing on these regulations was not held
because there were no requests to speak.
This rulemaking finalizes the portion of
the section 958 proposed regulations un-
der section 1297 regarding the treatment
of foreign corporations for purposes of
section 1297(e).
1
See Part III.D.1 of the
Summary of Comments and Explanation
of Revisions section.
A notice of proposed rulemaking pub-
lished in the Proposed Rules section of
this issue of the Federal Register (REG-
111950-20) (the “2020 NPRM”) provides
additional guidance on the treatment of
income and assets of a foreign corpora-
tion for purposes of the PFIC rules and on
the exception from passive income under
section 1297(b)(2)(B) (“PFIC insurance
exception”).
Summary of Comments and
Explanation of Revisions
I. Overview
The final regulations retain the basic
approach and structure of the proposed
regulations, with certain revisions. This
Summary of Comments and Explanation
of Revisions section discusses those revi-
sions as well as comments received in re-
sponse to the solicitation of comments in
the notice of proposed rulemaking. Com-
ments outside the scope of this rulemak-
ing are generally not addressed but may
be considered in connection with the po-
tential issuance of future guidance.
II. Comments and Revisions to Proposed
§1.1291-1 – Taxation of U.S. persons that
are shareholders of section 1291 funds
Section 1298(a) provides attribution
rules that apply to the extent the effect
is to treat stock of a PFIC as owned by
a United States person. These rules apply
when a United States person directly or
indirectly owns an interest in a PFIC, a
1
The other portions of the section 958 proposed regulations were finalized at 85 FR 59428.
February 1, 2021 508 Bulletin No. 2021–5

partnership, an estate or a trust, or when
a United States person directly or indi-
rectly owns 50 percent or more in value
of the stock of a corporation that is not a
PFIC. In such cases, the attribution rules
of section 1298(a) may apply to treat the
United States person as owning shares of a
PFIC owned directly or indirectly by such
an entity. Stock considered to be owned
by a person by reason of any of the fore-
going rules is treated as actually owned
by that person for purposes of the further
application of those rules (the “successive
application rule”). Except as provided in
regulations, the attribution rules do not
apply to treat stock owned or treated as
owned by a United States person as owned
by any other person. The current rules in
§1.1291-1(b)(8) are consistent with these
statutory provisions.
A. Attribution of ownership through a
partnership, S corporation, estate or trust
Proposed §1.1291-1(b)(8)(iii) provid-
ed that an owner of an interest in a part-
nership, S corporation, estate or trust (a
“pass-through entity”) would be treated as
owning stock owned by the pass-through
entity only if the pass-through owner owns
50 percent or more of the pass-through en-
tity. Examples in the proposed regulations
illustrated the operation of this rule in
cases where a United States person owns
50 percent, in one case, or 40 percent, in
another case, of a foreign partnership. The
preamble to the proposed regulations indi-
cated that the proposed rule was intended
to ensure that the attribution rules apply
consistently whether a United States per-
son owns stock of a non-PFIC foreign cor-
poration indirectly through a partnership
or directly.
The only comment received on this
proposed rule agreed with the results of
the first example but recommended that a
different approach be taken with respect
to attribution through partnerships. The
comment responded to the statement in
the preamble that the proposed regula-
tions would have results consistent with
an aggregate approach to partnerships by
noting that in certain circumstances the
proposed rule would deviate from a true
aggregation approach. It posited an ex-
ample in which application of the rule in
the proposed regulations would prevent
a United States person from being treat-
ed as owning stock of a PFIC owned by
a non-PFIC corporation, even though the
United States person directly and indi-
rectly owned, in the aggregate, more than
50 percent of the stock of the non-PFIC
corporation and argued that this result was
inappropriate. Accordingly, the comment
suggested that the final regulations, in-
stead of adopting the rule included in the
proposed regulations, adopt a rule that
uses an aggregation approach to attribu-
tion through partnerships.
The Treasury Department and the IRS
agree with the comment that the rule in
the proposed regulations could have in-
appropriate results, and that a partner in a
partnership should be treated as indirectly
owning the same number of shares of a
non-PFIC corporation owned by the part-
nership as if the partner held those shares
directly. Accordingly, the final regulations
do not adopt the rules in the proposed reg-
ulations to amend the rules of §1.1291-
1(b)(8)(iii), relating to pass-through enti-
ties (partnerships, S corporations, estates
and nongrantor trusts).
B. Application of “top-down” approach
The preamble to the proposed regu-
lations indicated that proposed §1.1291-
1(b)(8)(iii) was intended to apply the
attribution rules to a tiered ownership
structure involving a pass-through entity
on a “top-down” basis, by starting with
a United States person and determining
what stock is considered owned at each
successive lower tier on a proportionate
basis. The preamble requested comments
as to whether the “top-down” approach
should be extended to attribution through
corporations.
The only comment received on the
issue indicated that the “top-down” ap-
proach should not be so extended, on the
grounds that the successive application
rule of section 1298(a)(5) requires a “bot-
tom-up” approach (that is, applying the at-
tribution rules to a tiered ownership struc-
ture by starting with the lowest-tier entity
and determining which persons are treated
as owning stock of that entity at each suc-
cessive higher tier on a proportionate ba-
sis) for corporate structures. The comment
acknowledged that this would result in
inconsistency in attribution of ownership
between stock of a PFIC held through a
partnership (which, in many cases, may
be a foreign corporate entity treated as a
partnership for U.S. federal income tax
purposes as the result of a check-the-box
election) and stock of a PFIC held through
a corporation.
The Treasury Department and the IRS
have determined that the same approach
should apply to attribution through a
pass-through entity, a PFIC or a 50 per-
cent-owned non-PFIC corporation. In
each case, the statutory language provides
that an owner of an interest in such an en-
tity is treated as owning its proportionate
share of stock owned by the entity. The
same approach to attribution therefore
should apply regardless of which entity a
United States person holds an interest in.
The successive application rule of
section 1298(a)(5) can be applied either
under a “top-down” or “bottom-up” ap-
proach. While both approaches to attribu-
tion may treat a United States person as
owning an amount of stock of a PFIC that
is less than that person’s economic inter-
est in the PFIC, a “top-down” approach
takes into account both the direct and in-
direct ownership of stock of a corporation
by the same person while the bottom-up
approach may not do so. For example, as-
sume that U.S. individual A owns 49 per-
cent of the partnership interests in a part-
nership that owns 95 percent of the stock
of a tested foreign corporation. The test-
ed foreign corporation is not a PFIC but
owns all of the single class of stock of a
PFIC. Individual A also owns the remain-
ing 5 percent of the tested foreign corpora-
tion’s stock directly. Under a “top-down”
approach, individual A is deemed to hold
46.55 percent of the tested foreign cor-
poration’s stock through the partnership
and owns 5 percent of the tested foreign
corporation’s stock directly. Therefore,
individual A is treated as owning 51.55
percent of the tested foreign corporation’s
stock and 51.55 percent of the PFIC stock.
Under a “bottom-up” approach, the tested
foreign corporation owns all of the PFIC
stock; the partnership owns 95 percent
of the tested foreign corporation’s stock
and therefore is treated as owning 95 per-
cent of the PFIC stock; and individual A
is treated as owning 49 percent of what
the partnership owns, or 46.55 percent of
the PFIC stock. In this example, the “top-
Bulletin No. 2021–5 509 February 1, 2021

February 1, 2021 510 Bulletin No. 2021–5
down” approach treats individual A as
owning its economic share of the PFIC’s
stock, while the “bottom-up” approach
may not take into account the PFIC stock
that is owned through the 5 percent of the
tested foreign corporation’s stock that in-
dividual A owns directly. Accordingly,
the final regulations apply a “top-down”
approach to the attribution of ownership
through all tiered ownership structures.
The final regulations also include a
new rule addressing the application of the
successive application rule to tiered own-
ership structures. The new rule specifical-
ly provides for a top-down approach to at-
tribution of ownership. See §1.1291-1(b)
(8)(iv). The examples in the existing and
proposed regulations have been revised
to clarify how the top-down approach
applies to those examples. See §1.1291-
1(b)(8)(v). A new example is added to
illustrate the operation of the successive
application rule in a fact pattern in which
a United States person owns stock of a
foreign corporation both directly and indi-
rectly through a partnership. See §1.1291-
1(b)(8)(v)(D).
C. Ownership attribution through
nongrantor trusts
A comment requested that the final
regulations provide additional guidance
on attributing PFIC stock held by a non-
grantor trust to the beneficiaries of the
trust, suggesting that determining owner-
ship by U.S. beneficiaries of PFIC stock
held directly or indirectly by a nongrantor
trust warrants more specificity than deter-
mining ownership in PFIC stock held di-
rectly or indirectly by other pass-through
entities.
Section 1298(a)(3) and §1.1291-1(b)
(8)(iii)(C) provide that each beneficiary is
considered to own a proportionate amount
of stock held by a foreign or domestic es-
tate or nongrantor trust. Section 1.1291-
1(b)(8)(i) provides that the determination
of a person’s indirect ownership is made
on the basis of all the facts and circum-
stances of each case and that the substance
rather than the form of the ownership is
controlling, taking into account the pur-
poses of sections 1291 through 1298.
On December 31, 2013, the Trea-
sury Department and the IRS published
final and temporary regulations under
several Code sections including section
1291 (78 FR 79602, as corrected at 79
FR 26836) (“2013 temporary and final
regulations”). The preamble to those
regulations provided that pending fur-
ther guidance, beneficiaries of estates
and nongrantor trusts that hold PFIC
stock subject to the section 1291 regime
should use a reasonable method to de-
termine their ownership interests in the
PFIC. The preamble to those regulations
also provided that section 1291 and the
principles of subchapter J must be ap-
plied in a reasonable manner with re-
spect to estates and trusts, and beneficia-
ries thereof, to preserve or trigger the tax
and interest charge rules under section
1291. Accordingly, the preamble provid-
ed that the estate or trust, or the benefi-
ciary thereof, must take excess distribu-
tions into account under section 1291 in
a reasonable manner, consistent with the
general operating rules of subchapter J
and that it would be unreasonable for the
shareholders of the section 1291 fund to
take the position that neither the benefi-
ciaries nor the estate or trust are subject
to the tax and interest charge rules under
section 1291.
The Treasury Department and the IRS
remain aware of the need for guidance
regarding both the ownership attribu-
tion rules and the interaction of the rules
in subchapter J with the PFIC rules. The
Treasury Department and the IRS are also
aware that in some cases, the application
of the PFIC attribution rules may impose
tax on U.S. beneficiaries of foreign trusts
that never receive the related distributions.
The Treasury Department and the IRS be-
lieve that further guidance with respect to
the identification of indirect shareholders
in such circumstances requires coordina-
tion of the PFIC rules with the rules of
subchapter J, which is beyond the scope
of this regulation project. Pending the
issuance of further guidance, taxpayers
should continue to apply these rules in
a reasonable manner as expressed in the
preamble to the 2013 temporary and final
regulations.
III. Comments and Revisions to Proposed
§1.1297-1 – Definition of passive foreign
investment company
Proposed §1.1297-1 provided general
rules and definitions under section 1297
including general rules concerning the
application of the income test of section
1297(a)(1) (“Income Test”) and the asset
test of section 1297(a)(2) (“Asset Test”),
clarification on the scope of the section
1297(b)(1) cross-reference to section
954(c) for purposes of defining passive in-
come, and general rules that address cer-
tain computational and characterization
issues that arise in applying the Asset Test.
A. Definition of passive income
1. In General
Section 1297(b)(1) defines passive in-
come, for purposes of the PFIC rules, as
income of a kind that would be foreign
personal holding company income (“FPH-
CI”) under section 954(c), and proposed
§1.1297-1(c)(1)(i) provided accordingly
that passive income means income of a
kind that would be FPHCI under section
954(c)(1). A comment suggested that
the cross-reference to section 954(c)(1)
should incorporate only those provisions
of section 954(c) (and the regulations
thereunder) that were in effect in 1986
when section 1297 was enacted and not,
for example, section 954(c)(1)(H), re-
lating to income from personal services
contracts, or recent revisions to the regu-
latory rules for active rents and royalties
under section 954(c)(2)(C). The Treasury
Department and the IRS disagree, and
believe that, in view of the original pur-
pose of referencing section 954(c), section
1297 incorporates the law in respect of the
referenced provisions—both statutory and
regulatory—when it is applied. Compare
section 951A(d)(3).
2
Therefore, the final
regulations do not adopt this comment.
2. PFIC/CFC Overlap Rule and RPII
Income
Section 1297(d) provides that, for
PFIC purposes, a corporation shall not be
2
As enacted, section 951A(d) contains two paragraphs designated as paragraph (3). The section 951A(d)(3) referenced in this preamble relates to the paragraph on determination of the ad-
justed basis in property for purposes of calculating QBAI.

Bulletin No. 2021–5 511 February 1, 2021
treated as a PFIC with respect to a share-
holder during the qualified portion of such
shareholder’s holding period with respect
to stock in such corporation during which
time the corporation is a CFC (“PFIC/
CFC overlap rule”). The qualified por-
tion of a shareholder’s holding period
generally is the period during which the
shareholder is a United States shareholder
(“U.S. shareholder”), as defined in sec-
tion 951(b). Section 951(b) defines a U.S.
shareholder, for purposes of the Code, as a
U.S. person that owns 10 percent or more
of the voting power or value of a foreign
corporation. Section 957(a) provides that,
for purposes of the Code, a CFC means
any foreign corporation more than 50 per-
cent owned (by vote or value, taking into
account section 958(b) constructive own-
ership rules) by U.S. shareholders on any
day during the taxable year of the foreign
corporation.
In certain circumstances, the subpart
F insurance rules lower the CFC owner-
ship threshold requirements used to de-
termine CFC status and eliminate the 10
percent vote or value test for determining
U.S. shareholder status that are otherwise
applicable for purposes of the Code. Un-
der section 957(b), a special definition of
a CFC applies and lowers the more than
50 percent ownership rule to a more than
25 percent ownership rule for taking into
account section 953(a) insurance income,
but only if the foreign corporation’s gross
amount of premiums or other consider-
ation in respect of reinsurance or the issu-
ing of insurance or annuity contracts not
described in section 953(e)(2) exceeds 75
percent of the gross amount of all premi-
ums or other consideration in respect of
all risks. Also, under section 953(c)(1)
(B), for purposes of taking into account
related party insurance income (“RPII”)
as defined in section 953(c)(2), the CFC
ownership requirement is reduced to a “25
percent or more” requirement. In addition,
for purposes of determining RPII, the 10
percent of vote or value test for determin-
ing U.S. shareholder status is eliminated.
See section 953(c)(1)(A). Instead, for
RPII purposes, a U.S. shareholder means
any U.S. person that directly or indirectly
owns any of the stock of the foreign cor-
poration at any time during the foreign
corporation’s taxable year. See section
953(c)(1)(A). Constructive ownership
under section 958(b) is not taken into ac-
count for this purpose.
A comment requested that the pro-
posed regulations be modified to provide
an exception to the PFIC rules for all U.S.
shareholders (meaning without regard to
the 10 percent vote or value test in sec-
tion 951(b)) of all CFCs (including those
that satisfy the 25 percent threshold ap-
plicable solely for the subpart F purposes
described above). The final regulations do
not adopt this comment. Consideration of
the scope of the PFIC/CFC overlap rule,
including the interaction with the RPII
rules, is beyond the scope of this rulemak-
ing. The Treasury Department and the IRS
continue to study the interaction of these
provisions and if necessary, will provide
guidance in the future.
B. Exceptions from passive income
1. Application of Active Banking and
Active Insurance Exceptions
Proposed §1.1297-1(c)(1)(i)(A) pro-
vided that section 954(h), which excludes
from FPHCI income derived by a CFC
in the active conduct of a banking or fi-
nancing business from customers outside
of the United States, applied for purposes
of determining PFIC status. The proposed
regulations also provided that section
954(i), which excludes from FPHCI cer-
tain income derived in the active conduct
of an insurance business, did not apply for
purposes of determining PFIC status. See
proposed §1.1297-1(c)(1)(i)(B). Sever-
al comments approved of the application
of section 954(h) to the determination of
whether income is treated as passive for
purposes of section 1297. One comment
noted that, in the case of tested foreign
corporations with look-through subsidiar-
ies that are domestic corporations, section
954(h)(3)(A)(ii)(I) would result in the
section 954(h) exception being inapplica-
ble to active financing income earned by
these subsidiaries from transactions with
local customers, even though it would
otherwise be of a type that would not be
passive. The comment suggested that sec-
tion 954(h) should be applied in the PFIC
context by treating income as qualified
banking or financing income even if the
income is derived from transactions with
customers in the United States. Several
comments recommended that the section
954(h) exception continue to apply in the
PFIC context in the event that final reg-
ulations implementing the active banking
exception in section 1297(b)(2)(A) are ad-
opted. Comments also requested that the
final regulations apply the section 954(i)
insurance exception for purposes of de-
termining PFIC status of an insurance
company in a parallel manner as section
954(h).
In response to these comments, the
Treasury Department and the IRS have
further studied sections 954 and 1297 and
their legislative history. As described in
more detail in the remainder of this Part
III.B.1 of this Summary of Comments
and Explanation of Revisions section, the
Treasury Department and the IRS have
determined that sections 954(h) and (i) do
not apply for purposes of section 1297(b)
absent regulations and that the appropriate
statutory authority for any such regula-
tions is section 1297(b)(2) rather than sec-
tion 1297(b)(1). The Treasury Department
and the IRS have further concluded that
section 954(i) does not apply for purposes
of section 1297(b)(2)(B), and that certain
principles of section 954(h) should be ap-
plied for purposes of section 1297(b)(2)
(A) but that a different approach is war-
ranted with respect to section 954(h) than
the approach taken in the proposed regu-
lations. Accordingly, the 2020 NPRM pro-
poses rules that would treat qualifying in-
come of certain taxpayers that satisfy the
requirements of section 954(h) as income
derived in the active conduct of a banking
business within the meaning of section
1297(b)(2). See proposed §1.1297-1(c)
(2).
As previously discussed, section
1297(b)(1) provides that, except as oth-
erwise provided in section 1297(b)(2),
passive income means any income of a
kind that would be FPHCI as defined in
section 954(c). The definitions of the cat-
egories of FPHCI listed in section 954(c)
describe types of gross income, for exam-
ple interest, dividends, gains from the sale
of property and foreign currency gains,
as well as exceptions to those definitions.
While these definitions and exceptions in
some places refer to CFCs, the definitions
and exceptions themselves do not require
that a foreign corporation be a CFC. By
contrast, although sections 954(h) and (i)

February 1, 2021 512 Bulletin No. 2021–5
apply “for purposes of section 954(c)(1),”
those provisions explicitly require that a
foreign corporation be a CFC to qualify
for an exception to FPHCI. Section 954(h)
applies only to eligible CFCs, as defined in
section 954(h)(2), and section 954(i) ap-
plies only to qualifying insurance compa-
ny CFCs, as defined in section 953(e)(3).
Accordingly, sections 954(h) and (i) do
not apply for purposes of section 1297(b)
(1) unless a tested foreign corporation is
treated pursuant to regulations as a CFC
for that purpose or otherwise qualifies as a
CFC. See proposed §1.1297-1(c)(1)(i)(D)
of the 2019 proposed regulations (treating
a tested foreign corporation as a CFC for
purposes of applying section 954(h)).
The Treasury Department and the IRS
have further determined that any regula-
tions treating sections 954(h) and (i) as
applicable for purposes of section 1297(b)
should be issued under section 1297(b)
(2) and not under section 1297(b)(1). As
originally enacted, section 1297(b)(1)
provided a rule of general application, and
section 1297(b)(2) provided a limited set
of exceptions to section 1297(b)(1). While
the list of exceptions in section 1297(b)(2)
has changed from time to time, that stat-
utory scheme remains intact today. Sec-
tion 1297(b)(2) provides exceptions for
income derived in the active conduct of a
banking or insurance business, subject to
various conditions. If section 954(h) or (i)
were treated as applicable for purposes of
section 1297(b)(1), section 1297(b)(2)(A)
and (B) would provide duplicative excep-
tions for banking or insurance income, re-
spectively. Moreover, interpreting section
1297(b)(1) in this manner would have the
effect of narrowing the scope of the ex-
ceptions provided by section 1297(b)(2),
because the income of some foreign banks
or insurance companies would already
be treated as non-passive under section
1297(b)(1). No explicit action by Con-
gress authorizes the narrowing of section
1297(b)(2) in this manner. The legislative
history of the enactment of section 954(h)
(as a temporary rule relating to both bank-
ing and insurance income) in 1997 and
the enactment of sections 954(h) and (i)
in 1998 are void of any indication that
Congress intended such an interpretation
of section 1297(b)(1).
3
The legislative
history provides further evidence that sec-
tion 954(h) was not intended to apply for
purposes of section 1297(b)(1); the con-
ference report states that “the conferees
intend that a corporation will be consid-
ered to be engaged in the active conduct
of a banking ... business if the corpora-
tion would be treated as so engaged under
the regulations proposed under” section
1297(b)(2).
4
Incorporating this standard
into section 1297(b)(1) would limit the
scope of section 1297(b)(2). Accordingly,
given the specialized nature of these ex-
ceptions within the subpart F regime, the
Treasury Department and the IRS have
determined that it is inappropriate to apply
them in defining the types of income that
are “of a kind” described in section 954(c)
(that is, FPHCI) for purposes of section
1297(b)(1).
In addition, as explained in the pre-
amble to the 2019 proposed regulations,
the Treasury Department and the IRS
have determined that because the recent
changes to section 1297(b)(2)(B) require
that income eligible for the exception be
earned by a qualifying insurance corpora-
tion, section 954(i) should not apply in ad-
dition to the newly modified exception in
section 1297(b)(2)(B). See 84 FR 33120,
at 33123. Therefore, the final regulations
do not adopt the comments requesting
that the section 954(i) exception apply for
purposes of determining PFIC status. As
a result, section 954(i) remains listed in
§1.1297-1(c)(1)(i)(B) as one of the excep-
tions in section 954 that is not applied in
the PFIC context.
Section 954(h) has been removed from
the list of exceptions that are applied to
PFICs with respect to section 1297(b)
(1). See §1.1297-1(c)(1)(i)(A). Despite
the conclusion that it is inappropriate to
incorporate section 954(h) as an excep-
tion to the definition of passive income
under section 1297(b)(1), the Treasury
Department and the IRS have considered
whether principles of section 954(h) could
apply in the context of the rules of sec-
tion 1297(b)(2)(A). Section 1297(b)(2)
(A) provides that passive income does not
include any income derived in the active
conduct of a banking business by an in-
stitution licensed to do business as a bank
in the United States (or, to the extent pro-
vided in regulations, by any other corpora-
tion). Pursuant to this grant of regulatory
authority, the 2020 NPRM proposes an
active banking exception that incorporates
certain principles of section 954(h) in de-
fining other corporations that are eligible
to apply this exception in addition to U.S.
licensed banks. See proposed §1.1297-
1(c)(2). The preamble to the 2020 NPRM
discusses comments that address issues
relating to the potential application of sec-
tion 954(h) in the PFIC context.
2. Treatment of Gains from Certain
Transactions
Proposed §1.1297-1(c)(1)(ii) provided
that for purposes of the Income Test, cate-
gories of income under section 954(c) that
are determined by netting gains against
losses are taken into account by a corpo-
ration on that net basis. However, under
the proposed regulations, the net amount
of income in each category of FPHCI
was calculated separately for each rel-
evant corporation, such that net gains or
losses of a look-through subsidiary may
not be netted against net losses or gains
of another look-through subsidiary or of
a tested foreign corporation. See proposed
§1.1297-1(c)(1)(ii).
One comment recommended that the
final regulations not adopt the separate
entity approach in proposed §1.1297-1(c)
(1)(ii) and, instead, permit a tested foreign
corporation to net its gains and losses with
those of its directly or indirectly owned
look-through subsidiaries and its direct-
ly or indirectly owned partnerships. The
comment noted that the separate entity
approach could result in an overstatement
of FPHCI of an integrated business that is
conducted through multiple subsidiaries.
3
See H.R. Rep. No. 220, 105
th
Cong. 1
st
Sess. 623-28 (July 30, 1997) (discussing adoption of section 1297(d) CFC overlap rule and section 1296 mark-to-market rule; no discussion of con-
temporaneous adoption of section 954(h)); id. at 639-45 (discussing adoption of active financing income (section 954(h)) rule; no suggestion that rules apply for PFIC purposes).
4
Id. at 642; see also H.R. Rep. No. 105-825, at 1555 (Oct. 19, 1998) (Conf. Rep.) (“[I]n this regard, a corporation is considered to be engaged in the active conduct of a banking or securities
business if the corporation would be treated as so engaged under the regulations proposed under prior law section 1296(b) (as in effect prior to the enactment of the Taxpayer Relief Act of
1997)”).

Bulletin No. 2021–5 513 February 1, 2021
The Treasury Department and the IRS
have determined that the integrated treat-
ment proposed by the comment with re-
spect to look-through subsidiaries and
look-through partnerships is consistent
with the statutory language treating the
owner of a look-through subsidiary as
receiving directly its proportionate share
of the income of the subsidiary, and with
the policies underlying section 1297(c).
Accordingly, §1.1297-1(c)(1)(ii) provides
that the net gains or income for a catego-
ry of FPHCI that is determined by netting
gains against losses are determined at the
level of a tested foreign corporation taking
into account individual items of the tested
foreign corporation and its look-through
subsidiaries and look-through partner-
ships. Because these regulations do not
adopt an overall look-through approach
with respect to all partnerships, netting
is not provided with respect to gains and
losses derived from partnerships that are
not look-through partnerships. For exam-
ple, netting does not apply to gains and
losses that are part of a tested foreign cor-
poration’s distributive share from a part-
nership that is a related person within the
meaning of section 954(d)(3) but not a
look-through partnership.
3. Treatment of Effectively Connected
Income and Income Attributable to U.S.
Permanent Establishments
Section 952(b) excludes from subpart F
income the U.S. source income of a CFC
that is effectively connected with the con-
duct by such CFC of a trade or business in
the United States (“effectively connected
income”). Comments noted that the pro-
posed regulations did not address the treat-
ment of effectively connected income, or
the assets held to produce such income, of
a foreign corporation or the treatment of
income that is attributable to a U.S. per-
manent establishment, or the assets held
to produce such income. The comments
noted that section 952(b) can exclude
from subpart F income amounts that are
FPHCI in order to prevent such amounts
from being double-taxed, once directly to
the foreign corporation, and a second time
to United States shareholders of the for-
eign corporation, and stated that the PFIC
rules should not discriminate against in-
come earned through a U.S. branch rather
than through a domestic subsidiary that
may qualify for the special rules of sec-
tion 1298(b)(7). These comments suggest-
ed that the final regulations either charac-
terize such income, and the assets held to
produce such income, as non-passive or
not include such income for purposes of
the Income and Asset Tests.
As noted in Part III.B.1 of this Sum-
mary of Comments and Explanation of
Revisions, the determination of whether
amounts should be taken into account
for purposes of the Income Test or the
Asset Test is based on whether income
would be FPHCI under section 954(c),
not whether the income is treated as sub-
part F income. The PFIC rules address
whether income is passive, which is a
different question from whether it should
be treated as subpart F income. Section
1298(b)(7) does not provide non-passive
treatment for all income of domestic sub-
sidiaries, but rather only for income of
domestic subsidiaries that meet specified
requirements, indicating that Congress
did not consider it appropriate to exclude
all income of domestic subsidiaries that
are subject to U.S. net income taxation
from passive income treatment. As a
corollary, the limited scope of section
1298(b)(7) implies that a broad excep-
tion for effectively connected income
is not warranted. Furthermore, section
1293(g)(1)(B)(ii) provides authority to
exclude effectively connected income of
a PFIC that is subject to U.S. net income
taxation from inclusion in the hands of a
shareholder of the PFIC that has made a
qualified electing fund election, indicat-
ing that effectively connected income is
otherwise treated as income of a tested
foreign corporation for PFIC purposes.
The Treasury Department and the IRS
have determined that an exclusion of ef-
fectively connected income (and income
attributable to a U.S. permanent estab-
lishment) from passive income would be
inconsistent with the statutory definition
of passive income in section 1297(b)(1),
with the limited application of section
1298(b)(7) and with the exclusion provid-
ed by section 1293(g)(1)(B)(ii), and that
the treatment of effectively connected in-
come (and income attributable to a U.S.
permanent establishment) is contemplated
and appropriately addressed by the exist-
ing PFIC rules. Consequently, the final
regulations do not adopt the suggestions
in these comments.
C. Income subject to the related person
look-through rule
Section 1297(b)(2)(C) characterizes
dividends, interest, rents, and royalties
received or accrued from a related person
as non-passive income to the extent those
amounts are properly allocable to income
of such related person that is not passive.
Proposed §1.1297-1(c)(3) provided ad-
ditional guidance on the application of
the section 1297(b)(2)(C) related person
exception for dividends, interest, rents,
and royalties. In response to comments,
changes have been made to these regu-
lations and additional guidance has been
provided.
Under the final regulations, for pur-
poses of the Asset Test and Income Test,
corporations and partnerships owned in
whole or part by a tested foreign corpo-
ration are generally classified into one or
more of three categories. Lower-tier enti-
ties generally are treated as one or more
of (i) a look-through subsidiary or look-
through partnership (a “look-through enti-
ty”), (ii) a related person or (iii) an entity
that is neither a look-through entity nor a
related person. The rules for look-through
entities are discussed in Part IV of this
Summary of Comments and Explanation
of Revisions. Dividends and the distrib-
utive share of income from a lower-tier
entity that is neither a look-through entity
nor a related person generally are treated
as passive income, regardless of whether
the income of the lower-tier entity is ac-
tive or passive in its hands. See §1.1297-
1(c)(3). Similarly, ownership interests in
such entities are treated as passive assets.
See §1.1297-1(d)(4).
For purposes of section 1297(b)(2)(C),
the term related person has the meaning
provided by section 954(d)(3). See section
1297(b)(2) and §1.1297-1(f)(8). Because
the ownership threshold required for an
entity to be treated as a related person
is higher than the ownership threshold
required for an entity to be treated as a
look-through entity, there may be many
entities that qualify as both or solely as
look-through entities. However, because
section 954(d)(3) has broader attribution
rules than the rules that apply for purposes

February 1, 2021 514 Bulletin No. 2021–5
of determining look-through entity clas-
sification, there may be entities that are
treated as related persons with respect to a
tested foreign corporation but not as look-
through entities with respect to that tested
foreign corporation.
For purposes of section 1297(b)(2)(C),
interest, dividends, rents or royalties actu-
ally received or accrued by a tested foreign
corporation are considered received or
accrued from a related person only if the
payor of the interest, dividend, rent or roy-
alty is a related person with respect to the
tested foreign corporation. In the case of
income received or accrued from a look-
through entity, the rules that eliminate in-
tercompany income described in Part IV.D
of this Summary of Comments and Expla-
nation of Revisions apply before the rules
applicable to income received or accrued
from a related person. See §1.1297-1(c)(4)
(ii). Consequently, the rules of §1.1297-
1(c)(4) apply to dividends, interest, rents,
and royalties received or accrued from a
look-through entity only if those amounts
are treated as regarded after application
of the intercompany income rules. These
rules also apply to income from a relat-
ed person that is received or accrued by
a look-through entity. The determination
of whether income received or accrued
by a look-through entity is treated as re-
ceived from a related person is made at
the level of the look-through entity, both
for purposes of determining whether the
look-through entity is a PFIC, if relevant,
and for purposes of determining whether
an upper-tier tested foreign corporation is
a PFIC. See §1.1297-2(d).
If a partnership is a related person (that
is not a look-through entity) with respect
to a tested foreign corporation or look-
through entity, and therefore subject to
these rules, the tested foreign corporation’s
or look-through entity’s distributive share
of income from the partnership is treated
as passive or non-passive in whole or part
based on the activities of the partnership,
and the partnership interest is correspond-
ingly treated as passive or non-passive in
whole or part. See §1.1297-1(c)(4)(vii),
(d)(3)(i), and (d)(4). An asset that gives
rise to income that is treated as in part pas-
sive and in part non-passive pursuant to
these rules is subject to the rules that apply
to dual-character assets. See §1.1297-1(d)
(3)(i).
1. Treatment of Interest
The proposed regulations provided
that, for purposes of the section 1297(b)
(2)(C) exception, interest is properly allo-
cable to income of the related person that
is not passive income based on the rela-
tive portion of the related person’s income
for its taxable year that ends in or with the
taxable year of the recipient that is not
passive income. See proposed §1.1297-
1(c)(3)(i). Comments generally supported
the pro rata approach taken in the pro-
posed regulations. One comment noted
that the final regulations should clarify
that the allocation is based on the ratio of
gross non-passive income to gross total
income. Another comment that support-
ed the pro rata approach in the proposed
regulations recommended that the final
regulations address situations in which
the related person does not have income
during the taxable year of the payment.
In such a case, this comment suggested
that the final regulations apply the prin-
ciples of §1.861-9T, which provides rules
for allocating and apportioning interest
expense, to determine whether the inter-
est payments are allocated to passive or
non-passive income of the related person.
The comment also requested that the ap-
proach using the principles of §1.861-9T
to allocate interest when the related per-
son does not have gross income be made
available as an alternative method at the
election of the tested foreign corporation.
As suggested by the first comment, the
final regulations clarify that the ratio for
allocating interest to income is based on
gross income. See §1.1297-1(c)(4)(iii).
Similar clarifications are made for the
rule for rents and royalties. See §1.1297-
1(c)(4)(v). The Treasury Department and
the IRS have determined that the pro rata
approach provided in the proposed reg-
ulations is the most straightforward and
consistent with the purposes of the section
1297(b)(2)(C) exception if the related per-
son has gross income in the taxable year,
and accordingly, the final regulations do
not provide a generally applicable elec-
tion to apply the principles of §1.861-9T
in lieu of the general rule. See §1.1297-
1(c)(4)(iii).
It is anticipated that it will rarely be the
case that a related person will not have
gross income, because gross income for
most taxpayers is determined without tak-
ing expenses into account. However, in
the case of taxpayers that determine gross
income after taking operating expenses
into account, it is possible that a taxpayer
will not have gross income for a taxable
year. In such a case, the Treasury Depart-
ment and the IRS agree that the principles
of §1.861-9T may properly apply for a
year in which the related person does not
have gross income, because §1.861-9T is
a general rule — the default rule in the
absence of a more specific rule – relating
to the allocation of interest expense. Al-
ternatively, because section 1297(b)(2)(C)
characterizes interest received or accrued
from a related person as non-passive in-
come to the extent it is properly allocable
to non-passive income of the related per-
son, it may also be appropriate for interest
received or accrued by the tested foreign
corporation to be allocated entirely to pas-
sive income in such a case, and that treat-
ment may be simpler for a tested foreign
corporation to determine. Accordingly, the
final regulations provide that for a year in
which the related person does not have
gross income, a tested foreign corpora-
tion may use the principles of §1.861-9
through -13T, applied in a reasonable and
consistent manner taking into account the
general operation of the PFIC rules and the
purpose of section 1297(b)(2)(C) in order
to allocate interest received or accrued
from the related person between passive
and non-passive income. Alternatively, at
a tested foreign corporation’s election, it
may treat the interest income entirely as
passive income.
2. Treatment of Dividends
The proposed regulations provided
that, for purposes of the section 1297(b)
(2)(C) exception, dividends are treated as
properly allocable to income of the relat-
ed person that is not passive income based
on the portion of the related payor’s cur-
rent earnings and profits (“E&P”) for the
taxable year that ends in or with the tax-
able year of the recipient that is attribut-
able to non-passive income. See proposed
§1.1297-1(c)(3)(ii).
A comment observed that foreign cor-
porations often do not maintain E&P based
on U.S. tax principles. The comment rec-
ommended that dividends be treated as al-

Bulletin No. 2021–5 515 February 1, 2021
located between passive and non-passive
amounts based on the ratio of passive to
non-passive gross income.
Two comments requested that pro-
posed §1.1297-1(c)(3)(ii) be modified to
allocate dividend income based on both
current and accumulated E&P of the relat-
ed payor to which the dividend income is
attributable, in accordance with the prin-
ciples of section 316. A third comment
observed that there are administrative
benefits to characterizing dividends by
reference to current E&P, because it may
be easier to obtain relevant information
for current E&P and because the nature of
a company’s activities may change. This
comment further requested that dividends
be determined by reference to gross in-
come over a reasonable look-back period
such as three to five years, rather than by
reference to E&P under section 316 prin-
ciples, in order to reflect the economic re-
ality of the corporation’s activities and to
avoid undue emphasis on the timing of the
dividends. The comment suggested as an
alternative that this method might apply
only if the related payor does not maintain
E&P using U.S. tax principles, while if the
related party does maintain E&P based on
U.S. tax principles, then, to the extent of
current E&P, dividends would be charac-
terized based on the portion of the related
payor’s current-year E&P that is attribut-
able to non-passive income, and the re-
maining amount would be characterized
based on the relative portion of accumu-
lated E&P that is attributable to non-pas-
sive income. The comment suggested that
the ratio for accumulated E&P could be
based on accumulated E&P for the period
in which the related payor was a related
person under section 954(d)(3).
Another comment suggested that the
difficulty in obtaining information nec-
essary to determine the character of ac-
cumulated E&P with respect to foreign
corporations could be addressed by allow-
ing taxpayers to use reasonable methods
to determine the character of accumulated
E&P and proposed that characterizing the
accumulated E&P based on the current
year’s E&P be considered a reasonable
method.
The Treasury Department and the IRS
agree that dividends from related parties
should be allocated between passive and
non-passive E&P based on the principles
of section 316, which apply generally
for purposes of the U.S. international tax
rules. Accordingly, the final regulations
adopt the recommendation to characterize
dividends in accordance with first current
and then accumulated E&P of the related
payor to which the dividend income is
attributable. See §1.1297-1(c)(4)(iv)(A).
In order to address concerns that foreign
corporations that are not CFCs may not
maintain E&P based on U.S. tax princi-
ples, taxpayers are permitted to allocate
E&P in proportion to the ratio of passive
gross income to non-passive gross income
for the relevant period. See §1.1297-1(c)
(4)(iv)(B).
The Treasury Department and the IRS
also agree with the premise of all of the
comments that if dividends are paid out
of E&P other than current E&P, either be-
cause there is no current E&P or because
the amount of the dividends exceeds the
current E&P, it would be appropriate to
take into account the character of the in-
come supporting the dividend. The final
regulations provide that dividends paid
out of accumulated E&P are allocated be-
tween passive and non-passive E&P under
the same rules that apply with respect to
dividends paid out of current E&P. See
§1.1297-1(c)(4)(iv)(C).
The Treasury Department and the IRS
understand that it may be difficult for
shareholders to determine the character of
accumulated E&P with respect to foreign
corporations, particularly for E&P from
pre-acquisition periods. The suggestion of
referring to a look-back period of several
years is consistent with the rule for char-
acterizing stock, discussed in Part III.D.4
of this Summary of Comments and Expla-
nation of Revisions, which is intended to
effectively treat stock as, in whole or part,
held for the production of non-passive in-
come if dividends received with respect
to it within a three-year period constitute
non-passive income due to the application
of section 1297(b)(2)(C). Accordingly, the
final regulations permit taxpayers to use
the default approach, consistent with gen-
eral U.S. federal income tax principles, of
allocating dividends paid out of accumu-
lated E&P based on the ratio of passive
to non-passive E&P for each prior year
(beginning with the most recently accu-
mulated), or to use one of two adminis-
tratively simpler alternatives. See id. The
first alternative is to allocate dividends
paid out of accumulated E&P based on the
ratio of passive to non-passive E&P that
is attributable to E&P accumulated in the
years in which the payor was related to the
recipient. If the payor has been related to
the recipient for more than three years, a
second alternative is available, which is to
allocate dividends paid out of accumulat-
ed E&P based on the ratio of passive to
non-passive E&P that is attributable to
E&P accumulated during a look-back pe-
riod of the three years before the current
taxable year. See id.
D. Asset test
1. Section 958 Proposed Regulations
Shareholders of a foreign corporation
that became a CFC as a result of the repeal
of section 958(b)(4) would have to apply
the Asset Test based on the adjusted basis
of the foreign corporation’s assets under
section 1297(e). The section 958 proposed
regulations modified the definition of a
CFC for purposes of section 1297(e) to
disregard downward attribution from for-
eign persons. See proposed §1.1297-1(d)
(1)(iii)(A). No comments were received
with respect to this rule in the section 958
proposed regulations. Accordingly, the
rule is finalized without modification. See
§1.1297-1(d)(1)(v)(B)(2).
2. Determination of Average Amount of
Assets Based on Value or Adjusted Basis
Section 1297(e) provides that the as-
sets of a tested foreign corporation are to
be measured based on (i) value, pursuant
to section 1297(e)(1), if it is a publicly
traded corporation for the taxable year, or
if section 1297(e)(2) does not apply to it
for the taxable year; or (ii) adjusted basis,
pursuant to section 1297(e)(2), if it is a
CFC or elects the application of section
1297(e)(2). These statutory provisions
create a hierarchy for determining the
method for measuring the assets of a test-
ed foreign corporation, as follows: (a) first
by value, if the tested foreign corporation
is a publicly traded corporation for the
taxable year; (b) second by adjusted basis,
if the tested foreign corporation is not a
publicly traded corporation and is a CFC;
and (c) third by value, or at the election

February 1, 2021 516 Bulletin No. 2021–5
of the tested foreign corporation, by ad-
justed basis, in other cases. The Treasury
Department and the IRS understand that
taxpayers typically prefer to use value to
measure assets of a tested foreign corpo-
ration.
The proposed regulations provided
that, for purposes of the Asset Test, com-
panies that were publicly traded for only
part of the year were required to mea-
sure assets on the basis of value for the
entire year if the corporation was public-
ly traded on the majority of days during
the year or if section 1297(e)(2) did not
apply to the corporation on the majority
of days of the year. If the tested foreign
corporation was not publicly traded on
the majority of days during the year, the
tested foreign corporation was required to
use adjusted basis to measure assets if it
was a CFC or if an election to use adjust-
ed basis was made under section 1297(e)
(2)(B). See proposed §1.1297-1(d)(1)(v).
The majority of days rule in the proposed
regulations would have required a tested
foreign corporation that was a CFC and
whose shares were publicly traded for less
than the majority of days during the year
to use adjusted basis to measure its assets
for that taxable year because the corpora-
tion would not have been treated as a pub-
licly traded corporation. The requirement
to use adjusted basis might apply, for ex-
ample, to a foreign corporation treated as
a CFC that issues publicly traded shares in
an initial public offering in the second half
of the year.
A comment requested that the proposed
regulations be modified to provide that
the Asset Test be applied based on value
if shares of the tested foreign corporation
were publicly traded at any time during
the taxable year. The comment asserted
that the use of value more appropriately
reflects the purposes of the PFIC rules in
general, and that the statute requires only
non-publicly traded CFCs to use basis
for purposes of the Asset Test and other-
wise allows a tested foreign corporation
to apply the Asset Test based on value.
The comment also noted that, due to the
repeal of section 958(b)(4), there may be
more tested foreign corporations that are
CFCs. In such cases, less-than-10-percent
shareholders of those tested foreign cor-
porations would be required to use basis
rather than value in determining PFIC sta-
tus. The comment requested relief from
this result. The comment further noted
that publicly traded corporations required
to use basis would not be able to take into
account goodwill and other self-created
business intangibles for purposes of the
Asset Test because such items often do not
have tax basis.
The Treasury Department and the IRS
agree with the concerns expressed by the
comment regarding the effects of the re-
peal of section 958(b)(4). As discussed
in Part III.D.1 of this Summary of Com-
ments and Explanation of Revisions, this
rulemaking finalizes the portion of the
section 958 proposed regulations con-
cerning the definition of the term CFC for
purposes of the Asset Test, which accord-
ingly allows use of the value method of
measuring assets to the extent permissible
under the statute. See §1.1297-1(d)(1)(v)
(B)(2) (treating foreign corporations that
are CFCs solely due to the repeal of sec-
tion 958(b)(4) as not CFCs for purposes
of section 1297(e)). The Treasury Depart-
ment and the IRS believe that this change
may alleviate much of the concern ex-
pressed about the proposed rule because
the change makes it less likely that a test-
ed foreign corporation will be treated as a
CFC that is required to use adjusted basis
to measure its assets.
The Treasury Department and the IRS
also agree that section 1297(e) favors the
use of value as a method to measure assets
and that the use of value aligns with the
objective of the PFIC rules. As a result,
the final regulations expand the definition
of publicly traded corporation for pur-
poses of section 1297(e) to include more
circumstances in which a tested foreign
corporation is treated as a publicly trad-
ed foreign corporation. See §1.1297-1(f)
(7). However, the Treasury Department
and the IRS believe that it would be in-
appropriate to require a corporation to use
value for purposes of the Asset Test if it
was publicly traded for a de minimis pe-
riod during its taxable year. Accordingly,
the final regulations provide that a public-
ly traded corporation, which is defined as
a corporation that has been publicly traded
in more than de minimis amounts for at
least twenty trading days (approximately
one month) during a taxable year, is re-
quired to apply the Asset Test based on
value. See §1.1297-1(d)(1)(v)(A) and (f)
(7). Pursuant to section 1297(e), a tested
foreign corporation that does not qualify
as a publicly traded foreign corporation
may use value to measure assets as long
as it is not a non-publicly traded CFC, but
it is not required to do so.
The comment also requested clarifica-
tion on the application of section 1297(e)
in the case of tiers of tested foreign corpo-
rations. The comment recommended the
final regulations provide that, for purposes
of applying the Asset Test, a publicly trad-
ed tested foreign corporation should mea-
sure all of its assets—including the assets
of its non-publicly traded look-through
subsidiaries—based on value. The Trea-
sury Department and the IRS generally
agree with the premise of this comment,
except in cases where section 1297(e) re-
quires a different treatment for the assets
of subsidiaries (as discussed in the next
paragraph). For the avoidance of doubt,
the final regulations include cross-refer-
ences to §1.1297-2(b)(2)(i) (which pro-
vides the rule that a tested foreign corpo-
ration is deemed to directly own the assets
of the look-through subsidiary) in the final
section 1297(e) rules. See §1.1297-1(d)(1)
(i) and (d)(1)(v)(A).
The comment also observed that, un-
like the typical situation where a publicly
traded tested foreign corporation would
measure all of its assets (including the
assets of its non-publicly traded look-
through subsidiaries) based on value in
accordance with section 1297(e)(1)(A),
it is questionable whether a CFC that is a
non-publicly traded subsidiary of a pub-
licly traded parent corporation could also
use value, rather than basis, for purposes
of testing its own PFIC status. The com-
ment noted that such a subsidiary might be
a CFC as a result of the repeal of section
958(b)(4). As discussed in Part III.D.1 of
this Summary of Comments and Expla-
nation of Revisions, §1.1297-1(d)(1)(v)
(B)(2), which provides that foreign cor-
porations that are CFCs solely due to the
repeal of section 958(b)(4) are not treated
as such for purposes of section 1297(e),
mitigates this concern. Further, if a low-
er-tier tested foreign corporation is a CFC
that is not publicly traded, section 1297(e)
(2)(A) requires that adjusted basis be used
as the method for measuring its assets.
Therefore, the final regulations clarify that
a lower-tier tested foreign corporation that

Bulletin No. 2021–5 517 February 1, 2021
is a non-publicly traded CFC must use ad-
justed basis and not value to measure its
assets, regardless of whether it is owned
by a publicly traded foreign corporation.
In order to clarify the application of the
statutory hierarchy for measuring a tested
foreign corporation’s assets more gener-
ally, including with respect to lower-tier
tested foreign corporations, §1.1297-1(d)
(1)(v) has been revised. The regulation
provides a hierarchy that generally applies
to every tested foreign corporation, regard-
less of whether it is an upper-tier or low-
er-tier tested foreign corporation. Pursuant
to section 1297(e) and this hierarchy, (i) a
publicly traded foreign corporation (as de-
fined in §1.1297-1(f)(7)) must use value
to measure its assets, (ii) a non-publicly
traded CFC must use basis to measure its
assets, unless the CFC becomes a public-
ly traded foreign corporation (as defined
in §1.1297-1(f)(7)) during a taxable year,
and (iii) any other tested foreign corpora-
tion would use value to measure its assets
unless an election is made to use adjusted
basis, except if it is a lower-tier subsidiary
in which case additional rules apply. See
§1.1297-1(d)(1)(v)(A), (B), and (C)(1).
Section 1.1297-1(d)(1)(iii) clarifies that
the election to use adjusted basis may be
made by the tested foreign corporation or
its shareholders.
Revised §1.1297-1(d)(1)(v) provides
specific rules for measuring the assets of
lower-tier subsidiaries, which in the usu-
al case are expected to be look-through
subsidiaries. These rules follow the same
hierarchy described in the prior paragraph,
except that the method used to measure
the assets of a lower-tier subsidiary may
be determined either by the status of the
lower-tier subsidiary if it is a publicly
traded foreign corporation or a non-pub-
licly traded CFC, or by the status of a
tested foreign corporation that directly or
indirectly owns all or part of the shares
of the lower-tier subsidiary (a parent for-
eign corporation), if the parent foreign
corporation has one of those statuses. See
§1.1297-1(d)(1)(v)(C)(2).
As a general matter, the method used
by a parent foreign corporation to measure
its assets also must be used to measure the
assets of a lower-tier foreign corporation
owned in whole or part by that parent for-
eign corporation. This rule applies both
for purposes of determining whether the
parent foreign corporation is a PFIC and
for purposes of determining whether the
lower-tier foreign corporation is a PFIC.
If a tested foreign corporation indirectly
owns a lower-tier subsidiary through one
or more other foreign corporations, the
status of the parent foreign corporation
in that chain of corporations that has the
highest status in the hierarchy described
above governs. See §1.1297-1(d)(1)(v)(C)
(2)(iii).
This general consistency rule does not
apply, however, if the lower-tier foreign
corporation has a status for which section
1297(e) mandates a method for measuring
assets (that is, it is a publicly traded for-
eign corporation or non-publicly traded
CFC). In such a case, the statutorily man-
dated method applies to measure the low-
er-tier foreign corporation’s assets, both
for purposes of determining whether the
parent foreign corporation is a PFIC and
for purposes of determining whether the
lower-tier foreign corporation is a PFIC.
For example, if a tested foreign corpora-
tion is a publicly traded foreign corpora-
tion, then both its assets and the assets of
its lower-tier subsidiaries must be mea-
sured on the basis of value, unless a low-
er-tier subsidiary is a non-publicly traded
CFC, in which case the assets of that sub-
sidiary must be measured using adjusted
basis. Similarly, if a tested foreign cor-
poration is a non-publicly traded CFC,
then both its assets and the assets of its
lower-tier subsidiaries must be measured
using adjusted basis, unless a lower-tier
subsidiary is a publicly traded foreign cor-
poration, in which case the assets of that
subsidiary must be measured using value.
See §1.1297-1(d)(1)(v)(C)(2)(i) and (ii).
If a lower-tier tested foreign corporation
does not have a status for which section
1297(e) mandates a method for measuring
assets, and it is a subsidiary of more than
one parent foreign corporation, then U.S.
shareholders of the two different parent
corporations may be required to use dif-
ferent methods to measure the assets of
the lower-tier foreign corporation based
on the method used for each respective
parent foreign corporation. See the last
sentence of §1.1297-1(d)(1)(v)(C)(2)(iii)
and §1.1297-1(d)(1)(v)(E)(3) (Example
3).
The Treasury Department and the IRS
recognize that section 1297(e)(1) requires
in many cases that a valuation must be
performed for assets of an operating com-
pany for which no publicly available val-
uation is available, apart from information
provided in financial statements prepared
under widely-used financial reporting
standards, and that ascertaining such a
valuation creates a compliance burden.
The Treasury Department and the IRS are
studying whether to provide rules permit-
ting taxpayers to rely on financial state-
ment information in appropriate cases,
and the final regulations reserve on this is-
sue. See §1.1297-1(d)(1)(v)(D). The 2020
NPRM proposes a rule to address this is-
sue and solicits comments on the proposed
rule. See proposed §1.1297-1(d)(1)(v)(D).
3. Treatment of Working Capital for
Purposes of Asset Test
The proposed regulations did not ad-
dress the treatment of working capital for
purposes of the Asset Test. Notice 88-22,
1988-1 C.B. 489 (“Notice 88-22”) pro-
vides that cash and other current assets
readily convertible into cash, including
assets that may be characterized as the
working capital of an active business, are
treated as passive assets for purposes of
the Asset Test. Notice 88-22 indicated that
passive treatment is warranted because
working capital produces passive income
(interest income).
A comment on the proposed regula-
tions asserted that the approach taken in
Notice 88-22 with respect to working cap-
ital undermines the purpose of the PFIC
regime to distinguish between investments
in passive assets and investments in active
businesses. The comment requested that
the final regulations adopt an approach,
similar to the treatment of dual-character
assets, pursuant to which working capital
would be bifurcated between passive and
non-passive assets in proportion to the rel-
ative amount of gross income that is pas-
sive or non-passive.
The Treasury Department and the
IRS continue to study the appropriate
treatment of working capital, and the fi-
nal regulations reserve on this issue. See
§1.1297-1(d)(2). The 2020 NPRM pro-
poses a limited exception to the treatment
of working capital to take into account the
short-term cash needs of operating com-
panies. See proposed §1.1297-1(d)(2).

February 1, 2021 518 Bulletin No. 2021–5
4. Assets that Produce Income Subject to
the Related Person Look-Through Rule
The proposed regulations defined the
term passive asset, consistent with section
1297(a), as an asset that produces passive
income, or which is held for the produc-
tion of passive income, taking into ac-
count the rules in proposed §1.1297-1(c),
which defined passive income, and pro-
posed §1.1297-1(d), which provided rules
for the application of the Asset Test. See
proposed §1.1297-1(f)(6). The proposed
regulations also provided that an asset
that produces both passive income and
non-passive income during a taxable year
is treated as two assets, one of which is
passive and one of which is non-passive,
with the value (or adjusted basis) of the
asset being allocated between the passive
asset and non-passive asset in proportion
to the relative amounts of passive and
non-passive income produced by the as-
set during the taxable year. See proposed
§1.1297-1(d)(2)(i).
A number of comments expressed con-
cern that the proposed regulations did not
provide a general rule to characterize as-
sets—in particular shares of stock—that
give rise to income subject to the relat-
ed person look-through rule of section
1297(b)(2)(C), discussed in Part III.C of
this Summary of Comments and Expla-
nation of Revisions. The comments sug-
gested that the final regulations include
a rule that treats assets that give rise to
income subject to section 1297(b)(2)(C)
as a passive or non-passive asset to the
extent the income that is received with
respect to such asset is treated as passive
or non-passive by the tested foreign cor-
poration. The Treasury Department and
the IRS agree that it is consistent with the
statutory language and intent of section
1297(a)(2) to treat assets that give rise to
both passive and non-passive income as
partly passive and partly non-passive. The
Treasury Department and the IRS believe
that it was clear under proposed §1.1297-
1(d)(2)(i) and (f)(6) that assets that pro-
duced income subject to the related per-
son look-through rule of section 1297(b)
(2)(C) were treated as non-passive in pro-
portion to the non-passive income pro-
duced by the asset, subject to the special
rules in §1.1297-1(d). However, for the
avoidance of doubt, the final regulations
provide an explicit cross-reference to sec-
tion 1297(b)(2)(C) to clarify that assets
that produce income subject to the related
person look-through rule are subject to
the general and special rules with respect
to treatment of assets under §1.1297-1(d),
for example related party stock, loans,
leases or licenses that produce dividends,
interest, rent or royalties that are treated
as passive and non-passive under sec-
tion 1297(b)(2)(C). See §1.1297-1(d)
(3)(i). Accordingly, assets that give rise
to income subject to section 1297(b)(2)
(C) generally are treated as a passive or
non-passive asset to the extent the income
that is received with respect to such asset
is treated as passive or non-passive by the
tested foreign corporation.
The proposed regulations also provid-
ed that stock of a related person with re-
spect to which no dividends are received
or accrued during a taxable year but that
previously generated dividends that were
characterized as non-passive income, in
whole or in part, under section 1297(b)
(2)(C) is characterized based on the div-
idends received or accrued with respect
thereto for the prior two years. See pro-
posed §1.1297-1(d)(2)(iii).
Comments noted that there may be
instances in which the related person has
not paid dividends in more than two years.
One comment suggested that, in this in-
stance, stock be apportioned in proportion
to the average percentage of the dividends
that were characterized as passive and
non-passive in the last two years in which
the related person paid dividends. If the
related person never paid a dividend that
was excluded under section 1297(b)(2)
(C), the comment recommended that the
stock be characterized based on the earn-
ings during the last two years in which
the related person generated earnings or,
if the related person has never generated
earnings, based on the earnings that are
reasonably expected to be generated in the
future. Another comment requested that
proposed §1.1297-1(d)(2)(iii) be replaced
with a general rule with respect to stock
of a related party that would characterize
the stock based on whether the stock is
expected to generate passive income. The
comment asserted that this rule would al-
low for taxpayers to use reasonable meth-
ods to determine if the stock is expected to
generate passive income.
One comment argued that, for purpos-
es of characterizing stock that does not
generate dividends in the current year, a
look-back period of two years would be
appropriate if the final regulations adopt
an approach that characterizes the stock
based on the character of hypothetical div-
idends and uses the proportionate amount
of non-passive gross income over the
look-back period to determine the charac-
ter of the dividends. If such an approach is
not adopted, the comment recommended
that, instead of a look-back period of two
years, the stock could be characterized
based on dividends paid during the pre-
ceding five years or, if shorter, the period
during which the subsidiary was a related
person under section 954(d)(3).
Proposed §1.1297-1(d)(2)(iii) was
premised on the understanding that stock
that has recently generated dividends that
are, in whole or in part, non-passive under
the related person look-through rule can
be understood to be held for the produc-
tion of non-passive income. If, however,
the stock has not recently generated div-
idends, it is more appropriate to treat the
stock as held for the production of gains
upon disposition, which would generally
be passive income. Accordingly, the Trea-
sury Department and the IRS have deter-
mined that it would not be appropriate to
allow stock to be treated as a non-passive
asset on the basis of speculation that div-
idends might be received with respect to
the stock and that such dividends could be
non-passive under section 1297(b)(2)(C)
as most of the comments’ recommenda-
tions would provide. Moreover, the chang-
es to the rules for determining the passive
or non-passive character of dividends, dis-
cussed in Part III.C.2 of this Summary of
Comments and Explanation of Revisions,
also take into account the actual history
of the stock and allow taxpayers to treat
the most recent prior years as most rele-
vant in determining the character of the
stock. Thus, the final regulations do not
adopt these comments and, instead, the fi-
nal regulations provide that stock that did
not produce dividends within the current
taxable year or within either of the preced-
ing two taxable years is characterized as a
passive asset. See §1.1297-1(d)(3)(iii); but
see section 1297(c) and §1.1297-2(c)(1)(i)
(eliminating stock of look-through subsid-
iaries for purposes of the Asset Test).

Bulletin No. 2021–5 519 February 1, 2021
E. Stapled entities
Proposed §1.1297-1(e) provided that,
for purposes of determining whether
any stapled entity (as defined in section
269B(c)(2)) is a PFIC, all entities that are
stapled entities with respect to each other
are treated as one entity. A comment sug-
gested that the definition of stapled enti-
ties provided in section 269B(c)(2) and
§1.269B-1 could be overbroad and thus
lead to planning opportunities for purpos-
es of PFIC testing. Therefore, the com-
ment recommended that the final regula-
tions provide a more restrictive definition
for stapled entities so that, for purposes
of PFIC testing, single-entity treatment
would be limited to situations in which
nearly 100 percent of the outstanding eq-
uity interests in both entities are stapled
to each other. Alternatively, the comment
suggested, the Treasury Department and
the IRS could issue rules applicable to the
holders of stapled interests clarifying the
application of the anti-abuse rule in sec-
tion 1298(b)(4) (which would treat sepa-
rate classes of stock (or other interests) in
a corporation as interests in separate cor-
porations, pursuant to regulations, where
necessary to carry out the purposes of the
PFIC regime) to such stapled interests by
providing that the rule would apply only
if unusual features exist and the arrange-
ment would allow avoidance of the PFIC
rules. The comment also highlighted the
inappropriateness of potentially applying
the rule in proposed §1.1297-1(e) to treat
a shareholder of an entity that would not
be a PFIC, but for the rule, as the share-
holder of a PFIC.
Another comment requested clarifica-
tion on the extent to which stapled entities
that were treated as a single entity for pur-
poses of PFIC testing would be treated as
a single entity with respect to other provi-
sions in the PFIC regime. In particular, the
comment requested that the final regula-
tions indicate whether the stapled entities
are treated as one PFIC for purposes of
including income under the PFIC regime
and for purposes of making an election
with respect to income inclusions under
the PFIC regime. Like the first comment,
it also requested guidance when not all in-
terests are stapled.
The Treasury Department and the IRS
have determined that it is appropriate to
apply the single entity treatment of pro-
posed §1.1297-1(e) even when not all
interests in the stapled entities are stapled
because section 269B(c)(2) applies only
when controlling interests in the stapled
entities are stapled, but that the applica-
tion of the rule should be limited to apply
only to U.S. persons that hold stapled in-
terests and should not affect U.S. persons
that directly or indirectly own only one of
the stapled entities. Accordingly, the rule
in proposed §1.1297-1(e) is modified to
apply only if a U.S. person that would be
a shareholder of the stapled entities owns
stock in all entities that are stapled entities
with respect to each other. In this case, the
stapled entities are treated as an interest
in a single entity for all purposes of the
PFIC rules, which may have the effect of
causing a stapled entity that would not be
a PFIC on a stand-alone basis to be treat-
ed as a PFIC when stapled, or the reverse.
See §1.1297-1(e). Given these modifica-
tions to the rule and the fact that the defini-
tion of stapled entities in section 269B(c)
(2) already limits stapling to situations in
which more than 50 percent in the value
of the beneficial ownership in each of the
entities consists of stapled interests, the
Treasury Department and the IRS have
determined that it is not necessary at this
time to provide guidance on the applica-
tion of section 1298(b)(4) or to further
limit the interests that can be stapled.
IV. Comments and Revisions to Proposed
§1.1297-2 – Special rules regarding look-
through subsidiaries and look-through
partnerships
Proposed §1.1297-2 provided guidance
on the application of the look-through rule
of section 1297(c) for purposes of the In-
come Test and the Asset Test.
A. Overview
1. Treatment of Income and Assets
Under the final regulations, a tested
foreign corporation is treated as directly
owning the assets of, and directly deriv-
ing the gross income of, a look-through
subsidiary or look-through partnership.
See §1.1297-2(b)(2) and (b)(3). The tested
foreign corporation disregards the equity
interest in the look-through entity for pur-
poses of the Asset Test. See §1.1297-2(c)
(1)(i) and (c)(3). As discussed in more
detail in Part IV.D of this Summary of
Comments and Explanation of Revisions,
dividends from a lower-tier subsidiary and
distributions and the distributive share of
income from a lower-tier partnership gen-
erally are treated as if they did not exist
(“eliminated”) for purposes of the Income
Test. See §1.1297-2(c)(2)(i) and (c)(3).
For Income Test purposes, the proposed
regulations provided that the disposition
of the stock of a look-through subsidiary
is treated as the disposition of stock and
provided rules for the calculation of gain.
See proposed §1.1297-2(f)(1). The final
regulations also include rules addressing
the disposition of partnership interests in a
look-through partnership, which are sim-
ilar in concept to the rules that apply to
the disposition of stock of a look-through
subsidiary, and rules addressing the dispo-
sition of partnership interests in a partner-
ship described in section 954(c)(4)(B). See
§1.1297-2(f)(4). Where both rules could
potentially apply, the disposition is sub-
ject to the rules of section 954(c)(4). See
§1.1297-2(f)(4)(i) and (ii). Consequently,
it is anticipated that the sale of interests
in a partnership that a tested foreign cor-
poration owns at least 25 percent of by
value generally will be subject to section
954(c)(4), and therefore will be treated as
a disposition of assets rather than a dis-
position of the partnership interest, while
the sale of interests in a partnership that a
tested foreign corporation owns less than
25 percent of by value may or may not be
subject to section 954(c)(4) in light of the
different 25-percent ownership test in that
statutory provision. The effect on the de-
termination of gain under section 954(c)
(4) of partnership earnings that have been
included in income by the tested foreign
corporation but not distributed is beyond
the scope of these regulations.
Payments of interest, rent and royalties,
and the related debt obligation, lease or li-
cense, between the tested foreign corpo-
ration and the look-through entity or be-
tween look-through entities generally also
are eliminated for purposes of both the
Income and the Asset Tests, as discussed
in Part IV.D of this Summary of Com-
ments and Explanation of Revisions. See
§1.1297-2(c)(1)(ii), (c)(2)(ii), and (c)(3).
If the obligation is between look-through

February 1, 2021 520 Bulletin No. 2021–5
entities that are not wholly owned by the
tested foreign corporation, a proportionate
part of the obligation and income from it
is eliminated. See id.
2. Definition of Look-Through Subsidiary
A subsidiary of a tested foreign corpo-
ration is treated as a look-through subsidi-
ary if both an asset test and an income test
are satisfied. See §1.1297-2(g)(3). If only
one test is satisfied, the subsidiary is not
treated as a look-through subsidiary. See
generally id. The asset test is satisfied for
any measuring period (for example, one
quarter of a taxable year) if on the rele-
vant measuring date (for example, the end
of a quarter) the tested foreign corporation
owns at least 25 percent of the value of the
stock of the subsidiary. See §1.1297-2(g)
(3)(i). The income test is satisfied if either
(i) the tested foreign corporation owns an
average of at least 25 percent of the value
of the subsidiary’s stock on the measuring
dates of an entire taxable year, or (ii) the
tested foreign corporation owns at least
25 percent of the value of the subsidiary’s
stock on a measuring date and the subsid-
iary’s gross income for the measuring pe-
riod can be determined. See §1.1297-2(g)
(3)(ii). Consequently, if a tested foreign
corporation owns at least 25 percent of a
subsidiary’s stock for part but not all of a
taxable year, the subsidiary is treated as
a look-through subsidiary for that part of
the taxable year only if the tested foreign
corporation can determine the subsidi-
ary’s gross income on the measuring dates
within that part of the taxable year. These
rules are intended to ensure that a subsidi-
ary is not treated as a look-through subsid-
iary unless the tested foreign corporation
can determine the proportionate share of
the subsidiary’s assets and income that it
is treated as directly owning and deriving.
B. Look-through partnerships
1. Overview
The proposed regulations defined a
look-through partnership as a partnership
in which the tested foreign corporation
owned at least 25 percent in value. See
proposed §1.1297-1(c)(2)(i), (d)(3)(i), and
(f)(1). The preamble to the proposed reg-
ulations indicated that the look-through
partnership rules were drafted to apply
look-through treatment as provided in
section 1297(c) consistently to lower-tier
partnerships and lower-tier corporations.
See 84 FR 33120, at 33124. The preamble
stated that the difference between the 25
percent threshold for look-through part-
nerships in the proposed regulations and
the treatment of partnership income for
FPHCI purposes is warranted because of
the flexibility that entities have in their
characterization under §301.7701-3 and
because of the fact that treating a subsid-
iary as a partnership may not have U.S.
income tax consequences for a tested for-
eign corporation as it could for a CFC. See
id. The preamble also noted that this rule
ensured that the tested foreign corpora-
tion would have significant control over
the partnership activities, such that a part-
nership interest could represent an active
business interest. See id. The preamble re-
quested comments on whether 25 percent
was the right threshold, whether different
rules should apply to general partnerships
and limited partnerships, and whether a
material participation test should apply.
The definition of look-through partner-
ship in the final regulations is revised to
more closely align with the definition of
look-through subsidiary. Under the final
regulations, a look-through partnership is
a partnership that would be a look-through
subsidiary with respect to the tested for-
eign corporation if the partnership were
a corporation. See §1.1297-2(g)(4)(i)(A).
Accordingly, as noted by one comment,
the taxpayer-favorable rules of section
1297(c) will apply to look-through part-
nerships, for example by allowing attri-
bution of the activities of other affiliates
in determining whether rental or royal-
ty income of the partnership is treated
as passive or non-passive. In response
to other comments, additional changes
have been made to the definition of look-
through partnership to allow look-through
treatment for certain minority interests
in partnerships. See §1.1297-2(g)(4)(i)
(B). These changes are discussed in Part
IV.B.2 of this Summary of Comments and
Explanation of Revisions.
The look-through partnership rules
were located in proposed §1.1297-1,
which provided general rules concerning
the Income and Asset Tests. Because look-
through treatment for purposes of PFIC
testing is provided in section 1297(c) and
§1.1297-2 provides guidance on the appli-
cation of section 1297(c), the rules in the
final regulations concerning look-through
partnerships are in §1.1297-2 along with
all of the other rules discussing look-
through treatment. See §1.1297-2(b)(3)
and (g)(4).
2. Definition of Look-Through
Partnership
Under the proposed regulations, a
look-through partnership with respect to a
tested foreign corporation was defined as
a partnership if (i) for purposes of section
1297(a)(2), the tested foreign corporation
owned at least 25 percent of its value on
a measuring date and (ii) for purposes of
section 1297(a)(1), the tested foreign cor-
poration owned at least 25 percent of its
value on the date on which income was re-
ceived or accrued by the partnership. See
proposed §1.1297-1(f)(1). The proposed
regulations also provided that, if a tested
foreign corporation owns, directly or indi-
rectly, less than 25 percent of the value of
a partnership, the corporation’s distribu-
tive share of the partnership’s income was
treated as passive income for purposes
of the Income Test and the corporation’s
interest in the partnership was treated as
a passive asset for purposes of the Asset
Test. See proposed §1.1297-1(c)(2)(ii) and
(d)(3)(ii).
Three comments were received ad-
dressing these rules. The comments sup-
ported the proposed regulations’ general
treatment of look-through partnerships
and addressed the determination of when
a partnership is treated as a look-through
partnership. Two comments recommend-
ed that the 25-percent threshold be elim-
inated so that look-through treatment
would apply to all partnerships regardless
of the ownership level by the tested for-
eign corporation. A third comment stated
that the proper approach to partnerships
in applying look-through rules raises dif-
ficult issues and made several alternative
recommendations.
The two comments recommending that
all partnerships be treated as look-through
partnerships noted that partnerships are
pass-through entities that are generally
treated as aggregates for many purpos-
es throughout the Code and asserted that

Bulletin No. 2021–5 521 February 1, 2021
section 1297(c) implicitly indicates that
aggregate treatment was intended to ap-
ply to all partnerships because it provides
a 25-percent threshold only for corpora-
tions. The comments also stated that the
differences between corporate treatment
and partnership treatment have ramifica-
tions for many other parts of the Code,
such as subpart F, GILTI, and the anti-hy-
brid rules. The comments asserted that mi-
nority shareholders generally cannot com-
pel an upper-tier foreign corporation to
make an election for a lower-tier foreign
corporation to be treated as a partnership
under §301.7701-3 and that it is unlikely
that a tested foreign corporation would
make a non-commercial investment in or-
der to benefit minority shareholders.
The Treasury Department and the IRS
do not agree with these comments, oth-
er than the comment that partnerships
are treated as aggregates for many Code
purposes. Many of the legal entities po-
tentially treated as look-through partner-
ships under section 1297 would have been
treated as corporations for U.S. federal in-
come tax purposes when section 1297(c)
was enacted, because the enactment of
section 1297(c) preceded the promulga-
tion of §301.7701-3 by approximately ten
years and before that time foreign corpo-
rate entities were generally classified as
corporations for U.S. federal income tax
purposes. The differences between corpo-
rate treatment and partnership treatment
referred to by the comments generally are
not relevant to foreign corporations that
are not subject to U.S. net income taxation
or to U.S. shareholders as to whom a for-
eign corporation is not treated as a CFC.
As stated in the preamble to the proposed
regulations, an election under §301.7701-
3 to treat a foreign subsidiary of such a
foreign corporation as a partnership for
U.S. federal income tax purposes may
have no U.S. tax consequences other than
to affect the determination of whether the
foreign corporation is a PFIC.
The Treasury Department and the IRS
recognize that minority shareholders may
not be able to compel a foreign corpo-
ration to make a U.S. tax election or to
make particular investments. However, a
foreign corporation may cause a subsidi-
ary to make an election to be treated as a
partnership for U.S. tax purposes or take
other steps in order to avoid classification
as a PFIC in order to retain or attract U.S.
investors, since there are likely to be no
non-tax and no foreign tax consequences
to the election.
The two comments indicated that the
subpart F regime characterizes a partner’s
distributive share of partnership income
without regard to the partner’s level of
control or involvement for purposes of
determining subpart F income and rec-
ommended that the same approach apply
in these regulations. The final regulations
do not adopt this comment. The Treasury
Department and the IRS believe that the
difference in treatment between these
regulations and the subpart F regime is
warranted in light of the fact that Con-
gress imposed a 25-percent threshold for
look-through treatment for subsidiaries in
section 1297 but not in subpart F, and that
consistency of treatment for look-through
subsidiaries and look-through partner-
ships in these regulations is consistent
with Congressional intent.
One comment recommended, as an al-
ternative to automatic passive treatment
for less than 25-percent-owned interests,
that the distributive share of income from,
and the interest in, a less than 25-per-
cent-owned partnership be characterized
as passive only if the necessary informa-
tion cannot be obtained for purposes of
the Income Test and the Asset Test. The
Treasury Department and the IRS agree
that it may be difficult for a tested foreign
corporation to obtain adequate informa-
tion from a subsidiary in which a tested
foreign corporation holds a less-than-25-
percent investment, and that if that is the
case, the investment should be treated as
passive. The Treasury Department and the
IRS have taken this comment into account
in the new rules described at the end of
this Part IV.B.2. The Treasury Department
and the IRS do not agree that a tested
foreign corporation that has less than a
25-percent-interest in an active partner-
ship should be able to automatically treat
such partnership interest as active if such
information is available, for the reasons
already stated.
A third comment stated that the ap-
proach proposed in the proposed regula-
tions has the advantage of certainty and
ease of administration because it provides
a relatively clear bright-line test and limits
the need to obtain information about the
assets and income of a lower-tier partner-
ship that may be difficult for small part-
ners to obtain. The comment also noted
that the proposed approach creates greater
equivalence between lower-tier entities
that have or have not elected to be treated
as pass-through entities, but observed that
the proposed regulations did not create
complete equivalence between such enti-
ties because the distributive share from a
related partnership was not subject to the
same rules as dividends from a related
corporation. The final regulations address
this concern by providing that the distrib-
utive share derived by a tested foreign
corporation from a related partnership is
subject to rules similar to such dividends.
See §1.1297-1(c)(4)(vii).
This comment also stated that a 25-per-
cent threshold is not a good proxy for an
active business interest and is not consis-
tent with long-standing market practice.
The comment recommended four alter-
natives for the threshold for partnership
look-through treatment. Under the first
alternative, the comment suggested that
the final regulations adopt a 25 percent
threshold similar to that of section 954(c)
(4). Under a second alternative, the com-
ment suggested that the final regulations
not take into account elections under
§301.7701-3 for purposes of PFIC testing.
Under a third alternative, the comment
proposed that the final regulations treat
every pass-through entity as an aggregate
without regard to ownership threshold.
Under the fourth alternative, the comment
recommended that the final regulations
adopt a “material participation” approach
pursuant to which look-through with re-
spect to a partnership applies if the tested
foreign corporation materially participates
in the underlying business of the partner-
ship.
The Treasury Department and the IRS
recognize that although Congress has
mandated a 25-percent threshold in order
to treat a corporate subsidiary as a look-
through entity, that threshold may not be
a good proxy for an active business in-
terest. The Treasury Department and the
IRS considered whether the alternatives
suggested would better identify an active
partnership interest. The final regulations
do not adopt any of the alternatives sug-
gested by the third comment but do adopt
an approach similar in concept to the

February 1, 2021 522 Bulletin No. 2021–5
fourth of the alternatives. With respect to
the first and third alternatives, the Treasury
Department and the IRS have determined
that the 25-percent threshold should be the
same for lower-tier entities regardless of
whether they have elected pass-through
treatment for the reasons already dis-
cussed. With respect to the second alter-
native, the Treasury Department and the
IRS do not believe that it is appropriate in
this context to draw distinctions between
entities in the legal form of a partnership
and other entities treated as partnerships
for U.S. federal income tax purposes.
In regard to the fourth alternative, the
Treasury Department and the IRS agree
that if a tested foreign corporation is ac-
tively involved in the business of a part-
nership with active business operations,
look-through treatment may be appropri-
ate, even if the tested foreign corporation
is a minority investor in the partnership,
so that the tested foreign corporation may
take into account the active assets and in-
come of the partnership rather than treat-
ing the partnership investment as passive.
The Treasury Department and the IRS
considered a material participation test
but determined that the passive activity
loss rules of section 469 are not appro-
priate for a foreign corporate investor in
a partnership owned directly or indirectly
by a tested foreign corporation. The sec-
tion 469 material participation rules focus
primarily on the activities of individuals.
See §1.469-5 and -5T. While section 469
also provides rules for partners that are
closely held corporations, those rules are
likely to be difficult to apply and to audit
in the PFIC context.
The Treasury Department and the IRS
also considered other participation and
attribution rules of the Code, including
proposed rules addressing when a corpo-
rate partner would be attributed the trade
or business assets and activities of a part-
nership for purposes of the active trade or
business requirement in section 355(b).
See 88 FR 26012 (REG-123365-03) (pro-
posing a rule that a partner that owns a
meaningful interest in a partnership would
be attributed the trade or business assets
and activities of the partnership if the part-
ner performs active and substantial man-
agement functions for the partnership with
respect to the trade or business assets or
activities (for example, by making deci-
sions regarding significant business issues
of the partnership and regularly participat-
ing in the overall supervision, direction,
and control of the employees performing
the operational functions for the partner-
ship)). However, the Treasury Department
and the IRS determined that such a rule
would not be appropriate for purposes of
section 1297. As stated in a comment, the
disadvantage of participation-based tests
is that they are factual and potentially sub-
jective, and therefore less administrable.
For example, the proposed section 355(b)
test described above would be difficult for
the IRS to audit in the case of a foreign
corporation that is not controlled by U.S.
shareholders. Moreover, if the “meaning-
ful interest” requirement applied, look-
through treatment might apply only to a
small number of partnerships that are not
already treated as look-through partner-
ships. The Treasury Department and the
IRS did not consider these approaches
to be more appropriate than applying the
rules of section 1297 at the partner level as
a means of testing whether an investment
in a partnership is an active business in-
terest. Accordingly, the definition of look-
through partnership is further altered to
include certain partnerships in which the
tested foreign corporation owns a minori-
ty interest if the tested foreign corporation
has sufficient active assets and income as
determined under the rules of section 1297
apart from the partnership. See §1.1297-
2(g)(4)(i)(B).
Under the final regulations, a look-
through partnership is defined as (i) a
partnership that would be a look-through
subsidiary if such partnership were a cor-
poration—as discussed in Part IV.B.1 of
this Summary of Comments and Expla-
nation of Revisions—or (ii) any other
partnership if the tested foreign corpora-
tion satisfies the active partner test. See
§1.1297-2(g)(4)(i). The active partner
test is satisfied if the tested foreign cor-
poration would not be a PFIC if both the
Income and the Asset Test were applied
to it without including its interest in any
partnership that would not be a look-
through subsidiary if such partnership
were a corporation. See §1.1297-2(g)(4)
(ii). If the tested foreign corporation has
no passive assets or income, even a very
small active business would allow the
interest to qualify as a look-through part-
nership under the active partner test. On
the other hand, qualifying under the active
partner test can only prevent a partner-
ship interest from tainting an otherwise
non-PFIC corporation, rather than be
used affirmatively. Because the Treasury
Department and the IRS understand that
it may be difficult for minority investors
in partnerships to obtain the information
necessary to apply the Income and Asset
Tests taking into consideration the income
and assets of a look-through partnership,
the final regulations provide an election
out of the look-through partnership defi-
nition for partnerships that would not be
a look-through subsidiary if such partner-
ship were a corporation. See §1.1297-2(g)
(4)(iii). The final regulations also provide
two new examples illustrating the active
partner test. See §1.1297-2(g)(4)(iv).
C. Overlap between section 1297(c) and
section 1298(b)(7)
The proposed regulations provided that
the look-through rule of section 1297(c)
does not apply to a domestic corporation
if the stock of the domestic corporation is
characterized under section 1298(b)(7) as
a non-passive asset that produces non-pas-
sive income. See proposed §1.1297-2(b)
(2)(iii). The preamble to the proposed
regulations noted that the Treasury De-
partment and the IRS determined that
section 1298(b)(7) should generally take
precedence over section 1297(c) when
both rules would apply simultaneously
because section 1298(b)(7) contains the
more specific rule applicable to a tested
foreign corporation that owns a domestic
subsidiary.
Comments asserted that the legisla-
tive history concerning section 1297(c)
and section 1298(b)(7) does not support
the approach taken by proposed §1.1297-
2(b)(2)(iii). These comments argued that
section 1298(b)(7) was intended to apply
only in circumstances in which income
and assets would be passive if section
1297(c) applied. According to the com-
ments, Congress did not intend for one
section to take precedence over the other
because the legislative history does not
discuss whether section 1298(b)(7) is
supposed to take precedence over section
1297(c) or express any limitations on the
application of section 1297(c).

Bulletin No. 2021–5 523 February 1, 2021
Because section 1298(b)(7) contains
the more specific rule applicable to a test-
ed foreign corporation that owns a domes-
tic subsidiary, the Treasury Department
and the IRS have determined that the sec-
tion 1298(b)(7) coordination rule is con-
sistent with the relevant statutory provi-
sions and results in appropriate treatment
with respect to look-through subsidiaries.
Accordingly, the final regulations do not
adopt these comments.
D. Elimination of certain assets and
income for purposes of applying section
1297(a)
The proposed regulations provided
that, for purposes of applying the Income
and Asset Tests, certain intercompany
payments of dividends and interest from a
look-through entity, and the related stock
and debt receivables, are eliminated. See
proposed §1.1297-2(c)(1) and (2). The
preamble to the proposed regulations in-
dicated that the Treasury Department and
the IRS intended for the elimination of
such items to prevent double counting of
intercompany income and assets. In re-
sponse to comments, the final regulations
revise the rules relating to intercompany
dividends and expand the elimination
rules to address intercompany rents and
royalties and to address distributions and
the distributive share of income from a
look-through partnership.
1. Treatment of Intercompany Dividends
Proposed §1.1297-2(c)(2) provided
that, for purposes of applying the Income
Test, intercompany payments of dividends
between a look-through subsidiary and a
tested foreign corporation are eliminated
to the extent the payment is attributable to
income of a look-through subsidiary that
was included in gross income by the tested
foreign corporation for purposes of deter-
mining its PFIC status.
A comment expressed concern that the
proposed regulation did not eliminate a
payment of a dividend by a look-through
subsidiary to a tested foreign corporation
that is made out of earnings and profits
not attributable to income of the subsid-
iary previously included in the gross in-
come of the tested foreign corporation for
purposes of determining its PFIC status.
One example of such a case would be a
dividend paid after a look-through subsid-
iary is acquired out of earnings and profits
accumulated before the tested foreign cor-
poration’s acquisition of the look-through
subsidiary. Another example of such a div-
idend would be a dividend paid to a tested
foreign corporation from a subsidiary that
was a subsidiary but not a look-through
subsidiary when the relevant earnings and
profits were accumulated and the dividend
was paid but later became a look-through
subsidiary. The comment questioned
whether a dividend from pre-acquisition
earnings and profits represents true eco-
nomic income of the tested foreign corpo-
ration, since the tested foreign corporation
“purchased” the pre-acquisition earnings
and profits, and observed that it could be
difficult for a tested foreign corporation
to determine what portion of a dividend
received is attributable to pre-acquisition
earnings and profits, particularly if the ac-
quisition was not recent. As a result, the
tested foreign corporation might not in
practice be able to determine when it can
eliminate a dividend from a look-through
subsidiary from its gross income.
The proposed regulation eliminated
dividends from a look-through subsidiary
only to the extent attributable to gross in-
come included by the tested foreign cor-
poration. The comment recommended
that the final regulations remove the lim-
itation. In the alternative, the comment re-
quested that the final regulations provide
that dividends in an amount equal to cur-
rent-year earnings would be deemed at-
tributable to income included by the tested
foreign corporation and that dividends in
excess of that amount would be deemed to
be paid first from years in which the sub-
sidiary was a look-through subsidiary and
treated as attributable to income included
by the tested foreign corporation during
that period. As an additional alternative,
the comment proposed that taxpayers
be allowed to determine the earnings to
which dividends were considered attrib-
utable in the case of an acquisition of the
look-through subsidiary based on the ratio
of pre-acquisition earnings to post-acqui-
sition earnings over a limited period.
The Treasury Department and the IRS
agree that dividends should be treated as
paid out of current earnings and profits
and then out of accumulated earnings and
profits (beginning with the most recently
accumulated), in accordance with section
316, and the final regulations so provide.
See §1.1297-2(c)(2). However, the final
regulations do not adopt the comment’s
recommendation to treat all dividends
from a look-through subsidiary as elim-
inated from the tested foreign corpora-
tion’s gross income even if the dividend
is paid out of earnings and profits that are
attributable to gross income of the sub-
sidiary that the tested foreign corporation
has not included in income. As explained
in the next two paragraphs, the rules re-
garding dividends paid out of earnings
not taken into account by a tested foreign
corporation must be coordinated with the
rules that apply to determine residual gain
when the stock of a look-through subsidi-
ary is sold in order to avoid elimination of
income for purposes of the Income Test.
Under §1.1297-2(f), if a tested for-
eign corporation disposes of the stock of
a look-through subsidiary, the amount of
gain taken into account for purposes of
the Income Test generally is the total gain
recognized by the tested foreign corpo-
ration less unremitted earnings (residual
gain). Unremitted earnings are the excess
of income taken into account by the test-
ed foreign corporation with respect to that
look-through subsidiary less dividends
from the subsidiary. The amount of gain
derived from the disposition of stock of a
look-through subsidiary and dividends re-
ceived from the look-through subsidiary is
determined on a share-by-share basis un-
der a reasonable method. such as the rules
under section 951 or 1248.
Thus, if a look-through subsidiary with
a value of $1000 earns $20 that is taken
into account by a tested foreign corporation
owner, any gain on a sale of the subsidiary’s
stock for $1020 will be reduced by $20 of
unremitted earnings. If the subsidiary pays
a $15 dividend before the sale, the receipt
of the dividend is disregarded for purposes
of the Income Test and a sale of the sub-
sidiary’s stock for $1005 should give rise
to the same amount of residual gain. Thus,
the $20 will be taken into account for pur-
poses of the Income Test and will not af-
fect the amount of residual gain regardless
of whether a dividend is paid. By contrast,
if the look-through subsidiary pays a $15
dividend out of earnings that do not reflect
income taken into account by the tested

February 1, 2021 524 Bulletin No. 2021–5
foreign corporation, the dividend would re-
duce the amount of gain on the sale of the
look-through subsidiary’s stock compared
to not paying a dividend because the div-
idend would reduce unremitted earnings
pursuant to §1.1297-2(f). Consequently,
if the payment of the dividend were disre-
garded as requested by the comment, the
$15 dividend would reduce potential future
gain but never give rise to corresponding
income to the tested foreign corporation for
purposes of the Income Test.
In order to prevent such a dividend from
reducing potential future gain on the sale
of the look-through subsidiary,

it would be
necessary to reduce the basis of the stock
of the look-through subsidiary held by the
tested foreign corporation or make some
other adjustment to the taxation of gain
upon the disposition of the look-through
subsidiary’s stock. A basis reduction or
adjustment of that kind raises potentially
broader issues that were not addressed in
the proposed regulations. The Treasury De-
partment and the IRS continue to study this
recommendation and additional guidance
on such elimination is proposed in the 2020
NPRM. See proposed §1.1297-2(c)(2).
2. Treatment of Intercompany Rents and
Royalties
The proposed regulations provided that
intercompany debt receivables and interest
are eliminated in proportion to the share-
holder’s direct and indirect ownership
(by value) in the look-through subsidiary
with respect to a tested foreign corpora-
tion that owns less than 100 percent of a
look-through subsidiary. See proposed
§1.1297-2(c)(1) and (2). The preamble to
the proposed regulations explained that
this rule was based on the legislative his-
tory of the PFIC rules and was intended
to prevent duplication of passive assets
or passive income, for example if a whol-
ly-owned look-through subsidiary with
entirely passive income paid a dividend to
the tested foreign corporation parent.
Comments supported the approach
taken in the proposed regulations with
regard to interest. A comment indicated
that payments of intercompany rents and
royalties raises similar concerns with re-
spect to double counting. Accordingly, the
comment requested that, for purposes of
applying the Income Test and the Asset
Test, the final regulations extend the elim-
ination rules to payments of intercompany
rents and royalties and any associated in-
tangible assets in proportion to the tested
foreign corporation’s direct and indirect
ownership (by value) in the look-through
subsidiary or look-through partnership.
The Treasury Department and the IRS
agree with the comments, and §1.1297-
2(c) accordingly extends the rules applica-
ble to debt and interest to rents, royalties,
leases, and licenses.
The application of the elimination rule
to leases and licenses raises issues not
present with debt receivables. A lease or
license held by a look-through entity pro-
vides legal rights to use underlying prop-
erty, such as a building or an intangible.
If the lease or license is disregarded by a
tested foreign corporation, it would not be
taken into account by the tested foreign
corporation in determining whether the
underlying property produces non-passive
income or is held for the production of
non-passive income. Moreover, while the
underlying property may be used as part
of an active business, it may be used as
part of the business of the lessee or licens-
ee and not by the owner of the property.
Accordingly, the final regulations provide
that, for purposes of the Asset Test as ap-
plied to a tested foreign corporation, the
underlying property that is the subject of
the eliminated lease or license is charac-
terized as a passive or non-passive asset
by taking into account the activities of
qualified affiliates of the tested foreign
corporation (as discussed in Part IV.E of
this Summary of Comments and Explana-
tion of Revisions). A new example illus-
trates the expansion. See §1.1297-2(c)(4)
(v).
The final regulations also address more
precisely the calculations required in or-
der to determine how much of an obliga-
tion and related income is eliminated if the
obligation runs between two look-through
entities that are not wholly-owned. The fi-
nal regulations provide that the tested for-
eign corporation’s proportionate share of
a LTS obligation (as defined in §1.1297-
2(c)(1)(ii)) or a TFC obligation (as defined
in §1.1297-2(c)(1)(ii)) is the value (or
adjusted basis) of the item multiplied by
the tested foreign corporation’s percent-
age ownership (by value) in each relevant
look-through subsidiary. See §1.1297-2(c)
(1)(ii). Examples 3 and 4 of §1.1297-2(c)
(4) illustrate that when an obligation runs
between two non-wholly-owned look-
through entities, the percentage ownership
in each of those entities is taken into ac-
count. In Example 2, LTS2 has borrowed
$200x from LTS1. The tested foreign cor-
poration owns 40 percent of LTS1’s stock
and 30 percent of LTS2’s stock. If the loan
had been made to LTS2’s shareholders,
on a pro rata basis, 30 percent of the loan
held by LTS1 ($60x) would be a TFC ob-
ligation and 70 percent of the loan held
by LTS1 ($140x) would be a third-party
obligation. The tested foreign corporation
would be treated for purposes of the Asset
Test as owning 40 percent of the TFC ob-
ligation, which would be eliminated. See
§1.1297-2(c)(1)(ii). The tested foreign
corporation also would be treated for pur-
poses of the Asset Test as owning 40 per-
cent of the hypothetical $140x third-party
loan, or $56x. Example 3 illustrates the
same principle.
3. Ownership Interests and Obligations of
a Look-Through Partnership
The final regulations provide that for
purposes of the Asset Test and the In-
come Test, the principles applicable to
the elimination of stock and obligations
of look-through subsidiaries and divi-
dends, interest, rents and royalties paid by
look-through subsidiaries apply to look-
through partnerships. See §1.1297-2(c)
(3). Since partnerships do not pay divi-
dends, the regulations provide that those
principles apply to distributions and the
distributive share of income from a look-
through partnership. See id. It is intended
that the same amount of assets and income
will be eliminated regardless of whether
the look-through entity or entities in-
volved are look-through subsidiaries or
look-through partnerships that would be
look-through subsidiaries absent an elec-
tion under §301.7701-3.
E. Attribution of activities of look-
through subsidiaries and look-through
partnerships
1. Scope of Attribution
The proposed regulations provided
that, for purposes of section 1297, an item

Bulletin No. 2021–5 525 February 1, 2021
of rent or royalty income received or ac-
crued by a tested foreign corporation (or
treated as received or accrued by the test-
ed foreign corporation pursuant to section
1297(c)) that would otherwise be pas-
sive income if character were determined
based on the activities of the income-earn-
ing entity is not passive income if the item
would be excluded from FPHCI under
section 954(c)(2)(A) and §1.954-2(b)(6),
(c), and (d), determined by taking into ac-
count the activities performed by the offi-
cers and employees of the tested foreign
corporation, certain look-through subsid-
iaries, and certain partnerships in which
the tested foreign corporation or one of the
look-through subsidiaries is a partner. See
proposed §1.1297-2(e)(1).
One comment agreed that the activities
of the look-through subsidiary should be
taken into account to determine whether
an item of rent or royalty income of the
tested foreign corporation is passive or
non-passive and suggested that activity at-
tribution be extended to apply to the sec-
tion 954(h) and commodity producer tests.
The comment indicated that such treat-
ment would be proper because financial
businesses generally segregate assets and
operations that are part of an integrated
business into different entities for non-tax
reasons. Because these final regulations
do not treat section 954(h) as applicable
for purposes of section 1297(b)(1), the
portion of the comment relating to section
954(h) is addressed in the preamble to the
2020 NPRM and not here. However, the
Treasury Department and the IRS agree
that it is appropriate to extend the activi-
ty attribution rules for purposes of certain
exceptions under section 954(c) that are
based on whether the entity is engaged in
the active conduct of a trade or business.
Accordingly, the final regulations extend
the activity attribution rules to income that
would be excluded from FPHCI under
section 954(c)(1)(B) (relating to property
transactions), (c)(1)(C) (relating to com-
modities), (c)(1)(D) (relating to foreign
currency gains), (c)(2)(A) (relating to
active rents and royalties), (c)(2)(B) (re-
lating to export financing), and (c)(2)(C)
(relating to dealers). See §1.1297-2(e)(1).
Another comment noted that under the
rule in the proposed regulations, the in-
come or assets of a look-through subsid-
iary classified as non-passive in the hands
of a tested foreign corporation might
nevertheless be classified as passive in
the hands of the look-through subsidiary,
for example in the case where one look-
through subsidiary held rental real estate
and another look-through subsidiary em-
ployed the employees who managed the
rental property. Under the rule in the pro-
posed regulations the first look-through
subsidiary would be a PFIC and residual
gain with respect to the sale of the look-
through subsidiary may be classified as
passive, even if the attribution of both the
property owned by the first subsidiary and
the activities of the employees of the sec-
ond subsidiary caused the rental income
from the property to be treated as active
for a tested foreign corporation owner. To
mitigate this potential issue, the comment
suggested the final regulations provide
that such a look-through subsidiary be
treated as a non-PFIC with respect to that
tested foreign corporation under certain
circumstances. The Treasury Department
and the IRS have determined that the ul-
timate concerns raised by the comments
should largely be addressed by the mod-
ifications to the activity attribution rules
suggested by other comments and adopt-
ed in the final regulations, as discussed in
Part IV.E.2 of this Summary of Comments
and Explanation of Revisions. Those
modifications should generally result in
income and assets of a look-through sub-
sidiary that are treated as non-passive in
the hands of a tested foreign corporation
also being treated as non-passive in the
hands of the look-through subsidiary, in
which case the look-through subsidiary
could be a non-PFIC and residual gain
on the sale of the look-through subsidiary
could be characterized as non-passive.
One comment recommended that rules
in the proposed regulations be modified to
apply the rules for active rents and roy-
alties under section 954(c)(2)(A) as they
existed in 1986, as discussed in Part III.A
of this Summary of Comments and Expla-
nation of Revisions, and if the regulations
were not modified in that manner the ac-
tivity attribution rules should be revised to
take into account the “transition” rules in
the 2016 modifications to the active rents
and royalties rules. See TD 9792 (81 FR
76497) (adding the express requirement
to the active development tests in §1.954-
2(c)(1)(i) and (d)(1)(i) that the relevant
activities be performed by the lessor’s or
licensor’s own officers or staff of employ-
ees, and providing a transition rule that the
modified active development tests apply
only with respect to property manufac-
tured, produced, developed, or created, or
in the case of acquired property, property
to which substantial value has been add-
ed, on or after September 1, 2015). The
2016 modifications are taken into account
through the cross-reference in §1.1297-
1(c)(1)(i)(A) to section 954(c)(2)(A) (re-
lating to active rents and royalties). The
Treasury Department and the IRS have
determined that no revisions to the PFIC
activity attribution rule are necessary, giv-
en that the PFIC activity attribution rules
clearly apply to take into account the ac-
tivities of officers and employees of other
specified entities whether the rules under
section 954(c)(2)(A) apply as modified
(in the case of property manufactured,
produced, developed, or created, or in
the case of acquired property, property
to which substantial value has been add-
ed, on or after September 1, 2015) or the
rules under section 954(c)(2)(A) pre-mod-
ification apply (because no changes to the
property have occurred since September
1, 2015). Accordingly, the comment is not
adopted.
2. Ownership Threshold for Activity
Attribution
The proposed regulations provided
that, for purposes of the activity attribu-
tion rule described in Part IV.E.1 of this
Explanation of Comments and Summary
of Revisions, a tested foreign corpora-
tion may take into account the activities
performed only by those look-through
subsidiaries or look-through partnerships
with respect to which the tested foreign
corporation owns (directly or indirectly)
more than 50 percent by value. See pro-
posed §1.1297-2(e)(1). The preamble to
the proposed regulations indicated that
the Treasury Department and the IRS de-
termined that an ownership level of more
than 50-percent would prevent the activ-
ities of the look-through subsidiary or
look-through partnership from being at-
tributed to an unrelated entity.
In response to a request for comments
in the preamble to the proposed regula-
tions concerning the appropriate owner-

February 1, 2021 526 Bulletin No. 2021–5
ship threshold for attribution of activities,
one comment recommended an affiliation
approach for the ownership threshold.
Under this approach, activities would
be attributed among members of the in-
come-earning entity’s affiliated group, de-
termined under principles of §1.904-4(b)
(2)(iii) modified to include partnerships
that are owned at least 50 percent by value
and corporations that are owned at least 50
percent by vote or value. For example, un-
der this affiliation approach, the activities
of a group member could be attributed not
only “up” to a tested foreign corporation
that owned a sufficient amount of stock in
that group member (as would be the case
under the approach in the proposed regu-
lations), but also “across” to a sister mem-
ber that is a part of the affiliated group or
“down” to a subsidiary member that is a
part of the affiliated group.
Some comments noted that an approach
that takes into account voting rights in lieu
of value may be appropriate to take into
account instances where more than one
owner materially participates in the un-
derlying activity. One of the comments
suggested that an ownership threshold of
at least 25 percent by vote would provide
the tested foreign corporation with suffi-
cient control over the subsidiary for it to
be appropriate to attribute a portion of the
subsidiary’s activities to the tested foreign
corporation. Another comment recom-
mended an ownership threshold of more
than 50 percent by vote or value by the
tested foreign corporation, with a require-
ment that the tested foreign corporation
materially participate in the same or com-
plementary line of business of the activi-
ty-conducting subsidiary if it owns more
than 50 percent by vote but less than 50
percent by value of the activity conducting
subsidiary. In the alternative, the comment
suggested that the activities be attributed
in proportion to the ownership interest in
the activity-conducting subsidiary.
The Treasury Department and the
IRS disagree that satisfying a 25 per-
cent threshold for ownership of an entity
is sufficient to conclude that the entity’s
business is sufficiently integrated with
that of a tested foreign corporation that
the entity’s activities should be taken
into account for purposes of determining
the character of income and assets of the
tested foreign corporation. However, the
Treasury Department and the IRS agree
with the comments that it is generally ap-
propriate to expand the activity attribution
rule to attribute activities among members
of an affiliated group, determined by ap-
plying a more than 50 percent threshold
and by including partnerships and U.S.
affiliates in which corporate members of
the affiliated group satisfy such ownership
requirements. Accordingly, the final reg-
ulations so provide. See §1.1297-2(e)(1)
and (2) (defining qualified affiliates of the
affiliated group). However, the Treasury
Department and the IRS have determined
that because the rule applies for purposes
of section 1297(c), which focuses on own-
ership of at least 25 percent by value, the
threshold for inclusion in the group should
be determined by value. See §1.1297-2(e)
(2)(iv). Moreover, the parent of the affil-
iated group must also be foreign (a for-
eign corporation or partnership) in order
to apply the activity attribution rule. See
§1.1297-2(e)(2)(v). If the parent of the af-
filiated group were domestic (a U.S. cor-
poration or partnership), then any quali-
fied affiliate that is a foreign corporation
(including the tested foreign corporation)
would qualify as a controlled foreign cor-
poration, and any U.S. investor with at
least a 10 percent ownership interest in
the tested foreign corporation would be
subject to the subpart F rules rather than
the PFIC rules under section 1297(d). Ac-
cordingly, an upstream foreign owner of
the tested foreign corporation and entities
that are held directly or indirectly by such
same upstream foreign owner as the test-
ed foreign corporation may be considered
qualified affiliates, assuming the requisite
ownership percentage requirements are
met.
V. Comments and Revisions to Proposed
§1.1297-4 – Qualifying insurance
corporation
Section 1297(f) provides that a quali-
fying insurance corporation (“QIC”) is a
foreign corporation that (1) would be sub-
ject to tax under subchapter L if it were
a domestic corporation, and (2) either
(A) has applicable insurance liabilities
(“AIL”) constituting more than 25 percent
of its total assets on its applicable finan-
cial statement (“AFS”) (“the 25 percent
test”), or (B) meets an elective alternative
facts and circumstances test which lowers
the AIL ratio to 10 percent (“alternative
facts and circumstances test”). Proposed
§1.1297-4 elaborated on these require-
ments accordingly.
A. 25 percent test
1. Applicable Insurance Liabilities
The 25 percent test in section 1297(f)
(1)(B) requires that the ratio of a foreign
corporation’s AIL to total assets exceed
25 percent. Section 1297(f)(3)(A) defines
AIL as loss and loss adjustment expens-
es (“LAE”) and reserves (other than de-
ficiency, contingency, or unearned premi-
um reserves) for life and health insurance
risks and life and health insurance claims
with respect to contracts providing cover-
age for mortality or morbidity risks.
Proposed §1.1297-4(f)(2) provided
that with respect to any life or property
and casualty insurance business of a for-
eign corporation, AIL mean (1) occurred
losses for which the foreign corporation
has become liable but has not paid before
the end of the last annual reporting period
ending with or within the taxable year, in-
cluding unpaid claims for death benefits,
annuity contracts, and health insurance
benefits; (2) unpaid expenses (including
reasonable estimates of anticipated ex-
penses) of investigating and adjusted un-
paid losses described in (1); and (3) the
aggregate amount of reserves (excluding
deficiency, contingency, or unearned pre-
mium reserves) held for future, unaccrued
health insurance claims and claims with
respect to contracts providing coverage
for mortality or morbidity risks, including
annuity benefits dependent upon the life
expectancy of one or more individuals.
Comments requested that the term “oc-
curred losses” be changed because it is
not an industry standard term. Some com-
ments suggested that the word “occurred”
be replaced with the word “incurred” or
“unpaid” and be clarified to explicitly in-
clude incurred but not reported (“IBNR”)
losses. Other comments suggested that the
term be defined as the term is used in the
Code, U.S. regulatory statements, or un-
der U.S. generally accepted accounting
principles (“GAAP”) or international fi-
nancial reporting standards (“IFRS”). Two
comments also requested clarification that

Bulletin No. 2021–5 527 February 1, 2021
unpaid LAE related to both paid and un-
paid losses be included in the definition of
AIL.
The Treasury Department and the
IRS agree that further clarification of the
definition of AIL is necessary. While still
covering only losses that have occurred,
the final regulations clarify the definition
of AIL to adopt the comments which re-
quested that AIL include incurred losses
(both reported and unreported) and unpaid
LAE on all incurred losses (whether the
losses are paid or unpaid).
Comments differed as to what items
should be included in the definition of
AIL. For example, several comments
suggested that AIL include insurance lia-
bilities or loss reserves as reported on an
AFS (without further modification) while
other comments suggested that paid losses
and paid LAE be included as AIL (even
though they are not liabilities since they
have been paid and, as a result, do not ap-
pear on the AFS as liabilities).
A comment also requested that special
rules be created for financial guaranty
insurers and another comment requested
a special rule for mortgage guaranty in-
surers. The first comment recommended
that final regulations permit a financial
guaranty insurer to include in losses the
greater of two amounts: (1) the aggregate
amount of reserves (excluding deficien-
cy, contingency, or unearned premium
reserves) held for future unaccrued insur-
ance claims, or (2) the average of losses
incurred for policies over the previous ten
years of the life of the policy, whichever
is shorter. The second comment requested
that the 25 percent test be waived for a for-
eign corporation engaged in the business
of mortgage insurance and reinsurance if
at least 80 percent of its net written premi-
ums are derived from mortgage guaranty
insurance (or reinsurance) and its gross
investment income is less than 50 percent
of its net written premiums as reported on
its AFS.
The final regulations do not adopt the
suggestion that paid losses or paid LAE
be treated as AIL nor the proposed special
rules for financial guaranty insurers and
mortgage guaranty insurers. These sug-
gestions are contrary to the statute and the
intent of Congress. Section 1297(f) is lim-
ited to amounts that constitute liabilities,
whereas losses and LAE that have been
paid are no longer liabilities and there-
fore do not qualify as AIL. Further, when
losses and LAE are paid, assets are also
reduced. It would not be appropriate to in-
clude loss and LAE amounts in the numer-
ator of the 25 percent test (or alternative
facts and circumstances test), when the
corresponding assets are no longer report-
ed on the AFS and included in the denom-
inator. The statute also requires that liabil-
ities include only insurance liabilities and
further excludes certain types of insurance
liabilities that may be included in a finan-
cial statement, such as unearned premium
reserves, contingency reserves, and defi-
ciency reserves. See section 1297(f)(3)
(A); H.Rpt. No. 115-409, 115
th
Cong.1
st

Sess., at 411; and Conference Rpt.No.115-
466, 115
th
Cong. 1
st
Sess., at 670 (“Un-
earned premium reserves with respect to
any type of risk are not treated as appli-
cable insurance liabilities for purposes of
the provision.”). Therefore, §1.1297-4(f)
(2)(ii) provides that liabilities not within
the definition of AIL are not included in
the numerator of the 25 percent test (or
alternative facts and circumstances test)
and also specifies that amounts that are
not insurance liabilities (for example, li-
abilities related to non-insurance products
issued by an insurance company that may
be treated as debt, such as certain deposit
arrangements, structured settlements, and
guaranteed investment contracts or GICs)
are not AIL. The statute also does not con-
template averaging liabilities over a multi-
year period because section 1297(f)(1)
(B) provides for an annual calculation by
looking to the foreign corporation’s AFS
“for the last year ending with or within the
taxable year.” Therefore, the final regula-
tions do not include special rules for spe-
cialty insurers that would require multi-
year averaging or disregard the liability
requirement.
Section 1297(f) contemplates that QIC
status is determined on an entity-by-enti-
ty basis. Therefore, §1.1297-4(f)(2)(i)(D)
(2) clarifies that the liabilities eligible to
be taken into account in determining AIL
include only the liabilities of the foreign
corporation whose QIC status is being
determined. For example, if a parent and
subsidiary both issue insurance contracts
to unrelated parties and the AFS is a
combined financial statement, the AIL of
parent and subsidiary must be separately
determined and each of parent and subsid-
iary includes only the liabilities from the
contracts that it has issued (without regard
to the contracts issued by the other party).
This rule is consistent with §1.1297-4(f)
(2)(i)(D)(1) which provides the general
principle that no item may be taken into
account more than once.
2. Conformity Among Financial
Reporting Standards in Computing
Applicable Insurance Liabilities
Section 1297(f)(4) contemplates that a
foreign corporation can use GAAP, IFRS,
or the accounting standard used for the an-
nual statement required to be filed with the
local regulator (if a statement prepared for
financial reporting purposes using GAAP
or IFRS is not available) as the starting
point to determine AIL. The annual state-
ment required to be filed with the local
regulator may typically be prepared in
compliance with local statutory account-
ing standards. The Treasury Department
and IRS are aware that GAAP, IFRS, and
local statutory accounting sometimes have
different categories (and nomenclature)
and different methods of measuring losses
and reserves for insurance companies. The
final regulations define AIL more specifi-
cally so that only those liabilities that meet
the regulatory definition are included in
AIL irrespective of differences in nomen-
clature and methods that may be used by
different financial reporting standards.
It is anticipated that the starting point
for determining the amount of AIL will
be the AFS balance sheet. However, it
may be necessary in some circumstances
to disaggregate components of balance
sheet liabilities to determine the amount
of a company’s insurance liabilities that
meet the regulatory definition of AIL.
For example, the International Account-
ing Standards Board (“IASB”) issued a
new accounting standard called IFRS 17
for the accounting of insurance contracts
which was expected to become effective
January 1, 2021, and is now deferred to
be effective January 1, 2023. Some com-
panies may have already adopted IFRS
17 for financial reporting purposes on an
optional basis. IFRS 17 generally does
not use the terms unpaid losses and LAE
or unearned premium reserve on its bal-
ance sheet. Instead, those amounts are

February 1, 2021 528 Bulletin No. 2021–5
included in the overall insurance liabili-
ties on the balance sheet and are required
to be separately identified in the notes,
as respectively, “liability for incurred
claims” and “liability for remaining cov-
erage.” While they bear a different name,
they are intended to be substantially the
same in concept to claims reserves and
unearned premium reserves. Therefore, it
is expected that a foreign corporation us-
ing IFRS 17 only include those amounts
derived from the balance sheet that fall
within the final regulation’s definition
of AIL. Similarly, a foreign corporation
using IFRS 17 (or any other financial re-
porting standard) is expected to exclude
contingency reserves and deficiency re-
serves (in addition to unearned premium
reserves), as applicable, even when those
categories do not separately appear on
the balance sheet as a liability and are
subsumed within another reported line
item.
The Treasury Department and IRS rec-
ognize that IFRS 17 is a new accounting
standard and that questions may arise as
to how amounts relevant to the PFIC in-
surance exception are derived from an
IFRS 17 AFS. Similar questions may also
arise with respect to financial statements
prepared using GAAP and local statuto-
ry accounting, particularly as accounting
reporting standards evolve. The Treasury
Department and IRS request comments on
whether further guidance is necessary to
clarify how AILs are determined or make
further adjustments to ensure that similar-
ly situated taxpayers are treated similarly
without regard to the financial reporting
standard adopted by the foreign corpora-
tion.
B. Alternative facts and circumstances
test
If a foreign corporation predominantly
engaged in an insurance business fails the
25 percent test solely due to runoff-related
or rating-related circumstances involving
its insurance business, and the ratio of
its applicable insurance liabilities to its
total assets is at least 10 percent, section
1297(f)(2) allows a United States person
that owns stock in the corporation to elect
to treat such stock as stock of a QIC. Pro-
posed §1.1297-4(d) provided guidance re-
garding this election.
1. Predominantly Engaged in an
Insurance Business
Section 1297(b)(2)(B) provides that
passive income does not include income
derived in the active conduct of an insur-
ance business by a QIC. Section 1297(f)(1)
(A) provides that a QIC must be a foreign
corporation which would be subject to tax
under subchapter L if such corporation
were a domestic corporation. Then, for
purposes of the alternative facts and cir-
cumstances test, section 1297(f)(2)(B)(i)
adds another requirement that the foreign
corporation be predominantly engaged in
an insurance business under regulations
provided by the Secretary based upon the
applicable facts and circumstances.
Proposed §1.1297-4(d)(2) provided
more specific guidance regarding the cir-
cumstances under which a foreign corpo-
ration is considered to be predominantly
engaged in an insurance business for
purposes of the alternative facts and cir-
cumstances test by setting forth a predom-
inantly engaged test (separate from the ac-
tive conduct test and the requirements of
subchapter L) by reference to the facts and
circumstances that tend to show (or not
show) that a foreign corporation is pre-
dominantly engaged in an insurance busi-
ness based upon the factors set forth in
the legislative history. The proposed rule
provided that the determination is made
based on whether the particular facts and
circumstances of the foreign corporation
are comparable to commercial insurance
arrangements providing similar lines of
coverage to unrelated parties in arm’s
length transactions.
A comment pointed to a number of
ambiguities in the predominantly engaged
standard and asked for clarification. First,
it stated that it is not clear whether the pro-
posed regulation’s predominantly engaged
test is in addition to the insurance com-
pany status test in subchapter L. Second,
it stated that it is unclear how non-arm’s
length insurance transactions are taken
into account when determining whether
more than half the business of the foreign
corporation is the issuing of insurance or
annuity contracts or the reinsuring of risks
underwritten by insurance companies and
how to compare related party transactions
to commercial insurance arrangements.
Third, it stated that it is unclear whether
the list of facts and circumstances is an
exclusive set of factors.
In response to the comment, the final
regulations make clear that the predomi-
nantly engaged requirement in the alterna-
tive facts and circumstances test is in ad-
dition to the subchapter L requirement that
more than half the business of the foreign
corporation is the issuing of insurance or
annuity contracts or the reinsuring of risks
underwritten by insurance companies. It
also deletes the sentence regarding compa-
rable commercial insurance arrangements
because the standard was unclear and in-
stead replaces it with a statement that the
determination is made upon the character
of the business actually conducted in the
taxable year. Lastly, it clarifies that the list
of facts and circumstances is not exclusive
and can include other factors as may be
relevant to a specific situation.
2. Runoff-Related Circumstances
Proposed §1.1297-4(d)(3) provided
that “runoff-related circumstances” means
that the foreign corporation: (1) was ac-
tively engaged in the process of terminat-
ing its pre-existing, active insurance or
reinsurance underwriting operation pur-
suant to an adopted plan of liquidation or
termination of operations under the super-
vision of its applicable insurance regulato-
ry body; (2) did not issue or enter into any
insurance, annuity, or reinsurance con-
tract, other than a contractually obligated
renewal of an existing insurance contract
or a reinsurance contract pursuant to and
consistent with the plan of liquidation or
a termination of operations; and (3) made
payments during the annual reporting
period covered by the AFS to satisfy the
claims under insurance, annuity, or rein-
surance contracts, and the payments cause
the corporation to fail to satisfy the 25 per-
cent test.
A comment recommended that the final
regulations remove the requirement that
the runoff company have a plan of liquida-
tion, remove the requirement that amounts
paid by the runoff company cause the cor-
poration to fail to satisfy the 25 percent
test, and add a condition that the foreign
corporation has no current plan or inten-
tion to enter into any insurance, annuity,
or reinsurance contract other than in the
case of a contractually obligated renewal.

Bulletin No. 2021–5 529 February 1, 2021
The comment stated that there is no pre-
vailing practice in the insurance industry
for a regulator to supervise a plan of liq-
uidation or termination of a runoff compa-
ny. The comment further stated that runoff
carriers may be part of a larger insurance
group, and that management of the runoff
business is not necessarily a prelude to liq-
uidation but can be a way for the active
insurance businesses to shift their core
business segments and maximize their use
of capital. In addition, some companies
(known as “runoff specialists”) are in the
business of acquiring reserve liabilities to
profitably manage the settlement and pay-
out of claims until all of the liabilities are
exhausted.
The Treasury Department and IRS have
considered these comments and believe
that the exception from the 25 percent test
should not be extended to runoff occurring
in the context of the ordinary course of an
ongoing business. The Conference Report
to the Act describes a company with run-
off-related circumstances as “not taking
on new insurance business” and “using
its remaining assets to pay off claims with
respect to pre-existing insurance risks on
its books.” See H.R. Rep. No. 115-466,
at 671 (2017) (Conf. Rep.). The lower 10
percent threshold (which permits an insur-
ance company to hold assets that are 1,000
percent of its AIL) should be limited to
extraordinary circumstances in which the
insurance company fails the 25 percent
test solely because it is in the process of
exiting the insurance business and is re-
quired to hold additional capital in excess
of the 400 percent of AIL permitted by the
25 percent test due to its business being
in runoff.
The final regulations delete, however,
the requirement that the runoff company
have a plan of liquidation and instead re-
quire that the company be in the process
of terminating its pre-existing, active con-
duct of an insurance business under the
supervision of its applicable insurance
regulatory body or any court-ordered re-
ceivership proceeding (liquidation, reha-
bilitation, or conservation), which covers
a broader array of circumstances than the
proposed regulation. See §1.1297-4(d)(3)
(i).
The final regulations retain the re-
quirement in the proposed regulations
that the insurance company make claims
payments during the annual reporting pe-
riod. See §1.1297-4(d)(3)(iii). However,
in response to comments, the final reg-
ulations do not require such payments
to cause the insurance company’s ratio
of liabilities to assets to fail the 25 per-
cent test and instead clarify in §1.1297-
4(d)(3)(i) that the company must fail to
satisfy the 25 percent test because it is
required to hold additional assets due to
its business being in runoff. Finally, for
clarity and consistent with the comment’s
suggestion, §1.1297-4(d)(3)(ii) adds a
condition that the foreign corporation has
no plan or intention to enter into any in-
surance, annuity, or reinsurance contract
other than in the case of a contractually
obligated renewal.
3. Rating-Related Circumstances
Proposed §1.1297-4(d)(4) provid-
ed that “rating-related circumstances”
means that a foreign corporation’s failure
to satisfy the 25 percent test was a result
of specific requirements with respect to
its capital and surplus that a generally
recognized credit rating agency imposes
that the foreign corporation must com-
ply with to maintain the minimum credit
rating required for it to be classified as
secure to write new insurance business
for the current year. This condition in
the proposed regulations was based upon
the premise that although the generally
recognized credit rating agencies (A.M.
Best, Fitch, Moody’s, and Standard and
Poor) may use separate rating codes, the
ratings could be classified into “secure”
and “vulnerable” categories, and that the
rating agencies require reporting entities
to maintain a minimum amount of capital
appropriate to support its overall busi-
ness operations in consideration of its
size and risk profile.
Comments suggested that the proposed
regulation’s reference to “secure” be
changed. Some comments suggested that
the standard should be revised to reflect
only a rating agency’s requirements that
are “necessary” to write new business in
accordance with the foreign corporation’s
regulatory or board supervised business
plan. Another comment requested that the
term necessary be defined to mean that a
foreign corporation complies with the re-
quirements of the credit rating agency to
maintain a rating equivalent to A- by A.M.
Best for reinsurers or BBB+ by Standard
& Poor’s for all other insurers.
The Treasury Department and IRS
agree that the use of the term “secure”
should be amended. Therefore, the final
regulations provide that the rating-relat-
ed circumstances standard requires that
the 25 percent test is not met due to cap-
ital and surplus amounts that a generally
recognized credit rating agency considers
necessary for the foreign corporation to
obtain a public rating with respect to its
financial strength, and the foreign corpo-
ration maintains such capital and surplus
in order to obtain the minimum credit rat-
ing necessary for the current year by the
foreign corporation to be able to write the
business in its regulatory or board super-
vised business plan.
A comment also requested that the pro-
posed regulations be revised to provide
that the rating-related circumstances stan-
dard not be an annual test. The comment
requested that once the foreign corpora-
tion satisfies the rating-related circum-
stances standard, the alternative facts and
circumstances test should not need to be
reapplied unless there is a change in cir-
cumstances. The final regulations do not
adopt this comment because the test for a
foreign corporation’s PFIC status and the
AIL tests are annual tests.
Several comments requested that ad-
ditional categories of rating-related cir-
cumstances be included under which cer-
tain types of entities or businesses would
be treated as per se meeting the rating-re-
lated circumstances requirement. These
businesses include reinsurance that is
fully collateralized, mortgage insurance
and reinsurance, and financial guaranty
insurance. Another comment noted that
lines of business that require a higher
level of capital as compared to reserves
are those that cover risks that are low
frequency but high severity, such as cat-
astrophic risk (for example, hurricanes
and earthquakes) and financial obligation
insurance such as mortgage and financial
guaranty insurance.
Comments noted that financial guar-
anty and mortgage guaranty insurers are
generally required to operate as monoline
businesses, such that the company does
not have the option to pool its financial
obligation risks with other types of risks

February 1, 2021 530 Bulletin No. 2021–5
(whereas pooling of different types of
risks can reduce overall risk exposure,
and thus capital needs). Comments also
noted that the loss experience of mort-
gage and financial guaranty insurers is
closely tied to the economy as a whole,
such that insurance liabilities are rela-
tively low when the economy is strong
but much higher in times of economic
crisis, and that credit rating agencies cor-
respondingly expect such companies to
hold additional capital to protect policy-
holders due to the monoline nature and
volatility of the businesses.
With respect to mortgage insurers, the
Federal Housing Agency (FHA), in its role
as regulator of Fannie Mae and Freddie
Mac (government-sponsored entities who
purchase or guarantee a majority of U.S.
home mortgage loans), also prescribes
capital requirements that must be satisfied
by private mortgage insurers to be eligible
to provide mortgage insurance on loans
owned or guaranteed by Fannie Mae or
Freddie Mac. These guidelines were set
after the 2007-2008 financial crisis and
are designed to ensure that mortgage guar-
anty insurers maintain sufficient capital
to cover obligations in times of financial
distress, when defaults and foreclosures
increase. Rating agencies evaluate sat-
isfaction of FHA guidelines when rating
mortgage guaranty insurers, and FHA and
rating agency capital standards geared
to ensuring capital adequacy in times of
crisis may result in a mortgage guaranty
insurer being required to hold an amount
of capital that causes its current insurance
liabilities to be less than 25 percent of its
assets in low loss years when the economy
is strong.
Financial guaranty insurance is a line of
insurance business in which an insurance
company guarantees scheduled payments
of interest and principal on a bond or oth-
er debt security in the event of issuer de-
fault. A comment explained that financial
guaranty insurance is unique in that the
policyholder is effectively paying for use
of the financial guaranty insurer’s credit
rating. For example, if a municipality in-
sures its municipal bond obligations with
a financial guarantee insurer, the munici-
pality can charge a lower interest rate on
its bond, because the obligation is guaran-
teed by the insurer’s high credit rating. A
very high credit rating is thus essential for
a financial guarantee insurer to write new
business. Further (and similar to mortgage
guaranty insurers) rating agency capital
standards for financial guaranty insurers
are geared to ensuring capital adequacy
in times of crisis and may require a high-
er level of capital to get the same rating
as an insurer with a different portfolio of
risks. The combination of enhanced rating
agency capital requirements and the need
for a very high credit rating to write new
business often results in a financial guar-
anty insurer being required to hold capital
such that its current insurance liabilities
are less than 25 percent of its assets in low
loss years.
The Treasury Department and IRS
considered these comments and the cir-
cumstances under which an insurance
company would need assets in excess of
400 percent of its insurance liabilities in
order to obtain the credit rating needed
to write new business. As described in
comments, companies that may require
a higher level of capital as compared
to insurance liabilities are companies
that provide primarily catastrophic loss
coverage and also monoline companies
providing mortgage or financial guaran-
ty insurance that experience significant
losses on a low frequency but high sever-
ity basis. In low loss years, these types of
companies may have less than 25 percent
insurance liabilities to assets, but the ad-
ditional assets may be viewed as neces-
sary by rating agencies for the companies
to meet insurance obligations in high loss
years, and thus to receive the credit rat-
ing that the companies require to write
the business in their business plan. Thus,
the final regulations provide that the rat-
ing related circumstances exception is
only available to a foreign corporation if
it is a company that exclusively provides
mortgage insurance or if more than half
of the foreign corporation’s net written
premiums for the annual reporting period
(or the average of the net written premi-
ums for the foreign corporation’s annual
reporting period and the two immediate-
ly preceding annual reporting periods)
are from insurance coverage against the
risk of loss from a catastrophic loss event
(that is, a low frequency but high severity
loss event). See §1.1297-4(d)(4)(i).
The final regulations also provide that
a financial guaranty insurance company
that fails the 25 percent test is deemed to
satisfy the rating-related circumstances
requirement. See §1.1297-4(d)(4)(ii). The
final regulations define a financial guar-
anty insurance company as an insurance
company whose sole business is to in-
sure or reinsure only the type of business
written by (or that would be permitted to
be written by) a company licensed un-
der, and compliant with, a U.S. state law,
modeled after the National Association of
Insurance Companies Financial Guaranty
Insurance Guideline, that specifically gov-
erns the licensing and regulation of finan-
cial guaranty insurance companies. See
§1.1297-4(f)(5).
The final regulations do not include
a special rule for fully collateralized re-
insurance because the decision to fully
collateralize reinsurance obligations is
not necessarily linked to rating agency
requirements and (as noted in comments)
many fully collateralized reinsurance
companies do not obtain credit ratings.
4. Election to Apply Alternative Facts and
Circumstance Test
Section 1297(f)(2) requires a United
States person to make an election in order
to treat a foreign corporation that satisfies
the alternative facts and circumstances
test as a QIC. Proposed §1.1297-4(d)(5)
provided that the election could not be
made unless the foreign corporation di-
rectly provided the United States person
with a statement or made a publicly avail-
able statement, in each case indicating
that the foreign corporation satisfied the
requirements of the alternative facts and
circumstances test. However, the foreign
corporation’s statement could not be relied
on if the shareholder knew or had reason
to know that the statement was incorrect.
One comment objected to the proposed
rule providing that a shareholder cannot
rely on a statement of the foreign corpora-
tion if it has reason to know that the state-
ment is incorrect. The comment asserted
that a shareholder may not have access to
the information needed to determine the
accuracy of a foreign corporation’s repre-
sentations. In response to this comment,
the final regulations clarify that a share-
holder is permitted to rely on a statement
provided by the foreign corporation un-
less it has reason to know the statement is

Bulletin No. 2021–5 531 February 1, 2021
incorrect based on reasonably accessible
information. Whether information is rea-
sonably accessible is determined based
on all relevant facts and circumstances,
including the size of the shareholder’s
ownership interest and whether the share-
holder is an officer or employee of the
foreign corporation. Thus, reliance is not
permitted under circumstances in which
a reasonable person in the shareholder’s
position would know, based on informa-
tion to which the shareholder has reason-
able access, that the foreign corporation’s
statement is incorrect. In any case, an
election is not valid unless the foreign cor-
poration actually meets the requirements
of §1.1297-4(d)(1), regardless of wheth-
er the foreign corporation represents that
those requirements have been met.
A shareholder makes the election on
Form 8621, which must be attached to the
shareholder’s U.S. federal income tax re-
turn (under the final regulations, there is
no requirement to attach also the statement
provided by the foreign corporation). A
shareholder who makes the election is not
required to disclose the value of the for-
eign corporation’s stock and, therefore, is
not treated as having reported the foreign
corporation’s stock as an asset on Form
8621 for purposes of §1.6038D-7(a)(1)(i)
(C). As a result, the shareholder would be
required to report the stock on Form 8938,
subject to the thresholds and exceptions
provided in section 6038D and the regu-
lations thereunder. The final regulations
clarify that the election can be made by a
United States person who holds an option
to purchase stock in a foreign corporation
that meets the requirements of section
1297(f)(2).
One comment requested a special rule
for foreign corporations owned indirect-
ly through a foreign parent corporation,
under which the foreign parent corpo-
ration could provide (or make publicly
available) the statement required by the
proposed regulations, and the election
could be made at the level of the foreign
parent corporation. In response to this
comment, the final regulations have been
modified to allow a foreign parent cor-
poration to make the required statement
publicly available on behalf of its subsid-
iaries. However, the final regulations do
not permit the election to be made at the
foreign parent level.
Some comments asserted that it would
be unduly burdensome for certain share-
holders to file Form 8621 in order to make
the election under section 1297(f)(2). The
comments requested that shareholders of
publicly traded companies or small share-
holders of non-publicly traded companies
be deemed to make the election under
section 1297(f)(2) without the need for an
affirmative filing.
In response to these comments, the fi-
nal regulations provide that a shareholder
in a publicly traded foreign corporation
who owns stock (either directly or indi-
rectly) with a value of $25,000 or less is
deemed to make the election under sec-
tion 1297(f)(2) with respect to the pub-
licly traded foreign corporation and its
subsidiaries. If a shareholder owns stock
in a publicly traded foreign corporation
through a domestic partnership, an elec-
tion will not be deemed made unless the
stock held by the partnership has a value
of $25,000 or less. The same rule applies
to stock owned through a domestic trust or
estate, or through an S corporation. All the
requirements necessary to permit an actu-
al election under section 1297(f)(2) must
be satisfied in order to permit a deemed
election under this rule. For example, an
election will not be deemed made unless
the foreign corporation (or its foreign par-
ent) provides a statement to the United
States person or makes a publicly avail-
able statement indicating that it has sat-
isfied the requirements of the alternative
facts and circumstances test.
In addition, the final regulations pro-
vide that if a shareholder fails to make
the election under section 1297(f)(2) on
its original return for a taxable year, the
election may be made on an amended re-
turn, provided there is reasonable cause
for the failure to make the election on the
original return. A United States person
that makes the election on an amended
return must be prepared to demonstrate
reasonable cause upon request, but is not
required to provide documentation of
reasonable cause when the amended re-
turn is filed. This rule is intended to pro-
vide relief to a shareholder that inadver-
tently neglects to make the election under
section 1297(f)(2) and does not qualify
for a deemed election (for example, if the
shareholder owns stock with a value in
excess of $25,000).
C. Limitations on amount of applicable
insurance liabilities
1. Mechanics of the Limitation
Proposed §1.1297-4(e) provided rules
limiting the amount of AIL for purposes
of the 25 percent test and the alternative
facts and circumstances test and stated
that AIL may not exceed the lesser of (1)
AIL shown on the most recent AFS, (2)
the minimum AIL required by the applica-
ble law or regulation of the jurisdiction of
the applicable insurance regulatory body,
and (3) AIL reported on the most recent
financial statement made on the basis of
GAAP or IFRS if such financial statement
was not prepared for financial reporting
purposes.
A comment requested changes to the
second limitation amount under the pro-
posed regulations (the minimum AIL re-
quired by the applicable law or regulation
of the jurisdiction of the applicable insur-
ance regulatory body). The comment as-
serted that the reference to a “minimum
amount” is either redundant (because the
amount required under the applicable
law or regulation will always be a mini-
mum amount) or ambiguous (because the
“minimum amount” could be interpreted
to mean a hypothetical minimum amount
required for any insurer without regard
to its particular circumstances, including
its lines of business). The same comment
also noted that proposed §1.1297-4(e)(2)
(ii) did not take into account AIL actually
reported to the applicable insurance reg-
ulatory body, if lower than the minimum
required amount (which a local regulator
sometimes allows as a permitted practice).
Other comments requested that the min-
imum amount required under the appli-
cable law or regulation be determined by
reference to GAAP or IFRS requirements.
With respect to the third limitation
amount under the proposed regulations
(AIL reported on the most recent financial
statement made on the basis of GAAP or
IFRS if such financial statement was not
prepared for financial reporting purposes),
one comment expressed concern that a
statement which is not prepared for finan-
cial reporting purposes is potentially un-
reliable and should not be used as a basis
for determining AIL. In addition, the com-
ment requested guidance as to the mean-

February 1, 2021 532 Bulletin No. 2021–5
ing of the terms “financial statement” and
“financial reporting standard.”
The limitation under §1.1297-4(e) has
been modified in response to these com-
ments. Under the final regulations, a for-
eign corporation’s AIL may not exceed
the lesser of (1) the amount shown on any
financial statement filed (or required to be
filed) with the applicable insurance regu-
latory body for the same reporting period
covered by the applicable financial state-
ment; (2) the amount determined on the
basis of the most recent AFS, if the AFS is
prepared on the basis of GAAP or IFRS,
regardless of whether the AFS is filed with
the applicable insurance regulatory body;
or (3) the amount required by the applica-
ble law or regulation of the jurisdiction of
the applicable regulatory body (or a lower
amount allowed as a permitted practice).
If one of the limitation amounts is not ap-
plicable (for example, if the AFS is not
prepared on the basis of GAAP or IFRS),
the limitation is equal to the lesser of the
other amounts described.
Although the limitation under section
1297(f)(3) refers to the amount reported to
the applicable insurance regulatory body in
the AFS, the final regulations clarify that
an AFS prepared under GAAP or IFRS is
taken into account as part of the limitation
under §1.1297-4(e)(2)(ii) regardless of
whether it is filed with the local regulator.
This rule is intended to prevent foreign cor-
porations that choose not to file GAAP or
IFRS statements with the local regulator
from relying on statutory accounting stan-
dards that define liabilities more broadly
than GAAP or IFRS. The limitation in the
proposed regulations addressing financial
statements prepared for a purpose other
than financial reporting has been deleted.
The definition of the term “financial
statement” has been revised to treat a
statement as such only if it is prepared
for a reporting period in accordance with
the rules of a financial accounting or stat-
utory accounting standard and includes a
complete balance sheet, statement of in-
come, and a statement of cash flows (or
equivalent statements under the applicable
reporting standard). Consequently, a statu-
tory accounting statement that is used for
purposes of the limitation should provide
all information necessary to apply the 25
percent test and the alternative facts and
circumstances test.
2. Discounting
Under proposed §1.1297-4(e)(3), if an
AFS that was not prepared under GAAP
or IFRS did not discount losses on an
economically reasonable basis, AIL were
required to be reduced under the discount-
ing rules that would apply if a financial
statement had been prepared under either
GAAP or IFRS. Some comments request-
ed that the discounting requirement be
removed because GAAP does not require
discounting of liabilities in certain cir-
cumstances.
The Treasury Department and the
IRS agree that AIL reported on a finan-
cial statement that have been discounted
to reflect the time value of money only
to the extent required by GAAP or IFRS
have been discounted on an economical-
ly reasonable basis. Therefore, additional
discounting of AIL is not necessary under
circumstances in which it is not required
under either GAAP or IFRS. For exam-
ple, IFRS 17 does not require discount-
ing of liabilities under nonlife insurance
contracts with terms of one year or less.
However, the Treasury Department and
the IRS have determined that discounting
is required where AIL have not been oth-
erwise discounted on a reasonable basis.
Accordingly, the final regulations clarify
that, where a financial statement described
in §1.1297-4(e)(2) does not discount AIL
on an economically reasonable basis, the
foreign corporation may meet this require-
ment by choosing to apply the discounting
methods required under either GAAP or
IFRS.
3. Change of Financial Reporting
Standard
Under proposed §1.1297-4(e)(4), if a
foreign corporation had previously pre-
pared a financial statement under GAAP
or IFRS, it could not cease to do so in sub-
sequent years without a non-Federal tax
business purpose. If the foreign corpora-
tion failed to prepare a financial statement
under GAAP or IFRS in a subsequent year
without a non-Federal tax business pur-
pose, it was treated as having no AIL for
purposes of the 25 percent test and the 10
percent test.
A comment requested that this rule be
removed because taxpayers should not be
required to establish a business purpose
for their choice of an accounting standard.
In addition, financial reports are prepared
to inform a corporation’s stakeholders and
regulators of its financial condition, and
this function is so significant that a corpo-
ration is unlikely to change its accounting
standard for tax purposes. The Treasury
Department and the IRS have concluded
that other rules and limitations provided in
the final regulations are sufficient to pro-
tect the integrity of the amounts reported
on the AFS. Therefore, the final regula-
tions delete the special rule addressing a
change of financial reporting standard.
D. Definition of an insurance business
The proposed regulations defined an
insurance business to include the invest-
ment activities and administrative ser-
vices that are required to support (or that
are substantially related to) insurance,
annuity, or reinsurance contracts issued
or entered into by the QIC. See proposed
§1.1297-5(c)(2). One comment interpret-
ed this definition as potentially exclud-
ing any investment activities in excess
of the minimum amount required to meet
the QIC’s insurance obligations from
the scope of the exception under section
1297(b)(2)(B). The comment requested
that the definition be broadened to include
all investment activities related to insur-
ance, annuity, or reinsurance contracts is-
sued or entered into by the QIC. Although
the definition of an insurance business
(now contained in §1.1297-4(f)(8)) has
not been changed, it is not intended to
provide a maximum threshold for invest-
ment assets and income that may qualify
for non-passive treatment under section
1297(b)(2)(B). This definition merely
requires a sufficient factual relationship
between a company’s insurance contracts
and its investment activity.
VI. Comments and Revisions to Proposed
§1.1297-5 and New §1.1297-6: Exception
from the Definition of Passive Income for
Active Insurance Income
Section 1297(b)(2)(B) provides an
exclusion from the definition of passive
income for income derived in the active
conduct of an insurance business by a
QIC. Proposed §1.1297-5(b) provided a

Bulletin No. 2021–5 533 February 1, 2021
general rule that excluded from passive
income certain income of a QIC and in-
come of a qualifying domestic insurance
corporation (QDIC). Proposed §1.1297-
5(c) described the requirements for in-
come to be treated as derived in the active
conduct of an insurance business and pro-
vided rules for determining the amount of
a QIC’s income that is excluded. Proposed
§1.1297-5(d) provided rules for determin-
ing whether income of a domestic cor-
poration is income of a QDIC. Proposed
§1.1297-5(e) provided that assets of a QIC
are not treated as passive assets if they are
available to satisfy liabilities of the QIC
related to its insurance business. In addi-
tion, proposed §1.1297-5(e) provided that
assets of a QDIC generally are not treated
as passive assets. Proposed §1.1297-5(f)
provided a special look-through rule for
interests held by a QIC in subsidiary en-
tities.
A. Active conduct of an insurance
business
Under proposed §1.1297-5(c)(1), a
QIC’s passive income was treated as de-
rived in the active conduct of an insurance
business only if its active conduct per-
centage was at least 50 percent. The ac-
tive conduct percentage was computed for
each taxable year based on the amount of
expenses incurred by a QIC for services
of its officers and employees (including
employees of qualifying related entities)
related to the production or acquisition
of premiums and investment income as a
fraction of all expenses related to the pro-
duction or acquisition of premiums and
investment income.
Proposed §1.1297-5(c)(3)(i) provided
that active conduct is determined based on
all the facts and circumstances. In general,
a QIC was treated as actively conducting
an insurance business only if the officers
and employees of the QIC carried out sub-
stantial managerial and operational activi-
ties. A QIC’s officers and employees were
considered to include the officers and em-
ployees of an affiliate if the QIC satisfied
the control test under proposed §1.1297-
5(c)(3)(ii), which incorporated require-
ments relating to ownership, control and
supervision, and compensation.
Comments were generally critical of
the proposed active conduct test. Some
noted that outsourcing is a common
practice in the insurance industry for
reasons of cost and efficiency, and an
insurance company should be treated as
engaged in the active conduct of an in-
surance business even if the fees it pays
for outsourced activities (for example,
to investment advisors or insurance bro-
kers) exceed employee expenses. Others
expressed concern that some reinsurers
(which hold substantial investments but
employ a limited staff) and alternative
risk vehicles could have difficulty satis-
fying the active conduct test under the
proposed regulations. Comments also
criticized the “cliff effect” of the active
conduct percentage, which precluded an
insurance company with an active con-
duct percentage that is slightly below 50
percent from treating any of its income
or assets as non-passive under section
1297(b)(2)(B).
Many comments recommended that
the proposed active conduct test be re-
placed with a broader facts and circum-
stances test. Some comments alternatively
requested that the active conduct percent-
age be used as a safe harbor alongside a
more flexible test, or that the threshold for
the active conduct percentage be reduced
to 25 percent.
A number of comments requested that
an insurance company be treated as en-
gaged in the active conduct of an insurance
business even if its day-to-day activities
are not performed by employees, so long
as its officers and employees adequately
supervise the outsourced functions. For
example, some comments recommended
a management and control test based upon
the Limitation on Benefits Article of the
2016 U.S. Model Income Tax Convention
(which requires a company’s executive of-
ficers and senior management employees
to exercise day-to-day responsibility for
strategic, financial, and operational policy
decision-making) or regulations issued by
the Bermuda Monetary Authority (which
permit outsourcing subject to the insur-
ance company’s supervision and over-
sight). Others proposed that if an entity
is treated as an insurance company under
subchapter L or is treated as a QIC under
section 1297(f), it should be deemed to be
engaged in the active conduct of an insur-
ance business without meeting any addi-
tional requirements.
Several comments recommended that
the active conduct test focus on the as-
sumption of insurance risk. One com-
ment specifically identified underwriting
as a core insurance function that must be
performed by an insurance company’s of-
ficers and employees. Another requested
that an insurance company be treated as
engaged in the active conduct of an in-
surance business if it assumes risk under
contracts with multiple counterparties that
are unrelated to one another, or under con-
tracts covering multiple divergent lines of
business. Some comments proposed an
active conduct test tied to the amount of
premium and investment income earned
by the QIC.
For purposes of computing the active
conduct percentage, some comments re-
quested clarification about whether over-
head and claims expenses are treated as
expenses incurred to produce or acquire
premium and investment income. One
comment recommended that certain func-
tions (for example, investment manage-
ment) be excluded from both the numera-
tor and denominator of the fraction.
Some comments requested that the
control test be expanded to cover employ-
ees of entities that are related to the QIC
within the meaning of section 954(d)(3) or
are under common practical control with
the QIC. Another proposed that a single
active conduct percentage be computed on
an aggregate basis when multiple insur-
ance companies are wholly owned within
a single corporate group.
The Treasury Department and the IRS
have determined that the active conduct
of an insurance business is a requirement
mandated by the statute in addition to
(and separate from) the requirements of
subchapter L and section 1297(f), but that
in response to comments, the active con-
duct test should be amended to provide
more flexibility in determining whether
a QIC is engaged in the active conduct
of an insurance business. Therefore, the
Treasury Department and the IRS are is-
suing a notice of proposed rulemaking
(the 2020 NPRM) with a new proposed
§1.1297-5 published in the same issue
of the Federal Register as these final
regulations that proposes rules for deter-
mining whether an insurance company is
engaged in the active conduct of an insur-
ance business.

February 1, 2021 534 Bulletin No. 2021–5
The new active conduct rules are pro-
posed to apply to taxable years of QICs
beginning on or after the date the Trea-
sury Decision adopting those rules as final
regulations is published in the Federal
Register. The rules contained in proposed
§1.1297-5(c) and (d) are withdrawn. The
other rules in proposed §1.1297-5 have
been modified as described below and
are provided in the final regulations under
new §1.1297-6.
B. Qualifying domestic insurance
corporations
Proposed §1.1297-5(d) defined a QDIC
as a domestic corporation that is subject to
tax as an insurance company under sub-
chapter L of chapter 1 of subtitle A of the
Code and is subject to Federal income tax
on its net income. Proposed §§1.1297-
5(b)(2) and 1.1297-5(e)(2) provided that
a QDIC’s income and assets are non-pas-
sive for purposes of determining wheth-
er a non-U.S. corporation is treated as a
PFIC (the QDIC Rule). However, pro-
posed §§1.1297-5(b)(2) and 1.1297-5(e)
(2) provided that the QDIC Rule did not
apply for purposes of section 1298(a)(2)
and determining if a U.S. person indirect-
ly owns stock in a lower tier PFIC (QDIC
Attribution Exception). Consequently, for
attribution purposes, a tested foreign cor-
poration was required to apply the section
1297(a) income and assets tests without
applying the QDIC Rule.
Several comments requested that the
QDIC Attribution Exception be removed
because U.S. shareholders of a tested for-
eign corporation that would not otherwise
be a PFIC but that owns a PFIC and a U.S.
insurance subsidiary that is a QDIC can
become indirect owners of a PFIC as a
result of the section 1298(a)(2) attribution
rule. Another comment requested that,
if the QDIC Attribution Exception is re-
tained, a special exception be provided for
active domestic mortgage insurance com-
panies if certain criteria are satisfied. The
Treasury Department and IRS agree that
the QDIC Attribution Exception is over-
broad, and therefore the final regulations
do not include it. However, the Treasury
Department and IRS believe that it may
be appropriate to limit the amount of a
QDIC’s assets and income that are treat-
ed as non-passive if they exceed a certain
threshold. Accordingly, the 2020 NPRM
proposes a new limitation.
The final regulations also clarify that a
U.S. insurance company must be a look-
through subsidiary in order to qualify as
a QDIC. If a QDIC is a look-through sub-
sidiary of a QIC, the QIC’s proportionate
share of the QDIC’s assets that is treated
as non-passive may be subject to limita-
tion under the special look-through rule
provided in §1.1297-6(d), which is de-
scribed in Part VI.C of this Summary of
Comments and Explanation of Revisions.
Because of the renumbering of sections
described in Part VI.A of this Summary
of Comments and Explanation of Revi-
sions, the QDIC rules are now contained
in §1.1297-6(b)(2), (c)(2), and (e)(1) of
the final regulations.
C. Treatment of income and assets of
certain look-through subsidiaries and
look-through partnerships held by a QIC
The proposed regulations provided a
special look-through rule that applied to a
subsidiary entity in which the QIC owned
at least 25 percent by value (that is, a
look-through subsidiary or a look-through
partnership) and which was subject to the
look-through rules provided in section
1297(c), proposed §1.1297-1(c)(2) and
(d)(3), and proposed §1.1297-2(b)(2) (the
“general look-through rules,” which are
now provided in §1.1297-2(b)(2) and (3)).
Under the general look-through rules, a
QIC is treated as earning directly its pro-
portionate share of the income, and hold-
ing directly its proportionate share of the
assets, of a look-through subsidiary or a
look-through partnership.
Proposed §1.1297-5(f) provided that, if
a QIC was treated as earning passive in-
come or holding passive assets of a subsid-
iary entity under the general look-through
rules, then the income could be treated as
derived by the QIC in the active conduct
of an insurance business (and thus treated
as non-passive under proposed §1.1297-
5(c)), and the assets could be treated as
assets of the QIC held to satisfy liabilities
related to its insurance business (and thus
treated as non-passive under §1.1297-
5(e)). However, for this rule to apply, the
subsidiary entity’s assets and liabilities
were required to be included in the QIC’s
AFS.
A number of comments asserted that
look-through treatment should not be
denied for subsidiary entities that do not
have assets and liabilities included in the
QIC’s AFS (which would typically occur
if a subsidiary entity is not consolidated
with the QIC under the relevant financial
accounting standard). The comments
noted that the equity value of a subsid-
iary entity is reflected on a QIC’s AFS
even if it is not consolidated for finan-
cial reporting purposes. Some comments
requested that the look-through rule un-
der proposed §1.1297-5(f) apply without
regard to whether a subsidiary entity’s
assets and liabilities are included in the
QIC’s AFS. Others requested that the
look-through rule be applied to a propor-
tionate amount of the income and assets
of a subsidiary entity, depending on how
the value of the subsidiary entity is re-
flected on the AFS.
In response to these comments, the
special look-through rule for assets and
income of a subsidiary entity held by a
QIC (now provided in §1.1297-6(d)) has
been modified to apply in all cases in
which a QIC is treated as owning the as-
sets or earning the income of the subsidi-
ary entity under the general look-through
rules. However, under §1.1297-6(d)(2),
the amount of assets or income that can
be treated as non-passive under the re-
vised rule is limited to the greater of two
amounts. The first amount is determined
by multiplying the QIC’s proportionate
share of the subsidiary entity’s income
or assets by a fraction equal to (i) the net
equity value of the QIC’s interests in the
subsidiary entity divided by (ii) the value
of the subsidiary entity’s assets. The sec-
ond amount is the amount of income or as-
sets that are treated as non-passive in the
hands of the subsidiary entity.
If assets are measured based on value
for purposes of applying the asset test un-
der section 1297(a)(2), the amount of oth-
erwise passive assets that may be treated
as non-passive under §1.1297-6(d) (that
is, the first amount described above) is
limited to the net equity value of the inter-
ests held by the QIC in the subsidiary enti-
ty. If assets are measured instead using ad-
justed bases, the fraction test is designed
to provide a proportionate limitation. Two
examples are added to illustrate the oper-
ation of these rules. See §1.1297-6(d)(3).

Bulletin No. 2021–5 535 February 1, 2021
Several comments requested clarifica-
tion regarding the treatment of an interest
held by a QIC in an entity other than a
look-through subsidiary or a look-through
partnership (for example, a corporation in
which a QIC owns less than 25 percent
of the stock). The income and assets of
such a subsidiary entity are not treated as
earned or held by the QIC in the active
conduct of an insurance business, consis-
tent with the general look-through rules.
However, the stock or partnership interest
held by the QIC (and the income it derives
from the subsidiary entity) is eligible for
the exception under section 1297(b)(2)(B)
and §1.1297-6(b) and (c) in the same man-
ner as any other (non-look-through) asset
held by a QIC.
VII. Comments and Revisions to
Proposed §1.1298-4 – Rules for certain
foreign corporations owning stock in
25-percent-owned domestic corporations
Section 1298(b)(7) provides a special
characterization rule that applies when a
tested foreign corporation owns at least
25 percent of the value of the stock of a
domestic corporation and is subject to the
accumulated earnings tax under section
531 (or waives any benefit under a treaty
that would otherwise prevent imposition
of such tax). In that case, section 1298(b)
(7) treats the qualified stock held by the
domestic corporation as a non-passive as-
set, and the related income as non-passive
income.
A. Interaction of the domestic subsidiary
rule and section 1298(a)(2) attribution
rule
The proposed regulations included
rules that disregarded the application of
section 1298(b)(7) for purposes of de-
termining whether a foreign corporation
is a PFIC for purposes of the ownership
attribution rules in section 1298(a)(2)
and §1.1291-1(b)(8)(ii) (“domestic sub-
sidiary attribution rules”). See proposed
§§1.1291-1(b)(8)(ii)(B) and 1.1298-4(e).
Several comments recommended that
the final regulations eliminate the domes-
tic subsidiary attribution rules in proposed
§§1.1291-1(b)(8)(ii)(B) and 1.1298-4(e).
These comments asserted that Con-
gress intended for stock that is treated as
non-passive pursuant to section 1298(b)
(7) to be characterized as non-passive for
all purposes, including for purposes of
section 1298(a)(2). Specifically, some of
these comments noted that the statutory
text of section 1298(a)(2) already speci-
fies that application of section 1297(d) is
excluded and, thus, asserted that an addi-
tional exclusion from section 1298(a)(2)
is precluded. The comments also asserted
that legislative history suggests that Con-
gress intended for section 1298(b)(7) to
incentivize investments in domestic cor-
porations. Other comments argued that
the domestic subsidiary attribution rules
would be administratively burdensome
on minority shareholders who would not
be able to obtain information with respect
to lower-tier PFICs to comply with the
PFIC rules. One comment suggested that
Congress acknowledged the lack of con-
trol that minority investors have in parent
companies by providing the 50-percent
threshold in section 1298(a)(2) to facil-
itate administrability. Another comment
recommended that, if the domestic sub-
sidiary attribution rules are retained, the
final regulations provide an exception to
allow shareholders who own less than
5-percent of the top-tier foreign corpora-
tion in a structure to apply section 1298(b)
(7) to determine PFIC status for purposes
of the ownership attribution rules in sec-
tion 1298(a)(2).
The Treasury Department and the IRS
have given further consideration to the
purpose of section 1298(b)(7), and have
determined that it is appropriate for sec-
tion 1298(b)(7) generally to apply for
purposes of the attribution of ownership
rules of section 1298(a), provided that
adequate measures are taken to prevent
taxpayers from holding primarily passive
assets in domestic subsidiaries in order to
avoid PFIC classification. The Treasury
Department and the IRS also agree with
the comment that the domestic subsidiary
attribution rule can be administratively
burdensome. Accordingly, the Treasury
Department and the IRS have determined
that the application of the domestic sub-
sidiary anti-abuse rule discussed in Part
VII.B of this Explanation of Comments
and Summary of Revisions is sufficient to
address concerns about abusive planning
related to section 1298(b)(7) without a
need for the domestic subsidiary attribu-
tion rules. Therefore, the domestic subsid-
iary attribution rules are eliminated in the
final regulations.
Several comments were received rec-
ommending clarification concerning the
consequences of disregarding section
1298(b)(7) for purposes of the Income
Test and the Asset Test and excepting
minority shareholders from the domestic
subsidiary rule. Because the final regula-
tions do not adopt the domestic subsidiary
attribution rules, these recommendations
are not adopted.
B. Revisions to domestic subsidiary anti-
abuse rules
The proposed regulations provided
that section 1298(b)(7) did not apply if
(i) the tested foreign corporation would
be a PFIC if the qualified stock held by
the 25-percent-owned domestic corpora-
tion or any income received or accrued
with respect thereto were disregarded
(“qualified stock anti-abuse rule”) or (ii)
a principal purpose for the tested foreign
corporation’s formation or acquisition
of the 25-percent-owned domestic cor-
poration was to avoid classification of
the tested foreign corporation as a PFIC
(“principal purpose anti-abuse rule”). See
proposed §1.1298-4(f). The preamble to
the proposed regulations explained that
the Treasury Department and the IRS be-
lieved that a taxpayer should not be per-
mitted to use the domestic subsidiary rule
in section 1298(b)(7) to avoid the PFIC
rules by indirectly holding predominantly
passive assets through a two-tiered chain
of domestic subsidiaries.
1. Qualified Stock Anti-Abuse Rule
Several comments requested that the
qualified stock anti-abuse rule in pro-
posed §1.1298-4(f)(1) be withdrawn.
These comments asserted that Congress
was aware of the potential for taxpayers
to rely on section 1298(b)(7) to avoid
PFIC status by treating otherwise passive
investments as non-passive and intended
for the accumulated earnings tax (“AET”)
to mitigate potential abuse. The comments
argued that the AET imposed on the test-
ed foreign corporation, the U.S. corporate
tax imposed on the domestic subsidiaries,
and the withholding tax imposed on dis-

February 1, 2021 536 Bulletin No. 2021–5
tributions to the tested foreign corporation
serve to discourage a tested foreign corpo-
ration from artificially overweighting its
investment assets held through domestic
subsidiaries. Another comment asserted
that the qualified stock anti-abuse rule cre-
ates a hypothetical PFIC test that super-
sedes the statute when it causes a tested
foreign corporation to be a PFIC in a fact
pattern in which the domestic subsidiary
rule in section 1298(b)(7) would other-
wise cause the tested foreign corporation
to not be a PFIC.
The Treasury Department and the IRS
have determined that the qualified stock
anti-abuse rule is unnecessary to address
the concerns of abuse that were expressed
in the preamble to the proposed regula-
tions and that tailoring the scope of the
principal purpose anti-abuse rule as dis-
cussed in Part VII.B.2 of this Summary
of Comments and Explanation of Revi-
sions would better target the concerns of
abuse. Accordingly, the qualified stock
anti-abuse rule in proposed §1.1298-4(f)
(1) is withdrawn.
2. Principal Purpose Anti-Abuse Rule
Under the principal purpose anti-abuse
rule in proposed §1.1298-4(f)(2), a prin-
cipal purpose was deemed to exist when
the 25-percent-owned domestic corpora-
tion was not engaged in an active trade or
business in the United States. One com-
ment asserted that the principal purpose
anti-abuse rule in proposed §1.1298-4(f)
(2) was overbroad and should be narrow-
ly drawn to prevent potential abuse. Oth-
er comments requested that the principal
purpose anti-abuse rule be eliminated, be-
cause, according to such comments, Con-
gress contemplated that taxpayers would
plan into section 1298(b)(7) and intended
for the AET to be the sole limitation on
the applicability of the domestic subsidi-
ary rule. Some of these comments asserted
that the principal purpose anti-abuse rule
was inconsistent with two private letter
rulings that, according to such comments,
endorsed the use of domestic subsidiaries
to manage PFIC status.
One comment noted that the 25-per-
cent-owned domestic corporation is likely
to be a holding company without an active
trade or business and, thus, the tested for-
eign corporation would likely be deemed
to have a principal purpose of avoiding
PFIC classification. Another comment ar-
gued that the standard for deeming a prin-
cipal purpose of avoiding PFIC status to
exist is misguided because a corporation
need not be engaged in an active trade or
business in order to generate non-passive
income. Other comments expressed con-
cern that the principal purpose anti-abuse
rule would disallow planning to manage
the PFIC risk of start-up companies and
active companies undergoing transition.
The Treasury Department and the
IRS have determined that the final regu-
lations should retain a principal purpose
anti-abuse rule to prevent the holding of
passive assets through a two-tiered chain
of domestic subsidiaries for the purpose
of avoiding the PFIC rules with respect
to passive assets held in foreign affiliates.
Absent an anti-abuse rule, a two-tiered
chain of domestic subsidiaries could be
used to shield U.S. investors in a tested
foreign corporation from the application
of the PFIC rules with respect to sub-
stantial amounts of passive assets held
by the tested foreign corporation or its
foreign subsidiaries. The Treasury De-
partment and the IRS have concluded that
the promulgation of a principal purpose
anti-abuse rule is consistent with section
1298 and the broad regulatory authority
under section 1298(g). The legislative his-
tory of section 1298(b)(7) envisions that
U.S. shareholders that hold passive assets
through a U.S. corporate structure rath-
er than in a foreign corporation in order
to avoid the PFIC regime will be subject
to tax treatment essentially equivalent to
that of the shareholders of a PFIC. While
Congress intended that the AET serve this
function, because the AET is rarely ap-
plied in practice, the Treasury Department
and the IRS have determined that the AET
is not, by itself, sufficient to curtail abuse.
The imposition of U.S. net income tax on
the income from passive assets held by a
domestic subsidiary also does not serve
as a sufficient disincentive to hold those
assets in a domestic subsidiary, because
the passive assets may generate a small
amount of income or the domestic sub-
sidiary may be leveraged so that its net
income subject to taxation is much less
than the gross income that would be taken
into account under the PFIC rules if the
assets were held by a foreign affiliate.
Section 1298(g) provides authority to pre-
vent abuse of the PFIC rules. Moreover,
the Treasury Department and the IRS have
determined that the comments did not ap-
preciate the underlying facts of the private
letter rulings and that the promulgation of
the principal purpose anti-abuse rule is not
inconsistent with the private letter rulings.
However, the Treasury Department and
the IRS agree that it is appropriate to more
closely tailor the scope of the principal
purpose anti-abuse rule to the potential
abuses of greatest concern. Accordingly,
the principal purpose anti-abuse rule in
the final regulations is modified to strike
the appropriate balance between prevent-
ing section 1298(b)(7) from applying in-
appropriately to avoid the PFIC rules and
allowing for planning to manage the PFIC
risk of start-up companies and active
companies undergoing transition phases
in the business cycle. Under the principal
purpose anti-abuse rule in the final regu-
lations, section 1298(b)(7) does not apply
if either (i) a principal purpose for the for-
mation, acquisition, or holding of stock of
either domestic corporation was to avoid
PFIC classification or (ii) a principal pur-
pose of the capitalization or other funding
of the second-tier domestic corporation
is to hold passive assets through such
corporation to avoid PFIC classification.
See §1.1298-4(e)(1). Unlike the proposed
regulations, which applied the principal
purpose anti-abuse rule only at the level
of the upper tier domestic corporation, the
final regulations were modified to apply
the principal purpose anti-abuse rule at
both levels. See id. Because a two-tiered
domestic structure can be planned into at
either tier level in the structure, the first
prong of the anti-abuse rule—which tar-
gets corporate formations, acquisitions, or
stock holding—applies at both levels. See
id. On the other hand, the second prong
of the anti-abuse rule—which targets cap-
italizing or funding—applies at the level
of the second-tier domestic subsidiary
because the benefit of section 1298(b)(7)
applies only with respect to assets held
at that level. See id. The Treasury De-
partment and the IRS continue to study
the need to narrow the principal purpose
anti-abuse test to avoid concerns with re-
spect to temporary holdings of passive as-
sets in a U.S. corporate structure for valid
business reasons, and additional guidance

Bulletin No. 2021–5 537 February 1, 2021
on safe harbors to address those concerns
is proposed in the 2020 NPRM. See pro-
posed §1.1298-4(e)(2) and (e)(3).
VIII. Comments and Revisions Regarding
Applicability Dates
The preamble to the proposed regula-
tions generally provided that until they
were finalized, taxpayers could choose
to apply the proposed regulations other
than the rules related to the PFIC insur-
ance exception in their entirety to all open
tax years as if they were final regulations
provided that taxpayers consistently ap-
plied those rules. Similarly, the preamble
provided that the rules of proposed §§
1.1297–4 and 1.1297–5 could be applied
for taxable years beginning after Decem-
ber 31, 2017, provided those rules were
applied consistently.
A. Applicability dates relating to the
PFIC insurance exception
Comments related to the PFIC insur-
ance income exception requested that the
final regulations apply to taxable years of
a U.S. shareholder beginning on or after
December 31, 2020 (or such date that
generally provides foreign corporations at
least one year to comply with the final reg-
ulations) or the date of publication of the
final regulations. Comments asserted that
foreign corporations needed additional
time to make changes to come into com-
pliance with the regulations, and that U.S.
shareholders needed additional time to
evaluate whether they were shareholders
of a PFIC. Because the final regulations
have removed rules turning off the QDIC
rule and section 1298(b)(7) for purposes
of testing for indirect ownership of a PFIC
and the rules defining active conduct of an
insurance business have been revised and
reproposed, the final regulations are sig-
nificantly less burdensome than as origi-
nally proposed. Accordingly, the Treasury
Department and the IRS have decided that
additional time is not necessary to comply
given that section 1297(f) has been in ef-
fect since January 1, 2018, and §§1.1297-
4 and 1.1297-6 merely implement section
1297(f).
Sections 1.1297-4(g) and 1.1297-6(f)
therefore provide that the final PFIC in-
surance regulations apply to taxable years
beginning on or after January 14, 2021.
Taxpayers may choose to apply the final
PFIC insurance regulations to any taxable
year beginning after December 31, 2017,
provided that all of those rules are applied
consistently with respect to that tested for-
eign corporation for the same year and all
succeeding taxable years.
B. Applicability dates relating to other
rules
Comments with respect to the rules
unrelated to the PFIC insurance excep-
tion argued that allowing taxpayers to
rely on the 2019 proposed regulations
for open years would provide insufficient
relief, given that a foreign corporation is
generally treated as a PFIC on an ongo-
ing basis with respect to a shareholder if
it was ever treated as a PFIC with respect
to that shareholder (the “once-a-PFIC, al-
ways-a-PFIC” rule). See sections 1291(a)
(1) and 1298(b)(1) and §1.1298-3(a). The
comments expressed concern that a tax-
payer that treated a tested foreign corpo-
ration as a PFIC in closed years, based on
its understanding of the rules at that time,
would be required to file amended returns.
The comments stated that requiring tax-
payers to file amended returns could limit
the relief provided by allowing taxpayers
to rely on the 2019 proposed regulations
for open years. One comment expressed
concern that the application of the once-a-
PFIC, always-a-PFIC rule in this context
would penalize taxpayers that took con-
servative positions under prior law, and
that filing amended returns may involve
significant administrative burdens. Anoth-
er comment expressed concern that new
investors in a tested foreign corporation
that would have been a PFIC under prior
law but not under the proposed regula-
tions would be subject to more favorable
rules than historic investors in that corpo-
ration. Accordingly, comments requested
that taxpayers be permitted to apply the
regulations to closed taxable years for
purposes of section 1298(b)(1), provided
that the relevant tested foreign corporation
would never have been a PFIC during the
taxpayer’s holding period as a result.
The Treasury Department and the IRS
agree that the once-a-PFIC, always-a-PF-
IC rule is implicated, because in some
cases these regulations may cause a test-
ed foreign corporation that was previous-
ly a PFIC with respect to a shareholder to
not satisfy the Asset Test or Income Test
going forward and therefore to become a
“former PFIC” as defined in §1.1291-9(j)
(2)(iv), but the foreign corporation would
still be treated as a PFIC with respect to
the shareholder by reason of the once-a-
PFIC, always-a-PFIC rule. The Treasury
Department and the IRS do not agree that
taxpayers subject to the once-a-PFIC,
always-a-PFIC rule should be permitted
to avoid the need to file amended re-
turns or to make an election under sec-
tion 1298(b)(1) and §1.1298-3 (“purging
election”). The possible applicability
dates of the final regulations do not in-
clude closed years, and the Treasury De-
partment and the IRS do not believe that
it would be appropriate for the final regu-
lations to apply in whole or part to closed
years for purposes of alleviating the ef-
fects of the once-a-PFIC, always-a-PFIC
rule. For example, providing the relief
requested by commenters would afford
a benefit to taxpayers that invested in a
tested foreign corporation treated as a
section 1291 fund in a now-closed year
and continue to hold the stock compared
to taxpayers that acquired the stock of
the tested foreign corporation at the same
time but sold the stock in a now-closed
year, which may be viewed as unfair. If
the tested foreign corporation would not
be treated as a PFIC under the proposed
regulations or the final regulations, the
taxpayers who sold the stock during a
closed year may have been subject to tax
under section 1291 on an excess distri-
bution while taxpayers who continue to
hold the stock would be spared taxation
under section 1291.
Finally, while it is true that the appli-
cation of the once-a-PFIC, always-a-PFIC
rule may apply to historic shareholders
and not to new shareholders, the rule as
enacted by Congress is designed to work
in that manner. For example, an investor
that buys shares in a tested foreign corpo-
ration that is a start-up with no operating
income may be required to treat that cor-
poration as a PFIC during its entire hold-
ing period for the shares, while an investor
that buys shares in the same corporation
once it is a going concern may never be
required to treat the tested foreign corpo-
ration as a PFIC.

February 1, 2021 538 Bulletin No. 2021–5
However, in light of the issues raised
by commenters, the Treasury Depart-
ment and the IRS have concluded that it
is appropriate to provide taxpayers with
some flexibility in choosing if and when
to end PFIC treatment by causing a for-
mer PFIC to no longer be subject to the
once-a-PFIC, always-a-PFIC rule. Under
current law, a shareholder seeking to end
PFIC treatment as a result of a change of
facts or law would need to make a purg-
ing election under section 1298(b)(1) and
§1.1298-3(b) or (c) on Form 8621 attached
to the shareholder’s tax return (includ-
ing an amended return filed within three
years of the due date, as extended under
section 6081, of the original return for
the election year), or request the consent
of the Commissioner to make an election
with respect to a closed taxable year un-
der section 1298(b)(1) and §1.1298-3(e)
(“late purging election”) on Form 8621-A.
A timely purging election under section
1298(b)(1) and §1.1298-3(b) or (c) may
be made if the tested foreign corporation
ceased to qualify as a PFIC under the In-
come Test and the Asset Test in an open
taxable year, but the election would not
affect the treatment of the tested foreign
corporation as a PFIC in the earliest open
year because it takes effect at the end of
the year for which the election is made,
as described in the next paragraph. If the
tested foreign corporation ceased to quali-
fy as a PFIC at the beginning of the earli-
est open year, the shareholder may request
the consent of the Commissioner to make
a late purging election, as described in the
next paragraph.
When a deemed sale purging election
is made, the stock of the former PFIC is
deemed sold for its fair market value on
the last day of the last taxable year of the
tested foreign corporation during which
it qualified as a PFIC (the “termination
date”). See §1.1298-3(b)(2) and (d). Ac-
cordingly, a taxpayer that files a timely
deemed sale purging election for an open
taxable year is treated as selling the stock
of the PFIC at the end of the tested foreign
corporation’s taxable year, and according-
ly the shareholder is subject to the PFIC
rules with respect to that stock during its
relevant taxable year and any prior open
years. If the taxpayer wishes to end PFIC
treatment as of its earliest open taxable
year, it must request the consent of the
Commissioner to make a late purging
election taking effect as of the end of the
tested foreign corporation’s taxable year
in the taxpayer’s most recent closed tax-
able year. For example, if a taxpayer had
chosen to apply the proposed regulations
to its earliest open taxable year with re-
spect to a tested foreign corporation that
has the same taxable year and that qual-
ified as a PFIC in closed taxable years,
and the application of the proposed reg-
ulations resulted in the tested foreign cor-
poration no longer qualifying as a PFIC,
to prevent PFIC treatment from continu-
ing into that earliest open taxable year and
beyond the taxpayer would have had to
request the consent of the Commissioner
to make a late purging election by filing
Form 8621-A for the year immediately
preceding its first open taxable year. See
also §1.1298-3(c) (deemed dividend purg-
ing election available if former PFIC was
a CFC during its last taxable year that it
qualified as a PFIC). The result of both
timely and late purging elections with
respect to former PFICs is that the share-
holder’s holding period resets solely for
PFIC purposes, such that the shareholder
is treated as no longer holding stock of a
foreign corporation that was ever a PFIC
during the shareholder’s holding period,
so the once-a-PFIC, always-a-PFIC rule
no longer applies.
The Treasury Department and the IRS
are aware that the reference to “all open
tax years” in the preamble to the proposed
regulations may have caused confusion as
to whether taxpayers could choose to ap-
ply the proposed regulations prospective-
ly to the first taxable year for which they
had not yet filed a return, or, alternatively,
whether the proposed regulations, if ap-
plied at all, had to be applied to all open
taxable years, including taxable years for
which returns had already been filed, re-
sulting in the necessity to amend returns.
As suggested by the comments, there may
also have been confusion regarding the
need to make a purging election in order
to end PFIC status, even though that is the
result under the statute and regulations.
Given these considerations, a taxpayer
may choose to apply the final regulations
(other than the rules related to the PFIC
insurance exception), with respect to a
particular tested foreign corporation, to
any open taxable year of the taxpayer, pro-
vided that all of the rules are applied con-
sistently with respect to that tested foreign
corporation for that year and all succeed-
ing taxable years. See §§1.1291-1(j)(4),
1.1297-1(g)(1), 1.1297-2(h), 1.1297-4(g),
1.1297-6(f), 1.1298-2(g), and 1.1298-4(f).
(This was also how the proposed regula-
tions, other than the rules related to the
PFIC insurance exception, were intended
to apply.) For taxable years ending on or
before December 31, 2020, a taxpayer
may rely on proposed §1.1297-1(c)(1)(A)
in the 2019 proposed regulations concern-
ing the application of section 954(h) rath-
er than §1.1297-1(c)(1)(i)(A) with respect
to a tested foreign corporation.
The Treasury Department and the IRS
recognize that the determination of wheth-
er to apply the 2019 proposed regulations
or the final regulations to a tested foreign
corporation may be advantageous with re-
spect to some tested foreign corporations
and not with respect to others. In order
to provide flexibility to U.S. investors
in tested foreign corporations, taxpayers
may apply the final regulations in any
open taxable year to all or less than all
of the tested foreign corporations whose
shares are owned by the taxpayer, subject
to the consistency rule described in the
prior paragraph with respect to any partic-
ular tested foreign corporation. However,
if the consequence of applying either the
proposed regulations or these final regu-
lations to prior open taxable years is that,
as of the date of application, a tested for-
eign corporation that was a PFIC ceases to
qualify as a PFIC, then the once-a-PFIC,
always-a-PFIC rule is implicated and a
taxpayer seeking to end PFIC status must
make a purging election or request the
consent of the Commissioner to make a
late purging election.
A taxpayer may choose to apply the
rules to open taxable years even if a qual-
ified electing fund election under section
1295 or a mark-to-market election under
section 1296 was in effect. See section
6511(a) (period of limitation for filing re-
fund claim).
Effect on Other Documents
The eighth (concerning the average
value of assets for purposes of the Asset
Test), ninth (concerning the characteri-
zation of assets for purposes of the Asset

Bulletin No. 2021–5 539 February 1, 2021
Test), fourteenth through sixteenth (con-
cerning dealer inventory and investment
assets for purposes of the Asset Test),
eighteenth (concerning look-through
rules for purposes of the Income Test),
and nineteenth (concerning look-through
treatment under section 1297(c)) para-
graphs of Notice 88-22, 1988 1 C.B. 489,
are obsoleted.
Special Analyses
I. Regulatory Planning and Review –
Economic Analyses
Executive Orders 13771, 13563, and
12866 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to se-
lect regulatory approaches that maximize
net benefits, including potential economic,
environmental, public health and safety
effects, distributive impacts, and equi-
ty. Executive Order 13563 emphasizes
the importance of quantifying both costs
and benefits, reducing costs, harmonizing
rules, and promoting flexibility. The Ex-
ecutive Order 13771 designation for this
final rule is regulatory.
The final regulation has been designat-
ed by the Office of Information and Regu-
latory Affairs (OIRA) as subject to review
under Executive Order 12866 pursuant to
the Memorandum of Agreement (MOA,
April 11, 2018) between the Treasury De-
partment and the Office of Management
and Budget regarding review of tax reg-
ulations. OIRA has determined that the
final rulemaking is significant and subject
to review under Executive Order 12866
and section 1(b) of the Memorandum of
Agreement. Accordingly, the final regula-
tions have been reviewed by OMB.
A. Background
Various provisions of the tax code
allow tax on certain sources of income
to be deferred, which means that the in-
come is not taxed when it is earned but at
some later date, based on specific events
or conditions. Tax deferral is advanta-
geous to taxpayers because the taxpayer
can in the meantime earn a return on the
amount that would otherwise have been
paid as tax. Prior to the Tax Cuts and
Jobs Act (TCJA), income earned abroad
by foreign corporations owned by U.S.
taxpayers generally was not taxed by the
United States until the income was repa-
triated to the United States or, as holds
broadly for capital gains, the stock of
the corporation was sold. However, un-
der controlled foreign corporation (CFC)
and passive foreign investment company
(PFIC) rules, U.S. persons owning stock
of foreign corporations were in some cir-
cumstances subject to current tax on some
or all of the foreign corporation’s income.
After TCJA, passive income and certain
insurance income earned abroad by a CFC
continues to be taxed immediately to the
United States shareholders of the CFC.
However, income of U.S. persons earned
by foreign corporations that are not CFCs
may still be eligible for deferral, or, in the
case of certain corporate shareholders,
exempt from U.S. corporate tax. Defer-
ral is not available, however, for income
of foreign corporations that are identified
as PFICs. The immediate taxation of this
income discourages U.S. taxpayers from
holding mobile, passive investments, such
as stock, in a foreign corporation in order
to defer U.S. tax.
The PFIC rules of the Internal Revenue
Code address situations in which taxable
U.S. persons indirectly hold assets that
earn passive income (generally interest,
dividends, capital gains, and similar types
of income) through a foreign corporation.
Without the PFIC rules, the income earned
by these assets would be subject to U.S.
tax only when and if that income is dis-
tributed as dividends by the foreign corpo-
ration or, as capital gains, when the shares
of the foreign corporate stock are sold by
the U.S. shareholder. In the absence of the
PFIC rules, these types of investment ar-
rangements could significantly lower the
effective tax rate on passive income faced
by U.S. investors from that incurred if the
assets were held directly.
Under the PFIC statutory rules, a for-
eign corporation is considered a PFIC if at
least 75 percent of the corporation’s gross
income for a given taxable year is passive
income (the Income Test) or if at least 50
percent of the corporation’s assets are as-
sets that produce passive income (the As-
set Test). The PFIC itself is not subject to
U.S. tax under the PFIC regime; rather,
only the U.S. owner of a foreign corpo-
ration is subject to that regime. The U.S.
owner of shares of a foreign corporation
consequently must obtain the appropriate
information, usually from the corporation,
in order to determine whether that corpo-
ration is a PFIC (by satisfying these and
other tests) and if so what tax is due as a
result.
The PFIC provisions provide a
long-standing exception from these pas-
sive income rules for any income earned
in the active conduct of an insurance
business by an insurance company. This
exception (the PFIC insurance exception)
allows insurance companies, which hold
significant amounts of investment assets
(which generate income that would other-
wise be classified as passive) in the normal
course of business to fund their insurance
obligations, to avoid PFIC status, provid-
ed they meet other statutory conditions.
TCJA substantially revised the PFIC
insurance exception. Before its amend-
ment by TCJA, this exception was pro-
vided to a foreign corporation that (i) was
predominantly engaged in an insurance
business and (ii) would be taxed as an
insurance company if it were a domestic
corporation. TCJA modified and narrowed
the PFIC insurance exception by requiring
that the excepted income be derived in the
active conduct of an insurance business
by a “qualifying insurance corporation”
(QIC). To be a QIC, a foreign insurance
corporation must be an entity that would
be taxed as an insurance company if it
were a domestic corporation (consistent
with prior-law requirements) and, in ad-
dition, be able to show that its “applica-
ble insurance liabilities” constitute more
than 25 percent of its total assets. TCJA
defines applicable insurance liabilities for
this purpose as including a set of enumer-
ated types of insurance-related loss and
expense items. Failing this test, the Code
provides that U.S. owners of the foreign
corporation may elect to treat their stock
in the corporation as stock of a QIC pro-
vided the corporation can satisfy an “al-
ternative facts and circumstances test.” If
a corporation is determined to be a QIC,
only income that is derived in the active
conduct of an insurance business qualifies
as income eligible for the PFIC insurance
exception.
The Treasury Department and the IRS
previously published proposed regula-
tions pertaining to the PFIC regime and

February 1, 2021 540 Bulletin No. 2021–5
changes due to TCJA (the proposed regu-
lations.) See 84 FR 33120.
B. Need for the final regulations
The final regulations are needed be-
cause many of the terms and calculations
required for the determination of PFIC
status would benefit from greater speci-
ficity. The final regulations provide such
details so that taxpayers can readily and
accurately determine if their investment is
in a PFIC, given the significant tax con-
sequences of owning a PFIC. The regu-
lations further resolve ambiguities in de-
termining ownership of a PFIC and in the
application of the PFIC Income and As-
set Tests. These final regulations are also
needed to respond to comments received
on the proposed regulations.
The Treasury Department and the IRS
have also identified actions or positions
that foreign companies might take to
claim qualification for the passive income
exception for income earned in the active
conduct of an insurance business even
though the nature of their insurance busi-
ness would not merit an exception under
the intent and purpose of the statute. The
final regulations are needed to prevent
U.S. investors from taking certain of these
tax avoidance measures.
C. Overview
The final regulations can be divided
into two parts: general guidance regarding
PFICs (the general rules) and guidance
that relates specifically to the implementa-
tion of the PFIC insurance income excep-
tion (the PFIC insurance exception rules).
The economic analysis first discusses
the regulations under the general rules
that: (1) clarify how assets are measured
for the PFIC Asset Test; (2) provide
rules for applying the statutory rules
regarding look-through subsidiaries to
partnerships; and (3) attribute activities
undertaken by certain affiliates of the
corporation being tested for its PFIC sta-
tus for the purpose of applying certain
exceptions contained in the passive in-
come definitional rules.
The economic analysis then discusses
the regulations under the PFIC insurance
exception rules that provide guidance re-
garding: (1) the discounting of applicable
insurance liabilities on certain financial
statements; (2) issues related to the facts
and circumstances test for treating a for-
eign corporation as a QIC, including (i)
“runoff-related circumstances,” (ii) “rat-
ing-related circumstances,” and (iii) the
deemed election under the facts and cir-
cumstances test for small shareholders;
and (3) application of the insurance ex-
ception as it relates to look-through sub-
sidiaries of a QIC.
D. Economic analysis
1. Baseline
In this analysis, the Treasury Depart-
ment and the IRS assess the benefits and
costs of the final regulations relative to a
no-action baseline reflecting anticipated
Federal income tax-related behavior in the
absence of these final regulations.
2. Summary of Economic Effects
The final regulations provide certain-
ty and consistency in the application of
sections 1297 and 1298 of the Internal
Revenue Code with respect to passive
foreign investment companies and quali-
fying insurance corporations by providing
definitions and clarifications regarding the
statute’s terms and rules. In the absence
of such guidance, the chances that dif-
ferent U.S. owners (or potential owners)
of foreign companies would interpret the
statute differentially (either differently
from each other or distinct from the in-
tent and purpose of the statute) would
be exacerbated. This divergence in inter-
pretations could cause U.S. investors to
choose investment vehicles based on dif-
ferent interpretations of the statute rather
than on different economic prospects. For
example, one investor might undertake
an investment opportunity that another
investor might forego based on different
interpretations of how the income from
that investment would be treated under
the Code. When economic investment is
not guided by uniform incentives across
otherwise similar investors and otherwise
similar investments, the resulting pattern
of investment will generally be inefficient.
Thus, in the context of U.S. investment in
foreign corporations, the final regulations
help to ensure that similar economic ac-
tivities, representing similar passive and
non-passive attributes, are taxed similar-
ly. The Treasury Department and the IRS
expect that the definitions and guidance
provided in the final regulations will lead
to an improved allocation of investment
among U.S. taxpayers, contingent on the
overall Code.
In assessing the economic effects of
the final regulations, the Treasury Depart-
ment and the IRS separately considered
(i) those provisions that may reduce the
opportunities for foreign corporations to
avoid PFIC status, relative to the no-ac-
tion baseline; and (ii) those provisions that
may expand the opportunities for foreign
corporations to avoid PFIC status, relative
to the no-action baseline.
As a result of the first set of provi-
sions, some corporations that may not
have had PFIC status under the baseline
may be treated for tax purposes as PFICs
under the final regulations. In response to
such provisions, some foreign companies
that are close to qualifying as a QIC, for
example, may take steps to adjust oper-
ations to ensure that they meet the QIC
qualifications.
5
Other foreign companies
may not be able to profitably undertake
these actions, possibly because of the
business’s structure or the local regula-
tory environment and thus would now
be treated as a PFIC. Yet other foreign
companies, particularly those that are
not reliant on U.S. investors, may also
remain (following these regulations)
classified for U.S. tax purposes as PFICs.
The Treasury Department and the IRS
expect that in these latter two cases, cur-
rent U.S. owners will largely continue to
retain their holdings of these companies
but future investors may turn to other for-
eign corporations that are not classified
as PFICs under the final regulations or to
domestic investments.
5
The Treasury Department and the IRS are aware of foreign companies that have redomiciled to the U.S. and thereby avoided PFIC status, although the number of such companies is believed
to small and the business calculations likely involved more than PFIC/non-PFIC considerations. The Treasury Department and the IRS expect that the number of foreign companies that do
not re-domicile but that are likely to change how they operate as the result of these final regulations will also be quite small.

Bulletin No. 2021–5 541 February 1, 2021
This reduction in the pool of non-PFIC
investment opportunities can be expected
to lower the after-tax return to U.S. in-
vestors relative to the no-action baseline.
To the extent that investors retain their
investments in companies that have been
determined to be PFICs or turn to domes-
tic investments, U.S. tax revenue may rise
relative to the no-action baseline. These
possible responses by U.S. investors (in-
vesting in a different non-PFIC; retaining
investment in the PFIC; investing in U.S.
companies) will also change the amount
and nature of risk in the affected inves-
tors’ portfolios. The nature of this shift is
difficult to gauge because foreign compa-
nies whose PFIC status may change as a
result of these final regulations (relative to
the no-action baseline) will generally be
earning a mix of passive and non-passive
income. Thus, the change in the nature of
the risk in U.S. investors’ portfolios can-
not be readily determined.
As a result of the second set of provi-
sions (those that expand opportunities for
foreign companies to avoid PFIC status
relative to the no-action baseline), some
corporations that may have had PFIC sta-
tus under the baseline may be determined
not to be PFICs under the final regulations.
This expansion of the pool of non-PFIC
investment opportunities can be expected
to raise the after-tax return to U.S. inves-
tors relative to the no-action baseline and,
to the extent that investors increase their
investment in foreign non-PFICs as a sub-
stitute for domestic investment, U.S. tax
revenue may fall. These effects again also
change the amount and nature of risk in
the affected investors’ portfolios and in an
undetermined direction.
The Treasury Department and the IRS
project that these final regulations will
have economic effects less than $100
million per year ($2020), relative to the
no-action baseline. The Treasury Depart-
ment and the IRS have not undertaken
more precise estimates of the differenc-
es in economic activity that might result
between the final regulations and the
no-action baseline because they do not
have readily available data or models that
capture in sufficient detail the investments
that taxpayers might make under the final
regulations relative to the no-action base-
line. They similarly have not estimated the
differences in compliance costs or admin-
istrative burden that would arise under the
final regulations or the no-action baseline
because they do not have readily available
data or models that capture these aspects
in sufficient detail.
The proposed regulations solicited
comments on the economic effects of the
proposed regulations. No such comments
were received.
3. Economic Analysis of Specific
Provisions of the General PFIC Rules
a. Treatment of look-through subsidiaries
and look-through partnerships
For the purpose of testing whether a
foreign corporation is a PFIC, the look-
through rule of section 1297(c) treats the
tested foreign corporation (“TFC”) as
holding its proportionate share of the as-
sets of a look-through entity and having
received directly its proportionate share of
the income of the look-through entity. This
rule affects both the amount of assets that
the TFC is treated as owning and the char-
acterization of those assets as passive or
non-passive. The statute is silent regard-
ing the application of look-through rules
to a TFC’s ownership interest in a partner-
ship. Therefore, the Treasury Department
and the IRS deemed it necessary to pro-
vide rules addressing the treatment of TFC
ownership interests in partnerships.
One regulatory option was to apply
rules similar to those that apply to sub-
sidiaries treated as corporations for tax
purposes. Under these rules, a partner-
ship generally would be treated as a look-
through partnership (LTP) only if the TFC
owned at least 25 percent of the value of
the partnership interest during a taxable
year (“minimum ownership threshold”).
A second regulatory option was to ap-
ply a complete look-through rule to part-
nerships (“aggregate approach”). Under
this option, a TFC would treat its pro-
portionate share of partnership assets and
income as assets and income of its own,
regardless of the size of its partnership
ownership share. This option is consistent
with the “aggregate” theory of partner-
ships under which each partner is treated
as incurring an allocable share of each
partnership item, such as gain, loss, in-
come, and expense, with the tax attributes
of that item passing through to the partner.
A third regulatory option was to adopt
an intermediate approach under which
look-through rules would apply to partner-
ships if either (i) the partnership would be
a look-through subsidiary if it were treat-
ed as a corporation, or (ii) the TFC partner
is actively engaged in the business of the
partnership. In practice, this approach is
likely to have consequences similar to the
aggregate approach for many TFCs en-
gaged in an active business.
The proposed regulations adopted the
first approach, using a minimum owner-
ship threshold of 25 percent. The 2019
NPRM asked for comments regarding
whether this threshold is the appropriate
threshold for look-through partnership
treatment. No comments were received
recommending a lower threshold. Instead,
commenters recommended that the aggre-
gate approach be adopted, which in this
context would be similar to a zero percent
minimum ownership threshold.
Under the aggregate approach, TFCs
that are interested in attracting capital
from U.S. investors would have an incen-
tive to purchase small minority invest-
ment interests in one or more active part-
nerships in order to increase their share
of non-passive assets and income so as to
enable the TFC to avoid PFIC status. The
TFC could do this without having any of
the partnership activities being connected
with the business of the TFC and without
requiring the TFC to exercise control over
any of the business activities of these part-
nerships. In this fashion, the aggregate op-
tion would create a bias in favor of busi-
ness structures containing entities treated
for U.S. tax purposes as partnerships and
against a structure using corporate sub-
sidiaries, since those subsidiaries would
require 25 percent ownership shares in
order to obtain look-through status for
the TFC. This bias toward such business
structures would be tax-driven rather than
market-driven and unlikely to confer gen-
eral economic benefits.
An aggregate approach to LTPs could
allow TFCs that hold significant amounts
of passive investment assets to purchase
sufficient amounts of minority investment
interests in active business partnerships so
as to increase the TFC’s non-passive as-
sets and income to levels that enable the
TFC to avoid PFIC status. Thus, the pur-
pose of the PFIC regime could be mean-

February 1, 2021 542 Bulletin No. 2021–5
ingfully defeated, especially if foreign
corporate subsidiaries chose to be treated
as partnerships for this purpose.
The Treasury Department and the IRS
determined that minor investment shares
of TFCs in partnerships are more indica-
tive of passive investments on the part of
TFCs, so that, in those cases, it is appro-
priate to treat the TFC’s distributive share
of partnership income as wholly passive.
Moreover, a 25-percent minimum own-
ership threshold for partnerships has the
advantage of being consistent with the
look-through threshold for corporate sub-
sidiaries. It is also broadly consistent with
a rule (found in the statutory definition of
passive income) that treats sales of part-
nership interests by a CFC as sales of the
partnership’s assets if the CFC owns 25
percent of the partnership’s capital or prof-
its interests. The drawing of a bright line
for strictly passive treatment of limited
partnership interests offers greater com-
pliance certainty and ease of tax adminis-
tration because it reduces the information-
al requirements concerning the character
of the assets and income of a partnership
when the partner has only very limited in-
vestments. It may be difficult for a TFC
that holds a less-than-25-percent invest-
ment in either a subsidiary or partnership
to obtain the necessary information for
determining the character of its share of
the entity’s income. Furthermore, entities
with ownership percentages below 25
percent generally do not exercise control
of the decisions and actions of the owned
entity. Consequently, there are both policy
and administrability reasons supporting
the treatment of ownership percentages of
less than 25 percent in a similar fashion
for PFIC purposes.
Because a 25-percent minimum own-
ership threshold for partnerships is not
necessarily an accurate proxy for an ac-
tive business interest, one commenter
proposed an option under which a look-
through approach would be taken if a TFC
materially participates in the business of
the partnership; in other words, an ag-
gregate approach would be used but only
if the TFC showed, through a separate
demonstration, that the TFC is actively
involved in the business of the partner-
ship. The Treasury Department and the
IRS agreed that, if a tested foreign cor-
poration is actively involved in the busi-
ness of a partnership with active business
operations, then look-through treatment
may be appropriate even if the TFC has
less than a 25 percent ownership interest.
In considering material participation and
similar standards, however, the Treasury
Department and the IRS found that cur-
rent material participation standards un-
der the passive activity loss rules are not
appropriate in the PFIC context. Thus, the
final regulations instead modify the LTP
standard by introducing an active partner
test in order to allow look-through treat-
ment to be applied in certain cases when
the ownership percentage falls below 25
percent. The active partner test is met as
of a measurement date if the TFC would
not be a PFIC if both the PFIC Asset Test
and the PFIC Income Test were applied
without regard to any partnership interest
owned by the TFC other than interests in
those partnerships that qualify as LTPs us-
ing the LTS tests. However, the final reg-
ulations did not make this modification of
the look-through ownership test mandato-
ry and instead provide an annual election
to allow the TFC to not to treat a partner-
ship qualifying under the active partner
test as an LTP.
The Treasury Department and the IRS
have not estimated the volume or char-
acter of investment that investors would
undertake under the 25 percent minimum
ownership threshold relative to other per-
centages or under the aggregate approach
applied to taxpayers that satisfy an active
partner test because they do not have read-
ily available data or models that capture
this level of specificity.
b. Attribution of activities for look-
through entities
The definition of passive income con-
tains exceptions for certain income that is
derived in the active conduct of a trade or
business or is a gain or loss from the sale
of certain business property. Under the
look-through rules of the statute and these
final regulations, a tested foreign corpo-
ration is treated as if it holds its propor-
tionate share of the income and assets of
its look-through subsidiaries (LTSs) and
look-through partnerships (LTPs), where
a 25 percent ownership requirement is
needed to define such entities. Further, the
passive or non-passive character of the at-
tributed income or assets is determined in
the hands of the LTS or LTP. However, for
legal or commercial reasons, some busi-
nesses structure their organizations to have
all employees in one foreign corporation,
say FC1, while the assets of the business
are held in, and income is received by, an-
other foreign corporation, say FC2. With-
out attribution of the business activities
of FC1 to FC2, the assets and income of
the latter corporation do not qualify for an
exception from the definition of passive
income. This can result in FC1 being des-
ignated as a PFIC even though its income
and assets would be treated as non-passive
if FC1 and FC2 were considered as a sin-
gle entity,
To address the attribution of activities
in foreign businesses having such struc-
tures, the Treasury Department and the
IRS considered three options: (1) do not
allow any attribution of business activities
among separate corporations; (2) allow
attribution of business activities to a TFC
from its LTSs or LTPs; or (3) allow attri-
bution of business activities only if the
entities are affiliated using an ownership
standard of greater than 50 percent.
Under the no-attribution option, a for-
eign corporate structure that separates
activities and income could satisfy the
passive income exception only if it reor-
ganizes in a manner that the TFC not only
earns rents, royalties or other normally
passive income items, but also employs
the officers and employees that perform
the related business activities or owns
the property that is being sold. This re-
organization is potentially costly or per-
haps even infeasible, depending on re-
quirements in the foreign jurisdiction and
commercial considerations. The Treasury
Department and the IRS determined that
this alternative would either lead to costly
reorganizations or, in the absence of such
reorganizations, inhibit U.S. investment
in a foreign corporation that carries on an
active business activity, both of which are
economically undesirable outcomes rela-
tive to other regulatory options.
Under the second option, activities of
LTSs and LTPs could be attributed to a TFC
in a manner similar to the look-through
rules. The look-through rules attribute as-
sets and income of a look-through entity
to its owner on a proportionate share ba-
sis. There are some difficulties applying

Bulletin No. 2021–5 543 February 1, 2021
this concept in the context of attribution of
activities. While income and assets can be
allocated between owners based on their
ownership percentages, activities are not
as easily allocated among multiple own-
ers. The purpose of activity attribution, in
combination with the look-through rules,
is effectively to treat the corporations as
a single commercial enterprise; that is, as
an affiliated group of corporations. But
affiliation in this sense usually demands
a recognition of a unified business pur-
pose and combined business activity. The
typical thresholds in the Code for treating
related parties as members of an affiliated
or consolidated or similar group are more
than 50 percent and 80 percent thresholds,
not 25 percent.
The third option would require more-
than-50-percent ownership in order to be
able to attribute the business activities of
one corporation to another. The proposed
regulations adopted this third alternative
but limited its application to rents and
royalties earned in the active conduct of a
trade or business, taking into account only
the activities performed by the officers
and employees of the TFC and those of an
LTS or LTP in which the TFC owns more
than 50 percent by value.
A comment pointed out this attribu-
tion rule would allow a TFC to recognize
certain rents or royalties of an LTS as
non-passive income if the business activ-
ity was conducted in one 50-percent sub-
sidiary and assets and income were held
in a separate 50-percent subsidiary. How-
ever, the rule would not prevent the look-
through holder of the property from be-
ing a PFIC, since the rule applied only to
income received by the TFC. Comments
also requested that activity attribution ap-
ply to other types of income and not only
to rents and royalties.
The final regulations modify the pro-
posed regulations in two respects. First,
they extend the application of the provi-
sion to other items of income other than
rents and royalties that would be exclud-
ed from passive income if the income is
earned in the active conduct of a trade or
business. Second, they expand the types
of affiliated entities from which activities
could be attributed. Under these rules, an
entity is deemed to be engaged in the ac-
tive conduct of a trade or business by tak-
ing into account the activities performed
by the officers and employees of the TFC
as well as activities performed by the offi-
cers and employees of any qualified affil-
iate of the tested foreign corporation. For
this purpose, a qualified affiliated group
is defined using an affiliation standard
of more than 50 percent. In addition, the
group includes only LTSs and LTPs of the
parent entity, and the parent entity must be
a foreign corporation or partnership. This
rule allows the LTS that holds the relevant
assets in the preceding example to avoid
PFIC status and extends the attribution
rules to activities of sibling and parent
companies of the TFC.
Accordingly, this final regulation is
less restrictive than current law by al-
lowing a greater variety of organization-
al structures among foreign corporations
and partnerships than would be available
by applying the passive income rules un-
der current law. The Treasury Department
and the IRS project that this final regula-
tion will allow entities to satisfy the pas-
sive income exception under conditions
consistent with the intent and purpose of
the statute without requiring potentially
substantial reorganization costs relative
to alternative regulatory approaches or the
no-action baseline. The adopted activity
attribution rule is neither overly restrictive
by causing certain active foreign corpo-
rations to be treated as PFICs nor overly
permissive by allowing U.S. shareholders
to evade the application of the PFIC re-
gime through an overindulgent applica-
tion of attribution rules.
4. Economic Analysis of Specific
Provisions Related to the PFIC Insurance
Exception
a. Description of the PFIC insurance
exception
For PFIC purposes, passive income
does not include income derived in the ac-
tive conduct of an insurance business by
a qualifying insurance corporation (QIC).
Under the statute, a QIC must have “ap-
plicable insurance liabilities” (AIL) that
generally constitute more than 25 percent
of its total assets. AIL generally include
amounts shown on a financial statement
for unpaid loss reserves (including unpaid
loss adjustment expenses) of insurance
and reinsurance contracts and certain life
and health insurance reserves and unpaid
claims with respect to contracts providing
coverage for mortality or morbidity risks.
For the purpose of the QIC test, AIL are
based on insurance liabilities as they are
accounted for on the taxpayer’s applica-
ble financial statement (AFS). Under the
statute, an AFS is a financial statement
prepared for financial reporting purposes
that is based on U.S. generally accepted
accounting principles (GAAP), or interna-
tional financial reporting standards (IFRS)
if there is no statement based on GAAP.
If neither of these statements exists then
an AFS can be an annual statement that is
required to be filed with an applicable in-
surance regulatory body. Thus, the statute
has a preference for financial statements
prepared on the basis of GAAP or IFRS,
which are rigorous and widely-respected
accounting standards, but will permit a
foreign corporation to have an AFS that
uses a local regulatory accounting stan-
dard if the foreign corporation does not
do financial reporting based on GAAP or
IFRS.
b. Discounting of applicable insurance
liabilities
Accounting standards have different
requirements regarding the use of dis-
counting in the measurement of unpaid
loss insurance reserves. Discounting of
unpaid loss reserves would generally be
appropriate to account for the amount of
time expected before future loss payments
are made. GAAP generally does not re-
quire the discounting of current non-life
insurance liabilities but does require dis-
counting for future liabilities under life
insurance and annuity contracts. IFRS 17
(an IFRS standard applicable to insurance
contracts with an anticipated effective date
of January 1, 2023) requires discounting
of all insurance liabilities whose expected
payment exceeds one year.
To address the discounting of AIL in
situations where the foreign corporation’s
AFS was not prepared on the basis of
GAAP or IFRS, the proposed regulations
provided that in situations where the tax-
payer’s AFS does not discount reserves on
an economically reasonable basis, then the
amount of AIL would be reduced in accor-
dance with the discounting principles that
would have applied under GAAP or IFRS.

February 1, 2021 544 Bulletin No. 2021–5
The foreign corporation could choose
whether to apply either GAAP or IFRS
for this purpose. In view of comments re-
ceived, the Treasury and the IRS reconsid-
ered these requirements.
As one alternative, the Treasury De-
partment and the IRS considered not is-
suing a regulation to govern the discount-
ing of insurance losses. This option was
rejected as being possibly inconsistent
with the intent and purpose of the statute
because other financial standards specified
by the statute have rules regarding the dis-
counting of future cash flows.
As a second alternative, the Treasury
Department and the IRS considered cap-
ping the amount of AIL at the amounts
that would be permitted to a domestic in-
surance company under the Internal Reve-
nue Code; these amounts would have been
discounted according to the relevant rules.
This approach would be considerably
more burdensome to a foreign corporation
than other regulatory alternatives because,
as a practical matter, it would require for-
eign corporations to apply complex U.S.
tax rules with which they are likely not
familiar. An excessive compliance burden
on foreign corporations not subject to U.S.
taxation would make it less likely that they
would do the work necessary to enable
their minority U.S. owners to determine if
the corporation is a PFIC. Thus, this al-
ternative was rejected because it was not
reasonable to require foreign companies
to recalculate insurance liabilities based
on U.S. law requirements and it could un-
duly inhibit U.S. investors from investing
in foreign corporations that are legitimate
active insurance companies, an activity
that is economically beneficial under the
intent and purpose of the statute.
The final regulations specify that if an
AFS is not prepared on the basis of GAAP
or IFRS and does not discount AIL on an
economically reasonable basis, the amount
of AIL must be reduced by applying the
discounting principles that would apply
under either GAAP or IFRS. The choice
of which accounting standard to use for
discounting is left to the foreign corpora-
tion. Thus, if GAAP or IFRS would not
require discounting for any of the AIL of
the foreign insurer, then no additional dis-
counting is required with respect to a non-
GAAP/IFRS statement filed with a local
regulator.
Compared to the no-action baseline,
this regulation could impose additional
compliance costs on foreign insurance
companies, although those costs are in-
curred only if the foreign corporation
files a financial statement with a local
insurance regulator that is not based on
GAAP or IFRS. This additional compli-
ance cost is felt indirectly by U.S. inves-
tors and potential investors in these for-
eign insurers. A company may find it too
costly to comply with these rules in order
to attract U.S. investors, in which case it
may not be possible for U.S. investors to
determine whether the company qualifies
as a QIC; an insurance company that is
not a QIC would likely be a PFIC. Thus,
the Treasury Department and the IRS rec-
ognize that under this regulation, some
U.S. investors may avoid investing in
such a company, when they would have
done so under the no-action baseline.
The Treasury Department and the IRS
recognize further, however, that such in-
vestment (under the no-action baseline)
would not have been consistent with ef-
ficient behavior under the intent and pur-
pose of the statute.
The Treasury Department and the IRS
have not estimated the amounts that U.S.
shareholders might invest in foreign insur-
ance companies with or without the dis-
counting requirement because they do not
have a model with this level of specificity.
However, because the rule is quite flexi-
ble, the Treasury Department and the IRS
project that the discounting requirement
will not represent a significant cost burden
for foreign corporations and thus will not
have any meaningful effect on investment
patterns by U.S. shareholders relative to
the no-action baseline.
c. Issues related to the alternative facts
and circumstances test
Under the statute, a foreign corporation
that fails the 25 percent AIL-to-total assets
test (but satisfies the 10 percent AIL-to-to-
tal asset test) may still be treated as a QIC
if it satisfies a “facts and circumstances
test,” which requires that (1) the corpora-
tion is predominantly engaged in an insur-
ance business, and (2) the failure to have
AIL in excess of 25 percent of total assets
is due solely to runoff-related or rating-re-
lating circumstances involving the corpo-
ration’s insurance business. Each of these
items would benefit from guidance that
provides further clarification of the terms
involved.
i. Runoff-related circumstances
The proposed regulations defined a
corporation satisfying the runoff-related
circumstances requirement as one that
(1) is actively engaged in the process
of terminating its pre-existing, active
insurance or reinsurance underwriting
operation pursuant to an adopted plan of
liquidation or a termination of operations
under the supervision of its applicable
insurance regulatory body, (2) does not
issue or enter into any insurance, annuity,
or reinsurance contract other than a con-
tractually obligated renewal, consistent
with the plan of liquidation or termina-
tion, and (3) is making payments during
the year to satisfy claims, and the pay-
ments cause the corporation to fail the 25
percent test.
The Treasury Department and the IRS
considered whether runoff-related cir-
cumstances should be limited to insurance
companies that plan to terminate their
business operations, as was required un-
der the proposed regulations, or whether
it should also include situations in which
(1) an insurance company is merely shift-
ing the focus of its business and running
off contracts from an “old” business that
it had entered into in the past, or (2) an
insurance company acquires and manag-
es insurance business that is in runoff, but
the company itself does not have a plan of
termination. Stated another way, this issue
is whether or why an insurance company
described in either of these two situations
would require assets that are more than
four times the company’s AIL. For exam-
ple, foreign companies facing a planned
termination may be required by foreign
regulators to hold additional capital and
assets relative to their insurance liabili-
ties in order to ensure that those liabilities
will be satisfied when the companies are
no longer able to rely on new business or
new inflows of equity or debt to bolster
cash flows from which to pay claims. This
additional capital may not be needed by
ongoing firms in either of the two situa-
tions described above. Unfortunately, no
comments on the proposed regulations

Bulletin No. 2021–5 545 February 1, 2021
presented data or other information that
address this issue.
The Treasury Department and the IRS
concluded that the legislative history of
the provision supported the argument that
“runoff-related circumstances” was in-
tended to be limited to situations in which
a corporation is engaged in the process of
terminating its pre-existing business, but
they also concluded that such termination
need not be pursuant to a supervised plan
of liquidation or termination, and could
also be pursuant to any court-ordered re-
ceivership proceeding for the company’s
liquidation, rehabilitation, or conserva-
tion. The final regulations also clarify that
the reason for failing the 25 percent test
must be that the corporation is required to
hold additional assets due to its business
being in runoff.
If the definition of runoff-related cir-
cumstances were broadened further to
include active, non-terminating busi-
nesses, then, without additional restric-
tions and rules, the facts and circum-
stances test may provide a means by
which companies could be treated as
QICs in a manner that is not consistent
with the intent and purpose of the stat-
ute. If any company with a terminating
line of business could qualify, then the
25 percent test might effectively become
a 10 percent test, an outcome that would
not be consistent with the intent and pur-
pose of the statute.
The final regulations broaden slightly
the circumstances under which a runoff
of business can be conducted, relative
to the regulatory option provided in the
proposed regulations. The Treasury De-
partment and the IRS recognize that this
change may increase the number of for-
eign insurance companies that are able to
meet the requirements for being treated as
a QIC relative to the proposed regulations.
The Treasury Department and the IRS
have not estimated the number of QICs
or the nature of their operations under the
final regulations or alternative regulato-
ry approaches or the no-action baseline
because they do not have a model with
this level of specificity. The Treasury De-
partment and the IRS do not have readily
available data on the number of foreign
corporations that would currently be con-
ducting a runoff business under the condi-
tions of the final regulations.
ii. Rating-related circumstances
The rating-related circumstances con-
dition required under the alternative facts
and circumstances test is not defined in the
statute and thus requires regulatory guid-
ance. The proposed regulations provided
that a foreign corporation could satisfy the
rating-related circumstances requirement
if failure to satisfy the 25 percent QIC test
was a result of specific capital and surplus
requirements that a generally recognized
credit rating agency (generally, A.M. Best,
Fitch, Moody’s, and Standard and Poor)
imposes, and that the corporation com-
plies with these requirements in order to
maintain a minimum credit rating needed
by the corporation to be classified as “se-
cure” to write new business for any line of
insurance that it is underwriting.
Upon further reflection and after re-
viewing comments on the proposed reg-
ulations, the Treasury Department and
the IRS decided that the rating-related
circumstances requirement should focus
on those corporations that would need to
hold assets in excess of 400 percent of
their AIL because of unique circumstanc-
es. The Treasury Department and the IRS
determined that the proposed rule failed to
capture the purpose of the PFIC require-
ments for QICs, but that certain types of
business often needed higher levels of
capital and surplus in order to meet rat-
ing requirements. As a result, the above
requirements were maintained in the final
regulations, with some technical chang-
es and clarifications, but the provision is
limited to companies that might require
at times a higher level of assets to insur-
ance liabilities. These companies include
insurers that cover risks that are typically
low-frequency events but with high ag-
gregate costs, such as coverage against the
risk of loss from a catastrophic loss event,
and coverage by certain financial guaranty
insurance companies.
The final regulations restrict the appli-
cation of the provision to a foreign corpo-
ration for which more than half of its net
written premiums for the annual reporting
period (or the average net written premi-
ums over the current year and preceding
two years) are from insurance coverage
against the risk of loss from a catastrophic
event. Such insurance is characterized by
relatively frequent “good” years in which
accumulated assets must be accrued as
capital and surplus in order to provide
sufficient funds to handle the relatively
infrequent “bad” years in which losses are
exceptionally large. Because unpaid loss
reserves qualifying as AIL are limited to
amounts that represent losses that have
already been incurred prior to the end of
the accounting period (whether or not a
claim has been made), such reserves do
not reflect the unknown future losses of
the “bad” years.
Under the final regulations, the rat-
ing-related circumstances provision is
also available for insurers whose sole
business is to insure or reinsure against
a lender’s loss of all or a portion of the
principal amount of a mortgage loan upon
default of the mortgagor. Aggregate losses
associated with such insurance are highly
correlated with the business cycle. In low
loss years, the ratio of total assets to AIL
may exceed 400 percent, but the addition-
al assets may be viewed as necessary by
rating agencies for the companies to meet
insurance obligations in high loss years.
The two largest insurance reserve cate-
gories of mortgage guaranty insurers are
their unearned premium reserves (often
including single premium amounts for
long-term contracts) and contingency re-
serves (usually established as a fixed per-
centage of net written premiums), but nei-
ther of these types of reserves are included
in the definition of AIL. Consequently,
AIL are relatively small on average com-
pared with the assets of these insurers.
In addition, a mortgage guaranty insurer
under the final regulations is required to
operate as monoline business to qualify
for the exception (in order to isolate the
benefit of this provision and as reflective
of general industry practice), because a
monoline company does not have the op-
tion to pool its financial obligation risks
with other types of risks (whereas pooling
of different types of risks can reduce over-
all risk exposure, and thus capital needs).
Credit rating agencies correspondingly
expect such companies to hold additional
assets to protect policyholders due to the
monoline requirements for such business
and because of the volatility of their loss-
es.
The final regulations also apply the
rating-related circumstances provision to
financial guaranty insurance companies.

February 1, 2021 546 Bulletin No. 2021–5
Financial guaranty insurance is a line of
insurance business in which an insurer
guarantees scheduled payments of inter-
est and principal on a bond or other debt
security in the event of issuer default. The
policyholder of a financial guaranty insurer
is effectively paying for use of the insurer’s
credit rating. For example, if a municipality
insures its municipal bond obligations with
a financial guarantee insurer, the munici-
pality can charge a lower interest rate on its
bond, because the obligation is effectively
supported by the insurer’s high credit rat-
ing. A very high credit rating is thus essen-
tial for a financial guarantee insurer to write
new business. Furthermore (and similar to
mortgage guaranty insurers), rating agen-
cy capital standards for financial guaranty
insurers are geared to ensuring capital ad-
equacy in times of crisis and may require
a higher level of capital to obtain the same
rating as an insurer with a different portfo-
lio of risks. The combination of enhanced
rating agency capital requirements and the
need for a very high credit rating to write
new business often results in a financial
guaranty insurer being required at times
to hold assets in excess of 400 percent of
current insurance liabilities. The final reg-
ulations provide that a financial guaranty
insurance company that fails the 25 percent
test is deemed to automatically satisfy the
rating-related circumstances requirement,
but it must still satisfy the 10 percent test
in order to be treated as a QIC. The Trea-
sury Department and the IRS project that
the final regulations will more accurately
identify those insurance businesses whose
activities are economically similar to the
activities targeted by Congress in creating
the PFIC insurance exception and the alter-
native facts and circumstances election for
QIC treatment.
Relative to the proposed regulations, the
final regulations will likely permit fewer
foreign insurance corporations to qualify as
QICs due to rating-related circumstances,
and therefore may result in more such cor-
porations being designated as PFICs absent
other changes in business practices.
iii. Requirements for making the facts
and circumstances election and relief for
small shareholders
Under the statute, a U.S. shareholder
must make an election in order to treat a
foreign corporation that would not oth-
erwise be a QIC but that satisfies the al-
ternative facts and circumstances test (in-
cluding the 10 percent test) as a QIC. To
specify the terms of this election, the final
regulations specify that such election can-
not be made unless the foreign corpora-
tion directly provides the U.S. person with
a statement, or makes a publicly available
statement, indicating that the foreign cor-
poration satisfies the requirements of the
alternative facts and circumstances test,
including the 10 percent test, and includes
a brief description of its runoff-related or
rating-related circumstances. A sharehold-
er generally makes the election on Form
8621, which must be attached to the share-
holder’s U.S. federal income tax return for
each year in which the election applies.
For this election, the final regulations
further contain a provision under which a
U.S. person who owns stock with a value
of $25,000 or less ($50,000 or less if filing
a joint return) in a publicly traded foreign
corporation is deemed to make the alter-
native facts and circumstances election
with respect to the publicly traded foreign
corporation and its subsidiaries (“deemed
election”). If a shareholder owns stock
through a domestic partnership or other
domestic passthrough entity, an election
will not be deemed made unless the stock
held by the passthrough entity has a value
of $25,000 or less. All requirements nec-
essary to permit an actual election must be
satisfied in order to permit a deemed elec-
tion under this rule. These dollar amounts
were chosen in part because they were
consistent with the filing thresholds for
Part I of Form 8621.
A deemed election provision is not
required by the statute. The Treasury De-
partment and the IRS created the deemed
election to relieve the burden from tax-
payers of making an actual election. Small
domestic taxpayers may not be very fa-
miliar with the PFIC rules, may have
difficulty in determining their ownership
shares of possible PFICs and QICs, or
may not know how to obtain information
on whether a foreign corporation has pro-
vided the requisite statement regarding the
alternative facts and circumstances test,
especially if they are indirect owners.
The Treasury Department and the IRS
considered not providing such a deemed
election by small shareholders but decided
that the reduction in compliance burden
that the deemed election would provide
outweighed the tax administrative benefit
that a requirement for an explicit election
would provide. For example, under an ex-
plicit election, the IRS would know with
certainty that the taxpayer has made the
election.
The Treasury Department and the IRS
have not estimated the change in compli-
ance costs or administrative burden under
the final regulations versus an alternative
regulatory approach of requiring an affir-
mative election because they do not have
data or models that capture such items.
d. Passive income exception for income
and assets of QIC look-through entities
Under the statute, passive income does
not include income derived in the active
conduct of an insurance business by a
QIC, and assets held to produce such in-
come are treated as assets that produce
non-passive income. The final regulations
contain rules to clarify the application of
this rule. For example, certain companies
structure their insurance operations by
placing some or all of their investment
assets in one or more lower-tier invest-
ment corporations or partnerships while
investment managers are employed by the
QIC or by a related or unrelated service
provider. In these cases, unless there is
an attribution of non-passive status to the
income and assets of the lower-tier affili-
ated company, the QIC exclusion granted
to income earned by the “active” entity is
somewhat meaningless.
Under the general PFIC look-through
rules, a tested foreign corporation (TFC)
is treated as receiving directly its propor-
tionate share of the income, or holding
its proportionate share of the assets, of a
look-through subsidiary (LTS) or look-
through partnership (LTP), but the income
and assets generally retain the charac-
ter that they had in the hands of the LTS
or LTP for purposes of determining the
TFC’s PFIC status. See §1.1297-2(b) and
(c). Under the proposed regulations and
the final regulations, if certain require-
ments are met, otherwise-passive income
or assets of an LTS or LTP owned by a
QIC may be treated as active in the hands
of the QIC, to the extent that such income
is attributed to the active conduct of the

Bulletin No. 2021–5 547 February 1, 2021
QIC’s insurance business and such assets
are available to satisfy liabilities of the
QIC’s insurance business (“look-through
recharacterization rule”).
Under the proposed regulations, this
attribution of non-passive character to
otherwise-passive income and assets of
an LTS or LTP of a QIC was not allowed
unless the applicable financial statement
(AFS) used to test the QIC status of the
foreign corporation included the assets
and liabilities of the subsidiary entity. This
rule was intended to ensure that all other-
wise-passive LTS or LTP assets available
to satisfy the QIC’s insurance liabilities
and treated as non-passive under the look-
through recharacterization rule would also
necessarily be taken into account for pur-
poses of the 25 percent test for judging
the corporation’s QIC status. However,
assets and liabilities of a subsidiary entity
are not included on the parent’s financial
statement unless the financial statement
is prepared on a consolidated basis. If the
QIC’s AFS is prepared using separate en-
tity accounting, only the QIC’s share of
the net equity value of the lower-tier entity
would be included in assets under the 25
percent QIC test. Thus, a QIC could not
take advantage of the proposed QIC look-
through recharacterization rule unless it
used a consolidated financial statement as
its AFS.
A consolidated financial statement gen-
erally (but not always) requires at least a
50 percent ownership share in a controlled
subsidiary in order to include the assets
and liabilities of the subsidiary in the con-
solidated financial statement. Less-than-
50-percent subsidiaries generally must
be accounted for on an equity basis, such
that the financial statement reflects the net
equity value of the subsidiary. Thus, the
look-through recharacterization rule of
the proposed regulations would not have
allowed non-passive treatment of other-
wise-passive assets of an LTS unless the
QIC owned at least 50 percent interest
in the subsidiary and had a consolidated
AFS. This meant that the income and as-
sets of an LTS in which the QIC owned
between 25 percent and 50 percent interest
would generally be treated as passive un-
der the proposed regulations, even if all of
those income and assets were available to
satisfy the QIC’s insurance liabilities, be-
cause consolidated accounting treatment
was not available. A beneficial aspect of
the rule, however, was that it treated QICs
that chose to place their investment as-
sets in a wholly-owned subsidiary (which
would generally be consolidated with the
QIC for financial statement purposes) in
the same manner as QICs that conducted
their insurance operations and held their
investment assets in a single corporation.
These considerations led the Treasury
Department and the IRS to adopt an al-
ternative regulatory option. Under the fi-
nal regulations, the amount of assets and
income of an LTS or LTP that may be
treated as non-passive assets and income
of the QIC are limited, respectively, to
the greater of (i) the QIC’s proportionate
share of assets and income of the LTS or
LTP, respectively, multiplied by a fraction,
the numerator of which is the net equity
value of the interests held by the QIC in
the LTS or LTP, and the denominator of
which is the QIC’s proportionate share of
the value of assets of the LTS or LTP; or
(ii) the QIC’s proportionate share of assets
and income that are treated as non-passive
in the hands of the LTS or LTP without
regard to the look-through recharacter-
ization rule. This rule reflects the idea
that only assets of the LTP or LTS that
exceed the liabilities of the look-through
entity are available to satisfy liabilities
of the insurance business of the QIC and
should be excludible from passive income
under the QIC look-through recharacteri-
zation rule. However, if the general look-
through rules determine a greater amount
of non-passive assets or income, then that
rule prevails.
When assets are measured by val-
ue, rather than by adjusted basis, part (i)
of the above asset formula reduces the
amount of potentially non-passive assets
to the net equity value of the QIC’s own-
ership interest in the LTS or LTP. This is
the same asset value used in the 25 percent
test for testing QIC status in the case of a
non-consolidated AFS. Thus, this solution
ensures that assets treated as being avail-
able to satisfy insurance liabilities of the
QIC are also taken into account for the
purpose of the 25 percent test for judging
the corporation’s QIC status.
Whenever the QIC’s subsidiary has
liabilities, this rule will likely limit the
amount of the subsidiary’s assets and in-
come that are treated as non-passive under
the look-through recharacterization rule,
in which case the QIC would have a great-
er value of non-passive assets if it operated
instead as a single corporation. However,
the value of total assets used in the 25 per-
cent test would also be correspondingly
higher in that case, perhaps making it less
likely for the foreign insurance company
to satisfy the 25 percent test.
The Treasury Department and the IRS
have not estimated whether the adopt-
ed option would lead to different values
for amounts treated as non-passive as-
sets and non-passive income of QICs
under the insurance exception relative to
the no-action baseline. The Treasury and
the IRS do not have data or models that
could estimate quantitatively the relative
impacts of the alternatives considered.
However, the adopted option is expected
to result in a more accurate identification
of non-passive income used in the active
conduct of the QIC’s insurance business
and non-passive assets used to satisfy the
insurance liabilities of the QIC relative to
the no-action baseline and alternative reg-
ulatory approaches.
5. Number of Affected Taxpayers
A U.S. person must generally file a sep-
arate Form 8621 for each PFIC for which
it has an ownership interest. Exceptions
currently exist for persons that indirect-
ly own PFIC stock through another U.S.
shareholder of a PFIC, unless such per-
sons are required to report PFIC income or
need to file a Form 8621 in order to make
an election. Further exceptions exist under
current rules, including exemptions for
tax-exempt entities and for taxable U.S.
shareholders owning less than $25,000 in
aggregate PFIC stock ($50,000 if filing
a joint return) that is not owned through
another U.S. shareholder of a PFIC or
through another PFIC (unless such share-
holders are required to report PFIC in-
come or need to file a Form 8621 in order
to make an election).
The accompanying table indicates
how many persons have filed at least
one Form 8621 between 2016 and 2018
based on currently available IRS master
files of tax return filings. To date, nearly
62,000 Forms 8621 have been filed for
2018. Over 70 percent of the filings are
individuals. Another 27 percent are pass-

February 1, 2021 548 Bulletin No. 2021–5
through entities, the overwhelming num-
ber of which are partnerships, but which
also include S corporations, estates, and
non-grantor trusts. These pass-through
entities primarily have individuals as
partners, shareholders, or beneficiaries,
but may also have corporate partners.
It is likely there is some double count-
ing whereby both partnerships and part-
ners are filing a Form 8621 for the same
PFIC. C corporations constitute just over
one percent of these filings. Just under
two percent of Forms 8621 do not iden-
tify on the form the filing status of the
filer.
Table
Number of U.S. Persons Filing Form 8621
201620172018
Individuals36,97840,89143,406
Passthrough Entities
15,32616,13316,607
C Corporations
713733739
Unreported Filer Type1,1141,0531,084
All Entities54,13158,81061,836
In 2018, reporting taxpaying persons
filed an average of 12 Forms 8621. This
average was 11 forms for individuals, 16
forms for partnerships and other pass-
through entities, and 28 forms for C cor-
porations.
The Treasury Department and the
IRS do not have information in current
tax filings regarding how many U.S.
persons own shares in qualifying insur-
ance companies or how many potential
filings of Form 8621 would be avoided
by the regulatory provision regarding a
small investor deemed election for ap-
plying the facts and circumstances test
for purposes of the insurance income ex-
ception to passive income. In 2018 there
were 40 actual such elections made
on Form 8621, 26 of which involved
partnerships and 11 of which involved
non-grantor trusts, and only one that
was an individual.
The numbers in the accompanying ta-
ble provide a general idea of the number
of entities that must pay attention to the
final regulations but do not measure the
number of investors whose investment
decisions are affected by the final regula-
tions. This is because most current PFICs
will remain PFICs after application of the
final regulations. Similarly, most non-PF-
IC foreign corporations will continue not
to be PFICs after application of the final
regulations. The Treasury Department and
the IRS expect that only a small percent-
age of current PFIC and non-PFIC share-
holders will be affected by these regula-
tions.
II. Paperwork Reduction Act
The collections of information in these
final regulations are in §1.1297-1(d)(1)(ii)
(B), (d)(1)(iii), and (d)(1)(iv), §1.1297-
4(d)(5)(i), (ii), and (iii), and §1.1298-4(d)
(2). The information in all of the collec-
tions of information provided will be used
by the IRS for tax compliance purposes.
A. Collections of information under
existing tax forms
The collections of information in
§1.1297-1(d)(1)(ii)(B), (d)(1)(iii), and
(d)(1)(iv) are required to be provided by
taxpayers that make an election or revoke
an election to use an alternative measur-
ing period or adjusted bases to measure
assets for purposes of the Asset Test with
respect to a foreign corporation. These
collections of information are satisfied by
filing Form 8621 or attachments thereto.
For purposes of the Paperwork Reduction
Act, 44 U.S.C. 3501 et seq. (“PRA”), the
reporting burden associated with the col-
lection of information in the Form 8621
will be reflected in the Paperwork Re-
duction Act Submission associated with
that form (OMB control number 1545-
1002). If a Form 8621 is not required to
be filed, the collections of information
under §1.1297-1(d)(1)(ii)(B), (d)(1)(iii),
and (d)(1)(iv) are satisfied by attaching
a statement to the taxpayer’s return. For
purposes of the PRA, the reporting bur-
den associated with these collections of
information will be reflected in the Paper-
work Reduction Act Submissions associ-
ated with Forms 990-PF and 990-T (OMB
control number 1545-0047); Form 1040
(OMB control number 1545-0074); Form
1041 (OMB control number 1545-0092);
Form 1065 (OMB control number 1545-
0123); and Forms 1120, 1120-C, 1120-F,
1120-L, 1120-PC, 1120-REIT, 1120-RIC,
and 1120-S (OMB control number 1545-
0123).
The collection of information in
§1.1297-4(d)(5)(iii) is required to be pro-
vided by taxpayers that make an election
under section 1297(f)(2) to treat a foreign
corporation as a QIC in order to qualify
for the exception from passive income
under section 1297(b)(2)(B). In response
to comments addressing the notice of pro-
posed rulemaking preceding the final reg-
ulations, the Treasury Department and the
IRS have revised the collection of infor-
mation with respect to section 1297(f)(2).
The collection of information in
§1.1297-4(d)(5)(iii) requires a United
States person to make an election with
respect to an eligible foreign corporation
under section 1297(f)(2) by completing
the appropriate part of Form 8621 (or suc-
cessor form) for each taxable year of the
United States person in which the election
applies. In response to comments, §1.1297-
4(d)(5)(iv) generally provides that any
United States person that owns stock in a
publicly traded foreign corporation eligi-
ble for the election with a value of $25,000
or less ($50,000 or less if a joint return) is
deemed to make the election under section
1297(f)(2) without the need to file Form

Bulletin No. 2021–5 549 February 1, 2021
8621. This rule is intended to provide re-
lief to small shareholders who may not be
aware that an election is required. In addi-
tion, §1.1297-4(d)(5)(iii) provides that the
election under section 1297(f)(2) may be
made on an amended return.
The collection of information in
§1.1297-4(d)(5)(iii) is satisfied by filing
Form 8621. For purposes of the PRA, the
reporting burden associated with the col-
lection of information in the Form 8621
will be reflected in the Paperwork Reduc-
tion Act Submission associated with Form
8621 (OMB control number 1545-1002).
The number of entities subject to these
collections of information will be those
entities filing Form 8621 or attaching a
statement to their tax return. The number
of filers of Form 8621 in 2018 based on
current filings was approximately 62,000.
The Treasury Department and the IRS
project that at most, an additional 10 per-
cent of filers (6,200) that were not required
to file Form 8621 in 2018 may be subject
to these collections of information. Thus,
the upper bound estimate of the number
of entities subject to these collections of
information is 68,200.
The accompanying Table shows the
upper bound estimates of the number of
filers filing an election, by Form. The first
column shows estimates under the as-
sumption that all filers will file the required
election by filing Form 8621. The second
column shows these estimates under the
assumptions that: (i) filers who generally
file Form 8621 will file the required elec-
tion as part of the filing of Form 8621; and
(ii) an additional ten percent of filers will
file the required election as an attachment
to Form 1040, 1065, 1120-S, 1120, or oth-
er form, as appropriate.
6
Number of Filers (upper bound),
assuming all elections are made on
Form 8621
Number of Filers (upper bound),
assuming a portion of elections are
made as attachments to standard
forms
Attachment to Form 1040
0
4,300
Attachment to Form 1065 or 1120-S
0
1,700
Attachment to Form 1120 other than 1120-S
0
100
Attachment to Form 1040, 1065, 1120-S, 1120 or other
form (2018 Filing status unknown)
0
100
Form 8621
68,200
62,000
Total
68,200
68,200
Source: Compliance Data Warehouse (IRS). See text for explanation
6
Upper bound estimates of the number of filers who will file attachments to specific tax forms are derived by multiplying the number of filers shown in the Table in I.D.4. by 10 percent, for
each filing status. The Table in I.D.4 shows that there were 43,406 individuals, 16,607 passthrough entities, 739 corporations, and 1,084 unknown filers who filed Form 8621 in 2018 using
currently available filings, for a total of 61,836 filers.
The current status of the PRA submis-
sions related to the tax forms on which
reporting under these regulations will be
required is summarized in the following
table. The burdens associated with the
information collections in the forms are
included in aggregated burden estimates
for the OMB control numbers 1545-0047
(which represents a total estimated bur-
den time for all forms and schedules for
tax-exempt entities of 50.5 million hours
and total estimated monetized costs of
$3.59 billion ($2018)), 1545-0074 (which
represents a total estimated burden time
for all forms and schedules for individu-
als of 1.784 billion hours and total esti-
mated monetized costs of $31.764 billion
($2017)), 1545-0092 (which represents a
total estimated burden time for all forms
and schedules for trusts and estates of
307.8 million hours and total estimated
monetized costs of $9.95 billion ($2016)),
and 1545-0123 (which represents a total
estimated burden time for all forms and
schedules for corporations of 3.157 billion
hours and total estimated monetized costs
of $58.148 billion ($2017)). The burden
estimates provided in the OMB control
numbers in the following table are aggre-
gate amounts that relate to the entire pack-
age of forms associated with the OMB
control number, and will in the future in-
clude, but not isolate, the estimated bur-
den of only those information collections
associated with these final regulations.
These numbers are therefore unrelated to
the future calculations needed to assess
the burden imposed by these regulations.
To guard against over-counting the burden
that international tax provisions imposed
before the Act, the Treasury Department
and the IRS urge readers to recognize that
these burden estimates have also been cit-
ed by regulations (such as the foreign tax
credit regulations, 84 FR 69022) that rely
on the applicable OMB control numbers
in order to collect information from the
applicable types of filers.
In 2018, the IRS released and invit-
ed comment on drafts of Forms 990-PF
(Return of Private Foundation or Sec-
tion 4947(a)(1) Trust Treated as Private
Foundation), 990-T (Exempt Organiza-
tion Business Income Tax Return), 1040
(U.S. Individual Income Tax Return),
1041 (U.S. Income Tax Return for Estates
and Trusts), 1065 (U.S. Return of Part-
nership Income), 1120 (U.S. Corporation
Income Tax Return), and 8621 (Return by
a Shareholder of a Passive Foreign Invest-
ment Co. or Qualified Electing Fund). The
IRS received comments only regarding
Forms 1040, 1065, and 1120 during the

February 1, 2021 550 Bulletin No. 2021–5
comment period. After reviewing all such
comments, the IRS made the forms avail-
able on December 21, 2018 for use by the
public.
The Treasury Department and the IRS
have not estimated the burden for any
new information collections arising from
either the Act or these final regulations.
The Treasury Department and the IRS re-
quest comment on all aspects of informa-
tion collection burdens related to the final
regulations. In addition, when available,
drafts of IRS forms are posted for com-
ment at https://apps.irs.gov/app/picklist/
list/draftTaxForms.htm.
Form
Type of Filer
OMB
Number(s)
Status
Forms 990
Tax exempt entities
(NEW Model)
1545-0047Approved by OIRA 2/12/2020 until 2/28/2021.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201912-1545-014
Form 1040
Individual (NEW Model)1545-0074Approved by OIRA 1/30/2020 until 1/31/2021.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201909-1545-021
Form 1041
Trusts and estates1545-0092Approved by OIRA 5/08/2019 until 5/31/2022.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201806-1545-014
Form 1065 and 1120
Business (NEW Model)1545-0123Approved by OIRA 1/30/2020 until 1/31/2021.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201907-1545-001
Form 8621
Share-holders1545-1002Approved by OIRA 12/31/2018 until 12/31/2021.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201805-1545-007
B. Collections of information generally
not included on existing forms
The collection of information in
§1.1298-4(d)(2) is required for a foreign
corporation that relies on the rule in section
1298(b)(7) and §1.1298-4(b)(1). This col-
lection of information is satisfied by filing
a statement attached to the foreign corpora-
tion’s return. For purposes of the PRA, the
reporting burden associated with this col-
lection of information will be reflected in
the Paperwork Reduction Act Submissions
associated with Form 1120-F (OMB con-
trol number 1545-0123). The number of
affected filers, burden estimates, and PRA
status for this OMB control number are dis-
cussed in connection with the Form 1120 in
Part II.A of the Special Analyses.
Alternatively, if a foreign corporation
is not required to file a return, the collec-
tion of information in §1.1298-4(d)(2)
is satisfied by the foreign corporation’s
maintaining a statement in its records or
including it in its public filings.
The collection of information in
§1.1297-4(d)(5)(i) and (ii) is required for
a foreign corporation for which a taxpayer
makes an election under section 1297(f)
(2). In response to comments addressing
the notice of proposed rulemaking pre-
ceding the final regulations, the Treasury
Department and the IRS have revised
the collection of information from for-
eign corporations with respect to section
1297(f)(2). The collection of information
under §1.1297-4(d)(5)(i) and (ii) requires
a foreign corporation to provide a state-
ment to a shareholder or make a state-
ment publicly available. In response to
comments, §1.1297-4(d)(5)(i) permits a
foreign parent corporation to make a pub-
licly available statement on behalf of its
subsidiaries.
The collection of information con-
tained in §1.1298-4(d)(2) (for foreign cor-
porations that are not required to file Form
1120-F) and §1.1297-4(d)(5)(i) and (ii)
has been reviewed and approved by the
Office of Management and Budget under
control number [X].
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and tax
return information are confidential, as re-
quired by 26 U.S.C. 6103.
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is hereby
certified that the final regulations will not
have a significant economic impact on a
substantial number of small entities within
the meaning of section 601(6) of the Reg-
ulatory Flexibility Act (“small entities”).
The statutory provisions in sections
1291 through 1298 (the “PFIC regime”)
generally affect U.S. taxpayers that have
ownership interests in foreign corpora-
tions that are not CFCs.
A U.S. person must generally file a sep-
arate Form 8621 for each PFIC for which
it has an ownership interest. To date, near-
ly 62,000 Forms 8621 have been filed for
2018. Over 70 percent of the filings are
individuals. Another 27 percent are pass-
through entities, the overwhelming num-
ber of which are partnerships, but which
also include S corporations, estates, and
non-grantor trusts. These pass-through
entities primarily have individuals as
partners, shareholders, or beneficiaries,
but may also have corporate partners. It
is likely there is some double counting
whereby both partnerships and partners
are filing a Form 8621 for the same PFIC.
C corporations constitute just over one

Bulletin No. 2021–5 551 February 1, 2021
percent of these filings. Nearly two per-
cent of Forms 8621 do not identify the fil-
ing status of the filer.
Regardless of the number of small en-
tities potentially affected by the final reg-
ulations, the Treasury Department and the
IRS have concluded that there is no signif-
icant economic impact on small entities as
a result of the final regulations based on
the following argument.
To provide a bound on the impact of
these regulations on businesses, the Trea-
sury Department and the IRS calculated
the ratio of the PFIC regime tax to (gross)
total income for 2013 through 2018 for
C corporations that filed the Form 8621.
Total income was determined by matching
each C corporation filing the Form 8621
to its Form 1120. Ordinary QEF income,
QEF capital gains, and mark-to-market
income were assumed to be taxed at 35
percent (21 percent for 2018), and the
section 1291 tax and interest charge were
included as reported. Only those corpora-
tions where a match was found and that
had positive total income were included
in the analysis. For the approximately 150
to 300 C corporations for which a match
was available in a given year, the average
annual ratio of the calculated tax to total
income was never greater than 0.00035
percent. For the approximately 60 to 200
C corporations with total income of $25
million or less for which a match was
available, the average annual ratio was
never greater than 1.08 percent.
201320142015201620172018
($ millions)
All C corporations
Tax5121482242
Total Income4,204,79510,154,52019,935,84520,076,87621,625,15913,317,244
Tax to Total Income0.000%0.000%0.000%0.000%0.000%0.000%
C corporations with total income of $25 million or less
Tax**4453
Total Income463563627573460741
Tax to Total Income0.060%0.014%0.576%0.689%1.068%0.400%
Source: RAAS, CDW. * indicates less than $1 million.
The economic impact of the final reg-
ulations will generally be a small fraction
of the calculated tax and thus considerably
smaller than the effects reported in the ta-
ble. Thus, the economic impact of the final
regulations should not be regarded as sig-
nificant under the Regulatory Flexibility
Act.
A portion of the economic impact of
the final regulations may derive from the
collection of information requirements
imposed by §1.1297-1(d)(1)(ii)(B), (d)(1)
(iii)(B), and (d)(1)(iv) and §1.1297-4(d)
(5)(iii). The Treasury Department and
the IRS have determined that the average
burden is 1 hour per response. The IRS’s
Research, Applied Analytics, and Statis-
tics division estimates that the appropriate
wage rate for this set of taxpayers is $95
per hour. Thus, the annual burden per tax-
payer from the collection of information
requirement is $95. These requirements
apply only if a taxpayer chooses to make
an election or rely on a favorable rule.
Accordingly, it is hereby certified
that the final rule would not have a sig-
nificant economic impact on a substan-
tial number of small entities. Pursuant to
section 7805(f), the proposed regulations
preceding these final regulations (REG-
105474-18) were submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on their
impact on small business. The proposed
regulations also solicited comments from
the public on both the number of entities
affected (including whether specific in-
dustries are affected) and the economic
impact of this proposed rule on small enti-
ties. No comments were received.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 (UMRA) requires
that agencies assess anticipated costs and
benefits and take certain other actions be-
fore issuing a final rule that includes any
Federal mandate that may result in expen-
ditures in any one year by a state, local,
or tribal government, in the aggregate, or
by the private sector, of $100 million in
1995 dollars, updated annually for infla-
tion. This rule does not include any Fed-
eral mandate that may result in expendi-
tures by state, local, or tribal governments,
or by the private sector in excess of that
threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive Order. This final rule does
not have federalism implications and does
not impose substantial direct compliance
costs on state and local governments or
preempt state law within the meaning of
the Executive Order.
VI. Congressional Review Act
Pursuant to the Congressional Review
Act (5 U.S.C. 801 et seq.), the Office of
Information and Regulatory Affairs des-
ignated this rule as not a ‘major rule’, as
defined by 5 U.S.C. 804(2).

February 1, 2021 552 Bulletin No. 2021–5
Statement of Availability of IRS
Documents
IRS Revenue Procedures, Revenue
Rulings, notices, and other guidance cit-
ed in this document are published in the
Internal Revenue Bulletin (or Cumulative
Bulletin) and are available from the Su-
perintendent of Documents, U.S. Govern-
ment Publishing Office, Washington, DC
20402, or by visiting the IRS website at
www.irs.gov.
Drafting Information
The principal drafters of these regula-
tions are Josephine Firehock and Christina
Daniels of the Office of Associate Chief
Counsel (International). Other personnel
from the Treasury Department and the
IRS also participated in the development
of these regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amend-
ed as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding entries for §§
1.1297-1, 1.1297-2, 1.1297-4, 1.1297-5,
1.1297-6, 1.1298-2, and 1.1298-4 in nu-
merical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1297-1 also issued under 26
U.S.C. 1298(g).
Section 1.1297-2 also issued under 26
U.S.C. 1298(g).
* * * * *
Section 1.1297-4 also issued under 26
U.S.C. 1297(b)(2)(B) and 1298(g).
Section 1.1297-5 also issued under 26
U.S.C. 1297(b)(2)(B) and 1298(g).
Section 1.1297-6 also issued under 26
U.S.C. 1297(b)(2)(B) and 1298(g).
* * * * *
Section 1.1298-2 also issued under 26
U.S.C. 1298(b)(3) and (g).
Section 1.1298-4 also issued under 26
U.S.C. 1298(g).
* * * * *
Par. 2. Section 1.1291-0 is amended by:
1. Redesignating the entry for §1.1291-
1(b)(8)(iv) as the entry for §1.1291-1(b)
(8)(v).
2. Adding a new entry for §1.1291-1(b)
(8)(iv).
3. Adding entries for newly redesignat-
ed §1.1291-1(b)(8)(v)(A) and (B), (b)(8)
(v)(A)(1) and (2), (b)(8)(v)(A)(2)(i) and
(ii), (b)(8)(v)(B)(1) and (2), (b)(8)(v)(C),
(b)(8)(v)(C)(1) and (2), (b)(8)(v)(D), (b)
(8)(v)(D)(1) and (2).
The revisions and additions read as fol-
lows:
§1.1291-0 Treatment of shareholders
of certain passive foreign investment
companies; table of contents.
* * * * *
§1.1291-1 Taxation of U.S. persons that
are shareholders of section 1291 funds.
* * * * *
(b) * * *
(8) * * *
(iv) Successive application.
(v) Examples.
(A) Example 1.
(1) Facts.
(2) Results.
(i) Treatment of DC.
(ii) Treatment of A.
(B) Example 2.
(1) Facts.
(2) Results.
(C) Example 3.
(1) Facts.
(2) Results.
(D) Example 4.
(1) Facts.
(2) Results.
* * * * *
Par. 3. Section 1.1291-1 is amended by:
1. Redesignating paragraph (b)(8)(iv)
as paragraph (b)(8)(v).
2. Adding new paragraph (b)(8)(iv).
3. Redesignating Example 1 in newly
redesignated paragraph (b)(8)(v) as para-
graph (b)(8)(v)(A).
4. Revising newly redesignated para-
graph (b)(8)(v)(A).
5. Adding paragraphs (b)(8)(v)(B), (C),
and (D).
6. Revising paragraph (j)(3).
7. Adding paragraph (j)(4).
The revisions and additions read as fol-
lows:
§1.1291-1 Taxation of U.S. persons that
are shareholders of section 1291 funds.
* * * * *
(b) * * *
(8) * * *
(iv) Successive application. Stock
considered to be owned by a person by
reason of paragraphs (b)(8)(ii) or (iii) of
this section is, for purposes of applying
such paragraphs, considered to be actual-
ly owned by such person. Subject to the
limitations provided in section 1298(a)
and paragraphs (b)(8)(ii) and (b)(8)(iii)
of this section, this paragraph applies by
successively considering a person as ac-
tually owning its proportionate share of
stock or other equity interest directly held
by an entity directly owned by the person.
Paragraph (b)(8)(ii)(C)(2) of this section
applies after the other subparagraphs of
paragraph (b)(8) of this section.
(v) Examples. The rules of this para-
graph (b)(8) are illustrated by the follow-
ing examples:
(A) Example 1—(1) Facts. A is a United States
person who owns 49% of the stock of FC1, a foreign
corporation that is not a PFIC, and separately all of
the stock of DC, a domestic corporation that is not an
S corporation. DC, in turn, owns the remaining 51%
of the stock of FC1, and FC1 owns 100 shares of
stock in a PFIC that is not a controlled foreign corpo-
ration (CFC) within the meaning of section 957(a).
The remainder of the PFIC’s shares are owned by
unrelated foreign persons.
(2) Results—(i) Treatment of DC. Under para-
graph (b)(8)(ii)(A) of this section, DC is considered
to actually own 51 shares of the PFIC stock directly
held by FC1 because DC directly owns 50% or more
of the stock of FC1.
(ii) Treatment of A. In determining whether A is
considered to own 50% or more of the value of FC1
for purposes of applying paragraphs (b)(8)(ii)(A)
and (b)(8)(iv) of this section to the PFIC stock held
through FC1, A is considered under paragraphs (b)
(8)(ii)(C)(1) and (b)(8)(iv) of this section as indirect-
ly owning all the stock of FC1 that DC directly owns,
before the application of paragraph (b)(8)(ii)(C)(2)
of this section. Because A also directly owns 49% of
the stock of FC1, before the application of paragraph
(b)(8)(ii)(C)(2) of this section A would be treated as

Bulletin No. 2021–5 553 February 1, 2021
owning all 100 shares of PFIC stock held by FC1.
However, because 51 shares of the PFIC stock held
by FC1 are indirectly owned by DC under paragraph
(b)(8)(ii)(A) of this section, pursuant to the limita-
tion imposed by paragraph (b)(8)(ii)(C)(2) of this
section, only the remaining 49 shares of the PFIC
stock are considered as indirectly owned by A under
paragraph (b)(8) of this section.
(B) Example 2—(1) Facts. B, a United States
citizen, owns 50% of the interests in Foreign Part-
nership, a foreign partnership treated as a partnership
for U.S. federal income tax purposes, the remaining
interests in which are owned by an unrelated foreign
person. Foreign Partnership owns 100% of the stock
of FC1 and 50% of the stock of FC2, the remainder
of which is owned by an unrelated foreign person.
Both FC1 and FC2 are foreign corporations that are
not PFICs. FC1 and FC2 each own 50% of the stock
of FC3, a foreign corporation that is a PFIC.
(2) Results. Under paragraphs (b)(8)(iii)(A) and
(b)(8)(iv) of this section, for purposes of determining
whether B is a shareholder of FC3, B is considered
to actually own 50% (50% x 100%) of the stock of
FC1 and 25% (50% x 50%) of the stock of FC2.
Under paragraphs (b)(8)(ii)(A) and (b)(8)(iv) of this
section, B is then considered to own 25% (50% x
100% x 50%) of the stock of FC3 indirectly through
FC1, and thus is a shareholder of FC3 for purposes of
the PFIC provisions. Because B is considered to own
less than 50% of FC2, B is not considered to own any
stock of FC3 indirectly through FC2.
(C) Example 3—(1) Facts. The facts are the same
as in paragraph (b)(8)(v)(B)(1) of this section (the
facts in Example 2), except that B owns 40% of the
interests in Foreign Partnership.
(2) Results. Under paragraph (b)(8)(iii)(A) and
(b)(8)(iv) of this section, for purposes of determin-
ing whether B is a shareholder of FC3, B is con-
sidered to actually own 40% (40% x 100%) of the
stock of FC1 and 20% (40% x 50%) of the stock
of FC2, and thus is not considered to own 50% or
more of the stock of FC1 or FC2. Under paragraphs
(b)(8)(ii)(A) and (b)(8)(iv) of this section, B is
not considered to own any stock of FC3 indirectly
through FC1 or FC2.
(D) Example 4—(1) Facts. The facts are the
same as in paragraph (b)(8)(v)(C)(1) of this section
(the facts in Example 3), except that FP owns only
80% of FC1 and B also directly owns 20% of FC1.
(2) Results. Under paragraph (b)(8)(iii)(A) and
(b)(8)(iv) of this section, for purposes of determining
whether B is a shareholder of FC3, B is considered
to own 32% (40% x 80%) of the stock of FC1 and
20% (40% x 50%) of the stock of FC2. Because B di-
rectly owns 20% of FC1, B is considered to actually
own 52% (32% + 20%) of the stock of FC1 in total.
Under paragraphs (b)(8)(ii)(A) and (b)(8)(iv) of this
section, B is considered to own 26% (52% x 50%) of
the stock of FC3 indirectly through FC1, and thus is
a shareholder of FC3 for purposes of the PFIC pro-
visions. B is not considered to own any stock of FC3
indirectly through FC2.
* * * * *
(j) * * *
(3) Except as otherwise provided in
paragraph (j)(4) of this section, para-
graphs (b)(2)(ii) and (v), (b)(7) and (8),
and (e)(2) of this section apply to taxable
years of shareholders ending on or after
December 31, 2013.
(4) Paragraphs (b)(8)(iv) and (b)(8)
(v)(A), (B), (C), and (D) of this section
apply for taxable years of shareholders
beginning on or after January 14, 2021.
A shareholder may choose to apply such
paragraphs for any open taxable year be-
ginning before January 14, 2021, provided
that, with respect to a tested foreign cor-
poration, the shareholder consistently ap-
plies such paragraphs and the provisions
of §§1.1297-1 (except that consistent
treatment is not required with respect to
§1.1297-1(c)(1)(i)(A)), 1.1297-2, 1.1297-
4, 1.1297-6, 1.1298-2, and 1.1298-4 for
such year and all subsequent years.
Par. 4. Section 1.1297-0 is amended by
revising the introductory text and adding
entries for §§1.1297-1, 1.1297-2, 1.1297-
4, 1.1297-5, and 1.1297-6 in numerical
order to read as follows:
§1.1297-0 Table of contents.
This section contains a listing of
the headings for §§1.1297-1, 1.1297-
2, 1.1297-3, 1.1297-4, 1.1297-5, and
1.1297-6.
§1.1297-1 Definition of passive foreign
investment company.
(a) Overview.
(b) Dividends included in gross in-
come.
(1) General rule.
(2) Example.
(i) Facts.
(ii) Results.
(c) Passive income.
(1) Foreign personal holding company
income.
(i) General rule.
(ii) Determination of gross income or
gain on a net basis for certain items of for-
eign personal holding company income.
(iii) Amounts treated as dividends.
(2) [Reserved].
(3) Passive treatment of dividends and
distributive share of partnership income.
(4) Exception for certain interest, divi-
dends, rents, and royalties received from a
related person.
(i) In general.
(ii) Ordering rule.
(iii) Allocation of interest.
(iv) Allocation of dividends.
(A) In general.
(B) Dividends paid out of current earn-
ings and profits.
(C) Dividends paid out of accumulated
earnings and profits.
(v) Allocation of rents and royalties.
(vi) Determination of whether amounts
are received or accrued from a related per-
son.
(vii) Allocation of distributive share of
income from related partnership.
(d) Asset test.
(1) Calculation of average annual value
(or adjusted bases).
(i) General rule.
(ii) Measuring period.
(A) General rule.
(B) Election to use alternative measur-
ing period.
(C) Short taxable year.
(iii) Adjusted basis election.
(iv) Time and manner of elections and
revocations.
(A) Elections.
(B) Revocations and subsequent elec-
tions.
(v) Method of measuring assets.
(A) Publicly traded foreign corpora-
tions.
(B) Non-publicly traded controlled for-
eign corporation.
(1) In general.
(2) Controlled foreign corporation de-
termination.
(C) Other foreign corporations.
(1) In general.
(2) Lower-tier subsidiaries.
(i) Lower-tier subsidiaries that are pub-
licly traded foreign corporations.
(ii) Lower-tier subsidiaries that are
non-publicly traded controlled foreign
corporations.
(iii) Other lower-tier subsidiaries.
(D) [Reserved].
(E) Examples.
(1) Example 1.
(i) Facts.
(ii) Results.
(2) Example 2.
(i) Facts.
(ii) Results.
(3) Example 3.

February 1, 2021 554 Bulletin No. 2021–5
(i) Facts.
(ii) Results.
(2) [Reserved].
(3) Dual-character assets.
(i) General rule.
(ii) Special rule when only part of an
asset produces income.
(iii) Special rule for stock that previ-
ously produced income that was exclud-
ed from passive income under section
1297(b)(2)(C).
(iv) Example.
(A) Facts.
(B) Results.
(4) Passive treatment of stock and part-
nership interests.
(5) Dealer property.
(e) Stapled stock.
(f) Definitions.
(1) Measuring date.
(2) Measuring period.
(3) Non-passive asset.
(4) Non-passive income.
(5) Passive asset.
(6) Passive income.
(7) Publicly traded foreign corporation.
(8) Related person.
(9) Tested foreign corporation.
(g) Applicability date.
(1) In general.
(2) Paragraph (d)(1)(v)(B)(2) of this
section.
§1.1297-2 Special rules regarding look-
through subsidiaries and look-through
partnerships.
(a) Overview.
(b) General rules.
(1) Tested foreign corporation’s owner-
ship of a corporation.
(2) Tested foreign corporation’s pro-
portionate share of the assets and income
of a look-through subsidiary.
(i) Proportionate share of subsidiary
assets.
(ii) Proportionate share of subsidiary
income.
(A) General rule.
(B) Partial year.
(iii) Coordination of section 1297(c)
with section 1298(b)(7).
(3) Tested foreign corporation’s pro-
portionate share of the assets and income
of a look-through partnership.
(i) Proportionate share of partnership
assets.
(ii) Proportionate share of partnership
income.
(A) General rule.
(B) Partial year.
(4) Examples.
(i) Example 1.
(A) Facts.
(B) Results.
(1) LTS.
(2) TFC.
(ii) Example 2.
(A) Facts.
(B) Results.
(iii) Example 3.
(A) Facts.
(B) Results.
(c) Elimination of certain intercompa-
ny assets and income.
(1) General rule for asset test.
(i) LTS stock.
(ii) LTS obligation.
(2) General rule for income test.
(i) LTS stock.
(ii) LTS obligation.
(3) Partnerships.
(4) Examples.
(i) Example 1.
(A) Facts.
(B) Results.
(1) LTS.
(2) TFC.
(ii) Example 2.
(A) Facts.
(B) Results.
(iii) Example 3.
(A) Facts.
(B) Results.
(iv) Example 4.
(A) Facts.
(B) Results.
(v) Example 5.
(A) Facts.
(B) Results.
(1) Asset test.
(2) Income test.
(3) Treatment of intangible and rental
property.
(d) Related person determination for
purposes of section 1297(b)(2)(C).
(1) General rule.
(2) Example.
(i) Facts.
(ii) Results.
(e) Treatment of activities of certain
look-through subsidiaries and look-
through partnerships for purposes of cer-
tain exceptions.
(1) General rule.
(2) Qualified affiliate.
(3) Examples.
(i) Example 1.
(A) Facts.
(B) Results.
(1) Qualified affiliates.
(2) FS1 and FS2.
(3) FS4.
(ii) Example 2.
(A) Facts.
(B) Results.
(iii)Example 3.
(A) Facts.
(B) Results.
(f) Gain on disposition of a look-
through subsidiary or look-through part-
nership.
(1) [Reserved].
(2) Amount of gain taken into account
from disposition of look-through subsid-
iary.
(3) Characterization of residual gain as
passive income.
(4) Gain taken into account from dis-
position of 25%-owned partnerships and
look-through partnerships.
(i) Section 954(c)(4) partnerships.
(ii) Look-through partnerships.
(5) Examples.
(i) Example 1.
(A) Facts.
(B) Results.
(ii) Example 2.
(A) Facts.
(B) Results.
(iii) Example 3.
(A) Facts.
(B) Results.
(g) Definitions.
(1) Direct LTS obligation.
(2) Indirect LTS obligation.
(3) Look-through subsidiary.
(4) Look-through partnership.
(i) In general.
(ii) Active partner test.
(A) Partnership interest under asset
test.
(B) Partnership income under income
test.
(iii) Election.
(iv) Examples.
(A) Example 1.
(1) Facts.
(2) Results.
(i) Active partner test with respect to
partnership interest.

Bulletin No. 2021–5 555 February 1, 2021
(ii) Active partner test with respect to
partnership income.
(iii) Qualification of look-through part-
nership.
(B) Example 2.
(1) Facts.
(2) Results.
(i) Active partner test with respect to
partnership interest.
(ii) Active partner test with respect to
partnership income.
(iii) Failure to qualify as look-through
partnership.
(5) LTS debt.
(6) LTS lease.
(7) LTS license.
(8) LTS obligation.
(9) LTS stock.
(10) Qualified affiliate.
(11) Residual gain.
(12) TFC obligation.
(13) Unremitted earnings.
(h) Applicability date.
* * * * *
§1.1297-4 Qualifying insurance
corporation.
(a) Scope.
(b) Qualifying insurance corporation.
(c) 25 percent test.
(d) Election to apply the alternative
facts and circumstances test.
(1) In general.
(2) Predominantly engaged in an insur-
ance business.
(i) In general.
(ii) Facts and circumstances.
(iii) Examples of facts indicating a for-
eign corporation is not predominantly en-
gaged in an insurance business.
(3) Runoff-related circumstances.
(4) Rating-related circumstances.
(5) Election.
(i) In general.
(ii) Information provided by foreign
corporation.
(iii) Time and manner for making the
election.
(iv) Deemed election for small share-
holders in publicly traded companies.
(A) In general.
(B) Publicly traded stock.
(v) Options.
(6) Stock ownership.
(e) Rules limiting the amount of appli-
cable insurance liabilities.
(1) In general.
(2) General limitation on applicable in-
surance liabilities.
(3) Discounting.
(4) [Reserved].
(5) [Reserved].
(f) Definitions.
(1) Applicable financial statement.
(i) GAAP statements.
(ii) IFRS statements.
(iii) Regulatory annual statement.
(iv) [Reserved].
(2) Applicable insurance liabilities.
(i) In general.
(ii) Amounts not specified in paragraph
(f)(2)(i) of this section.
(3) Applicable insurance regulatory
body.
(4) Applicable reporting period.
(5) Financial guaranty insurance com-
pany.
(6) Financial statements.
(i) In general.
(ii) [Reserved].
(iii) [Reserved].
(7) Generally accepted accounting
principles or GAAP.
(8) Insurance business.
(9) International financial reporting
standards or IFRS.
(10) Mortgage insurance company.
(11) Total assets.
(g) Applicability date.
§1.1297-5 [Reserved].
§1.1297-6 Exception from the definition
of passive income for active insurance
income.
(a) Scope.
(b) Exclusion from passive income of
active insurance income.
(c) Exclusion of assets for purpos-
es of the passive asset test under section
1297(a)(2).
(d) Treatment of income and assets of
certain look-through subsidiaries and look
through partnerships for purposes of the
section 1297(b)(2)(B) exception.
(1) General rule.
(2) Limitation.
(3) Examples.
(i) Example 1: QIC holds all the stock
of an investment subsidiary.
(A) Facts.
(B) Result.
(C) Alternative Facts.
(1) Facts.
(2) Result.
(ii) Example 2: QIC holds all the stock
of an operating subsidiary.
(A) Facts.
(B) Result.
(e) Qualifying domestic insurance cor-
poration.
(1) General rule.
(2) [Reserved].
(3) [Reserved].
(f) Applicability date.
Par. 5. Sections 1.1297-1 and 1.1297-2
are added to read as follows:
§1.1297-1 Definition of passive foreign
investment company.
(a) Overview. This section provides
rules concerning the income test set forth
in section 1297(a)(1) and the asset test set
forth in section 1297(a)(2). Paragraph (b)
of this section provides a rule relating to
the definition of gross income with respect
to certain dividends that are excluded
from gross income under section 1502 for
purposes of section 1297. Paragraph (c) of
this section provides rules relating to the
definition of passive income for purpos-
es of section 1297. Paragraph (d) of this
section provides rules relating to the asset
test of section 1297. See §§1.1297-2 and
1.1297-6 for additional rules concerning
the treatment of the income and assets of a
corporation subject to look-through treat-
ment under section 1297(c). Paragraph (e)
of this section provides rules relating to
the determination of passive foreign in-
vestment company (PFIC) status for sta-
pled entities. Paragraph (f) of this section
provides definitions applicable for this
section, and paragraph (g) of this section
provides the applicability date of this sec-
tion.
(b) Dividends included in gross in-
come—(1) General rule. For purposes
of section 1297, gross income includes
dividends that are excluded from gross in-
come under section 1502 and §1.1502-13.
(2) Example—(i) Facts. USP is a domestic cor-
poration that owns 30% of TFC, a foreign corpora-
tion. The remaining 70% of TFC is owned by FP,
a foreign corporation that is unrelated to USP. TFC
owns 25% of the value of USS1, a domestic cor-
poration. USS1 owns 80% of the value of USS2, a
domestic corporation. USS1 and USS2 are members
of an affiliated group (as defined in section 1504(a))

February 1, 2021 556 Bulletin No. 2021–5
filing a consolidated return. USS2 distributes a divi-
dend to USS1 that is excluded from USS1’s income
pursuant to §1.1502-13 for purposes of determining
the U.S. Federal income tax liability of the affiliated
group of which USS1 and USS2 are members.
(ii) Results. Although the dividend received by
USS1 from USS2 is excluded from USS1’s income
for purposes of determining the U.S. Federal income
tax liability of the affiliated group of which USS1
and USS2 are members, pursuant to paragraph (b)
(1) of this section, for purposes of section 1297,
USS1’s gross income includes the USS2 dividend.
Accordingly, for purposes of section 1297, TFC’s
gross income includes 25% of the dividend received
by USS1 from USS2 pursuant to section 1297(c)
and §1.1297-2(b)(2)(ii). See section 1298(b)(7) and
§1.1298-4 for rules concerning the characterization
of the USS2 dividend.
(c) Passive income—(1) Foreign per-
sonal holding company income—(i) Gen-
eral rule. For purposes of section 1297(b)
(1), except as otherwise provided in sec-
tion 1297(b)(2), this section, and §1.1297-
6, the term passive income means income
of a kind that would be foreign personal
holding company income as defined un-
der section 954(c). For the purpose of this
paragraph (c)(1)—
(A) The exceptions to foreign person-
al holding company income in section
954(c)(1), 954(c)(2)(A) (relating to active
rents and royalties), 954(c)(2)(B) (relating
to export financing income), and 954(c)
(2)(C) (relating to dealers) are taken into
account;
(B) The exceptions in section 954(c)
(3) (relating to certain income received
from related persons), 954(c)(6) (relating
to certain amounts received from relat-
ed controlled foreign corporations), and
954(i) (relating to entities engaged in the
active conduct of an insurance business)
are not taken into account;
(C) The rules in section 954(c)(4) (re-
lating to sales of certain partnership in-
terests) and 954(c)(5) (relating to certain
commodity hedging transactions) are tak-
en into account; and
(D) An entity is treated as a controlled
foreign corporation within the meaning
of section 957(a) for purposes of ap-
plying an exception to foreign person-
al holding company income in section
954(c)(1)(B)’s flush language, (1)(C)(ii),
(1)(D), (4), and (5) and §1.954-2 and for
purposes of identifying whether a person
is a related person with respect to such
entity within the meaning of section
954(d)(3).
(ii) Determination of gross income or
gain on a net basis for certain items of
foreign personal holding company in-
come. For purposes of section 1297, the
excess of gains over losses from property
transactions described in section 954(c)
(1)(B), the excess of gains over losses
from transactions in commodities de-
scribed in section 954(c)(1)(C), the ex-
cess of foreign currency gains over for-
eign currency losses described in section
954(c)(1)(D), and positive net income
from notional principal contracts de-
scribed in section 954(c)(1)(F) are taken
into account as gross income. The excess
of gains over losses (or, with respect to
notional principal contracts, positive net
income) for a category of transactions is
calculated by a tested foreign corporation
taking into account individual items of
gain or loss (or, with respect to notional
principal contracts, net income or net de-
duction) recognized by the tested foreign
corporation and those items of gain or
loss (or, with respect to notional principal
contracts, net income or net deduction)
treated as recognized by the tested for-
eign corporation with respect to its look-
through subsidiaries and look-through
partnerships pursuant to section 1297(c)
and §1.1297-2(b)(2) or (3).
(iii) Amounts treated as dividends. For
purposes of section 1297, the term divi-
dend includes all amounts treated as divi-
dends for purposes of this chapter, includ-
ing amounts treated as dividends pursuant
to sections 302, 304, 356(a)(2), 964(e),
and 1248.
(2) [Reserved].
(3) Passive treatment of dividends and
distributive share of partnership income.
For purposes of section 1297, a tested
foreign corporation’s share of dividends
received from a corporation that is not a
look-through subsidiary (as defined in
§1.1297-2(g)(3)) and distributive share of
any item of income of a partnership that
is not a look-through partnership (as de-
fined in §1.1297-2(g)(4)) with respect to
a tested foreign corporation are treated as
passive income, except to the extent that
the item of income would not be treated as
passive under section 1297(b)(2)(C) and
paragraph (c)(4) of this section.
(4) Exception for certain interest,
dividends, rents, and royalties received
from a related person—(i) In general.
For purposes of section 1297(b)(2)(C),
interest, dividends, rents, or royalties
actually received or accrued by a tested
foreign corporation are considered re-
ceived or accrued from a related person
only if the payor of the interest, dividend,
rent, or royalty is a related person (with-
in the meaning of section 954(d)(3))
with respect to the tested foreign cor-
poration, taking into account paragraph
(c)(1)(i)(D) of this section. For rules
determining when amounts received or
accrued by a look-through subsidiary or
look-through partnership (and treated as
received directly by a tested foreign cor-
poration pursuant to section 1297(c) and
§1.1297-2(b)(2) and (b)(3)) are treated
as received from a related person, see
§1.1297-2(d).
(ii) Ordering rule. Gross income that is
interest, a dividend, or a rent or royalty that
is, in each case, received or accrued from
a related person is allocated to income that
is not passive under the rules of this para-
graph (c)(4). If the related person is also a
look-through subsidiary or a look-through
partnership with respect to the tested for-
eign corporation, this paragraph (c)(4) ap-
plies after the application of the intercom-
pany income rules of §1.1297-2(c).
(iii) Allocation of interest. For purpos-
es of section 1297(b)(2)(C), interest that
is received or accrued, as applicable based
on the recipient’s method of accounting,
from a related person is allocated to in-
come of the related person that is not
passive income in proportion to the ra-
tio of the portion of the related person’s
non-passive gross income for its taxable
year that ends with or within the taxable
year of the recipient to the total amount
of the related person’s gross income for
the taxable year. If the related person does
not have gross income for the taxable
year that ends with or within the taxable
year of the recipient, the interest is either
allocated to income of the related person
that is not passive income to the extent the
related person’s deduction for the interest
would be allocable to non-passive income
of the related person under the principles
of §§1.861-9 through 1.861-13T, applied
in a reasonable and consistent manner
taking into account the general operation
of the PFIC rules and the purpose of sec-

Bulletin No. 2021–5 557 February 1, 2021
tion 1297(b)(2)(C) or, alternatively, at the
election of the tested foreign corporation
is treated as allocated entirely to passive
income.
(iv) Allocation of dividends—(A) In
general. For purposes of section 1297(b)
(2)(C), the principles of §1.316–2(a)
apply in determining from what year’s
earnings and profits a dividend from a
related person is treated as distributed. A
dividend is considered to be distributed,
first, out of the earnings and profits of the
taxable year of the related person that in-
cludes the date the dividend is distribut-
ed (current earnings and profits) and that
ends with or within the taxable year of
the recipient; second, out of the earnings
and profits accumulated for the immedi-
ately preceding taxable year of the relat-
ed person; third, out of the earnings and
profits accumulated for the second pre-
ceding taxable year of the related person;
and so forth. For purposes of paragraph
(c)(4)(iv) of this section, the principles
of §1.243-4(a)(6) apply with respect to a
deficit in an earnings and profits account
for a prior year.
(B) Dividends paid out of current earn-
ings and profits. To the extent that a div-
idend is paid out of current earnings and
profits of the related person for its taxable
year that ends with or within the taxable
year of the recipient, the dividend is treat-
ed as paid ratably out of earnings and
profits attributable to passive income and
to non-passive income. The portion of the
current earnings and profits that is treated
as paid out of non-passive income of the
related person may be determined by mul-
tiplying the current earnings and profits by
the ratio of the related person’s non-pas-
sive gross income as determined under
this section (including paragraph (c)(1)
(ii) of this section) for the taxable year to
its total gross income as determined under
this section (including paragraph (c)(1)(ii)
of this section) for that year.
(C) Dividends paid out of accumulated
earnings and profits. To the extent that a
dividend from a related person is treated
as paid out of the related person’s accu-
mulated earnings and profits, the dividend
is treated as paid ratably out of accumu-
lated earnings and profits of the related
person for prior taxable years (beginning
with the most recently accumulated) that
are attributable to passive income and to
non-passive income, which may be deter-
mined in the same manner as in paragraph
(c)(4)(iv)(B) of this section. Alternatively,
the accumulated earnings and profits may
be allocated based on the ratio of accumu-
lated earnings and profits that are attribut-
able to passive income and to non-passive
income during either the related party pe-
riod or the three-year period. The related
party period is the entire period during
which the related person was related to
the recipient. The three-year period is the
three taxable years immediately preceding
the related person’s taxable year that ends
with or within the current taxable year of
the recipient. The three-year period may
be used only if the related person has been
related to the recipient for a period longer
than the three taxable years immediately
preceding the recipient’s taxable year.
(v) Allocation of rents and royalties.
For purposes of section 1297(b)(2)(C),
rents and royalties that are received or
accrued, as applicable based on the recip-
ient’s method of accounting, from a relat-
ed person are allocable to income of the
related person that is not passive income
to the extent the related person’s deduc-
tion for the rent or royalty is allocable to
non-passive gross income of the related
person under the principles of §§1.861-8
through 1.861-14T.
(vi) Determination of whether amounts
are received or accrued from a related
person. For purposes of section 1297(b)
(2)(C), the determination of whether in-
terest, dividends, rents, and royalties were
received or accrued from a related person
is made on the date of the receipt or accru-
al, as applicable based on the recipient’s
method of accounting, of the interest, div-
idend, rent, or royalty.
(vii) Allocation of distributive share
of income from related partnership. For
purposes of section 1297(a)(1), a tested
foreign corporation includes its distrib-
utive share as provided in section 704 of
the separate items of passive or non-pas-
sive income from a partnership that is a
related person (and not a look-through
partnership) with respect to the tested for-
eign corporation for the taxable year of the
tested foreign corporation.
(d) Asset test—(1) Calculation of av-
erage annual value (or adjusted bases)—
(i) General rule. For purposes of section
1297, the calculation of the average per-
centage of assets held by a tested foreign
corporation during its taxable year that
produce passive income or that are held
for the production of passive income is
determined based on the average of the
fair market values, or the average of the
adjusted bases, as appropriate, of the pas-
sive assets and total assets held (including
assets treated as held pursuant to section
1297(c) and §1.1297-2(b)(2)(i) and (b)
(3)) by the foreign corporation on the last
day of each measuring period (measuring
date) of the foreign corporation’s taxable
year. The average of the fair market val-
ues (or the average of the adjusted bases)
of the foreign corporation’s passive assets
or total assets for the taxable year is equal
to the sum of the values (or adjusted bas-
es) of the passive assets or total assets, as
applicable, on each measuring date of the
foreign corporation’s taxable year, divided
by the number of measuring dates in the
taxable year.
(ii) Measuring period—(A) Gener-
al rule. Except as otherwise provided in
paragraph (d)(1)(ii)(B) of this section, the
measuring periods for a tested foreign cor-
poration are the four quarters that make up
the foreign corporation’s taxable year.
(B) Election to use alternative mea-
suring period. The average percentage of
assets held by a tested foreign corpora-
tion during its taxable year that produce
passive income or that are held for the
production of passive income may be cal-
culated using a period that is shorter than
a quarter (such as a week or month). The
same period must be used to measure the
assets of the foreign corporation for the
first year (including a short taxable year)
that this alternative measuring period is
used, and for any and all subsequent years,
unless a revocation is made. An election
to use an alternative measuring period or
a revocation of such an election must be
made in accordance with the rules of para-
graph (d)(1)(iv) of this section.
(C) Short taxable year. For purposes of
applying section 1297 to a tested foreign
corporation that has a taxable year of less
than twelve months (short taxable year),
the average values (or adjusted bases) are
determined based on the measuring dates
of the foreign corporation’s taxable year
that fall within the short taxable year, and
by treating the last day of the short taxable
year as a measuring date.

February 1, 2021 558 Bulletin No. 2021–5
(iii) Adjusted basis election. An elec-
tion under section 1297(e)(2)(B) with re-
spect to an eligible tested foreign corpo-
ration or a revocation of such an election
may be made by the tested foreign corpo-
ration or alternatively by the owner (as
defined in paragraph (d)(1)(iv) of this sec-
tion). If made by the owner, the election
must be made in accordance with the rules
of paragraph (d)(1)(iv) of this section.
(iv) Time and manner of elections and
revocations—(A) Elections. An owner (as
defined in this paragraph (d)(1)(iv)) of a
foreign corporation makes an election de-
scribed in paragraph (d)(1)(ii)(B) or (d)(1)
(iii) of this section for a taxable year in
the manner provided in the Instructions
to Form 8621 (or successor form), if the
owner is required to file a Form 8621 (or
successor form) with respect to the for-
eign corporation for the taxable year of the
owner in which or with which the taxable
year of the foreign corporation for which
the election is made ends. If the owner is
not required to file Form 8621 (or succes-
sor form) with respect to the foreign cor-
poration for the taxable year, the owner
makes such an election by filing a written
statement providing for the election and
attaching the statement to an original or
amended Federal income tax return for
the taxable year of the owner in which or
with which the taxable year of the foreign
corporation for which the election is made
ends clearly indicating that such election
has been made. An election can be made
by an owner only if the owner’s taxable
year for which the election is made, and
all taxable years that are affected by the
election, are not closed by the period of
limitations on assessments under sec-
tion 6501. Elections described in para-
graphs (d)(1)(ii)(B) and (d)(1)(iii) of this
section are not eligible for relief under
§301.9100-3 of this chapter. For purpos-
es of this paragraph (d)(1)(iv), an owner
of a foreign corporation is a United States
person that is eligible under §1.1295-1(d)
to make a section 1295 election with re-
spect to the foreign corporation, or would
be eligible under §1.1295-1(d) to make a
section 1295 election if the foreign corpo-
ration were a PFIC.
(B) Revocations and subsequent elec-
tions. An election described in paragraph
(d)(1)(ii)(B) or (d)(1)(iii) of this section
made pursuant to paragraph (d)(1)(iv)(A)
of this section is effective for the taxable
year of the foreign corporation for which
it is made and all subsequent taxable years
of such corporation unless revoked by the
Commissioner or the owner (as defined
in paragraph (d)(1)(iv)(A) of this section)
of the foreign corporation. The owner of
a foreign corporation may revoke such
an election at any time. If an election de-
scribed in paragraph (d)(1)(ii)(B) or (d)
(1)(iii) of this section has been revoked
under this paragraph (d)(1)(iv)(B), a new
election described in paragraph (d)(1)(ii)
(B) or (d)(1)(iii) of this section, as appli-
cable, cannot be made until the sixth tax-
able year following the year for which the
previous election was revoked, and such
subsequent election cannot be revoked
until the sixth taxable year following the
year for which the subsequent election
was made. The owner revokes the election
for a taxable year in the manner provided
in the Instructions to Form 8621 (or suc-
cessor form), if the owner is required to
file a Form 8621 (or successor form) with
respect to the foreign corporation for the
taxable year of the owner in which or with
which the taxable year of the foreign cor-
poration for which the election is revoked
ends, or by filing a written statement pro-
viding for the revocation and attaching the
statement to an original or amended Fed-
eral income tax return for the taxable year
of the owner in which or with which the
taxable year of the foreign corporation for
which the election is revoked ends clear-
ly indicating that such election has been
revoked, if the owner is not required to
file Form 8621 (or successor form) with
respect to the foreign corporation for the
taxable year.
(v) Method of measuring assets—(A)
Publicly traded foreign corporations. For
purposes of section 1297, the assets of a
publicly traded foreign corporation as de-
fined in paragraph (f)(7) of this section
(including assets treated as held pursuant
to section 1297(c) and §1.1297-2(b)(2)(i)
and (b)(3)(i), other than assets of a look-
through subsidiary described in paragraph
(d)(1)(v)(B) of this section) must be mea-
sured for all measuring periods of the tax-
able year on the basis of value.
(B) Non-publicly traded controlled
foreign corporation—(1) In general. For
purposes of section 1297, the assets of
a controlled foreign corporation that is
not described in paragraph (d)(1)(v)(A)
of this section (including assets treated
as held pursuant to section 1297(c) and
§1.1297-2(b)(2)(i) and (b)(3)(i), other
than assets held by a look-through sub-
sidiary described in paragraph (d)(1)(v)
(A) of this section) must be measured for
all measuring periods of the taxable year
during which the foreign corporation is a
controlled foreign corporation on the basis
of adjusted basis.
(2) Controlled foreign corporation
determination. For purposes of section
1297(e)(2)(A) and this paragraph (d)(1)
(v), the term controlled foreign corpora-
tion has the meaning provided in section
957, determined without applying sub-
paragraphs (A), (B), and (C) of section
318(a)(3) so as to consider a United States
person as owning stock which is owned by
a person who is not a United States per-
son.
(C) Other foreign corporations—(1) In
general. Except as provided in paragraph
(d)(1)(v)(C)(2) of this section, the assets
of a foreign corporation that is not de-
scribed in paragraphs (d)(1)(v)(A) or (d)
(1)(v)(B) of this section (including assets
treated as held pursuant to section 1297(c)
and §1.1297-2(b)(2)(i) and (b)(3)(i), other
than assets held by a look-through sub-
sidiary described in paragraphs (d)(1)(v)
(A) or (d)(1)(v)(B) of this section) are
measured for all measuring periods of the
taxable year on the basis of value, unless a
tested foreign corporation or a shareholder
makes an election under section 1297(e)
(2)(B) in accordance with paragraph (d)
(1)(iii) of this section. In the case of a for-
eign corporation that is described in para-
graph (d)(1)(v)(B) of this section for some
but not all measuring periods during a tax-
able year, this paragraph (d)(1)(v)(C)(1)
applies to the remaining measuring period
or periods during that taxable year.
(2) Lower-tier subsidiaries—(i) Low-
er-tier subsidiaries that are publicly trad-
ed foreign corporations. For purposes of
applying section 1297(a)(2) to the assets
of a foreign corporation that is a lower-ti-
er subsidiary of a foreign corporation that
directly or indirectly owns all or part of
the lower-tier subsidiary (a parent foreign
corporation), if the lower-tier subsidiary is
described in paragraph (d)(1)(v)(A), the
rules of paragraph (d)(1)(v)(A) apply. The
previous sentence applies both for purpos-

Bulletin No. 2021–5 559 February 1, 2021
es of applying section 1297(a)(2) to the
lower-tier subsidiary as a tested foreign
corporation, and for purposes of applying
section 1297(a)(2) to a parent foreign cor-
poration with respect to the assets of the
lower-tier subsidiary.
(ii) Lower-tier subsidiaries that are
non-publicly traded controlled foreign
corporations. For purposes of applying
section 1297(a)(2) to the assets of a for-
eign corporation that is a lower-tier sub-
sidiary of a parent foreign corporation, if
the lower-tier subsidiary is described in
paragraph (d)(1)(v)(B), the rules of para-
graph (d)(1)(v)(B) apply. The previous
sentence applies both for purposes of ap-
plying section 1297(a)(2) to the lower-ti-
er subsidiary as a tested foreign corpora-
tion, and for purposes of applying section
1297(a)(2) to a parent foreign corporation
with respect to the assets of the lower-tier
subsidiary.
(iii) Other lower-tier subsidiaries. For
purposes of applying section 1297(a)(2)
to a foreign corporation that is a lower-ti-
er subsidiary of a parent foreign corpo-
ration, if the lower-tier subsidiary is not
described in paragraphs (d)(1)(v)(A) or
(d)(1)(v)(B) of this section, the assets of
the lower-tier subsidiary (including assets
treated as held pursuant to section 1297(c)
and §1.1297-2(b)(2)(i) and (b)(3)(i)) must
be measured under the rules of the same
paragraph of this section (d)(1)(v) that
applies to the parent foreign corpora-
tion. The previous sentence applies both
for purposes of applying section 1297(a)
(2) to the lower-tier subsidiary as a test-
ed foreign corporation, and for purposes
of applying section 1297(a)(2) to a parent
foreign corporation. If a tested foreign
corporation indirectly owns a lower-tier
subsidiary that is not described in para-
graphs (d)(1)(v)(A) or (d)(1)(v)(B) of this
section through one or more other foreign
corporations, the status of any parent for-
eign corporation in that chain of corpora-
tions that is described in paragraph (d)(1)
(v)(A) of this section, or if there is no such
parent foreign corporation then the status
of any parent foreign corporation in that
chain of corporations that is described
in paragraph (d)(1)(v)(B) of this section,
determines the basis on which the assets
of the lower-tier subsidiary are measured.
In the case of a foreign corporation that
is a lower-tier subsidiary with respect to
more than one parent foreign corporation,
this rule applies separately to measure the
assets of the lower-tier subsidiary with re-
spect to each parent foreign corporation.
(D) [Reserved].
(E) Examples. The following examples
illustrate the application of this paragraph
(d)(1)(v).
(1) Example 1—(i) Facts. USP, a domestic cor-
poration, owns 60% of TFC1, which is a foreign
corporation. The remaining 40% of TFC1’s stock
is regularly traded on a national securities exchange
that is registered with the Securities and Exchange
Commission and continues to be until September 1
of the taxable year, when USP acquires all of TFC1’s
stock pursuant to a tender offer. TFC1 owns 30% of
the stock of FS1, a foreign corporation that is neither
a publicly traded foreign corporation nor a controlled
foreign corporation.
(ii) Results. TFC1 is a controlled foreign corpo-
ration with respect to USP. TFC1 also is a public-
ly traded foreign corporation until September 1 of
the taxable year. For purposes of section 1297, the
assets of TFC1 (including the assets of FS1 treated
as held by TFC1 pursuant to section 1297(c) and
§1.1297-2(b)(2)(i)) must be measured on the basis
of value for each measuring period ending before
September 1, pursuant to paragraph (d)(1)(v)(A) of
this section. For purposes of applying section 1297
to FS1 as a tested foreign corporation with respect to
USP, the assets of FS1 must be measured using the
same method as is used for TFC1’s assets, pursuant
to paragraph (d)(1)(v)(C)(2) of this section.
(2) Example 2—(i) Facts. A, a United States per-
son, owns 1% of the stock of TFC2, a foreign corpo-
ration that is neither a publicly traded foreign cor-
poration nor a controlled foreign corporation. TFC2
owns 25% of the stock of FS2, a foreign corporation
that is neither a publicly traded foreign corporation
nor a controlled foreign corporation.
(ii) Results. For purposes of applying section
1297 to TFC2, the assets of TFC2 (including the
assets of FS2 treated as held by TFC2 pursuant to
section 1297(c) and §1.1297-2(b)(2)(i)) are mea-
sured for all measuring periods of the taxable year
on the basis of value, unless A or TFC2 makes an
election under section 1297(e)(2)(B) in accordance
with paragraph (d)(1)(iii) of this section, pursuant to
paragraph (d)(1)(v)(C)(1) of this section. For purpos-
es of applying section 1297 to FS2 as a tested foreign
corporation with respect to A, the assets of FS2 must
be measured using the same method as is used for
TFC2’s assets, pursuant to paragraph (d)(1)(v)(C)(2)
of this section.
(3) Example 3—(i) Facts. The facts are the same
as in paragraph (d)(1)(v)(E)(2)(i) (the facts in Exam-
ple 2), except that the 75% of FS2’s stock not owned
by TFC2 is owned by TFC3, a publicly traded for-
eign corporation that is neither related to TFC2 nor
to A. B, a United States person that is neither related
to A nor to TFC2, owns 1% of the stock of TFC3.
(ii) Results. For purposes of applying section
1297 to TFC2, the results are the same as in para-
graph (d)(1)(v)(E)(2)(ii) (the results in Example 2).
For purposes of applying section 1297 to FS2 as a
tested foreign corporation with respect to A, the as-
sets of FS2 must be measured using the same method
as is used for TFC2’s assets, pursuant to paragraph
(d)(1)(v)(C)(2) of this section. For purposes of ap-
plying section 1297 to TFC3, the assets of TFC3
must be measured by reference to value pursuant to
paragraph (d)(1)(v)(A) because it is a publicly traded
corporation. For purposes of applying section 1297
to FS2 as a tested foreign corporation with respect to
B, the assets of FS2 must be measured by reference
to value because TFC3 is a publicly traded foreign
corporation, pursuant to paragraphs (d)(1)(v)(C)(2)
and (d)(1)(v)(A) of this section.
(2) [Reserved].
(3) Dual-character assets—(i) Gener-
al rule. Except as otherwise provided in
paragraph (d)(3)(ii) or (d)(3)(iii) of this
section and in §1.1297-2(c), for purposes
of section 1297, an asset (or portion of an
asset) that produces both passive income
and non-passive income during a taxable
year (dual-character asset), including
stock and other assets that produce pas-
sive and non-passive income under sec-
tion 1297(b)(2)(C) and paragraph (c)(4)
of this section, is treated as two assets for
each measuring period in the taxable year,
one of which is a passive asset and one
of which is a non-passive asset. The value
(or adjusted basis) of the dual-character
asset is allocated between the passive as-
set and the non-passive asset in proportion
to the relative amounts of passive income
and non-passive income produced by the
asset (or portion of an asset) during the
taxable year. See paragraph (d)(3)(iii) of
this section for a special rule concerning
stock that has previously produced div-
idends subject to the exception provided
in section 1297(b)(2)(C). For purposes of
section 1297(b)(2)(C), a partnership inter-
est in a partnership that is a related person
to the tested foreign corporation is treated
as producing passive or non-passive in-
come in proportion to the tested foreign
corporation’s distributive share of partner-
ship passive or non-passive income for the
taxable year under paragraph (c)(4)(vii) of
this section.
(ii) Special rule when only part of an
asset produces income. For purposes of
section 1297, when only a portion of an
asset produces income during a taxable
year or a portion of a taxable year, the as-
set is treated as two assets for that period,
one of which is characterized as a passive
asset or a non-passive asset based on the
income that it produces, and one of which
is characterized based on the income that it
is held to produce. The value (or adjusted
basis) of the asset is allocated between the

February 1, 2021 560 Bulletin No. 2021–5
two assets pursuant to the method that most
reasonably reflects the uses of the property.
In the case of real property, an allocation
based on the physical use of the property
generally is the most reasonable method.
(iii) Special rule for stock that previ-
ously produced income that was excluded
from passive income under section 1297(b)
(2)(C). Stock with respect to which no div-
idends are received during a taxable year,
but with respect to which dividends were
received during one or both of the prior
two taxable years, is characterized based
on the relative portion of the dividends re-
ceived that was passive or non-passive. If
the dividends were in whole excluded from
passive income under section 1297(b)(2)
(C) and paragraph (c)(4)(iv) of this section,
the stock is treated as a single non-passive
asset. If the dividends were in part ex-
cluded from passive income under section
1297(b)(2)(C) and paragraph (c)(4)(iv) of
this section, the stock is treated as two as-
sets, one of which is a passive asset and one
of which is a non-passive asset. The value
(or adjusted basis) of the stock is allocated
between the two assets in proportion to the
average percentage of aggregate dividends
received in the prior two taxable years that
were characterized as passive income and
the average percentage of aggregate divi-
dends received in the prior two years that
were characterized as non-passive income,
for the previous two taxable years pursuant
to section 1297(b)(2)(C) and paragraph (c)
(4)(iv) of this section. If the tested foreign
corporation did not receive any dividends
from the stock for the current taxable year
or within either of the prior two taxable
years of the tested foreign corporation, then
the stock is treated as a passive asset.
(iv) Example. The following example illustrates
the application of this paragraph (d)(3).
(A) Facts. (1) USP is a domestic corporation that
owns 30% of TFC, a foreign corporation. The re-
maining 70% of TFC is owned by FP, a foreign cor-
poration that is unrelated to USP. TFC owns 20% of
the value of FS1, a foreign corporation, and FP owns
the remaining 80% of the value of FS1. FP, TFC, and
FS1 are not controlled foreign corporations within
the meaning of section 957(a), and each has a calen-
dar year taxable year.
(2) In Year 1, FS1 had current earnings and
profits of $1000x, attributable to passive income of
$500x and non-passive income of $500x, and paid
$300x of dividends to TFC. In Year 2, FS1 had cur-
rent earnings and profits of $1000x, attributable to
passive income of $100x and non-passive income of
$900x, and paid $100x of dividends to TFC. In Year
3, FS1 has passive income of $200x and non-passive
income of $800x and does not pay a dividend.
(3) Throughout Year 3, TFC holds an obligation
of FS1 with respect to which FS1 pays $100x of in-
terest.
(4) In addition to the stock in FS1 and the FS1
obligation, TFC holds an office building, 40% of
which is rented to FP throughout Year 3 for $100x per
quarter. During Year 3, FP has only passive income.
The remaining 60% of the office building is leased
throughout Year 3 to an unrelated person for $300x per
quarter, and TFC’s own officers or staff of employees
regularly perform active and substantial management
and operational functions while the property is leased.
(B) Results. (1) For purposes of section 1297(b)
(2)(C), FP is a “related person” with respect to TFC
because FP owns more than 50% of the vote or value
of TFC, and FS1 is a “related person” with respect to
TFC because FP owns more than 50% of the vote or
value of both TFC and of FS1.
(2) Under paragraph (c)(4)(iv) of this section, the
dividends paid by FS1 in Year 1 were characterized
as 50% passive income ($150x) and 50% non-pas-
sive income ($150x). Under paragraph (c)(4)(iv) of
this section, the dividends paid by FS1 in Year 2 were
characterized as 10% passive income ($10x) and 90%
non-passive income ($90x). Accordingly, the average
percentage of dividends for the previous two taxable
years that were characterized as passive income is
40% (((10% x $100x) + (50% x $300x))/($100x +
$300x)), and the average percentage of dividends
characterized as non-passive income is 60% (((90%
x $100x) + (50% x $300x))/($100x + $300x)). Thus,
under paragraph (d)(3)(iii) of this section, 60% of each
share of stock of FS1 is characterized as a non-passive
asset and 40% is characterized as a passive asset for
each quarter of Year 3 for purposes of applying section
1297(a)(2) to determine whether TFC is a PFIC.
(3) Under paragraph (c)(4)(iii) of this section, the
interest received by TFC from FS1 is characterized
as 20% ($200x/($200x+$800x)) passive income and
thus 80% non-passive income for purposes of apply-
ing section 1297(a)(1) to determine whether TFC is a
PFIC. Accordingly, under paragraph (d)(3)(i) of this
section, 20% of the obligation of FS1 is characterized
as a passive asset and 80% as a non-passive asset for
each quarter of Year 3 for purposes of applying section
1297(a)(2) to determine whether TFC is a PFIC.
(4) Under paragraph (c)(4)(v) of this section, the
rent received from FP throughout Year 3 is character-
ized as 100% passive income. Under paragraph (c)(1)
(i)(A) of this section and section 954(c)(2)(A), the rent
received from the unrelated person is characterized as
100% non-passive income. Accordingly, under para-
graph (d)(3)(i) of this section, the 40% of the office
building rented to FP has a value of 25% (($100x x 4)/
(($100x x 4)+($300x x 4))) of the value of the office
building and that 25% is a passive asset, and the 60%
of the office building rented to the unrelated person
has a value of 75% (($300x x 4)/(($100x x 4)+($300x
x 4))) of the value of the office building and is a
non-passive asset for purposes of applying section
1297(a)(2) to determine whether TFC is a PFIC.
(4) Passive treatment of stock and part-
nership interests. For purposes of section
1297(a)(2), shares of stock in a corporation
that is not a look-through subsidiary (as de-
fined in §1.1297-2(g)(3)) and partnership
interests in a partnership that is not a look-
through partnership (as defined in §1.1297-
2(g)(4)) with respect to a tested foreign
corporation for a taxable year or portion
thereof are treated as passive assets for the
taxable year or relevant portion thereof, ex-
cept to the extent the stock or partnership
interest is treated as a dual-character asset
under section 1297(b)(2)(C) and paragraph
(d)(3) of this section because it produces
both passive and non-passive income, or
the stock or partnership interest produces
solely non-passive income for the taxable
year under section 1297(b)(2)(C) and para-
graph (c)(4) of this section or under para-
graph (d)(5) of this section.
(5) Dealer property. For purposes of
section 1297(a)(2), an asset that produc-
es, or would produce upon disposition,
income or gain that is, or would be, ex-
cluded from passive income pursuant
to section 954(c)(2)(C) is treated as a
non-passive asset.
(e) Stapled stock. If a United States
person that would be a shareholder (with-
in the meaning of §1.1291-1(b)(7) and (b)
(8)) of a stapled entity (as defined in sec-
tion 269B(c)(2)) owns stock in all entities
that are stapled entities with respect to
each other and the shares are stapled in-
terests (as defined in section 269B(c)(3)),
the United States person’s interests in the
stapled entities are treated as an interest in
a single entity that holds all of the assets of
the stapled entities, conducts all of the ac-
tivities of the stapled entities, and derives
all of the income of the stapled entities for
all purposes of the PFIC regime.
(f) Definitions. The following defini-
tions apply for purposes of this section
and §1.1297-2:
(1) Measuring date. The term measur-
ing date has the meaning provided in para-
graph (d)(1)(i) of this section.
(2) Measuring period. The term mea-
suring period means a three-month period
or an alternative measuring period, within
the meaning provided in paragraph (d)(1)
(ii) of this section.
(3) Non-passive asset. The term
non-passive asset means an asset other
than a passive asset.
(4) Non-passive income. The term
non-passive income means income other
than passive income.
(5) Passive asset. The term passive as-
set means an asset that produces passive
income, or which is held for the produc-

Bulletin No. 2021–5 561 February 1, 2021
tion of passive income, taking into ac-
count the rules in paragraphs (c) and (d)
of this section.
(6) Passive income. The term passive
income has the meaning provided in para-
graph (c)(1) of this section.
(7) Publicly traded foreign corpora-
tion. The term publicly traded foreign
corporation means a foreign corporation
the stock of which is regularly traded on
an exchange described in section 1297(e)
(3), other than in de minimis quantities,
for at least twenty trading days during a
taxable year.
(8) Related person. For purposes of
applying the rules with respect to section
1297(b)(2)(C), the term related person
means a related person within the mean-
ing of section 954(d)(3).
(9) Tested foreign corporation. The
term tested foreign corporation means
a foreign corporation the PFIC status
of which is being tested under section
1297(a).
(g) Applicability date—(1) In general.
Except as otherwise provided in paragraph
(g)(2) of this section, the rules of this sec-
tion apply to taxable years of shareholders
beginning on or after January 14, 2021.
A shareholder may choose to apply such
rules for any open taxable year beginning
before January 14, 2021, provided that,
with respect to a tested foreign corpora-
tion, the shareholder consistently applies
the provisions of this section (except that
consistent treatment is not required with
respect to paragraph (c)(1)(i)(A) of this
section) and §1.1291-1(b)(8)(iv) and (b)
(8)(v)(A), (B), (C), and (D) and §§1.1297-
2, 1.1298-2, and 1.1298-4 for such year
and all subsequent years.
(2) Paragraph (d)(1)(v)(B)(2) of this
section. Paragraph (d)(1)(v)(B)(2) of this
section applies to taxable years of share-
holders ending on or after October 1,
2019. For taxable years of shareholders
ending before October 1, 2019, a share-
holder may apply paragraph (d)(1)(v)(B)
(2) of this section to the last taxable year
of a foreign corporation beginning before
January 1, 2018, and each subsequent
taxable year of the foreign corporation,
provided that the shareholder and United
States persons that are related (within the
meaning of section 267 or 707) to the tax-
payer consistently apply such paragraph
with respect to all foreign corporations.
§1.1297-2 Special rules regarding look-
through subsidiaries and look-through
partnerships.
(a) Overview. This section provides
rules concerning the treatment of in-
come and assets of a look-through sub-
sidiary (as defined in §1.1297-2(g)(3))
or look-through partnership (as defined
in §1.1297-2(g)(4)) for purposes of de-
termining whether a tested foreign cor-
poration (as defined in §1.1297-1(f)(9))
is a passive foreign investment company
(PFIC) under section 1297(a). Paragraph
(b) of this section provides guidance for
purposes of section 1297(c) on how to
determine a tested foreign corporation’s
ownership in a corporation and how to
determine a tested foreign corporation’s
proportionate share of a look-through sub-
sidiary’s or look-through partnership’s as-
sets and income. Paragraph (c) of this sec-
tion provides rules that eliminate certain
income and assets related to look-through
subsidiaries and look-through partnerships
for purposes of determining a tested for-
eign corporation’s PFIC status. Paragraph
(d) of this section provides a rule to deter-
mine whether certain income received or
accrued by look-through subsidiaries and
look-through partnerships is received or
accrued from a related person for purpos-
es of section 1297(b)(2)(C). Paragraph (e)
of this section provides rules concerning
the attribution of activities from qualified
affiliates (as defined in §1.1297-2(e)(2))
for purposes of characterizing the income
and assets of a look-through subsidiary or
look-through partnership. Paragraph (f) of
this section provides rules for determining
the amount of gain from the direct or in-
direct sale or exchange of stock of a look-
through subsidiary or partnership inter-
ests in a partnership described in section
954(c)(4) that is taken into account under
section 1297(a) and for determining the
passive or non-passive character of gain
from the sale of a look-through subsidi-
ary. Paragraph (g) of this section provides
definitions applicable for this section, and
paragraph (h) of this section provides the
applicability date of this section.
(b) General rules—(1) Tested foreign
corporation’s ownership of a corporation.
For purposes of section 1297(c) and this
section, the principles of section 958(a)
and the regulations in this chapter under
that section applicable to determining di-
rect or indirect ownership by value apply
to determine a tested foreign corporation’s
percentage ownership (by value) in the
stock of another corporation. These prin-
ciples apply whether an intermediate enti-
ty is domestic or foreign.
(2) Tested foreign corporation’s pro-
portionate share of the assets and in-
come of a look-through subsidiary—(i)
Proportionate share of subsidiary assets.
For each measuring period (as defined in
§1.1297-1(f)(2)), a tested foreign corpora-
tion is treated as if it held its proportion-
ate share of each asset of a look-through
subsidiary, determined based on the tested
foreign corporation’s percentage own-
ership (by value) (as determined under
paragraph (b)(1) of this section)) of the
look-through subsidiary on the measur-
ing date (as defined in §1.1297-1(f)(1)). A
tested foreign corporation’s proportionate
share of a look-through subsidiary’s asset
is treated as producing passive income, or
being held to produce passive income, to
the extent the asset produced, or was held
to produce, passive income in the hands
of such look-through subsidiary under the
rules of paragraph (b)(2)(ii) of this sec-
tion.
(ii) Proportionate share of subsidiary
income—(A) General rule. A tested for-
eign corporation is treated as if it received
directly its proportionate share of each
item of gross income or loss of a corpo-
ration for a taxable year if the corporation
is a look-through subsidiary with respect
to the tested foreign corporation for the
taxable year of the tested foreign corpo-
ration. In such case, a tested foreign cor-
poration’s proportionate share of a look-
through subsidiary’s gross income or loss
is determined based on the corporation’s
average percentage ownership (by value)
of the look-through subsidiary. The excep-
tions to passive income in section 1297(b)
(2) and the relevant exceptions to foreign
personal holding company income in sec-
tion 954(c) that are based on whether in-
come is derived in the active conduct of a
business or whether a corporation is en-
gaged in the active conduct of a business
apply to such income only if the exception
would have applied to exclude the income
from passive income or foreign personal
holding company income in the hands of
the subsidiary, determined by taking into

February 1, 2021 562 Bulletin No. 2021–5
account only the activities of the subsid-
iary except as provided in paragraph (e)
of this section. See paragraph (d) of this
section for rules determining whether a
person is a related person for purposes of
applying section 1297(b)(2)(C) in the case
of income received or accrued by a sub-
sidiary that is treated as received directly
by a tested foreign corporation pursuant to
this paragraph (b)(2).
(B) Partial year. When a corporation
is not a look-through subsidiary with re-
spect to a tested foreign corporation for
an entire taxable year of the tested foreign
corporation, the tested foreign corporation
may be treated as if it received directly its
proportionate share of the gross income or
loss of the first corporation for each mea-
suring period in the year for which the first
corporation is a look-through subsidiary,
if the conditions in paragraph (g)(3)(ii)(B)
of this section are satisfied. In such case, a
tested foreign corporation’s proportionate
share of a look-through subsidiary’s gross
income or loss is determined based on the
tested foreign corporation’s percentage
ownership (by value) (as determined un-
der paragraph (b)(1) of this section) of the
look-through subsidiary on the relevant
measuring date.
(iii) Coordination of section 1297(c)
with section 1298(b)(7). A tested foreign
corporation is not treated under section
1297(c) and this paragraph (b) as holding
its proportionate share of the assets of a
domestic corporation, or receiving direct-
ly its proportionate share of the gross in-
come or loss of the domestic corporation,
if the stock of the domestic corporation
is treated as an asset that is not a passive
asset (as defined in §1.1297-1(f)(5)) that
produces income that is not passive in-
come (as defined in §1.1297-1(f)(6)) un-
der section 1298(b)(7) (concerning the
treatment of certain foreign corporations
owning stock in certain 25-percent-owned
domestic corporations). See §1.1298-4 for
rules governing the application of section
1298(b)(7).
(3) Tested foreign corporation’s pro-
portionate share of the assets and in-
come of a look-through partnership—
(i) Proportionate share of partnership
assets. For each measuring period (as
defined in §1.1297-1(f)(2)), a tested for-
eign corporation is treated as if it held
its proportionate share of each asset of
a look-through partnership, determined
based on the tested foreign corporation’s
percentage ownership (by value) (as de-
termined under paragraph (b)(1) of this
section)) of the look-through partner-
ship on the measuring date (as defined
in §1.1297-1(f)(1)). A tested foreign cor-
poration’s proportionate share of a look-
through partnership’s asset is treated as
producing passive income, or being held
to produce passive income, to the extent
the asset produced, or was held to pro-
duce, passive income in the hands of the
partnership under the rules in paragraph
(b)(3)(ii) of this section.
(ii) Proportionate share of partnership
income—(A) General rule. A tested for-
eign corporation is treated as if it received
directly its proportionate share of any item
of gross income or loss of a partnership
that is a look-through partnership with
respect to the tested foreign corporation
for the taxable year of the tested foreign
corporation. The exceptions to passive
income in section 1297(b)(2) and the rel-
evant exceptions to foreign personal hold-
ing company income in section 954(c)
that are based on whether income is de-
rived in the active conduct of a business
or whether a corporation is engaged in
the active conduct of a business apply to
such income only if the exception would
have applied to exclude the income from
passive income or foreign personal hold-
ing company income in the hands of the
partnership, determined by taking into ac-
count only the activities of the partnership
except as provided in paragraph (e) of this
section. See paragraph (d) of this section
for rules determining whether a person is
a related person for purposes of applying
section 1297(b)(2)(C) in the case of in-
come received or accrued by a partnership
that is treated as received directly by a
tested foreign corporation pursuant to this
paragraph (b)(3).
(B) Partial year. When a partnership
is not a look-through partnership with re-
spect to a tested foreign corporation for
an entire taxable year of the tested foreign
corporation, the tested foreign corporation
may be treated as if it received directly its
proportionate share of the gross income of
the partnership for each measuring period
in the year for which the partnership is a
look-through partnership, provided that
the conditions set forth in paragraph (g)(3)
(ii)(B) of this section would be satisfied if
the partnership were a corporation.
(4) Examples. The following examples
illustrate the rules of this paragraph (b).
For purposes of these examples, USP is
a domestic corporation; TFC, LTS, and
FS are foreign corporations that are not
controlled foreign corporations within
the meaning of section 957(a); USP owns
30% of TFC; and LTS owns 25% of the
only class of FS stock.
(i) Example 1—(A) Facts. TFC directly owns
80% of the only class of LTS stock for TFC’s and
LTS’s entire taxable year.
(B) Results—(1) LTS. Under paragraph (b)(1) of
this section and pursuant to the principles of section
958(a), LTS owns 25% of the value of FS. Under
paragraph (b)(2)(i) and (ii) of this section, in deter-
mining whether LTS is a PFIC under section 1297(a),
LTS is treated as if it held 25% of each of FS’s assets
on each of the measuring dates in its taxable year and
received directly 25% of the gross income of FS for
the taxable year.
(2) TFC. Under paragraph (b)(1) of this section
and pursuant to the principles of section 958(a),
TFC owns 80% of the value of LTS and indirectly
owns 20% of the value of FS. Under paragraph (b)
(2) of this section, in determining whether TFC is a
PFIC under section 1297(a), TFC is treated as if it
held 80% of each of LTS’s assets on each of the mea-
suring dates in its taxable year and received directly
80% of the gross income of LTS for the taxable year.
However, because TFC indirectly owns less than
25% of FS, FS is not a look-through subsidiary with
respect to TFC and, therefore, TFC is treated as if it
held a 20% interest in the stock of FS (and not the as-
sets of FS), and received 80% of any dividends paid
from FS to LTS (and not any income of FS).
(ii) Example 2—(A) Facts. TFC directly owns
25% of the only class of LTS stock on the last day of
each of the first three quarters of its taxable year but
disposes of its entire interest in LTS during the fourth
quarter of its taxable year.
(B) Results. Under paragraph (b)(1) and pursuant
to the principles of section 958(a), on each of its first
three measuring dates, TFC owns 25% of the value
of LTS and indirectly owns 6.25% of the value of
FS. Under paragraph (g)(3) of this section, if infor-
mation about the gross income of LTS for each of
the first three quarters of its taxable year is available
to TFC, LTS is treated as a look-through subsidiary
with respect to TFC for those quarters because TFC
owned 25% of the value of LTS on the measuring
dates with respect to those measuring periods. In
that case, under paragraph (b)(2) of this section, in
determining whether TFC is a PFIC under section
1297(a), TFC is treated as if it held 25% of each of
LTS’s assets and received directly 25% of the gross
income of LTS on each of the first three measuring
dates in its taxable year. For each of its first three
quarters, if LTS is treated as a look-through subsid-
iary with respect to TFC under paragraph (g)(3) of
this section, then TFC is treated as if it held a 6.25%
interest in the stock of FS (and not the assets of FS)
and received 25% of any dividends paid from FS to
LTS (and not any income of FS). Under paragraph

Bulletin No. 2021–5 563 February 1, 2021
(g)(3) of this section, if information about the gross
income of LTS for each of the first three quarters of
its taxable year is not available to TFC, then LTS is
not a look-through subsidiary with respect to TFC.
(iii) Example 3—(A) Facts. TFC directly owns
100% of the only class of LTS stock for TFC’s and
LTS’s entire taxable year. TFC sells one item of
property described in section 954(c)(1)(B)(i) for a
gain of $25x and another for a loss of $10x, and
no exception from passive income applies to either
amount. During the taxable year, FS sells one item
of property described in section 954(c)(1)(B)(i) for
a gain of $50x and another for a loss of $55x; no
exception from passive income applies to either
amount.
(B) Results. Under paragraph (b)(1) of this
section and pursuant to the principles of section
958(a), TFC owns 100% of the value of LTS, and
TFC indirectly owns 25% of the value of FS. Un-
der paragraph (b) of this section, in determining
whether TFC is a PFIC under section 1297(a), TFC
is treated as if it held 100% of LTS’s assets on each
of the measuring dates in its taxable year and re-
ceived directly 100% of the gross income of LTS
for the taxable year. Furthermore, TFC is treated as
if it held 25% of each of FS’s assets and received
directly 25% of the gross income of FS. Pursuant to
§1.1297-1(c)(1)(ii), the excess of gains over loss-
es from property transactions described in section
954(c)(1)(B) is taken into account as gross income
for purposes of section 1297, and items of gain or
loss of look-through subsidiaries are treated as rec-
ognized by a tested foreign corporation. According-
ly, TFC takes into account the net $5x loss from
the sales of property by FS. TFC’s income from its
own sales of property constitutes passive income
pursuant to §1.1297-1(c) and section 954(c)(1)(B),
although, pursuant to §1.1297-1(c)(1)(ii), only the
excess of gains over losses, $15x ($25x-$10x), is
taken into account as gross income for purposes of
section 1297. As a result, TFC’s income (including
the $5x loss from FS), all of which is passive in-
come, equals $10x ($15x - $5x) of gross income.
(c) Elimination of certain intercom-
pany assets and income—(1) General
rule for asset test—(i) LTS stock. For
purposes of section 1297(a)(2), a tested
foreign corporation does not take into
account the value (or adjusted basis) of
stock of a look-through subsidiary (LTS
stock), including LTS stock that the
tested foreign corporation is treated as
owning on a measuring date pursuant to
section 1297(c) and paragraph (b)(2) or
(b)(3) of this section. Furthermore, for
purposes of section 1297(a)(2), a tested
foreign corporation does not take into
account the value (or adjusted basis) of
its own stock that it is treated as owning
on a measuring date pursuant to section
1297(c) and paragraph (b)(2) or (b)(3) of
this section.
(ii) LTS obligation. For purposes of
section 1297(a)(2), a tested foreign cor-
poration does not take into account the
value (or adjusted basis) of its propor-
tionate share of a direct LTS obligation,
an indirect LTS obligation or a TFC ob-
ligation that it is treated as owning on
a measuring date. The term direct LTS
obligation means a debt obligation of,
lease to, or license to a look-through
subsidiary (LTS debt, LTS lease, and
LTS license, respectively, and LTS obli-
gation collectively) from the tested for-
eign corporation that the tested foreign
corporation owns on a measuring date,
and the term indirect LTS obligation
means a LTS obligation from a look-
through subsidiary that the tested for-
eign corporation is treated as owning
on a measuring date pursuant to section
1297(c) and paragraph (b)(2) or (b)(3)
of this section. The term TFC obligation
means a debt obligation of, lease to, or
a license to the tested foreign corpora-
tion from a look-through subsidiary that
the tested foreign corporation is treated
as owning on a measuring date pursuant
to section 1297(c) and paragraph (b)(2)
or (b)(3) of this section. The tested for-
eign corporation’s proportionate share of
a LTS obligation or a TFC obligation is
the value (or adjusted basis) of the item
multiplied by the tested foreign corpora-
tion’s percentage ownership (by value)
in each relevant look-through subsidi-
ary. For purposes of section 1297(a)(2)
and §1.1297-1(d) as applied to a tested
foreign corporation, property subject to
a LTS lease or LTS license or a lease or
license to the tested foreign corporation
is characterized as either producing pas-
sive income or non-passive income (or
both) by taking into account the activi-
ties of the qualified affiliates (as defined
in paragraph (e)(2) of this section) of the
entity that owns the property. For this
purpose, the activities of the entity that
owns the property that is subject to the
lease or license are not taken into ac-
count to the extent that they relate to the
lease or license.
(2) General rule for income test—
(i) LTS stock. For purposes of section
1297(a)(1), a tested foreign corporation
does not take into account dividends de-
rived with respect to LTS stock, including
dividends that the tested foreign corpora-
tion is treated as receiving on a measur-
ing date pursuant to section 1297(c) and
paragraph (b)(2) or (b)(3) of this section;
provided that, notwithstanding the fore-
going, a tested foreign corporation takes
into account dividends that are attribut-
able to income that was not treated as
received directly by the tested foreign
corporation pursuant to paragraph (b)(2)
of this section. For this purpose, the rules
of §1.1297-1(c)(4)(iv)(A) apply to deter-
mine the earnings and profits from which
a dividend is paid, substituting the term
“look-through subsidiary” for “related
person.”
(ii) LTS obligation. For purposes of
section 1297(a)(1), a tested foreign cor-
poration does not take into account its
proportionate share of interest, rents, or
royalties derived with respect to direct
or indirect LTS obligations or TFC obli-
gations. The tested foreign corporation’s
proportionate share of interest, rents, or
royalties is the amount of the item mul-
tiplied by the tested foreign corporation’s
percentage ownership (by value) in each
relevant look-through subsidiary.
(3) Partnerships. For purposes of sec-
tion 1297(a)(1) and (a)(2), the principles
of paragraphs (c)(1) and (2) of this sec-
tion apply with respect to ownership in-
terests in, debt of, and leases or licenses
to a look-through partnership (as defined
in paragraph (g)(4) of this section), and
with respect to distributions and the dis-
tributive shares of income from a look-
through partnership and interest, rents, or
royalties derived with respect to the debt,
leases or licenses of a look-through part-
nership.
(4) Examples. The following examples
illustrate the rules of this paragraph (c).
For purposes of these examples, USP is
a domestic corporation; USP owns 30%
of TFC; TFC, LTS, LTS1, LTS2, and FS
are foreign corporations that are not con-
trolled foreign corporations within the
meaning of section 957(a); FPS is a for-
eign partnership; and TFC, LTS1, and
LTS2 measure assets for purposes of sec-
tion 1297(a)(2) based on value.
(i) Example 1—(A) Facts. TFC directly owns
80% of the only class of LTS stock for TFC’s and
LTS’s entire taxable year, and LTS is a look-through
subsidiary (as defined in paragraph (g)(3) of this sec-
tion) with respect to TFC. LTS owns 25% of the only
class of FS stock, and FS is a look-through subsid-
iary with respect to LTS. Pursuant to the principles
of section 958(a), TFC owns 80% of the value of
LTS, LTS owns 25% of the value of FS, and TFC
indirectly owns 20% of the value of FS. During the

February 1, 2021 564 Bulletin No. 2021–5
first quarter of the taxable year, LTS received a $20x
dividend from FS.
(B) Results—(1) LTS. Under paragraph (c)(1)
(i) of this section, for purposes of applying section
1297(a)(2) to LTS, LTS’s assets do not include the
stock of FS. Under paragraph (c)(2)(i) of this section,
for purposes of applying section 1297(a)(1) to LTS,
LTS’s income does not include the $20x dividend
from FS.
(2) TFC. Under paragraph (c)(1)(i) of this sec-
tion, for purposes of applying section 1297(a)(2)
to TFC, TFC’s assets do not include the stock of
LTS. Under paragraph (b)(2)(ii)(A) of this section,
for purposes of applying section 1297(a)(1) to TFC,
TFC is treated as receiving directly the income of
LTS. Because TFC indirectly owns less than 25% of
FS, FS is not a look-through subsidiary with respect
to TFC and, therefore, TFC’s assets include the val-
ue of TFC’s 20% interest in the stock of FS and do
not include 20% of FS’s assets. Similarly, TFC is
treated as if it received $16x (80% x $20x) of the
$20x dividend paid from FS to LTS (and not any
income of FS). Because the dividend constitutes
gross income to LTS (although it is eliminated for
purposes of applying section 1297(a)(1) to LTS),
TFC is treated as receiving the dividend from FS di-
rectly under paragraph (b)(2)(ii)(A) of this section.
Because the dividend is from a subsidiary that is
not a look-through subsidiary with respect to TFC,
paragraph (c)(2)(i) of this section does not apply to
eliminate the $16x dividend for purposes of section
1297(a).
(ii) Example 2—(A) Facts. TFC directly owns
40% of the value of LTS1 stock on each of the mea-
suring dates, and thus is treated under paragraph
(b)(1) of this section as owning 40% of LTS1’s as-
sets on each of the measuring dates. TFC’s assets
include a loan to LTS1 with a balance of $1,000x
on each of the measuring dates. During the first
quarter of the taxable year, TFC received $20x
of dividends from LTS1, which were attributable
to income of LTS1 treated as received directly by
TFC pursuant to paragraph (b)(2) of this section,
and $30x of interest on the loan, both of which
were paid in cash.
(B) Results. Under paragraph (c)(1)(i) of this
section, for purposes of applying section 1297(a),
TFC’s assets do not include the stock of LTS1, and
TFC’s income does not include the $20x of divi-
dends received from LTS1 pursuant to paragraph
(c)(2)(i) of this section. Similarly, under paragraph
(c)(1)(ii) of this section TFC’s assets include only
$600x ($1,000x loan – (40% x $1,000x)) of the
loan to LTS1, and under paragraph (c)(2)(ii) of this
section, TFC’s income includes only $18x ($30x
interest – (40% x $30x)) of the interest from LTS1.
However, TFC’s assets include the entire $50x of
cash ($20x of dividends and $30x of interest) re-
ceived from LTS1.
(iii) Example 3—(A) Facts. The facts are the
same as in paragraph (c)(4)(ii)(A) of this section (the
facts in Example 2), except that TFC also directly
owns 30% of the value of LTS2 stock on each of the
measuring dates, and thus is treated under paragraph
(b)(1) of this section as owning 30% of LTS2’s as-
sets, and LTS1’s assets also include a loan to LTS2
with a balance of $200x on each of the measuring
dates. During the first quarter of the taxable year,
LTS1 received $5x of interest on the loan, which was
paid in cash.
(B) Results. The results are the same as in para-
graph (c)(4)(i)(B) of this section (the results in
Example 1), except that TFC’s assets also do not
include the stock of LTS2. Similarly, although TFC
would be treated under paragraph (b)(2) of this sec-
tion as owning $80x (40% x $200x) of the LTS1
loan to LTS2, under paragraph (c)(1)(ii) of this sec-
tion TFC does not take into account its proportion-
ate share of an indirect LTS obligation and accord-
ingly, TFC does not take into account $24x (30%
x $80x) of the loan to LTS2. As a result, TFC’s
assets include only $56x ($80x-$24x) of the LTS1
loan to LTS2. Furthermore, although TFC would be
treated under paragraph (b)(2) of this section as re-
ceiving $2x (40% x $5x) of the interest received by
LTS1 from LTS2, under paragraph (c)(2)(ii) of this
section TFC does not take into account its propor-
tionate share of interest with respect to an indirect
LTS obligation and thus, TFC does not take into ac-
count $0.60x (30% x $2x) of the interest received
by LTS1. Accordingly, TFC’s income includes only
$1.40x ($2x-$0.60x) of the interest from LTS2. Fur-
thermore, TFC’s assets include $2x (40% x $5x) of
LTS1’s cash received from LTS2.
(iv) Example 4—(A) Facts. TFC directly owns
80% of the value of LTS1 stock on each of the mea-
suring dates, and thus is treated under paragraph (b)
(1) of this section as owning 80% of LTS1’s assets on
each of the measuring dates. TFC also directly owns
50% of the value in FPS on each of the measuring
dates. LTS1’s assets include the remaining 50% of
the value in FPS and a loan to FPS with a balance of
$500x on each of the measuring dates. FPS’s assets
include a loan to TFC with a balance of $1000x on
each of the measuring dates. During the first measur-
ing period of the taxable year, FPS received $30x of
interest from TFC, and LTS1 received $15x of in-
terest from FPS, both of which were paid in cash.
During the last measuring period of the taxable year,
FPS received $80x of income from an unrelated per-
son in cash and distributed $60x of such income in
cash to TFC and LTS1 in proportion to their interests
in FPS.
(B) Results. Under paragraph (c)(1)(i) and (ii)
of this section, for purposes of applying section
1297(a), TFC’s assets do not include the stock of
LTS1, the interests in FPS owned by TFC directly
and through LTS1, any of the loan by FPS to TFC,
or any of the loan by LTS1 to FPS. Similarly, under
paragraph (c)(2)(i) and (ii) of this section, TFC’s
income does not include any of the $30x of inter-
est received by FPS from TFC, any of the $15x of
interest received by LTS1 from FPS, or any of the
$60x of distributions received by TFC and LTS1
from FPS. However, on each of the measuring
dates, TFC’s assets include $27x ((50% x $30x) +
(80% x 50% x $30x)) of the $30 of cash received by
FPS from TFC and $12x (80% x $15x) of the $15x
of cash received by LTS1 from FPS. Moreover, on
the last measuring date of the taxable year, TFC’s
assets include $18x ((50% x $20x) + (80% x 50% x
$20x)) of the $20x ($80x - $60x) of cash received
by FPS from the unrelated person and retained
by FPS and $54x ((50% x $60x) + (80% x 50%
x $60x)) of the $60x cash received by FPS from
the unrelated person and distributed. Furthermore,
TFC’s income includes $72x ((50% x $80x) + (80%
x 50% x $80x)) of the $80x of income received by
FPS from an unrelated person.
(v) Example 5—(A) Facts. TFC directly owns
80% of the value of the stock of LTS1 and 60% of
the value of the stock of LTS2 on each of the mea-
suring dates, and thus is treated under paragraph (b)
(1) of this section as owning 80% of LTS1’s assets
and 60% of LTS2’s assets on each of the measuring
dates. TFC’s assets include a license for the use of its
intangible property by LTS1 with a value of $5,000x
on each of the measuring dates, LTS1’s assets in-
clude a sub-license of such license to LTS2 with a
value of $2,000x on each of the measuring dates, and
LTS2’s assets include a lease of its building to LTS1
with a value of $4,000x on each of the measuring
dates. LTS1 and LTS2 each use the intangible prop-
erty that is the subject of the license and sub-license
in its respective trade or business, and LTS1 uses
the building in its trade or business. During the last
quarter of the taxable year, TFC received a royalty
of $500x from LTS1 with respect to the license, and
LTS1 received a royalty of $200x from LTS2 with
respect to the sub-license, both of which were paid in
cash. LTS2 received $100x of rent paid in cash from
LTS1 during each quarter of the taxable year with
respect to the building lease.
(B) Results—(1) Asset test. Under paragraph
(c) of this section, for purposes of applying sec-
tion 1297(a)(2) to TFC’s final measuring period,
the following analysis applies. TFC’s assets do
not include the stock of LTS1 and LTS2. Similar-
ly, TFC’s assets include only $1,000x ($5,000x li-
cense – (80% x $5,000x)) of the license to LTS1.
However, TFC’s assets include the entire $500x of
cash it received from LTS1 as a result of the roy-
alty. Moreover, although TFC would be treated
under paragraph (b)(2) of this section as owning
$1,600x (80% x $2,000x) of the LTS1 sub-license
to LTS2, under paragraph (c)(1)(ii) of this section
TFC does not take into account its proportionate
share of an indirect LTS obligation, and according-
ly TFC does not take into account $960x (60% x
$1,600x) of LTS1’s sub-license to LTS2. As a re-
sult, TFC’s assets include $640x ($1,600x - $960x)
of the sub-license. In addition, TFC’s assets include
$160x (80% x $200x) of LTS1’s cash received from
LTS2 as a result of the royalty to LTS1. Similarly,
although TFC would be treated under paragraph
(b)(2) of this section as owning $2,400x (60% x
$4,000x) of the LTS2 lease to LTS1, under para-
graph (c)(1)(ii) of this section TFC does not take
into account $1,920x (80% x $2,400x) of the LTS2
building lease, and accordingly, its assets include
$480x ($2,400x - $1,920x) of the lease. TFC’s
assets also include $240x (60% x $100x x 4) of
LTS2’s cash received from LTS1 as a result of the
rental payment to LTS2.
(2) Income test. Under paragraph (c)(2)(ii) of this
section, because TFC does not take into account its
proportionate share of a direct LTS obligation, TFC’s
income includes only $100x ($500x royalty – (80%
x $500x)) of the royalties from LTS1. Furthermore,
although TFC would be treated under paragraph (b)
(2) of this section as receiving $160x (80% x $200x)

Bulletin No. 2021–5 565 February 1, 2021
of the royalty received by LTS1 from LTS2, under
paragraph (c)(2)(ii) of this section TFC does not take
into account its proportionate share of royalties de-
rived with respect to an indirect LTS obligation, and
accordingly TFC does not take into account $96x
(60% x $160x) of the royalty received by LTS1. As
a result, TFC’s income includes only $64x ($160x -
$96x) of the royalty from LTS2. Similarly, although
TFC would be treated under paragraph (b)(2) of this
section as receiving $240x (60% x $100x x 4) of the
rent received by LTS2 from LTS1, under paragraph
(c)(2)(ii) of this section TFC does not take into ac-
count its proportionate share of rent derived with re-
spect to an indirect LTS obligation, and accordingly
TFC does not take into account $192x (80% x $240)
of the rent received by LTS2. Therefore, TFC’s in-
come includes only $48 ($240x - $192x) of the rent
received from LTS1.
(3) Treatment of intangible and rental property.
For purposes of determining whether the intangible
property that TFC owns and the building that TFC
is treated as owning under paragraph (b)(2) of this
section is held in the production of passive income,
the activities performed by TFC and its qualified
affiliates with respect to the property are taken into
account under paragraphs (c)(1)(ii) and (e) of this
section. Because TFC is the common parent of the
affiliated group (as determined under paragraph (e)
(2) of this section) that includes LTS1 and LTS2,
LTS1 and LTS2 are qualified affiliates of TFC and
the activities of their officers and employees with
respect to the intangible property and building are
taken into account to determine whether the building
and intangible property would be treated as passive
assets.
(d) Related person determination for
purposes of section 1297(b)(2)(C)—(1)
General rule. For purposes of section
1297(b)(2)(C), interest, dividends, rents
or royalties received or accrued by a look-
through subsidiary (and treated as received
directly by a tested foreign corporation pur-
suant to section 1297(c) and paragraph (b)
(2) of this section) are considered received
or accrued from a related person only if
the payor of the interest, dividend, rent
or royalty is a related person (within the
meaning of section 954(d)(3)) with respect
to the look-through subsidiary, taking into
account §1.1297-1(c)(1)(i)(D). Similarly,
for purposes of 1297(b)(2)(C), interest,
dividends, rents or royalties received or
accrued by a look-through partnership (and
treated as received directly by a tested for-
eign corporation pursuant to paragraph (b)
(3) of this section) are considered received
or accrued from a related person only if the
payor of the interest, dividend, rent or roy-
alty is a related person (within the meaning
of section 954(d)(3)) with respect to the
look-through partnership, taking into ac-
count §1.1297-1(c)(1)(i)(D).
(2) Example. The following example illustrates
the rule of this paragraph (d).
(i) Facts. USP is a domestic corporation that
owns 30% of TFC. TFC directly owns 30% of the
value of FS1 stock, and thus under paragraph (b) of
this section is treated as owning 30% of FS1’s as-
sets and earning 30% of FS1’s gross income. The
remaining FS1 stock is owned by an unrelated for-
eign person. FS1 directly owns 60% of the vote of
FS2 stock and 20% of the value of FS2 stock. The
remaining vote and value of FS2 stock are owned by
an unrelated foreign person. TFC, FS1, and FS2 are
foreign corporations that are not controlled foreign
corporations within the meaning of section 957(a).
FS1 receives a $100x dividend from FS2.
(ii) Results. Pursuant to section 1297(c) and
paragraph (b)(2) of this section, TFC is treated as
receiving directly $30x of the dividend income
received by FS1. FS2 is a related person (within
the meaning of section 954(d)(3)) with respect to
FS1 for purposes of section 1297(b)(2)(C) because
FS1 owns more than 50% of the vote of FS2. FS2
is not a related person (within the meaning of sec-
tion 954(d)(3)) with respect to TFC for purposes of
section 1297(b)(2)(C) because TFC indirectly does
not own more than 50% of the vote or value of the
FS2 stock. Under paragraph (d)(1) of this section,
for purposes of determining whether the dividend
income received by FS1 is subject to the exception
in section 1297(b)(2)(C) for purposes of testing the
PFIC status of TFC, the dividend is treated as re-
ceived from a related person because FS1 and FS2
are related persons within the meaning of section
1297(b)(2)(C). Therefore, to the extent the dividend
income received by FS1 would be properly alloca-
ble to income of FS2 that is not passive income,
the dividend income that TFC is treated as receiv-
ing under section 1297(c) and paragraph (b)(2)(ii)
of this section is treated as non-passive income (as
defined in §1.1297-1(f)(4)).
(e) Treatment of activities of certain
look-through subsidiaries and look-
through partnerships for purposes of
certain exceptions—(1) General rule. An
item of income received by a tested for-
eign corporation (including an amount
treated as received or accrued pursuant
to section 1297(c) and paragraph (b)(2)
or (b)(3) of this section) that would be
passive income in the hands of the enti-
ty that actually received or accrued it is
not passive if the item would be excluded
from foreign personal holding company
income under the following exceptions
contained in section 954(c) that are based
on whether the entity is engaged in the ac-
tive conduct of a trade or business, deter-
mined by taking into account the activities
performed by the officers and employees
of the tested foreign corporation as well
as activities performed by the officers and
employees of any qualified affiliate of the
tested foreign corporation—
(i) Section 954(c)(1)(B) and §1.954-
2(e)(1)(ii) and (3)(ii), (iii) and (iv);
(ii) Section 954(c)(1)(C) and §1.954-
2(f)(1)(ii) and (2)(iii)(D);
(iii) Section 954(c)(1)(D) and §1.954-
2(g)(2)(ii);
(iv) Section 954(c)(2)(A) and §1.954-
2(b)(6), (c), and (d);
(v) Section 954(c)(2)(B) and §1.954-
2(b)(2); and
(vi) Section 954(c)(2)(C) and §1.954-
2(h)(3)(ii).
(2) Qualified affiliate. The term qual-
ified affiliate means a corporation or a
partnership that is included in an affiliated
group that includes the tested foreign cor-
poration. For purposes of this paragraph
(e), the term affiliated group has the mean-
ing provided in section 1504(a), except
that—
(i) The affiliated group is determined
without regard to sections 1504(a)(2)(A),
(b)(2) and (b)(3);
(ii) Subject to paragraph (e)(2)(iii) of
this section, a partnership is treated as an
includible corporation;
(iii) The common parent of the affiliat-
ed group is not a domestic corporation or
domestic partnership;
(iv) Section 1504(a)(2)(B) is applied
by substituting “more than 50 percent” for
“at least 80 percent”;
(v) A foreign corporation or foreign
partnership must be the common parent of
the affiliated group;
(vi) Subject to paragraph (e)(2)(vii) of
this section, a partnership is included as
a member of the affiliated group if more
than 50 percent of the value of its capital
interests or profits interests is owned by
one or more corporations or partnerships
that are included in the affiliated group;
and
(vii) A corporation or a partnership
that is not the common parent of an af-
filiated group is included in the affiliated
group only if it would be a look-through
subsidiary or look-through partnership, as
applicable, of the common parent if the
common parent were a tested foreign cor-
poration.
(3) Examples. The following examples
illustrate the rule of this paragraph (e).
(i) Example 1—(A) Facts. USP is a domestic
corporation that directly owns 20% of the outstand-
ing stock of FS1. The remaining 80% of the out-
standing stock of FS1 is directly owned by a foreign

February 1, 2021 566 Bulletin No. 2021–5
person that is not related to USP. FS1 directly owns
100% of the value of the outstanding stock of FS2
and directly owns 80% of the value of the outstand-
ing stock of FS3. The remaining 20% of the value
of the outstanding stock of FS3 is directly owned
by a foreign person that is not related to USP. FS2
directly owns 80% of the value of the outstanding
stock of FS4. The remaining 20% of the value of
the outstanding stock of FS4 is directly owned by a
foreign person that is not related to USP. FS1, FS2,
FS3 and FS4 are all organized in Country A and
are not controlled foreign corporations within the
meaning of section 957(a). FS4 owns real property
that is leased to a person that is not a related person,
but does not perform any activities. FS1 and FS2
also do not perform any activities. Officers and em-
ployees of FS3 in Country A perform activities with
respect to the real property of FS4 that, if performed
by officers or employees of FS4, would allow the
rental income in the hands of FS4 to qualify for the
exception from foreign personal holding company
income in section 954(c)(2)(A) and §1.954-2(b)(6)
and (c)(1)(ii).
(B) Results—(1) Qualified affiliates. FS1 is
the common parent of the affiliated group (as de-
termined under paragraph (e)(2) of this section)
that includes FS2, FS3, and FS4 because (i) FS1
owns more than 50% by value of FS2 and FS3, (ii)
FS2 owns more than 50% by value of FS4, and
(iii) FS2, FS3, and FS4 would be look-through
subsidiaries with respect to FS1 if FS1 were the
tested foreign corporation. Accordingly, each of
FS1, FS2, FS3 and FS4 are qualified affiliates (as
determined under paragraph (e)(2) of this section)
with respect to the other members of the group for
purposes of determining whether FS1, FS2, FS3,
or FS4 is a PFIC.
(2) FS1 and FS2. Under this paragraph (e), for
purposes of determining whether the rental income
actually received by FS4 with respect to the real
property owned and rented by FS4 and treated under
section 1297(c) and paragraph (b)(2) of this section
as received directly by FS1 or by FS2, respectively,
is passive income for purposes of section 1297, the
activities of FS3 are taken into account because FS3
is a qualified affiliate of FS1 and FS2, respectively.
Thus, the exception in section 954(c)(2)(A) would
apply, and the rental income treated as received by
FS1 or by FS2, respectively, would be treated as
non-passive income for purposes of determining
whether FS1 or FS2 is a PFIC.
(3) FS4. Under this paragraph (e), for purposes of
determining whether the rental income received by
FS4 with respect to the real property owned and rent-
ed by FS4 is passive income for purposes of section
1297, the activities of FS3 are taken into account,
because FS3 is a qualified affiliate of FS4. Thus, the
exception in section 954(c)(2)(A) would apply, and
the rental income received by FS4 would be treated
as non-passive income for purposes of determining
whether FS4 is a PFIC.
(ii) Example 2—(A) Facts. The facts are the
same as in paragraph (e)(3)(i)(A) of this section (the
facts in Example 1), except that FS2 also owns real
property that is leased to a person that is not a re-
lated person, and the officers and employees of FS2
in Country A engage in activities that would allow
rental income received by FS2 with respect to its
real property to qualify for the exception in section
954(c)(2)(A) and §1.954-2(b)(6) and (c)(1)(iv), re-
lying on the rule in §1.954-2(c)(2)(ii) that provides
that an organization is substantial in relation to rents
if active leasing expenses equal or exceed 25% of
adjusted leasing profit. However, the active leasing
expenses of FS1 are less than 25% of its adjusted
leasing profit, which includes the rental income of
FS4 treated as received directly by FS1 as well as
the rental income of FS2 treated as received directly
by FS1.
(B) Results. Because FS2’s rental income consti-
tutes non-passive income as a result of the applica-
tion of §1.1297-1(c)(1)(i)(A) and section 954(c)(2)
(A), it is treated as non-passive income that FS1 is
treated as receiving directly under section 1297(c)
and paragraph (b)(2) of this section for purposes of
determining whether FS1 is a PFIC, and accordingly,
it is not necessary to rely on paragraph (e) of this
section.
(iii) Example 3—(A) Facts. The facts are the
same as in paragraph (e)(3)(i)(A) of this section (the
facts in Example 1), except that USP directly owns
60% of the outstanding stock of FS1.
(B) Results. Under paragraph (e)(2)(iii) of this
section, USP cannot be the common parent of an
affiliated group for purposes of paragraph (e)(2) of
this section because it is a domestic corporation. Be-
cause FS1 is a foreign corporation, FS1 may be the
common parent of an affiliated group for purposes of
paragraph (e)(2) of this section. The results therefore
are the same as in paragraph (e)(3)(i)(B) of this sec-
tion (the results in Example 1).
(f) Gain on disposition of a look-
through subsidiary or look-through part-
nership—(1) [Reserved].
(2) Amount of gain taken into account
from disposition of look-through subsid-
iary. For purposes of section 1297(a)(1),
section 1298(b)(3), and §1.1298-2, the
amount of gain that is taken into account
by a tested foreign corporation from the
tested foreign corporation’s direct dispo-
sition of stock of a look-through subsid-
iary, or an indirect disposition resulting
from the disposition of stock of a look-
through subsidiary by other look-through
subsidiaries or by look-through partner-
ships, is the residual gain. The residual
gain equals the total gain recognized by
the tested foreign corporation (including
gain treated as recognized by the tested
foreign corporation pursuant to section
1297(c) and paragraph (b)(2) or (b)(3) of
this section) from the disposition of the
stock of the look-through subsidiary re-
duced (but not below zero) by unremit-
ted earnings. Unremitted earnings are the
excess (if any) of the aggregate income
(if any) taken into account by the tested
foreign corporation pursuant to section
1297(c) and paragraph (b)(2) or (b)(3) of
this section with respect to the stock of
the disposed-of look-through subsidiary
(including with respect to any other look-
through subsidiary, to the extent it is
owned by the tested foreign corporation
indirectly through the disposed-of look-
through subsidiary) over the aggregate
dividends (if any) received by the tested
foreign corporation from the disposed-of
look-through subsidiary with respect to
the stock, determined without regard to
paragraph (c)(2)(i) of this section. For
purposes of this paragraph (f)(2), the
amount of gain derived from the disposi-
tion of stock of a look-through subsidiary
and income of and dividends received
from the look-through subsidiary is de-
termined on a share-by-share basis under
a reasonable method.
(3) Characterization of residual gain
as passive income. For purposes of sec-
tion 1297(a)(1), section 1298(b)(3), and
§1.1298-2, the residual gain from the di-
rect or indirect disposition of stock of a
look-through subsidiary is characterized
as passive income or non-passive income
based on the relative amounts of passive
assets and non-passive assets (as defined
in §1.1297-1(f)(5) and (3), respectively)
of the disposed-of look-through subsidiary
(and any other look-through subsidiary to
the extent owned indirectly through the
look-through subsidiary) treated as held
by the tested foreign corporation on the
date of the disposition of the look-through
subsidiary. For the purpose of this para-
graph (f)(3), the relative amounts of pas-
sive assets and non-passive assets held by
the look-through subsidiary are measured
under the same method (value or adjusted
bases) used to measure the assets of the
tested foreign corporation for purposes of
section 1297(a)(2).
(4) Gain taken into account from dis-
position of 25%-owned partnerships and
look-through partnerships—(i) Section
954(c)(4) partnerships. The amount of
gain derived from a tested foreign cor-
poration’s direct or indirect (through a
look-through subsidiary or look-through
partnership) disposition of partnership
interests in a partnership described in
section 954(c)(4) (treating the tested for-
eign corporation as if it were a controlled
foreign corporation) that is taken into ac-
count by the tested foreign corporation for
purposes of section 1297(a)(1), section

Bulletin No. 2021–5 567 February 1, 2021
1298(b)(3), and §1.1298-2 is determined
under section 954(c)(4).
(ii) Look-through partnerships. In the
case of a look-through partnership that
is not described in paragraph (f)(4)(i) of
this section, the principles of paragraphs
(f)(2) and (f)(3) of this section apply to
determine the amount and characteriza-
tion of gain derived from a tested foreign
corporation’s direct or indirect (through a
look-through subsidiary or look-through
partnership) disposition of partnership
interests of the look-through partnership
that is taken into account by the tested
foreign corporation for purposes of sec-
tion 1297(a)(1), section 1298(b)(3), and
§1.1298-2.
(5) Examples. The following exam-
ples illustrate the rules of this paragraph
(f). For purposes of the examples in this
paragraph (f)(5), USP is a domestic cor-
poration, TFC and FS are foreign corpo-
rations that are not controlled foreign cor-
porations within the meaning of section
957(a), and USP, TFC, and FS each has a
single class of stock with 100 shares out-
standing and a calendar taxable year.
(i) Example 1—(A) Facts. USP owned 30%
of the outstanding stock of TFC throughout Years
1, 2, 3, and 4. In Year 1, TFC purchased 5 shares
of FS stock, representing 5% of the stock of FS,
from an unrelated person. On the first day of Year 3,
TFC purchased 20 shares of FS stock, representing
20% of the stock of FS, from an unrelated person.
TFC owned 25% of the outstanding stock of FS
throughout Years 3 and 4. Before Year 3, TFC did
not include any amount in income with respect to
FS under section 1297(c)(2). During Years 3 and 4,
for purposes of section 1297(a)(1), TFC included
in income, in the aggregate, $40x of income with
respect to FS under section 1297(c) and paragraph
(b)(2) of this section. TFC did not receive dividends
from FS during Year 1, 2, 3, or 4. For purposes of
section 1297(a)(2), TFC measures its assets based
on their fair market value as provided under sec-
tion 1297(e). On the last day of Year 4, TFC recog-
nizes a loss with respect to the sale of 5 shares of
FS stock, and a $110x gain with respect to the sale
of 20 shares of FS stock. On the date of the sale,
FS owns non-passive assets with an aggregate fair
market value of $150x, and passive assets with an
aggregate fair market value of $50x.
(B) Results. For purposes of applying section
1297(a)(1) to TFC for Year 4, TFC must take into
account $78x of residual gain, as provided by para-
graph (f)(2) of this section, which equals the amount
by which the $110x gain recognized on the sale of
20 shares in FS exceeds the aggregate pro rata share
of $32x income ($40x x 20/25) taken into account
by TFC with respect to the 20 shares in FS under
section 1297(c) and paragraph (b)(2) of this section
during Years 3 and 4. There is zero residual gain on
the sale of 5 shares of FS stock because they were
sold at a loss. Under paragraph (f)(3) of this section,
$58.50x of the residual gain is non-passive income
($78x x ($150x/$200x)) and $19.50x is passive in-
come ($78x x ($50x/$200x)).
(ii) Example 2—(A) Facts. The facts are the
same as in paragraph (f)(5)(i)(A) of this section (the
facts in Example 1), except that in Year 1, TFC pur-
chased 15 shares of FS stock, representing 15% of
the stock of FS, from an unrelated person, and on the
first day of Year 3, TFC purchased an additional 15
shares of FS stock, representing 15% of the stock of
FS, from an unrelated person, and on the last day of
Year 4, TFC recognizes gain of $10x of the sale of
15 shares of FS stock purchased in Year 1, and gain
of $60x on the sale of the other 15 shares of FS stock
purchased in Year 3.
(B) Results. For purposes of applying section
1297(a)(1) to TFC for Year 4, TFC must take into
account $40x of residual gain with respect to the 15
shares acquired in Year 3, as provided by paragraph
(f)(2) of this section, which equals the amount by
which the $60x gain recognized on the sale of those
15 shares exceeds the aggregate pro rata share of
$20x income ($40x x 15/30) taken into account by
TFC with respect to those 15 shares in FS under sec-
tion 1297(c)(2) during Years 3 and 4. There is zero
residual gain on the sale of the 15 shares of FS stock
acquired in Year 1 because the $10x of gain does not
exceed the aggregate pro rata share of $20x income
taken into account by TFC with respect to those 15
shares of FS under section 1297(c) and paragraph (b)
(2) of this section. Under paragraph (f)(3) of this sec-
tion, $30x of the residual gain is non-passive income
($40x x ($150x/$200x)) and $10x is passive income
($40x x ($50x/$200x)).
(iii) Example 3—(A) Facts. The facts are the
same as in paragraph (f)(5)(ii)(A) of this section (the
facts in Example 2), except that TFC received, in the
aggregate, $20x of dividends from FS during Year 2.
(B) Results. The results are the same as in para-
graph (f)(5)(ii)(B) of this section (the results in
Example 2) with respect to the 15 shares acquired
in Year 3 ($40x of residual gain attributable to the
15 shares acquired in Year 3). For purposes of ap-
plying section 1297(a)(1) to TFC for Year 4, TFC
must also take into account $10x of residual gain
with respect to the 15 shares acquired in Year 1.
As provided by paragraph (f)(2) of this section, the
residual gain equals the amount by which the $10x
gain recognized on the sale of those 15 shares ex-
ceeds the unremitted earnings with respect to those
shares. The unremitted earnings with respect to the
15 shares acquired in Year 1 are $0x, the amount
by which the pro rata share of aggregate income
($20x) taken into account by TFC with respect to
those 15 shares of FS stock under section 1297(c)
and paragraph (b)(2) of this section in Years 3 and
4 exceeds the aggregate pro rata amount of divi-
dends with respect to those 15 shares of FS stock
($20x) received by TFC from FS in Year 2. Total
residual gain therefore is $50x ($40x + $10x).
Under paragraph (f)(3) of this section, $37.50x
of the residual gain is non-passive income ($50x
x ($150x/$200x)) and $12.50x is passive income
($50x x ($50x/$200x)).
(g) Definitions. The following defini-
tions apply for purposes of §1.1297-1 and
this section:
(1) Direct LTS obligation. The term
direct LTS obligation has the meaning
provided in paragraph (c)(1)(ii) of this
section.
(2) Indirect LTS obligation. The term
indirect LTS obligation has the meaning
provided in paragraph (c)(1)(ii) of this
section.
(3) Look-through subsidiary. The term
look-through subsidiary means, with re-
spect to a tested foreign corporation, a
corporation as to which the asset test of
paragraph (g)(3)(i) and the income test
of paragraph (g)(3)(ii) of this section are
satisfied on each measuring date during
the taxable year of a tested foreign cor-
poration. If a corporation satisfies both
the asset test of paragraph (g)(3)(i) and
the income test of paragraph (g)(3)(ii)(B)
for some but not all measuring periods
within the taxable year of a tested foreign
corporation, the subsidiary is treated as
a look-through subsidiary only for those
measuring periods in which both tests are
satisfied.
(i) For purposes of section 1297(a)(2)
and paragraph (b)(2)(i) of this section, a
corporation at least 25 percent of the value
of the stock of which is owned (as deter-
mined under paragraph (b)(1) of this sec-
tion) by the tested foreign corporation on
the measuring date (as defined in §1.1297-
1(f)(1));
(ii) For purposes of section 1297(a)(1),
either—
(A) For the taxable year, a corpora-
tion with respect to which the average
percentage ownership (which is equal to
the percentage ownership (by value) (as
determined under paragraph (b)(1) of this
section) on each measuring date during
the taxable year, divided by the number of
measuring dates in the year) by the tested
foreign corporation during the tested for-
eign corporation’s taxable year is at least
25 percent; or
(B) For a measuring period (as de-
fined in §1.1297-1(f)(2)), a corporation at
least 25 percent of the value of the stock
of which is owned (as determined under
paragraph (b)(1) of this section) by the
tested foreign corporation on the mea-
suring date, provided all items of gross
income of the corporation for each of the
measuring periods in the taxable year for
which the tested foreign corporation owns
at least 25 percent of the value (as deter-

February 1, 2021 568 Bulletin No. 2021–5
mined under paragraph (b)(1) of this sec-
tion) on the relevant measuring dates can
be established; and
(iii) For purposes of paragraph (f) of
this section and §1.1298-2, a corporation
at least 25 percent of the value of the stock
of which is owned (as determined under
paragraph (b)(1) of this section) by the
tested foreign corporation immediately
before the disposition of stock of the cor-
poration.
(4) Look-through partnership—(i) In
general. The term look-through partner-
ship means, with respect to a tested for-
eign corporation—
(A) A partnership that would be a look-
through subsidiary (as defined in para-
graph (g)(3) of this section) if such part-
nership were a corporation; or
(B) A partnership that is not described
in paragraph (g)(4)(i)(A) of this section,
if the tested foreign corporation satisfies
both of the active partner tests set forth
in paragraphs (g)(4)(ii)(A) and (B) of this
section on the measurement date or for the
taxable year, as applicable, unless an elec-
tion is made under paragraph (g)(4)(iii) of
this section.
(ii) Active partner test—(A) Partner-
ship interest under asset test. For purposes
of paragraph (b)(3)(i) of this section, para-
graph (g)(4)(i)(B) of this section applies
for the measuring period only if the tested
foreign corporation would not be a PFIC if
section 1297(a)(1) and (2) and the regula-
tions thereunder were applied to the tested
foreign corporation without regard to any
partnership interest owned by the tested
foreign corporation that is not a partner-
ship described in paragraph (g)(4)(i)(A) of
this section. For purposes of the preceding
sentence, the active partner test is applied
on the measurement date (as defined in
§1.1297-1(f)(1)).
(B) Partnership income under income
test. For purposes of paragraph (b)(3)(ii)
of this section, paragraph (g)(4)(i)(B) of
this section applies for the taxable year
of the tested foreign corporation or for a
measuring period (as defined in §1.1297-
1(f)(2)), as applicable, only if the tested
foreign corporation would not be a PFIC
if section 1297(a)(1) and (2) and the reg-
ulations thereunder were applied to the
tested foreign corporation without regard
to any partnership interest owned by the
tested foreign corporation that is not a
partnership described in paragraph (g)(4)
(i)(A) of this section. For purposes of the
preceding sentence, the active partner test
is applied on the measuring date (as de-
fined in §1.1297-1(f)(1)) or for the taxable
year, as applicable using the same period
that was used under paragraph (g)(3)(ii) of
this section.
(iii) Election. For any taxable year,
an election may be made with respect to
a partnership described in paragraph (g)
(4)(i)(B) of this section to not apply the
provisions of this paragraph (g)(4) to such
partnership.
(iv) Examples. The following exam-
ples illustrate the rules of this paragraph
(g)(4). For purposes of the examples in
this paragraph (g)(4)(iv), TFC is a foreign
corporation that is not a controlled foreign
corporation; FC1 and FC2 are foreign cor-
porations that are not controlled foreign
corporations; FPS is a foreign partnership;
TFC owns 100% of the single class of
stock of FC1 and FC2; FC2 owns 10% of
the value of FPS, and the remaining 90%
of FPS is owned by an unrelated foreign
person; and TFC, FC1, FC2, and FPS are
all calendar year taxpayers.
(A) Example 1—(1) Facts. During Year 1, FC1
generated $100x of non-passive income, FC2 gener-
ated $150x of non-passive income, and FPS generat-
ed $50x of income. On all of the measurement dates
in Year 1, FC1 has assets with a value of $1000x that
FC1 uses in its trade or business generating non-pas-
sive income, FC2 has assets with a value of $1500x
that FC2 uses in its trade or business generating
non-passive income, and FPS has assets with a value
of $500x.
(2) Results—(i) Active partner test with respect
to partnership interest. Pursuant to section 1297(c)
and §1.1297-2(b)(2), TFC is treated as holding di-
rectly the assets held by FC1 and FC2. For purposes
of the active partner test under paragraph (g)(4)(ii)
(B) of this section, TFC does not take into account
its interest in FPS to determine whether it would be
a PFIC. Because 100% ($2500x/$2500x) of the as-
sets of FC1 and FC2 that TFC is treated as directly
holding, without taking into account the interest in
FPS, generates non-passive income, TFC satisfies
the active partner test in paragraph (g)(4)(ii)(B) of
this section.
(ii) Active partner test with respect to partner-
ship income. Pursuant to section 1297(c) and para-
graph (b)(2) of this section, TFC is treated as if it
received directly its proportionate share of income
of FC1 and FC2. For purposes of the active partner
test under paragraph (g)(4)(ii)(A) of this section,
TFC does not take into account its interest in FPS
to determine whether it would be a PFIC. Because
100% ($250x/$250x) of the income of FC1 and FC2
that TFC is treated as directly receiving, without tak-
ing into account the interest in FPS, is non-passive
income, TFC satisfies the active partner test in para-
graph (g)(4)(ii)(A) of this section with respect to the
income of FPS.
(iii) Qualification of look-through partnership.
For purposes of paragraph (b)(3) of this section,
FPS qualifies as a look-through partnership be-
cause TFC satisfies the active partner tests of both
paragraphs (g)(4)(i)(A) and (B) of this section.
Unless an election is made not to treat FPS as a
look-through partnership under paragraph (g)(4)
(iii) of this section, TFC is treated as receiving di-
rectly $5x of income (10% x $50x), TFC’s pro rata
share of the income of FPS, the character of which
is determined at the level of FPS for purposes of
section 1297. In addition, TFC is treated as holding
directly $50x of FPS’s assets (10% x $500x), TFC’s
proportionate share of the assets held by FPS. The
character of those assets as passive or non-passive
is determined in the hands of FPS for purposes of
section 1297.
(B) Example 2—(1) Facts. During Year 1, FC1
generated $50x of passive income, FC2 earned
$175x of non-passive income, and FPS generated
$50x of income. On all of the measurement dates in
Year 1, FC1 has assets with a value of $1100x that
produce passive income, and FC2 has assets with a
value of $900x that FC2 uses in its trade or business
generating non-passive income. The value of FPS is
$1000x taking into account its assets and liabilities.
(2) Results—(i) Active partner test with respect
to partnership interest. Pursuant to section 1297(c)
and §1.1297-2(b)(2), TFC is treated as holding di-
rectly the assets held by FC1 and FC2. For purposes
of the active partner test under paragraph (g)(4)(ii)
(B) of this section, TFC does not take into account
its interest in FPS to determine whether it would be
a PFIC. Accordingly, 55% ($1100x/$2000x) of the
assets that TFC is treated as directly holding, with-
out taking into account the interest in FPS, generate
passive income.
(ii) Active partner test with respect to part-
nership income. Pursuant to section 1297(c) and
§1.1297-2(b)(2), TFC is treated as if it received di-
rectly its proportionate share of income of FC1 and
FC2. For purposes of the active partner test under
paragraph (g)(4)(ii)(A) of this section, TFC does
not take into account its interest in FPS to determine
whether it would be a PFIC. Accordingly, 77.8%
($175x/$225x) of the income that TFC is treated as
directly receiving, without taking into account the
interest in FPS, is non-passive income.
(iii) Failure to qualify as look-through partner-
ship. TFC satisfies the active partner test in para-
graph (g)(4)(ii)(A) of this section but does not sat-
isfy the active partner test in paragraph (g)(4)(ii) (B)
of this section. Therefore, FPS does not qualify as a
look-though partnership. Under paragraph (b)(3)(iii)
of this section, TFC’s share of income with respect to
FPS is treated as passive income for purposes of sec-
tion 1297 and TFC’s $100x interest (10% x $1000x)
in FPS is treated as a passive asset for purposes of
section 1297.
(5) LTS debt. The term LTS debt has the
meaning provided in paragraph (c)(1)(ii)
of this section.
(6) LTS lease. The term LTS lease has
the meaning provided in paragraph (c)(1)
(ii) of this section.

Bulletin No. 2021–5 569 February 1, 2021
(7) LTS license. The term LTS license
has the meaning provided in paragraph (c)
(1)(ii) of this section.
(8) LTS obligation. The term LTS obli-
gation has the meaning provided in para-
graph (c)(1)(ii) of this section.
(9) LTS stock. The term LTS stock has
the meaning provided in paragraph (c)(1)
(i) of this section.
(10) Qualified affiliate. The term qual-
ified affiliate has the meaning provided in
paragraph (e)(2) of this section.
(11) Residual gain. The term residual
gain has the meaning provided in para-
graph (f)(2) of this section.
(12) TFC obligation. The term TFC
obligation has the meaning provided in
paragraph (c)(1)(ii) of this section.
(13) Unremitted earnings. The term
unremitted earnings has the meaning pro-
vided in paragraph (f)(2) of this section.
(h) Applicability date. The rules of this
section apply to taxable years of share-
holders beginning on or after January 14,
2021. A shareholder may choose to apply
such rules for any open taxable year be-
ginning before January 14, 2021, provid-
ed that, with respect to a tested foreign
corporation, the shareholder consistently
applies the provisions of §1.1291-1(b)(8)
(iv) and (b)(8)(v)(A), (B), (C), and (D)
and §§1.1297-1 (except that consistent
treatment is not required with respect to
§1.1297-1(c)(1)(i)(A)), 1.1298-2, and
1.1298-4 for such year and all subsequent
years.
Par. 6. Sections 1.1297-4, 1.1297-5,
and 1.1297-6 are added to read as follows:
§1.1297-4 Qualifying insurance
corporation.
(a) Scope. This section provides rules
for determining whether a foreign cor-
poration is a qualifying insurance cor-
poration for purposes of section 1297(f).
Paragraph (b) of this section provides
the general rule for determining wheth-
er a foreign corporation is a qualifying
insurance corporation. Paragraph (c) of
this section describes the 25 percent test
in section 1297(f)(1)(B). Paragraph (d) of
this section contains rules for applying the
alternative facts and circumstances test in
section 1297(f)(2). Paragraph (e) of this
section contains rules limiting the amount
of applicable insurance liabilities for pur-
poses of the 25 percent test described in
paragraph (c) of this section and the al-
ternative facts and circumstances test de-
scribed in paragraph (d) of this section.
Paragraph (f) of this section provides defi-
nitions that apply for purposes of this sec-
tion. Paragraph (g) of this section provides
the applicability date of this section.
(b) Qualifying insurance corporation.
For purposes of section 1297(b)(2)(B),
this section, and §§1.1297-5 and 1.1297-
6, with respect to a U.S. person, a qual-
ifying insurance corporation (QIC) is a
foreign corporation that—
(1) Is an insurance company as defined
in section 816(a) that would be subject to
tax under subchapter L if the corporation
were a domestic corporation; and
(2) Satisfies—
(i) The 25 percent test described in
paragraph (c) of this section; or
(ii) The requirements for an election
to apply the alternative facts and circum-
stances test as described in paragraph (d)
of this section and a United States person
has made an election as described in para-
graph (d)(5) of this section.
(c) 25 percent test. A foreign corpo-
ration satisfies the 25 percent test if the
amount of its applicable insurance liabil-
ities exceeds 25 percent of its total assets.
This determination is made on the basis
of the applicable insurance liabilities and
total assets reported on the corporation’s
applicable financial statement for the ap-
plicable reporting period.
(d) Election to apply the alternative
facts and circumstances test—(1) In gen-
eral. A United States person that owns
stock in a foreign corporation that fails to
qualify as a QIC solely because of the 25
percent test may elect to treat the stock of
the corporation as stock of a QIC if the
foreign corporation—
(i) Is predominantly engaged in an
insurance business as described in para-
graph (d)(2) of this section;
(ii) Failed to satisfy the 25 percent test
solely due to runoff-related circumstanc-
es, as described in paragraph (d)(3) of this
section, or rating-related circumstances,
as described in paragraph (d)(4) of this
section; and
(iii) Reports an amount of applica-
ble insurance liabilities that is at least 10
percent of the amount of the total assets
on the corporation’s applicable financial
statement for the applicable reporting pe-
riod.
(2) Predominantly engaged in an insur-
ance business—(i) In general. A foreign
corporation is not considered predomi-
nantly engaged in an insurance business
in any taxable year unless more than half
of the business of the foreign corporation
is the issuing of insurance or annuity con-
tracts or the reinsuring of risks underwrit-
ten by insurance companies. This deter-
mination is made based on the character
of the business actually conducted in the
taxable year. The fact that a foreign cor-
poration has been holding itself out as an
insurer for a long period is not determi-
native of whether the foreign corporation
is predominantly engaged in an insurance
business.
(ii) Facts and circumstances. Facts and
circumstances to consider in determining
whether a foreign corporation is predom-
inantly engaged in an insurance business
include (but are not limited to)—
(A) Claims payment patterns for the
current year and prior years;
(B) The foreign corporation’s loss ex-
posure as calculated for a regulator or for
a credit rating agency, or, if those are not
calculated, for internal pricing purposes;
(C) The percentage of gross receipts
constituting premiums for the current and
prior years; and
(D) The number and size of insurance
contracts issued or taken on through rein-
surance by the foreign corporation.
(iii) Examples of facts indicating a
foreign corporation is not predominantly
engaged in an insurance business. Exam-
ples of facts that may indicate a foreign
corporation is not predominantly engaged
in an insurance business include (but are
not limited to)—
(A) A small overall number of insured
risks with low likelihood but large poten-
tial costs;
(B) Employees and agents of the for-
eign corporation focused to a greater de-
gree on investment activities than under-
writing activities; and
(C) Low loss exposure.
(3) Runoff-related circumstances.
During the annual reporting period cov-
ered by the applicable financial statement,
a foreign corporation fails to satisfy the 25
percent test solely due to runoff-related
circumstances only if the corporation—

February 1, 2021 570 Bulletin No. 2021–5
(i) Was engaged in the process of termi-
nating its pre-existing, active conduct of
an insurance business (within the meaning
of section 1297(b)(2)(B)) under the super-
vision of its applicable insurance regulato-
ry body or pursuant to any court-ordered
receivership proceeding (liquidation,
rehabilitation, or conservation) and fails
to satisfy the 25 percent test because the
corporation is required to hold additional
assets due to its business being in runoff;
(ii) Has no plan or intention to enter
into, and did not issue or enter into, any
insurance, annuity, or reinsurance con-
tract, other than a contractually obligated
renewal of an existing insurance contract
or a reinsurance contract pursuant to and
consistent with the termination of its ac-
tive conduct of an insurance business; and
(iii) Made payments during the annual
reporting period covered by the applicable
financial statement as required to satisfy
claims under insurance, annuity, or rein-
surance contracts.
(4) Rating-related circumstances. A
foreign corporation fails to satisfy the 25
percent test solely due to rating-related
circumstances only if—
(i) The 25 percent test is not met due to
capital and surplus amounts that a gener-
ally recognized credit rating agency con-
siders necessary for the foreign corpora-
tion to obtain a public rating with respect
to its financial strength, and the foreign
corporation maintains such capital and
surplus in order to obtain the minimum
credit rating necessary for the annual re-
porting period by the foreign corporation
to be able to write the business in its reg-
ulatory or board supervised business plan.
This paragraph (c)(4)(i) applies only if the
foreign corporation is a mortgage insur-
ance company (as defined in paragraph (f)
(10) of this section) or if more than half
of the foreign corporation’s net written
premiums for the annual reporting period
(or the average of the net written premi-
ums for the foreign corporation’s annual
reporting period and the two immediately
preceding annual reporting periods) are
from insurance coverage against the risk
of loss from a catastrophic loss event (that
is, a low frequency but high severity loss
event); or
(ii) The foreign corporation is a finan-
cial guaranty insurance company (as de-
fined in paragraph (f)(5) of this section).
(5) Election—(i) In general. A Unit-
ed States person may make the election
under section 1297(f)(2) for its taxable
year if the foreign corporation directly
provides the United States person a state-
ment, signed by a responsible officer of
the foreign corporation or an authorized
representative of the foreign corporation,
or the foreign corporation (or its foreign
parent corporation on its behalf) makes a
publicly available statement (such as in a
public filing, disclosure statement, or oth-
er notice provided to United States per-
sons that are shareholders of the foreign
corporation) that it satisfied the require-
ments of section 1297(f)(2) and paragraph
(d)(1) of this section during the foreign
corporation’s applicable reporting period.
However, a United States person may not
rely upon any statement by the foreign
corporation (or its foreign parent corpo-
ration) to make the election under section
1297(f)(2) if the shareholder knows or
has reason to know based on reasonably
accessible information that the statement
made by the foreign corporation (or its
foreign parent corporation) was incorrect.
(ii) Information provided by foreign
corporation. In addition to a statement
that the foreign corporation satisfied the
requirements of section 1297(f)(2) and
paragraph (d)(1) of this section, the state-
ment described in paragraph (d)(5)(i) of
this section also must include:
(A) The ratio of applicable insurance
liabilities to total assets for the applicable
reporting period; and
(B) A statement indicating whether
the failure to satisfy the 25 percent test
described in paragraph (c) of this section
was the result of runoff-related or rat-
ing-related circumstances, along with a
brief description of those circumstances.
(iii) Time and manner for making the
election. Except as provided in paragraph
(d)(5)(iv), the election described in para-
graph (d)(1) of this section may be made
by a United States person who owns stock
in the foreign corporation by complet-
ing the appropriate part of Form 8621
(or successor form) for each taxable year
of the United States person in which the
election applies. A United States person
must attach the Form 8621 (or successor
form) to its original or amended Federal
income tax return for the taxable year of
the United States person to which the elec-
tion relates. A United States person can
attach the Form 8621 (or successor form)
to an amended return for the taxable year
of the United States person to which the
election relates if the United States person
can demonstrate the reason for not filing
the form with its original return was due
to reasonable cause.
(iv) Deemed election for small share-
holders in publicly traded companies—
(A) In general. A United States person
who owns publicly traded stock in a for-
eign corporation will be deemed to make
the election under section 1297(f)(2) with
respect to the foreign corporation and its
subsidiaries if the following requirements
are satisfied:
(1) The stock of the foreign corporation
that is owned by the United States person
(including stock owned indirectly) has a
value of $25,000 or less ($50,000 or less
in the case of a joint return) on the last day
of the United States person’s taxable year
and on any day during the taxable year on
which the United States person disposes
of stock of the foreign corporation; and
(2) If the United States person owns
stock of the foreign corporation indirectly
through a domestic partnership, domestic
trust, domestic estate, or S corporation (a
domestic pass-through entity), the stock
of the foreign corporation that is owned
by the domestic pass-through entity has a
value of $25,000 or less on the last day
of the taxable year of the domestic pass-
through entity that ends with or within the
United States person’s taxable year and on
any day during the taxable year of the do-
mestic pass-through entity on which it dis-
poses of stock of the foreign corporation.
(B) Publicly traded stock. For the pur-
pose of paragraph (d)(5)(iv)(A) of this
section, stock is publicly traded if it would
be treated as marketable stock within the
meaning of section 1296(e) and §1.1296-
2 (without regard to §1.1296-2(d)) if the
election under section 1297(f)(2) is not
made.
(v) Options. If a United States person
is considered to own stock in a foreign
corporation by reason of holding an op-
tion, the United States person may make
the election under section 1297(f)(2) (or
may be deemed to make an election under
paragraph (d)(5)(iv) of this section) with
respect to the foreign corporation or its
subsidiaries in the same manner as if the

Bulletin No. 2021–5 571 February 1, 2021
United States person owned stock in the
foreign corporation.
(6) Stock ownership. For purposes of
this section, ownership of stock in a for-
eign corporation means either direct own-
ership of such stock or indirect ownership
determined using the rules specified in
§1.1291-1(b)(8).
(e) Rules limiting the amount of appli-
cable insurance liabilities—(1) In gener-
al. For purposes of determining whether
a foreign corporation satisfies the 25 per-
cent test described in paragraph (c) of this
section or the 10 percent test described in
paragraph (d)(1)(iii) of this section, the
rules of this paragraph (e) apply to limit
the amount of applicable insurance liabili-
ties of the foreign corporation.
(2) General limitation on applicable
insurance liabilities. The amount of appli-
cable insurance liabilities may not exceed
any of the amounts described in para-
graphs (e)(2)(i) to (iii) of this section. This
paragraph (e)(2) applies after applying
paragraph (e)(3) of this section.
(i) The amount of applicable insur-
ance liabilities of the foreign corporation
shown on any financial statement that the
foreign corporation filed or was required
to file with its applicable insurance regu-
latory body for the financial statement’s
applicable reporting period;
(ii) If the foreign corporation’s applica-
ble financial statement is prepared on the
basis of either GAAP or IFRS, the amount
of the foreign corporation’s applicable in-
surance liabilities determined on the ba-
sis of its applicable financial statement,
whether or not the foreign corporation
files the statement with its applicable in-
surance regulatory body; or
(iii) The amount of applicable insur-
ance liabilities required for the foreign
corporation by the applicable law or regu-
lation of the jurisdiction of the applicable
insurance regulatory body at the end of
the applicable reporting period (or a lesser
amount of applicable insurance liabilities,
if the foreign corporation is holding a less-
er amount as a permitted practice of the
applicable regulatory body).
(3) Discounting. If an applicable finan-
cial statement or a financial statement de-
scribed in paragraph (e)(2) of this section
is prepared on the basis of an accounting
method other than GAAP or IFRS and
does not discount applicable insurance
liabilities on an economically reasonable
basis, the amount of applicable insurance
liabilities may not exceed the amount of
applicable insurance liabilities on the fi-
nancial statement reduced by applying the
discounting methods that would apply un-
der either GAAP or IFRS to the insurance
or annuity contracts to which the applica-
ble insurance liabilities at issue relate. The
foreign corporation may choose whether
to apply either GAAP or IFRS discounting
methods for this purpose.
(4) [Reserved].
(5) [Reserved].
(f) Definitions. The following defini-
tions apply for purposes of this section.
(1) Applicable financial statement.
The term applicable financial statement
means the foreign corporation’s financial
statement prepared for financial reporting
purposes, listed in paragraphs (f)(1)(i)
through (iii) of this section, and that has
the highest priority. The financial state-
ments are, in order of descending priori-
ty—
(i) GAAP statements. A financial state-
ment that is prepared in accordance with
GAAP;
(ii) IFRS statements. A financial state-
ment that is prepared in accordance with
IFRS; or
(iii) Regulatory annual statement. A fi-
nancial statement required to be filed with
the applicable insurance regulatory body.
(iv) [Reserved].
(2) Applicable insurance liabilities—
(i) In general. The term applicable insur-
ance liabilities means, with respect to any
life or property and casualty insurance
business—
(A) Reported losses (which are expect-
ed payments to policyholders for sustained
losses related to insured events under an
insurance contract that have occurred and
have been reported to, but not paid by,
the insurer as of the financial statement
end date), and incurred but not reported
losses (which are expected payments to
policyholders for sustained losses relating
to insured events under an insurance con-
tract that have occurred but have not been
reported to the insurer as of the financial
statement end date);
(B) Unpaid loss adjustment expenses
(including reasonable estimates of antic-
ipated loss adjustment expenses) associat-
ed with investigating, defending, settling,
and adjusting paid losses, unpaid reported
losses, and incurred but not reported loss-
es (of the type described in paragraph (f)
(2)(i)(A) of this section) as of the financial
statement end date; and
(C) The aggregate amount of reserves
(excluding deficiency, contingency, or un-
earned premium reserves) held as of the
financial statement end date to mature
or liquidate potential, future claims for
death, annuity, or health benefits that may
become payable under contracts provid-
ing, at the time the reserve is computed,
coverage for mortality or morbidity risks;
(D) Provided, however, that—
(1) No item or amount shall be taken
into account more than once in determin-
ing applicable insurance liabilities;
(2) The applicable insurance liabilities
eligible to be taken into account in apply-
ing this paragraph (f)(2) include only the
applicable insurance liabilities of the for-
eign corporation whose QIC status is be-
ing determined; and
(3) [Reserved].
(ii) Amounts not specified in paragraph
(f)(2)(i) of this section. Amounts not spec-
ified in paragraph (f)(2)(i) of this section
are not applicable insurance liabilities.
For example, the term applicable insur-
ance liability does not include any amount
held by an insurance company as a deposit
liability that is not an insurance liability,
such as a funding agreement, a guaranteed
investment contract, premium or other
deposit funds, structured settlements, or
any other substantially similar contract is-
sued by an insurance company. The term
applicable insurance liabilities also does
not include the amount of any reserve for
a life insurance or annuity contract the
payments of which do not depend on the
life or life expectancy of one or more in-
dividuals.
(3) Applicable insurance regulatory
body. The term applicable insurance regu-
latory body means the entity that has been
established by law to license or authorize
a corporation to engage in an insurance
business, to regulate insurance company
solvency, and, in the case of an applicable
financial statement described in paragraph
(f)(1)(iii), is the entity to which the appli-
cable financial statement is provided.
(4) Applicable reporting period. The
term applicable reporting period is the
last annual reporting period for a financial

February 1, 2021 572 Bulletin No. 2021–5
statement ending with or within the tax-
able year of a U.S. person owning stock in
a foreign corporation, within the meaning
of paragraph (d)(6) of this section.
(5) Financial guaranty insurance
company. The term financial guaranty
insurance company means any insurance
company whose sole business is to insure
or reinsure only the type of business writ-
ten by, or that would be permitted to be
written by, a company licensed under, and
compliant with, a U.S. state law, modeled
after the Financial Guaranty Insurance
Guideline as established by National As-
sociation of Insurance Companies, that
specifically governs the licensing and
regulation of financial guaranty insurance
companies.
(6) Financial statements—(i) In gen-
eral. The term financial statement means
a statement prepared for a legal entity for
a reporting period in accordance with the
rules of a financial accounting or statutory
accounting standard that includes a com-
plete balance sheet, statement of income,
and a statement of cash flows (or equiv-
alent statements under the applicable re-
porting standard).
(ii) [Reserved].
(iii) [Reserved].
(7) Generally accepted accounting
principles or GAAP. The term generally
accepted accounting principles or GAAP
means United States generally accepted
accounting principles described in stan-
dards established and made effective
by the Financial Accounting Standards
Board.
(8) Insurance business. For purposes
of this section, §1.1297-5, and §1.1297-
6, insurance business means the business
of issuing insurance and annuity contracts
and the reinsuring of risks underwritten by
insurance companies, together with those
investment activities and administrative
services that are required to support (or
are substantially related to) insurance, an-
nuity, or reinsurance contracts issued or
entered into by the foreign corporation.
(9) International financial reporting
standards or IFRS. The term internation-
al financial reporting standards or IFRS
means accounting standards established
and made effective by the International
Accounting Standards Board.
(10) Mortgage insurance company. For
purposes of this section, mortgage insur-
ance company means any insurance com-
pany whose sole business is to insure or
reinsure against a lender’s loss of all or a
portion of the principal amount of a mort-
gage loan upon default of the mortgagor.
(11) Total assets. For purposes of sec-
tion 1297(f) and this section, a foreign
corporation’s total assets are the aggre-
gate value of the real property and person-
al property that the foreign corporation re-
ports on its applicable financial statement
as of the financial statement end date.
(g) Applicability date. The rules of this
section apply to taxable years of share-
holders beginning on or after January 14,
2021. A shareholder may choose to apply
such rules for any open taxable year be-
ginning after December 31, 2017 and be-
fore January 14, 2021, provided that, with
respect to a tested foreign corporation, it
consistently applies the provisions of this
section and §1.1297-6 for such year and
all subsequent years.
§1.1297-5 [Reserved].
§1.1297-6 Exception from the
definition of passive income for active
insurance income.
(a) Scope. This section provides rules
pertaining to the exception from passive
income under section 1297(b)(2)(B) for
income derived in the active conduct of
an insurance business and rules related to
certain income of a qualifying domestic
insurance corporation. Paragraph (b) of
this section provides a general rule that
excludes from passive income certain
income of a qualifying insurance corpo-
ration (QIC), as defined in §1.1297-4(b),
and certain income of a qualifying domes-
tic insurance corporation. Paragraph (c)
of this section provides rules excluding
certain assets for purposes of the passive
asset test under section 1297(a)(2). Para-
graph (d) of this section provides rules
concerning the treatment of income and
assets of certain look-through subsidiaries
and look-through partnerships of a QIC.
Paragraph (e) of this section provides
rules relating to qualifying domestic in-
surance corporations. Paragraph (f) of this
section provides the applicability date of
this section.
(b) Exclusion from passive income of
active insurance income. For purposes of
section 1297 and §1.1297-1, passive in-
come does not include—
(1) Income that a QIC derives in the
active conduct of an insurance business
(within the meaning of section 1297(b)(2)
(B)); and
(2) Income of a qualifying domestic in-
surance corporation.
(c) Exclusion of assets for purpos-
es of the passive asset test under section
1297(a)(2). For purposes of section 1297
and §1.1297-1, passive assets (as defined
in §1.1297-1(f)(5)), do not include—
(1) Assets of a QIC available to satisfy
liabilities of the QIC related to its insur-
ance business (as defined in §1.1297-4(f)
(8)), if the QIC is engaged in the active
conduct of an insurance business (within
the meaning of section 1297(b)(2)(B));
and
(2) Assets of a qualifying domestic in-
surance corporation.
(d) Treatment of income and assets
of certain look-through subsidiaries and
look-through partnerships for purposes
of the section 1297(b)(2)(B) exception—
(1) General rule. For purposes of apply-
ing paragraphs (b)(1) and (c)(1) of this
section, a QIC is treated as receiving the
income or holding the assets of a look-
through subsidiary or look-through part-
nership to the extent provided in section
1297(c) and §1.1297-2(b)(2) or §1.1297-
2(b)(3). Subject to the limitation of para-
graph (d)(2) of this section, a QIC’s pro-
portionate share of the income or assets of
a look-through subsidiary or look-through
partnership may be treated as earned
or held directly by the QIC, and thus as
non-passive under paragraphs (b)(1) and
(c)(1) of this section, if the requirements
of those paragraphs are satisfied.
(2) Limitation. A QIC that is engaged
in the active conduct of an insurance
business (within the meaning of section
1297(b)(2)(B)) may not treat its propor-
tionate share of the income or assets of a
look-through subsidiary or look-through
partnership as non-passive to the extent
that it exceeds the greater of—
(i) The QIC’s proportionate share of
the income or assets, respectively, of the
look-through subsidiary or look-through
partnership multiplied by a fraction, the
numerator of which is the net equity value
of the interests held by the QIC in the look-
through subsidiary or look-through part-

Bulletin No. 2021–5 573 February 1, 2021
nership, and the denominator of which is
the value of the QIC’s proportionate share
of the assets of the look-through subsidi-
ary or look-through partnership; and
(ii) The QIC’s proportionate share of
the income or assets, respectively, of the
look-through subsidiary or look-through
partnership that are treated as non-passive
in the hands of the look-through subsidi-
ary or look-through partnership.
(3) Examples. The following examples
illustrate the rules of this section.
(i) Example 1: QIC holds all the stock of an in-
vestment subsidiary—(A) Facts.
(1) F1 is a foreign corporation. In Year 1, F1
meets the definition of a QIC under section 1297(f)
and §1.1297-4 and is engaged in the active conduct
of an insurance business within the meaning of sec-
tion 1297(b)(2)(B). Throughout Year 1, F1 owns all
the stock of F2, a foreign corporation that is not a
QIC and is engaged solely in the investment of pas-
sive assets. The stock of F2 is an asset that is avail-
able to satisfy liabilities of F1 related to its insurance
business within the meaning of paragraph (c)(1) of
this section. The assets of F1 are measured on the
basis of value under §1.1297-1(d)(1)(v)(C).
(2) Throughout Year 1, F2 owns assets with a
value of $1,000x and adjusted bases of $500x, all
of which are treated as passive in the hands of F2.
F2 has outstanding debt with a principal amount of
$250x. On the financial statement end date of F1’s
applicable financial statement, the net equity value
of the F2 stock held by F1 is $750x. In Year 1, F2
earned $100x of income that is treated as passive in
the hands of F2.
(B) Result—(1) Because F1 owns all of the stock
of F2, F2 is a look-through subsidiary of F1 with-
in the meaning of §1.1297-2(g)(3). Under section
1297(c) and §1.1297-2(b)(2), F1 is treated as if it
held 100% of the assets of F2 and received directly
100% of the income of F2. Under paragraph (d)(1)
of this section, because F1 is engaged in the active
conduct of an insurance business and the stock of F2
is an asset that is available to satisfy the insurance li-
abilities of F1, F1 treats its proportionate share of the
income and assets of F2 as non-passive. The amount
of income and assets that is treated as non-passive is
subject to the limitation of paragraph (d)(2) of this
section.
(2) Under paragraph (d)(2) of this section, the
amount of F1’s proportionate share of F2’s income
that is treated as non-passive cannot exceed the
greater of two amounts: $75x, which is F1’s propor-
tionate share of F2’s income ($100x) multiplied by
75% (the net equity value of the F2 stock held by F1,
which is $750x, divided by the value of F1’s propor-
tionate share of F2’s assets, which is $1,000x); and
zero, which is F1’s proportionate share of the income
of F2 that is treated as non-passive in the hands of
F2. Therefore, for the purpose of characterizing F1’s
proportionate share of F2’s income, $75x is treated
as non-passive, and $25x is treated as passive.
(3) Under paragraph (d)(2) of this section, the
amount of F1’s proportionate share of F2’s assets
that is treated as non-passive cannot exceed the
greater of two amounts: $750x, which is F1’s pro-
portionate share of F2’s assets ($1,000x) multiplied
by 75% (the net equity value of the F2 stock held by
F1, which is $750x, divided by the value of F1’s pro-
portionate share of F2’s assets, which is $1,000x);
and zero, which is F1’s proportionate share of the
assets of F2 that are treated as non-passive in the
hands of F2. Therefore, for the purpose of charac-
terizing F1’s proportionate share of the assets of F2,
$750x is treated as non-passive, and $250x is treated
as passive.
(C) Alternative facts—(1) Facts. The facts are
the same as in paragraph (d)(3)(i)(A) of this section
(paragraph (A) of this Example 1), except that the
assets of F1 are measured on the basis of adjusted
basis under §1.1297-1(d)(1)(v)(C) pursuant to a val-
id election under §1.1297-1(d)(1)(iii).
(2) Result. The result with respect to F1’s propor-
tionate share of the income of F2 is the same as in
paragraph (d)(3)(i)(B)(2) of this section (paragraph
(B)(2) of this Example 1). Because the assets of F1
are measured on the basis of adjusted basis under
§1.1297-1(d)(1)(v)(C), F1’s proportionate share of
the passive assets of F2 is equal to $500x (100% of
$500x adjusted bases). Under paragraph (d)(2) of
this section, the amount of F1’s proportionate share
of F2’s assets that may be treated as non-passive can-
not exceed the greater of two amounts: $375x, which
is F1’s proportionate share of F2’s passive assets
($500x) multiplied by 75% (the net equity value of
the F2 stock held by F1, which is $750x, divided by
the value of F1’s proportionate share of F2’s assets,
which is $1,000x); and zero, which is F1’s propor-
tionate share of the assets of F2 that are treated as
non-passive in the hands of F2. Therefore, for the
purpose of characterizing F1’s proportionate share of
the assets of F2, $375x is treated as non-passive, and
$125x is treated as passive.
(ii) Example 2: QIC holds all the stock of an op-
erating subsidiary—(A) Facts.
(1) F1 is a foreign corporation. In Year 1, F1
meets the definition of a QIC under section 1297(f)
and §1.1297-4 and is engaged in the active conduct
of an insurance business within the meaning of sec-
tion 1297(b)(2)(B). Throughout Year 1, F1 owns all
the stock of F2, a foreign corporation engaged in a
manufacturing business that is not a QIC. The stock
of F2 is an asset that is available to satisfy liabili-
ties of F1 related to its insurance business within the
meaning of paragraph (c)(1) of this section. The as-
sets of F1 are measured on the basis of value under
§1.1297-1(d)(1)(v)(C).
(2) Throughout Year 1, F2 owns assets with
a value of $1,200x, of which $1,000x is treated as
non-passive and $200x is treated as passive in the
hands of F2. F2 has outstanding debt of $600x. On
the financial statement end date of F1’s applicable fi-
nancial statement, the net equity value of the F2 stock
held by F1 is $600x. In Year 1, F2 earned $120x of
income, of which, in the hands of F2, $100x is treat-
ed as non-passive and $20x is treated as passive.
(B) Result—(1) Because F1 owns all the stock
of F2, F2 is a look-through subsidiary of F1 with-
in the meaning of §1.1297-2(g)(3). Under section
1297(c) and §1.1297-2(b)(2), F1 is treated as if it
held 100% of the assets of F2 and received directly
100% of the income of F2. Under paragraph (d)(1)
of this section, because F1 is engaged in the active
conduct of an insurance business and the stock of
F2 is an asset that is available to satisfy the insur-
ance liabilities of F1, F1 treats its proportionate
share of the income and assets of F2 as non-passive.
The amount of income and assets that is treated as
non-passive is subject to the limitation of paragraph
(d)(2) of this section.
(2) Under paragraph (d)(2) of this section, the
amount of F1’s proportionate share of F2’s income
that is treated as non-passive cannot exceed the great-
er of two amounts: $60x, which is F1’s proportionate
share of F2’s income ($120x) multiplied by 50% (the
net equity value of the F2 stock held by F1, which
is $600x, divided by the value of F1’s proportionate
share of F2’s assets, which is $1,200x); and $100x,
which is F1’s proportionate share of the income of
F2 that is treated as non-passive in the hands of F2.
Therefore, for the purpose of characterizing F1’s
proportionate share of F2’s income, $100x is treated
as non-passive, and $20x is treated as passive.
(3) Under paragraph (d)(2) of this section, the
amount of F1’s proportionate share of F2’s assets
that is treated as non-passive cannot exceed the
greater of two amounts: $600x, which is F1’s pro-
portionate share of F2’s income ($1,200x) multiplied
by 50% (the net equity value of the F2 stock held by
F1, which is $600x, divided by the value of F1’s pro-
portionate share of F2’s assets, which is $1,200x);
and $1,000x, which is F1’s proportionate share of
the assets of F2 that are treated as non-passive in
the hands of F2. Therefore, for the purpose of char-
acterizing F1’s proportionate share of the assets of
F2, $1,000x is treated as non-passive, and $200x is
treated as passive.
(e) Qualifying domestic insurance cor-
poration—(1) General rule. A domestic
corporation (or a foreign corporation that
is treated as a domestic corporation pursu-
ant to a valid section 953(d) election and
that computes its reserves as a domestic
insurance company would under subchap-
ter L) is a qualifying domestic insurance
corporation if it is—
(i) Subject to tax as an insurance com-
pany under subchapter L of the Internal
Revenue Code;
(ii) Subject to federal income tax on its
net income; and
(iii) A look-through subsidiary of a
tested foreign corporation.
(2) [Reserved].
(3) [Reserved].
(f) Applicability date. The rules of this
section apply to taxable years of share-
holders beginning on or after January 14,
2021. A shareholder may choose to apply
such rules for any open taxable year be-
ginning after December 31, 2017 and be-
fore January 14, 2021 , provided that, with
respect to a tested foreign corporation, it
consistently applies the provisions of this
section and §1.1297-4, for such year and
all subsequent years.

February 1, 2021 574 Bulletin No. 2021–5
Par. 7. Section 1.1298-0 is amended by:
1. Revising the introductory text.
2. Adding entries for §§1.1298-2 and
1.1298-4 in numerical order.
The revision and additions read as fol-
lows:
§1.1298-0 Passive foreign investment
company—table of contents.
This section contains a listing of the
paragraph headings for §§1.1298-1,
1.1298-2, 1.1298-3, and 1.1298-4.
* * * * *
§1.1298-2 Rules for certain
corporations changing businesses.
(a) Overview.
(b) Change of business exception.
(c) Special rules.
(d) Disposition of stock in a look-
through subsidiary or partnership interests
in a look-through partnership.
(e) Application of change of business
exception.
(f) Examples.
(1) Example 1.
(i) Facts.
(ii) Results.
(2) Example 2.
(i) Facts.
(ii) Results.
(g) Applicability date.
* * * * *
§1.1298-4 Rules for certain
foreign corporations owning stock
in 25-percent-owned domestic
corporations.
(a) Overview.
(b) Treatment of certain foreign cor-
porations owning stock in a 25-per-
cent-owned domestic corporation.
(1) General rule.
(2) Qualified stock and second-tier do-
mestic corporation.
(c) Indirect ownership of stock through
a partnership.
(d) Section 531 tax.
(1) Subject to section 531 tax.
(2) Waiver of treaty benefits.
(i) Tested foreign corporation that files,
or is required to file, a Federal income tax
return.
(ii) Tested foreign corporation that is
not required to file a Federal income tax
return.
(e) Anti-abuse rule.
(1) General rule.
(2) [Reserved].
(3) [Reserved].
(f) Applicability date.
Par. 8. Section 1.1298-2 is added to
read as follows:
§1.1298-2 Rules for certain
corporations changing businesses.
(a) Overview. This section provides
rules under section 1298(b)(3) and 1298(g)
that apply to certain foreign corporations
that dispose of one or more active trades
or businesses for purposes of determining
whether a foreign corporation is treated
as a passive foreign investment company
(PFIC). Paragraph (b) of this section pro-
vides a rule that applies to certain foreign
corporations that dispose of one or more
active trades or businesses. Paragraph
(c) of this section provides special rules.
Paragraph (d) of this section provides a
rule for the treatment of the disposition of
the stock of a look-through subsidiary (as
defined in §1.1297-2(g)(3)) or partnership
interests in a look-through partnership (as
defined in §1.1297-2(g)(4)). Paragraph (e)
of this section provides guidance on when
a tested foreign corporation can apply the
change of business exception. Paragraph
(f) provides examples illustrating the ap-
plication of the rules in this section. Para-
graph (g) provides the applicability date
for this section.
(b) Change of business exception. A
corporation is not treated as a PFIC for a
taxable year if—
(1) Neither the corporation (nor any
predecessor) was a PFIC for any prior tax-
able year;
(2) Either—
(i) Substantially all of the passive in-
come of the corporation for the taxable
year is attributable to proceeds from the
disposition of one or more active trades or
businesses; or
(ii) Following the disposition of one or
more active trades or businesses, substan-
tially all of the passive assets of the corpo-
ration on each of the measuring dates that
occur during the taxable year and after the
disposition are attributable to proceeds
from the disposition; and
(3) The corporation reasonably does
not expect to be and is not a PFIC for ei-
ther of the first two taxable years follow-
ing the taxable year.
(c) Special rules. The rules in this para-
graph (c) apply for purposes of section
1298(b)(3) and this section.
(1) Income is attributable to proceeds
from the disposition of one or more ac-
tive trades or businesses to the extent the
income is derived from the investment of
the proceeds from the disposition of assets
used in the active trades or businesses.
(2) Assets are attributable to proceeds
from the disposition of one or more active
trades or businesses only to the extent the
assets are the proceeds of the disposition
of assets used in the active trades or busi-
nesses, or are derived from the investment
of the proceeds.
(3) The determination of the existence
of an active trade or business and whether
assets are used in an active trade or busi-
ness is made under §1.367(a)-2(d)(2), (3),
and (5), except that officers and employ-
ees do not include the officers and em-
ployees of related entities as provided in
§1.367(a)-2(d)(3). However, if activities
performed by the officers and employees
of a look-through subsidiary of a corpora-
tion (including a look-through subsidiary
with respect to which paragraph (d) of this
section applies) or of a look-through part-
nership would be taken into account by
the corporation pursuant to §1.1297-2(e)
if it applied, such activities are taken into
account for purposes of the determination
of the existence of an active trade or busi-
ness and the determination of whether as-
sets are used in an active trade or business.
(4) In the case of a corporation that
satisfies the condition in paragraph (b)(2)
(ii) of this section, the condition in para-
graph (b)(3) of this section is deemed to
be satisfied if the corporation completely
liquidates by the end of the taxable year
following the year with respect to which
the tested foreign corporation applies the
exception in paragraph (b) of this section.
(d) Disposition of stock of a look-
through subsidiary or partnership inter-
ests in a look-through partnership. For
purposes of paragraph (b) of this section,
the proceeds from a tested foreign cor-

Bulletin No. 2021–5 575 February 1, 2021
poration’s disposition of the stock of a
look-through subsidiary or of partnership
interests in a look-through partnership are
treated as proceeds from the disposition
of a proportionate share of the assets held
by the look-through subsidiary or look-
through partnership on the date of the
disposition, based on the method (value
or adjusted bases) used to measure the as-
sets of the tested foreign corporation for
purposes of section 1297(a)(2). The pro-
ceeds attributable to assets used by the
look-through subsidiary or look-through
partnership in an active trade or business
are treated as proceeds attributable to the
disposition of an active trade or business.
(e) Application of change of business
exception. A tested foreign corporation
can apply the exception in paragraph (b)
of this section with respect to a taxable
year of a disposition of an active trade or
business or an immediately succeeding
taxable year, but cannot apply the excep-
tion with respect to more than one taxable
year for a disposition.
(f) Examples. The following exam-
ples illustrate the rules of this section. For
purposes of these examples: USP is a do-
mestic corporation; TFC and FS are for-
eign corporations that are not controlled
foreign corporations (within the meaning
of section 957(a)); each corporation has
outstanding a single class of stock; USP
has owned its interest in TFC since the
formation of TFC; each of USP, TFC, and
FS have a calendar taxable year; and for
purposes of section 1297(a)(2), TFC mea-
sures the amount of its assets based on
value.
(1) Example 1—(i) Facts. (A) USP owns 15% of
the outstanding stock of TFC. TFC owns 30% of the
outstanding stock of FS. FS operates an active trade
or business and 100% of its assets are used in the
active trade or business. The value of FS’s non-pas-
sive assets (as defined in §1.1297-1(f)(3)) is $900x;
the value of FS’s passive assets (which include cash
and cash equivalents) is $100x. TFC has not been
treated as a PFIC for any taxable year before Year
1 and has no predecessor. In addition to holding the
FS stock, TFC directly conducts its own active trade
or business. The value of TFC’s non-passive assets
(other than FS stock) is $50x; the value of TFC’s pas-
sive assets (other than FS stock and assets received
during Year 1) is $30x. TFC earns $1x of non-pas-
sive income (as defined in §1.1297-1(f)(4)) from its
directly conducted active trade or business.
(B) On January 1, Year 1, TFC sells all of its FS
stock for $300x. The residual gain computed under
§1.1297-2(f)(1) on the sale of the FS stock is $10x.
Under §1.1297-2(f)(3), $9x of residual gain is char-
acterized as non-passive income and $1x of residual
gain is characterized as passive income. TFC earned
$5x of passive income from the investment of the
proceeds from the disposition of the FS stock during
each quarter of Year 1, and TFC maintained those
earnings ($20x in total) as well as the disposition
proceeds in cash for the remainder of the year. TFC
reinvests the proceeds of the FS stock sale in an ac-
tive trade or business during Year 2, and, thus, TFC
is not a PFIC in Year 2 and Year 3. Less than 75%
of TFC’s gross income in Year 1 is passive income
(($20x + $1x)/($10x + $20x + $1x) = 68%). How-
ever, subject to the application of section 1298(b)(3)
and this section, TFC would be a PFIC in Year 1 un-
der section 1297(a)(2) because the proceeds from the
sale of the FS stock ($300x) together with TFC’s oth-
er passive assets exceed 50% of TFC’s total assets on
each quarterly measuring date. For example, on the
first quarterly measuring date TFC’s ratio of passive
assets to total assets is (($300x + $30x + $5x)/($300x
+ $30x + $5x + $50x)) and on the fourth quarterly
measuring date TFC’s ratio of passive assets to total
assets is (($300x + $30x + $20x)/($300x + $30x +
$20x + $50x)), each of which exceeds 87%. There-
fore, TFC chooses to apply the change of business
exception in paragraph (b) of this section to Year 1.
(ii) Results. (A) Under paragraph (d) of this sec-
tion, for purposes of applying section 1298(b)(3)(B)
(i) in Year 1, TFC’s proceeds from the disposition of
the stock of FS that are attributable to assets used by
FS in an active trade or business are considered as
from the disposition of an active trade or business.
Because 100% of FS’s assets are used in its active
trade or business, all of TFC’s proceeds are consid-
ered as from the disposition of an active trade or
business. Therefore, under paragraph (c)(1) of this
section, the passive income considered attributable
to proceeds from a disposition of one or more ac-
tive trades or businesses is $20x (from investment of
disposition proceeds). Because TFC reasonably does
not expect to be a PFIC in Year 2 and Year 3, and
TFC is not, in fact, a PFIC for those years, TFC will
not be treated as a PFIC in Year 1 by reason of section
1298(b)(3) and paragraph (b) of this section, based
on the satisfaction of the condition in paragraph (b)
(2)(i) of this section, because the 95% ($20x/($20x
+ $1x)) of TFC’s passive income for Year 1 that is
attributable to proceeds of the disposition of FS’s ac-
tive trade or business constitutes substantially all of
its passive income.
(B) TFC would also not be treated as a PFIC in
Year 1 by reason of section 1298(b)(3) and paragraph
(b) of this section, based on the satisfaction of the
condition in paragraph (b)(2)(ii) of this section, be-
cause the over 91% of TFC’s passive assets on the
quarterly measuring dates during Year 1 following
the disposition of the stock of FS that is attributable
to proceeds of the disposition of FS’s active trade or
business constitutes substantially all of its passive
assets. For example, on the first quarterly measur-
ing date TFC’s ratio of passive assets attributable to
the proceeds of the disposition of FS’s active trade
or business to its total passive assets is 91% ($305x/
($305x + $30x)), and the same ratio for the fourth
quarterly measuring date is 91.4% ($320x/($320x +
$30x)).
(C) Under paragraph (e) of this section, TFC can-
not claim the section 1298(b)(3) exception in rela-
tion to the income attributable to the proceeds of the
FS stock sale in Year 2 because TFC already claimed
the exception for Year 1.
(2) Example 2—(i) Facts. The facts are the same
as in paragraph (f)(1)(i) of this section (the facts in
Example 1), except that during the first quarter of
Year 1, TFC earned only $4x of passive income ($1x
per quarter) from the investment of the proceeds
from the disposition of the FS stock and earned $12x
of passive income ($3x per quarter) from its other
passive assets and maintained such earnings in cash
for the remainder of the year.
(ii) Results. The results are the same as in para-
graph (f)(1)(ii) of this section (the facts in Example
1), except that under paragraph (c)(1) of this sec-
tion, the passive income considered attributable to
proceeds from a disposition of one or more active
trades or businesses is $4x (from investment of
disposition proceeds). Because 24% ($4x/($4x +
$12x + $1x)) of TFC’s passive income for Year 1
is attributable to proceeds of the disposition of FS’s
active trade or business, and 24% does not consti-
tute substantially all of TFC’s passive income for
Year 1, TFC does not qualify for the exception from
treatment as a PFIC in section 1298(b)(3) and para-
graph (b)(2)(i) of this section for Year 1. However,
under paragraphs (b)(2)(ii) and (d) of this section,
more than $300x ($300x disposition proceeds +
amounts earned from investment of disposition pro-
ceeds) of TFC’s passive assets held on each quarter-
ly measuring date after the disposition is considered
attributable to the disposition of an active trade or
business. Because TFC reasonably does not expect
to be a PFIC in Year 2 and Year 3, and TFC is not, in
fact, a PFIC for those years, TFC will not be treated
as a PFIC in Year 1 by reason of paragraph (b) of
this section, based on the satisfaction of the condi-
tion in paragraph (b)(2)(ii) of this section, assuming
that the average 89% of TFC’s passive assets on the
quarterly measuring dates during Year 1 following
the disposition of the stock of FS that is attributable
to proceeds of the disposition of FS’s active trade or
business constitutes substantially all of its passive
assets.
(g) Applicability date. The rules of this
section apply to taxable years of share-
holders beginning on or after January 14,
2021. A shareholder may choose to apply
such rules for any open taxable year be-
ginning before January 14, 2021, provid-
ed that, with respect to the tested foreign
corporation, the shareholder consistently
applies the provisions of this section and
§1.1291-1(b)(8)(iv) and (b)(8)(v)(A), (B),
(C), and (D) and §§1.1297-1 (except that
consistent treatment is not required with
respect to §1.1297-1(c)(1)(i)(A)), 1.1297-
2, and 1.1298-4 for such year and all sub-
sequent years.
Par.9. Section 1.1298-4 is added to
read as follows:

February 1, 2021 576 Bulletin No. 2021–5
§1.1298-4 Rules for certain
foreign corporations owning stock
in 25-percent-owned domestic
corporations.
(a) Overview. This section provides
rules under section 1298(b)(7) that ap-
ply to certain foreign corporations that
own stock in 25-percent-owned domes-
tic corporations (as defined in paragraph
(b) of this section) for purposes of de-
termining whether a foreign corporation
is a passive foreign investment compa-
ny (PFIC). Paragraph (b) of this section
provides the general rule. Paragraph (c)
of this section provides rules concerning
ownership of 25-percent-owned domes-
tic corporations or qualified stock (as
defined in paragraph (b)(2) of this sec-
tion) through partnerships. Paragraph (d)
of this section provides rules for deter-
mining whether a foreign corporation
is subject to the tax imposed by section
531 (the section 531 tax) and for waiv-
ing treaty benefits that would prevent the
imposition of such tax. Paragraph (e) of
this section provides an anti-abuse rule
for the application of section 1298(b)(7).
Paragraph (f) provides the applicability
date for this section.
(b) Treatment of certain foreign cor-
porations owning stock in a 25-per-
cent-owned domestic corporation—(1)
General rule. Except as otherwise pro-
vided in paragraph (e) of this section,
when a tested foreign corporation (as
defined in §1.1297-1(f)) is subject to the
section 531 tax (or waives any benefit un-
der any treaty that would otherwise pre-
vent the imposition of the tax), and owns
(directly or indirectly under the rules in
paragraph (c) of this section) at least 25
percent (by value) of the stock of a do-
mestic corporation (a 25-percent-owned
domestic corporation), for purposes of
determining whether the foreign cor-
poration is a PFIC, any qualified stock
held directly or indirectly under the rules
in paragraph (c) of this section by the
25-percent-owned domestic corporation
is treated as an asset that does not pro-
duce passive income (and is not held for
the production of passive income), and
any amount included in gross income
with respect to the qualified stock is not
treated as passive income.
(2) Qualified stock and second-tier do-
mestic corporation. For purposes of this
section, the term qualified stock means
any stock in a C corporation that is a do-
mestic corporation and that is not a reg-
ulated investment company or real estate
investment trust and the term second-tier
corporation means the corporation.
(c) Indirect ownership of stock
through a partnership. For purposes of
paragraph (b)(1) of this section, a test-
ed foreign corporation that is a partner
in a partnership is considered to own its
proportionate share of any stock of a do-
mestic corporation held by the partner-
ship, and a domestic corporation that is
a partner in a partnership is considered to
own its proportionate share of any quali-
fied stock held by the partnership. An up-
per-tier partnership’s attributable share
of the stock of a domestic corporation
or of qualified stock held by a lower-tier
partnership is treated as held by the up-
per-tier partnership for purposes of ap-
plying the rule in this paragraph (c).
(d) Section 531 tax—(1) Subject to
section 531 tax. For purposes of para-
graph (b) of this section, a tested foreign
corporation is considered subject to the
section 531 tax regardless of whether the
tax is imposed on the corporation and of
whether the requirements of §1.532-1(c)
are met.
(2) Waiver of treaty benefits—(i) Test-
ed foreign corporation that files, or is re-
quired to file, a Federal income tax return.
For purposes of paragraph (b) of this sec-
tion, a tested foreign corporation that files,
or is required to file, a Federal income tax
return waives the benefit under a treaty
that would otherwise prevent the impo-
sition of the section 531 tax by attaching
to its original or amended return for the
taxable year for which section 1298(b)(7)
and paragraph (b)(1) of this section are ap-
plied or any prior taxable year a statement
that it irrevocably waives treaty protection
against the imposition of the section 531
tax, effective for all prior, current, and
future taxable years, provided the taxable
year for which the return is filed and all
subsequent taxable years are not closed by
the period of limitations on assessments
under section 6501.
(ii) Tested foreign corporation that is
not required to file a Federal income tax
return. For purposes of paragraph (b) of
this section, a tested foreign corporation
that is not required to file a Federal in-
come tax return waives the benefit under
a treaty that would otherwise prevent the
imposition of the section 531 tax by a date
no later than nine months following the
close of the taxable year for which section
1298(b)(7) and paragraph (b)(1) of this
section are applied by—
(A) Adopting a resolution or similar
governance document that confirms that it
has irrevocably waived any treaty protec-
tion against the imposition of the section
531 tax, effective for all prior, current,
and future taxable years, and maintaining
a copy of the resolution (or other gover-
nance document) in its records; or
(B) In the case of a tested foreign cor-
poration described in section 1297(e)(3),
including in its public filings a statement
that it irrevocably waives treaty protection
against the imposition of the section 531
tax, effective for all prior, current, and fu-
ture taxable years.
(e) Anti-abuse rule—(1) General rule.
Paragraph (b) of this section does not
apply with respect to qualified stock in a
second-tier domestic corporation owned
by a 25-percent-owned domestic corpo-
ration if a principal purpose for the for-
mation of, acquisition of, or holding of
stock of the 25-percent-owned domestic
corporation or the second-tier domestic
corporation, or for the capitalization or
other funding of the second-tier domes-
tic corporation, is to hold passive assets
(as defined in §1.1297-1(f)(5)) through
the second-tier domestic corporation to
avoid classification of the tested foreign
corporation as a PFIC.
(2) [Reserved].
(3) [Reserved].
(f) Applicability date. The rules of this
section apply to taxable years of share-
holders beginning on or after January 14,
2021. A shareholder may choose to apply
such rules for any open taxable year be-
ginning before January 14, 2021, provid-
ed that, with respect to a tested foreign
corporation, the shareholder consistently
applies the provisions of this section and
§1.1291-1(b)(8)(iv) and (b)(8)(v)(A), (B),
(C), and (D) and §§1.1297-1 (except that
consistent treatment is not required with
respect to §1.1297-1(c)(1)(i)(A)), 1.1297-

Bulletin No. 2021–5 577 February 1, 2021
2, and 1.1298-2 for such year and all sub-
sequent years.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: November 19, 2020
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on January
14, 2021, 8:45 a.m., and published in the issue of the
Federal Register for January 15, 2020, 85 F.R. 4516)
T.D. 9943
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Additional Guidance
Regarding Limitation on
Deduction for Business
Interest Expense
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations that provide additional
guidance regarding the limitation on the
deduction for business interest expense
under section 163(j) of the Internal Rev-
enue Code (Code) to reflect amendments
made by the Tax Cuts and Jobs Act and the
Coronavirus Aid, Relief, and Economic
Security Act. Specifically, the regulations
address the application of the limitation in
contexts involving passthrough entities,
regulated investment companies (RICs),
and controlled foreign corporations. The
regulations also provide guidance regard-
ing the definitions of real property devel-
opment, real property redevelopment, and
syndicate. The regulations affect taxpay-
ers that have business interest expense,
particularly passthrough entities, their
partners and shareholders, as well as for-
eign corporations and their United States
shareholders. The regulations also affect
RICs that have business interest income,
RIC shareholders that have business in-
terest expense, and corporations that are
members of a consolidated group.
DATES: Effective date: The regulations
are effective on January 13, 2021.
Applicability dates: For dates of applica-
bility, see §§1.163-15(b), 1.163(j)-1(c)(4),
1.163(j)-2(k), 1.163(j)-6, 1.163(j)-7(m),
1.163(j)-10(f), 1.469-11(a)(1) and (4), and
1.1256(e)-2(d).
FOR FURTHER INFORMATION CON-
TACT: Concerning §1.163-15, or 1.163(j)-
2(d)(3), Nathaniel Kupferman, (202)
317-4855, or James Williford, (202) 317-
3225; concerning §1.163(j)-1(b)(1)(iv),
§1.163(j)-2(b)(3)(iii) or (iv) or §1.163(j)-
10, John B. Lovelace, (202) 317-5357;
concerning §1.163(j)-1(b)(22) or (b)(35),
Steven Harrison, (202) 317-6842, or Mi-
chael Chin, (202) 317-6842; concerning
§1.163(j)-6, §1.469-4 or §1.469-9, Vishal
Amin, Brian Choi, or Jacob Moore, (202)
317-5279; concerning §1.163(j)-7, Azeka
J. Abramoff, (202) 317-3800, or Rapha-
el J. Cohen, (202) 317-6938; concerning
§1.1256(e)-2, Pamela Lew, (202) 317-
7053 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
I. Statutory Background
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under sections 163 (in particular,
section 163(j)), 469, and 1256(e) of the
Code. Section 163(j) was amended by
Public Law 115-97, 131 Stat. 2054 (De-
cember 22, 2017), commonly referred to
as the Tax Cuts and Jobs Act (TCJA), and
the Coronavirus Aid, Relief, and Econom-
ic Security Act, Public Law 116-136, 134
Stat. 281 (March 27, 2020) (CARES Act).
Section 13301(a) of the TCJA amended
section 163(j) by removing prior section
163(j)(1) through (9) and adding section
163(j)(1) through (10). The provisions
of section 163(j) as amended by section
13301 of the TCJA are effective for tax-
able years beginning after December 31,
2017. The CARES Act further amended
section 163(j) by redesignating section
163(j)(10), as amended by the TCJA, as
new section 163(j)(11), and adding a new
section 163(j)(10) providing special rules
for applying section 163(j) to taxable
years beginning in 2019 or 2020.
Section 163(j) generally limits the
amount of business interest expense (BIE)
that can be deducted in the current taxable
year (sometimes referred to in this pre-
amble as the current year). Under section
163(j)(1), the amount allowed as a deduc-
tion for BIE is limited to the sum of (1) the
taxpayer’s business interest income (BII)
for the taxable year; (2) 30 percent of the
taxpayer’s adjusted taxable income (ATI)
for the taxable year (30 percent ATI lim-
itation); and (3) the taxpayer’s floor plan
financing interest expense for the taxable
year (in sum, the section 163(j) limita-
tion). As further described later in this
Background section, section 163(j)(10),
as amended by the CARES Act, provides
special rules relating to the 30 percent ATI
limitation for taxable years beginning in
2019 or 2020. Under section 163(j)(2), the
amount of any BIE that is not allowed as
a deduction in a taxable year due to the
section 163(j) limitation is treated as busi-
ness interest paid in the succeeding tax-
able year.
The section 163(j) limitation applies
to all taxpayers, except for certain small
businesses that meet the gross receipts test
in section 448(c) of the Code and certain
trades or businesses listed in section 163(j)
(7) (excepted trades or businesses). More
specifically, section 163(j)(3) provides
that the section 163(j) limitation does not
apply to any taxpayer that meets the gross
receipts test under section 448(c), other
than a tax shelter prohibited from using
the cash receipts and disbursements meth-
od of accounting under section 448(a)
(3). Under section 163(j)(7), the excepted
trades or businesses are the trade or busi-
ness of providing services as an employee,
electing real property businesses, electing
farming businesses, and certain regulated
utility businesses.
Section 163(j)(4) provides special rules
for applying section 163(j) in the case of
passthrough entities. Section 163(j)(4)(A)
requires that the section 163(j) limitation

February 1, 2021 578 Bulletin No. 2021–5
be applied at the partnership level, and that
a partner’s ATI be increased by the part-
ner’s share of excess taxable income, as
defined in section 163(j)(4)(C), but not by
the partner’s distributive share of income,
gain, deduction, or loss. Section 163(j)(4)
(B) provides that the amount of partner-
ship BIE exceeding the section 163(j)(1)
limitation is carried forward at the partner
level as excess business interest expense
(EBIE). Section 163(j)(4)(B)(ii) provides
that EBIE allocated to a partner and car-
ried forward is available to be deducted in
a subsequent year only to the extent that
the partnership allocates excess taxable
income to the partner. As further described
later in this Background section, section
163(j)(10), as amended by the CARES
Act, provides a special rule for EBIE al-
located to a partner in a taxable year be-
ginning in 2019. Section 163(j)(4)(B)(iii)
provides rules for the adjusted basis in a
partnership of a partner that is allocated
EBIE. Section 163(j)(4)(D) provides that
rules similar to the rules of section 163(j)
(4)(A) and (C) apply to S corporations and
S corporation shareholders.
Section 163(j)(5) and (6) define “busi-
ness interest” and “business interest in-
come,” respectively, for purposes of sec-
tion 163(j). Generally, these terms include
interest expense and interest includible in
gross income that is properly allocable to
a trade or business (as defined in section
163(j)(7)) and do not include investment
income or investment expense within the
meaning of section 163(d). The legisla-
tive history states that “a corporation has
neither investment interest nor investment
income within the meaning of section
163(d). Thus, interest income and interest
expense of a corporation is properly allo-
cable to a trade or business, unless such
trade or business is otherwise explicitly
excluded from the application of the pro-
vision.” H. Rept. 115-466, at 386, fn. 688
(2017).
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer (1) com-
puted without regard to items not properly
allocable to a trade or business; BIE and
BII; net operating loss (NOL) deductions;
deductions for qualified business income
under section 199A; and deductions for
depreciation, amortization, and depletion
with respect to taxable years beginning
before January 1, 2022, and (2) computed
with such other adjustments as provided
by the Secretary of the Treasury or his del-
egate (Secretary).
As noted previously, section 163(j)(1)
includes floor plan financing interest in
computing the amount of deductible busi-
ness interest. Section 163(j)(9) defines
“floor plan financing interest” and “floor
plan financing indebtedness.” These pro-
visions allow taxpayers incurring interest
expense for the purpose of securing an
inventory of motor vehicles held for sale
or lease to deduct the full expense without
regard to the section 163(j) limitation.
Under section 163(j)(10)(A)(i), the
amount of BIE that is deductible under
section 163(j)(1) for taxable years begin-
ning in 2019 or 2020 is computed using
50 percent, rather than 30 percent, of the
taxpayer’s ATI for the taxable year (50
percent ATI limitation). A taxpayer may
elect not to apply the 50 percent ATI lim-
itation to any taxable year beginning in
2019 or 2020, and instead apply the 30
percent ATI limitation. This election must
be made separately for each taxable year.
Once the taxpayer makes the election,
the election may not be revoked without
the consent of the Secretary. See section
163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and 163(j)
(10)(A)(iii) provide that, in the case of a
partnership, the 50 percent ATI limitation
does not apply to partnerships for taxable
years beginning in 2019, and the election
to not apply the 50 percent ATI limita-
tion may be made only for taxable years
beginning in 2020, and may be made
only by the partnership. Under section
163(j)(10)(A)(ii)(II), however, a partner
treats 50 percent of its allocable share of
a partnership’s EBIE for 2019 as BIE in
the partner’s first taxable year beginning
in 2020 that is not subject to the section
163(j) limitation (50 percent EBIE rule).
The remaining 50 percent of the partner’s
allocable share of the partnership’s EBIE
remains subject to the section 163(j) lim-
itation applicable to EBIE carried forward
at the partner level. A partner may elect
out of the 50 percent EBIE rule.
Section 163(j)(10)(B)(i) allows a tax-
payer to elect to substitute its ATI for the
last taxable year beginning in 2019 (2019
ATI) for the taxpayer’s ATI for a taxable
year beginning in 2020 (2020 ATI) in de-
termining the taxpayer’s section 163(j)
limitation for the taxable year beginning
in 2020.
Section 163(j)(11) provides cross-ref-
erences to provisions requiring that elect-
ing farming businesses and electing real
property businesses excepted from the
section 163(j) limitation use the alterna-
tive depreciation system (ADS), rather
than the general depreciation system, for
certain types of property. The required use
of ADS results in the inability of these
electing trades or businesses to use the
additional first-year depreciation deduc-
tion under section 168(k) for those types
of property.
II. Published Guidance
On April 16, 2018, the Department of
the Treasury (Treasury Department) and
the IRS published Notice 2018-28, 2018-
16 I.R.B. 492, which described regulations
intended to be issued under section 163(j).
On December 28, 2018, the Treasury De-
partment and the IRS (1) published pro-
posed regulations under section 163(j),
as amended by the TCJA, in a notice of
proposed rulemaking (REG-106089-18)
(2018 Proposed Regulations) in the Fed-
eral Register (83 FR 67490), and (2)
withdrew the notice of proposed rulemak-
ing (1991-2 C.B. 1040) published in the
Federal Register on June 18, 1991 (56
FR 27907 as corrected by 56 FR 40285
(August 14, 1991)) to implement rules
under section 163(j) before its amendment
by the TCJA. On September 14, 2020,
the Treasury Department and the IRS
published final regulations under section
163(j) and other sections in the Federal
Register (85 FR 56686) (T.D. 9905) to fi-
nalize most sections of the 2018 Proposed
Regulations.
Concurrently with the publication of
T.D. 9905, the Treasury Department and
the IRS published additional proposed reg-
ulations under section 163(j) in a notice of
proposed rulemaking (REG-107911-18)
in the Federal Register (85 FR 56846)
(2020 Proposed Regulations) to provide
additional guidance regarding the sec-
tion 163(j) limitation in response to cer-
tain comments received in response to the
2018 Proposed Regulations and to reflect
the amendments made by the CARES Act.
The 2020 Proposed Regulations provided
proposed rules: for allocating interest ex-

Bulletin No. 2021–5 579 February 1, 2021
pense associated with debt proceeds of a
partnership or S corporation to supple-
ment the rules in §1.163-8T regarding the
allocation of interest expense for purpos-
es of section 163(d) and (h) and section
469 (proposed §§1.163-14 and 1.163-15);
amending the definition of ATI and per-
mitting certain RICs to pay section 163(j)
interest dividends (proposed §1.163(j)-1);
amending the rules for applying section
163(j)(4) to partnerships and S corpora-
tions (proposed §1.163(j)-6); re-proposing
the proposed rules for applying the section
163(j) limitation to foreign corporations
and United States shareholders (proposed
§1.163(j)-7) and to foreign persons with
effectively connected income (proposed
§1.163(j)-8); amending the definition of
real property trade or business (proposed
§1.469-9); amending the rules for de-
termining tax shelter status and provid-
ing guidance on the election to use 2019
ATI to determine 2020 section 163(j)
limitation (proposed §§1.163(j)-2 and
1.1256(e)-2); and amending the corporate
look-through rules as applicable to tiered
structures (proposed §1.163(j)-10).
All written comments received in re-
sponse to the 2020 Proposed Regulations
are available at www.regulations.gov or
upon request. After consideration of the
comments received, this Treasury deci-
sion adopts most of the 2020 Proposed
Regulations as revised in response to the
comments, which are described in the
Summary of Comments and Explanation
of Revisions section. The Treasury De-
partment and the IRS plan to finalize other
portions of the 2020 Proposed Regula-
tions separately, to allow additional time
to consider the comments received.
On April 27, 2020, the Treasury De-
partment and the IRS published Revenue
Procedure 2020-22, 2020-18 I.R.B. 745,
to provide the time and manner of making
a late election, or withdrawing an election,
under section 163(j)(7)(B) to be an elect-
ing real property trade or business or un-
der section 163(j)(7)(C) to be an electing
farming business for taxable years begin-
ning in 2018, 2019, or 2020. Revenue Pro-
cedure 2020-22 also provides the time and
manner of making or revoking elections
provided by the CARES Act under section
163(j)(10) for taxable years beginning in
2019 or 2020. These elections are: (1) to
not apply the 50 percent ATI limitation
under section 163(j)(10)(A)(iii); (2) to
use the taxpayer’s 2019 ATI to calculate
the taxpayer’s section 163(j) limitation for
any taxable year beginning in 2020 under
section 163(j)(10)(B); and (3) for a part-
ner to elect out of the 50 percent EBIE rule
under section 163(j)(10)(A)(ii)(II).
Summary of Comments and
Explanation of Revisions
I. Overview
The Treasury Department and the IRS
received approximately 20 written com-
ments in response to the 2020 Proposed
Regulations. Most of the comments ad-
dressing the 2020 Proposed Regulations are
summarized in this Summary of Comments
and Explanation of Revisions section.
However, comments merely summarizing
or interpreting the 2020 Proposed Regula-
tions generally are not discussed in this pre-
amble. Additionally, comments outside the
scope of this rulemaking are generally not
addressed in this Summary of Comments
and Explanation of Revisions section.
The Treasury Department and the IRS
continue to study comments on certain is-
sues related to section 163(j), including is-
sues that are beyond the scope of the final
regulations, and may discuss those com-
ments if future guidance on those issues
is published.
The final regulations retain the same
basic structure as the 2020 Proposed Reg-
ulations, with the revisions described in
this Summary of Comments and Explana-
tion of Revisions section.
II. Notice 89-35 and Comments on and
Changes to Proposed §1.163-15: Debt
Proceeds Distributed From Any Taxpayer
Account or From Cash
Section 1.163-15 of the 2020 Proposed
Regulations supplemented the rules in
§1.163-8T, temporary regulations issued
prior to TCJA, regarding debt proceeds
distributed from any taxpayer account
or from cash proceeds. Consistent with
section VI of Notice 89-35, 1989-1 C.B.
675, proposed §1.163-15 provided that
taxpayers may treat any expenditure made
from an account of the taxpayer, or from
cash, within 30 days before or after debt
proceeds are deposited in any account of
the taxpayer, or received in cash, as made
from such proceeds. Section 1.163-14 of
the 2020 Proposed Regulations related to
sections I-V of Notice 89-35. The Trea-
sury Department and the IRS received
no comments with respect to proposed
§1.163-15. Accordingly, the final regula-
tions adopt this section unchanged. Ad-
ditional consideration is being given to
§1.163-14, which is not being finalized in
these final regulations; thus Notice 89-35
remains in effect.
III. Comments on and Changes to
§1.163-1: Definitions
A. Adjustments to Tentative Taxable
Income
Part III.A.1.a of this Summary of
Comments and Explanation of Revisions
section provides an overview of the neg-
ative adjustments to tentative taxable in-
come in §1.163(j)-1(b)(1)(ii)(C) through
(E) and the alternative computations for
those negative adjustments in proposed
§1.163(j)-1(b)(1)(iv)(B) and (E). Part
III.A.1.b of this Summary of Comments
and Explanation of Revisions section pro-
vides an overview of the special rules in
§1.163(j)-1(b)(1)(iv)(A), (C), and (D) for
the application of §1.163(j)-1(b)(1)(ii)
(C) through (E). Part III.A.2 of this Sum-
mary of Comments and Explanation of
Revisions section summarizes the com-
ments received on §1.163(j)-1(b)(1)(ii)(C)
through (E) and the alternative computa-
tions in proposed §1.163(j)-1(b)(1)(iv)
(B) and (E). Part III.A.3 of this Summary
of Comments and Explanation of Revi-
sions section summarizes the comments
received on the special rules in §1.163(j)-
1(b)(1)(iv)(A), (C), and (D).
In response to comments received, the
final regulations provide a number of clar-
ifications to the ATI computation and pro-
vide new examples demonstrating their
application.
1. Overview
a. Section 1.163(j)-1(b)(1)(ii)(C) through
(E) and Proposed §1.163(j)-1(b)(1)(iv)
(B) and (E)
Section 1.163(j)-1(b)(43) provides
that tentative taxable income is the

February 1, 2021 580 Bulletin No. 2021–5
amount to which adjustments are made
in computing ATI. Section 1.163(j)-1(b)
(1)(i) provides for certain additions to
tentative taxable income in computing
ATI. For example, §1.163(j)-1(b)(1)(i)
(D) provides that, subject to the rule in
§1.163(j)-1(b)(1)(iii), any depreciation
under section 167, section 168, or former
section 168 for taxable years beginning
before January 1, 2022, is added back
to tentative taxable income to compute
ATI. Section 1.163(j)-1(b)(1)(i)(E) and
(F) provide similar rules for amortization
and depletion, respectively.
Section 1.163(j)-1(b)(1)(ii) provides
for certain subtractions from (or neg-
ative adjustments to) tentative taxable
income in computing ATI. For example,
§1.163(j)-1(b)(1)(ii)(C) provides that, if
property is sold or otherwise disposed of,
the greater of the allowed or allowable
depreciation, amortization, or depletion
of the property for the taxpayer (or, if the
taxpayer is a member of a consolidated
group, the consolidated group) for tax-
able years beginning after December 31,
2017, and before January 1, 2022 (such
years, the EBITDA period), with respect
to such property is subtracted from ten-
tative taxable income. Section 1.163(j)-
1(b)(1)(ii)(D) provides that, with respect
to the sale or other disposition of stock
of a member of a consolidated group by
another member, the investment adjust-
ments under §1.1502-32 with respect to
such stock that are attributable to deduc-
tions described in §1.163(j)-1(b)(1)(ii)
(C) are subtracted from tentative taxable
income. Section 1.163(j)-1(b)(1)(ii)(E)
provides that, with respect to the sale or
other disposition of an interest in a part-
nership, the taxpayer’s distributive share
of deductions described in §1.163(j)-1(b)
(1)(ii)(C) with respect to property held
by the partnership at the time of such sale
or other disposition is subtracted from
tentative taxable income to the extent
such deductions were allowable under
section 704(d). See the preamble to T.D.
9905 for a discussion of the rationale for
these adjustments.
The preamble to T.D. 9905 noted
that, in the 2018 Proposed Regulations,
§1.163(j)-1(b)(1)(ii)(C) incorporated a
“lesser of” standard. In other words, the
lesser of (i) the amount of gain on the sale
or other disposition of property, or (ii) the
amount of depreciation deductions with
respect to such property for the EBITDA
period, was required to be subtracted from
tentative taxable income to determine
ATI. As explained in the preamble to T.D.
9905, commenters raised several ques-
tions and concerns regarding this “less-
er of” standard. T.D. 9905 removed the
“lesser of” approach due in part to con-
cerns that this approach would be more
difficult to administer than the approach
reflected in T.D. 9905.
However, the Treasury Department
and the IRS recognize that, in certain
cases, the “lesser of” approach might
not create administrative difficulties for
taxpayers. Thus, the 2020 Proposed Reg-
ulations permitted taxpayers to choose
whether to compute the amount of their
adjustment upon the disposition of prop-
erty, member stock, or partnership in-
terests using a “lesser of” standard. See
proposed §1.163(j)-1(b)(1)(iv)(B) and
(E). The Treasury Department and the
IRS requested comments on the “less-
er of” approach, including how such an
approach should apply to dispositions of
member stock and partnership interests.
The comments received on the “less-
er of” approach are summarized in part
III.A.2 of this Summary of Comments
and Explanation of Revisions section.
b. Section 1.163(j)-1(b)(1)(iv)(A) through
(D)
Section 1.163(j)-1(b)(1)(iv) pro-
vides special rules for the application
of §1.163(j)-1(b)(1)(ii)(C) through (E).
Section 1.163(b)(1)(iv)(A)(1) provides
that, for purposes of §1.163(j)-1(b)(1)
(ii)(C) through (E), the term “sale or
other disposition” does not include a
transfer of an asset to an acquiring cor-
poration in a transaction to which sec-
tion 381(a) of the Code applies, except
as otherwise provided in §1.163(j)-1(b)
(1)(iv)(A). Section 1.163(j)-1(b)(1)(iv)
(A)(2) provides that, for purposes of
§1.163(j)-1(b)(1)(ii)(C) and (D), the
term “sale or other disposition” excludes
all intercompany transactions, within the
meaning of §1.1502-13(b)(1)(i). This
provision reflects the general treatment
of a consolidated group as a single en-
tity for purposes of section 163(j). Sec-
tion 1.163(j)-1(b)(1)(iv)(A)(3) provides
that, notwithstanding any other rule in
§1.163(j)-1(b)(1)(iv)(A) (including the
rule regarding section 381(a) transac-
tions), any transaction in which a mem-
ber leaves a consolidated group is treat-
ed as a “sale or other disposition” for
purposes of §1.163(j)-1(b)(1)(ii)(C) and
(D), unless the transaction is an acquisi-
tion described in §1.1502-13(j)(5)(i)(A).
Section 1.163(j)-1(b)(1)(iv)(B) pro-
vides that, for purposes of §1.163(j)-1(b)
(1)(ii)(C) through (E), the amount of a
consolidated group’s adjustment under
§1.163(j)-1(b)(1)(ii)(C) is computed by
reference to the depreciation, amorti-
zation, or depletion deductions of the
group. The 2020 Proposed Regulations
added §1.163(j)-1(b)(1)(iv)(B)(2) to
clarify the computation under proposed
§1.163(j)-1(b)(iv)(E)(1) for consolidated
groups.
Section 1.163(j)-1(b)(1)(iv)(C) pro-
vides successor asset rules for certain
intercompany transactions. More specifi-
cally, if deductions described in §1.163(j)-
1(b)(1)(ii)(C) are allowed or allowable
to a consolidated group member (S), the
depreciable property or S’s stock is trans-
ferred to another member (S1), and the
transferor’s basis in the S1 stock received
in the intercompany transaction is deter-
mined, in whole or in part, by reference
to its basis in the transferred property or S
stock, then the S1 stock is treated as a suc-
cessor asset for purposes of the negative
adjustments to tentative taxable income
upon the disposition of member stock.
Section 1.163(j)-1(b)(1)(iv)(D) con-
tains anti-duplication rules. For exam-
ple, §1.163(j)-1(b)(1)(iv)(D)(2) provides
that depreciation, amortization, or deple-
tion deductions allowed or allowable for
a corporation for a consolidated return
year of a group are disregarded in apply-
ing §1.163(j)-1(b)(1)(iv)(D) to a separate
return year of that corporation. Section
1.163(j)-1(b)(1)(iv)(D)(2) also provides
an example in which S deconsolidates
from a consolidated group (Group 1)
(thereby triggering an adjustment under
§§1.163(j)-1(b)(1)(ii)(D) and 1.163(j)-
1(b)(1)(iv)(A)(3)) and then sells the de-
preciable property. The example states
that no further adjustment is required un-
der §1.163(j)-1(b)(1)(ii)(C) upon the asset
disposition with regard to the amounts in-
cluded in Group 1.

Bulletin No. 2021–5 581 February 1, 2021
2. Comments on §1.163(j)-1(b)(1)(ii)(C)
through (E) and Proposed §1.163(j)-1(b)
(1)(iv)(B) and (E)
a. Adoption of a “lesser of” standard
Several commenters contended that the
final regulations should continue to allow
taxpayers to choose whether to compute
the amount of their adjustment upon the
disposition of property, member stock, or
partnership interests using a “lesser of”
standard, as in proposed §1.163(j)-1(b)(1)
(iv)(B) and (E). Commenters asserted that
such an approach would ameliorate the
adverse impact of the subtractions from
tentative taxable income in §1.163(j)-1(b)
(1)(ii)(C) through (E). One commenter
further asserted that a “lesser of” option
is preferable to the approach in T.D. 9905
because the latter could create an incen-
tive for taxpayers to retain assets solely
because the adverse tax consequences of
disposing of the assets outweigh the cost
of keeping the assets.
The Treasury Department and the IRS
agree with these comments, and the final
regulations retain a “lesser of” option
for purposes of the negative adjustments
to tentative taxable income in §1.163(j)-
1(b)(1)(ii)(C) through (E). The final reg-
ulations also update the special rules in
§1.163(j)-1(b)(1)(iv)(A), (C), and (D) to
add cross-references to the “lesser of”
computations in §1.163(j)-1(b)(1)(iv)(B)
and (E).
b. Modification of the “lesser of”
standard
Several commenters also recommend-
ed modifications to the “lesser of” rules
in proposed §1.163(j)-1(b)(1)(iv)(B) and
(E). For example, one commenter stated
that the proposed “lesser of” approach is
likely to be less accurate for dispositions
of member stock or partnership interests
than for asset dispositions because the
gain prong of the “lesser of” computation
in either case is based on the gain in the
member stock or partnership interests,
respectively, rather than on the gain that
would be recognized on the sale of the un-
derlying assets.
The Treasury Department and the IRS
received recommendations regarding sev-
eral alternative approaches. Under one
alternative, the negative adjustment under
the gain prong of the “lesser of” compu-
tation for dispositions of member stock
or partnership interests would equal the
amount of the negative adjustment if the
assets of the subsidiary or partnership
were sold. However, the commenter ac-
knowledged that this “deemed asset sale”
approach could create unnecessary admin-
istrative difficulties and lead to valuation
disputes by requiring asset valuations
upon dispositions of member stock or
partnership interests.
Among other alternative approaches,
a commenter recommended that the gain
prong of the “lesser of” computation for
dispositions of member stock should be
based on the excess of tax depreciation
over economic depreciation with respect
to the underlying assets. The comment-
er based this approach on the theory that
only stock gain that reflects non-economic
depreciation should give rise to a negative
basis adjustment. The commenter who
recommended this approach suggested
several different computational methods
for this alternative approach, but acknowl-
edged that this approach likely would not
be appropriate for certain types of assets
(for example, real estate or purchased
goodwill) because metrics that might be
used under this approach, such as earnings
and profits basis or book value, would not
be a good proxy for fair market value for
such assets. Another commenter recom-
mended revising the proposed “lesser of”
computation for dispositions of partner-
ship interests such that certain negative
adjustments would be made at the partner-
ship level and others would be made at the
partner level.
After considering these comments, the
Treasury Department and the IRS have
determined that the proposed “lesser of”
computations strike a proper balance be-
tween accuracy and administrability. In
particular, as one commenter noted, there
would be unnecessary administrative
complexity under the first suggested alter-
native approach. This complexity includes
the need for separate asset valuations that
would be costly and may be subject to
dispute, resulting in additional controver-
sy between taxpayers and the IRS. The
second proposed approach would require
an accurate determination of economic
depreciation. However, as the commenter
acknowledged, there is no single, simple
method for accurately determining eco-
nomic depreciation. Additionally, with
regard to economic depreciation, differ-
ent types of assets depreciate at different
rates, and some assets, such as land or
certain improvements to land, may not de-
preciate at all. As a result, basing the gain
prong of the “lesser of” computation on
non-economic depreciation would create
less certainty, and would not clearly be
a more accurate approach, than the pro-
posed “lesser of” standard. Requiring cer-
tain adjustments at the partner level and
other adjustments at the partnership level
also would add further complexity to the
“lesser of” computations.
Thus, the final regulations adopt the
approach in proposed §1.163(j)-1(b)(1)
(iv)(B) and (E). However, the Treasury
Department and the IRS acknowledge that
gain on upper-tier member stock generally
becomes further removed from asset gain
at each additional tier within a consolidat-
ed group. Therefore, for purposes of the
“lesser of” computation in §1.163(j)-1(b)
(1)(iv)(E)(2), the final regulations provide
that the only stock gain that is relevant is
the gain that is deemed recognized on the
stock of the member holding the item of
property (or the stock of a successor).
The Treasury Department and the IRS
appreciate the comments received on the
proposed “lesser of” rules and will contin-
ue to consider these comments for purpos-
es of potential future guidance.
c. Limitation of negative adjustments
to tax benefit from adding back
depreciation, amortization, and depletion
deductions to tentative taxable income
The additions to tentative taxable in-
come for depreciation, amortization, and
depletion deductions during the EBIT-
DA period (see §1.163(j)-1(b)(1)(i)(D)
through (F), respectively) do not necessar-
ily increase a taxpayer’s ability to deduct
BIE. For example, the taxpayer’s section
163(j) limitation already may be suffi-
ciently high to permit a deduction of all
of the taxpayer’s BIE even without such
additions to tentative taxable income.
Commenters have stated that, in such
a situation, the adjustments in §1.163(j)-
1(b)(1)(ii)(C) through (E) and proposed
§1.163(j)-1(b)(1)(iv)(B) and (E) could in-

February 1, 2021 582 Bulletin No. 2021–5
appropriately decrease the amount of the
taxpayer’s BIE deduction in the year the
property, member stock, or partnership in-
terest is sold because the taxpayer derived
no benefit from the adjustment under
§1.163(j)-1(b)(1)(i)(D) through (F) in a
prior taxable year. The commenters assert-
ed that this detrimental outcome is incon-
sistent with both congressional intent and
the statement in the preamble to T.D. 9905
that §1.163(j)-1(b)(1)(ii)(C) through (E)
and proposed §1.163(j)-1(b)(1)(iv)(B) and
(E) are intended to ensure that the positive
adjustment to tentative taxable income for
depreciation deductions results in a timing
benefit. See part II.A.5 of the Summary of
Comments and Explanation of Revisions
in the preamble to T.D. 9905. Moreover, if
a taxpayer that did not benefit from a posi-
tive adjustment under §1.163(j)-1(b)(1)(i)
(D) through (F) were required to reduce
its tentative taxable income in the year of
disposition, the negative adjustment could
put the taxpayer in a worse position than
if the depreciation, amortization, or deple-
tion deductions were not added back to
tentative taxable income in the first place.
The commenters thus recommended pro-
viding that a negative adjustment under
§1.163(j)-1(b)(1)(ii)(C) through (E) and
proposed §1.163(j)-1(b)(1)(iv)(B) and
(E) is required only to the extent the pri-
or-year addback under §1.163(j)-1(b)(1)
(i)(D) through (F) resulted in an increase
in deductible BIE.
The Treasury Department and the IRS
agree with this recommendation. Thus, the
final regulations provide that a negative
adjustment to tentative taxable income un-
der §1.163(j)-1(b)(1)(ii)(C) through (E) or
§1.163(j)-1(b)(1)(iv)(B) or (E) is reduced
to the extent the taxpayer establishes that
the additions to tentative taxable income
under §1.163(j)-1(b)(1)(i)(D) through
(F) in a prior taxable year did not result
in an increase in the amount allowed as a
deduction for BIE for such year. The final
regulations also provide examples illus-
trating the application of this rule.
d. Capitalized depreciation
T.D. 9905 provides that, for the ad-
ditions to tentative taxable income in
§1.163(j)-1(b)(1)(i), amounts of depre-
ciation, amortization, or depletion that
are capitalized under section 263A of the
Code (collectively, capitalized deprecia-
tion) during the taxable year are deemed to
be included in the computation of the tax-
payer’s tentative taxable income for such
year, regardless of when the capitalized
amount is recovered. See §1.163(j)-1(b)
(1)(iii). Thus, a taxpayer makes a positive
adjustment to tentative taxable income
under §1.163(j)-1(b)(1)(i)(D) through (F)
when the taxpayer capitalizes the depre-
ciation, amortization, or depletion, rather
than later when the capitalized amount is
recovered (for example, through cost of
goods sold).
Commenters requested clarification re-
garding the application of §§1.163(j)-1(b)
(1)(ii)(C) through (E) and 1.163(j)-1(b)(1)
(iv) to capitalized depreciation. For exam-
ple, commenters asked whether the ad-
justments in §1.163(j)-1(b)(1)(ii)(C) and
proposed §1.163(j)-1(b)(iv)(B) and (E)
occur upon the disposition of the depre-
ciated property or upon the disposition of
the property into which the depreciation
was capitalized. A commenter asked the
same question regarding the application of
the successor asset rules in §1.163(j)-1(b)
(1)(iv)(C). A commenter also requested
clarification as to how the negative adjust-
ments in §1.163(j)-1(b)(1)(ii)(D) and pro-
posed §1.163(j)-1(b)(1)(iv)(E)(2) apply to
capitalized depreciation because there are
no basis adjustments under §1.1502-32
when depreciation is capitalized.
The Treasury Department and the IRS
have determined that a negative adjust-
ment under §1.163(j)-1(b)(1)(ii)(C) or
proposed §1.163(j)-1(b)(1)(iv)(B) or (E)
would be required upon the sale or oth-
er disposition of property with respect to
which depreciation, amortization, or de-
pletion was allowed or allowable during
the EBITDA period, because it is the al-
lowed or allowable depreciation, amorti-
zation, or depletion of that property that
is added back to tentative taxable income.
The final regulations have been modified
accordingly. For the same reason, the fi-
nal regulations also clarify that the suc-
cessor asset rules in §1.163(j)-1(b)(1)(iv)
(C) would apply if such property subse-
quently were transferred to another mem-
ber (S1) in an intercompany transaction
in which the transferor receives S1 stock.
The Treasury Department and the IRS are
continuing to consider how the negative
adjustments in §1.163(j)-1(b)(1)(ii)(D)
and proposed §1.163(j)-1(b)(1)(iv)(E)(2)
apply to capitalized depreciation.
A commenter also expressed concern
that, if a taxpayer does not elect to apply
T.D. 9905 retroactively, then capitalized
depreciation arising in taxable years be-
ginning before November 13, 2020, would
not be added back to tentative taxable in-
come, but negative adjustments under
§1.163(j)-1(b)(1)(ii)(C) through (E) still
would be required for any “allowable”
depreciation, including capitalized depre-
ciation, if the relevant property, member
stock, or partnership interest were dis-
posed of in a year to which T.D. 9905 ap-
plies. The commenter thus recommended
that negative adjustments under §1.163(j)-
1(b)(1)(ii)(C) through (E) and proposed
§1.163(j)-1(b)(1)(iv)(B) and (E) not apply
to capitalized depreciation amounts that
were incurred in a taxable year that be-
gan before November 13, 2020, unless the
taxpayer included a positive adjustment
reflecting such amounts in calculating its
tentative taxable income.
As discussed in part III.A.2.c of this
Summary of Comments and Explanation
of Revisions section, the final regulations
adopt the recommendation that a negative
adjustment to tentative taxable income
under §1.163(j)-1(b)(1)(ii)(C) through (E)
and proposed §1.163(j)-1(b)(1)(iv)(B) and
(E) be reduced to the extent the taxpayer
establishes that the additions to tentative
taxable income under §1.163(j)-1(b)(1)
(i)(D) through (F) in a prior taxable year
resulted in no increase in deductible BIE
in that year. If a taxpayer does not elect
to apply T.D. 9905 retroactively, the tax-
payer will have no additions to tentative
taxable income under §1.163(j)-1(b)(1)
(i)(D) through (F) in a prior taxable year
(and, thus, no increase in deductible BIE
in that year) with respect to capitalized
depreciation. Because the final regulations
already address the commenter’s concern,
the Treasury Department and the IRS have
not incorporated the commenter’s specific
recommendation.
e. Dispositions by consolidated groups
The final regulations also revise
§§1.163(j)-1(b)(1)(iv)(A)(2), 1.163(j)-
1(b)(1)(iv)(B)(2), and 1.163(j)-1(b)(1)
(iv)(E) to clarify that the amount of gain
taken into account by a consolidated

Bulletin No. 2021–5 583 February 1, 2021
group upon a “sale or other disposition”
includes the net gain the group would take
into account, including as a result of in-
tercompany transactions. One commenter
contended that this clarification is need-
ed to ensure that the amount of gain tak-
en into account by a consolidated group
for purposes of the negative adjustments
in proposed §§1.163(j)-1(b)(1)(iv)(B)(2)
and 1.163(j)-1(b)(1)(iv)(E) is the same re-
gardless of whether the property, member
stock, or partnership interest is sold in an
intercompany transaction before leaving
the group (that is, to achieve single-entity
treatment of the group). For example, as-
sume that S would recognize $100 of gain
upon the sale of property to a nonmember.
However, rather than sell the property di-
rectly to a nonmember, S first might sell
the property to member B and recognize
$60 of gain, and B then could sell the
property to the nonmember and recognize
an additional $40 of gain. In either case,
the group would recognize a net gain of
$100 in relation to the property, and that
same $100 should be relevant in determin-
ing the amount of any negative adjustment
to ATI.
3. Comments on §1.163(j)-1(b)(1)(iv)(A),
(C), and (D)
a. Section 1.163(j)-1(b)(1)(iv)(A)
Commenters questioned why, under the
rules for deconsolidating transactions in
§1.163(j)-1(b)(1)(iv)(A)(3), the exception
to “sale or other disposition” treatment is
limited to whole-group acquisitions de-
scribed in §1.1502-13(j)(5)(i)(A) and does
not also include whole-group acquisitions
that take the form of reverse acquisitions,
as described in §1.1502-13(j)(5)(i)(B).
The Treasury Department and the IRS
did not intend this exception to exclude
transactions described in §1.1502-13(j)
(5)(i)(B), and the final regulations revise
§1.163(j)-1(b)(1)(iv)(A)(3) to correct this
typographical error.
The Treasury Department and the IRS
received another comment regarding the
exceptions to “sale or other disposition”
treatment for whole-group acquisitions in
§1.163(j)-1(b)(1)(iv)(A)(3) and for sec-
tion 381 transactions in §1.163(j)-1(b)
(1)(iv)(A)(1) (see the summary in part
III.A.1.b of this Summary of Comments
and Explanation of Revisions section).
The commenter noted that the tax law
generally treats the successor in a section
381 transaction (and the acquiring group
in a whole-group acquisition) as step-
ping into the shoes of the acquired enti-
ty (or group). However, the commenter
also noted that §1.163(j)-1(b)(1)(iv)(A)
does not expressly provide that the ac-
quiring entity (or group) steps into the
shoes of the acquired entity (or group)
for purposes of the negative adjustments
in §§1.163(j)-1(b)(1)(ii)(C) through (E)
and 1.163(j)-1(b)(1)(iv)(B) and (E). The
commenter recommended clarifying this
point.
The Treasury Department and the IRS
agree with the commenter. Thus, the final
regulations clarify this point by express-
ly stating that the acquiring corporation
in a section 381 transaction and the sur-
viving group in a transaction described in
§1.1502-13(j)(5)(i) is treated as a succes-
sor to the distributor or transferor corpora-
tion or the terminating group, respective-
ly, for purposes of §§1.163(j)-1(b)(1)(ii)
(C) through (E) and 1.163(j)-1(b)(1)(iv)
(B) and (E) of this section.
A commenter also noted that the “lesser
of” computation for dispositions of mem-
ber stock in proposed §1.163(j)-1(b)(1)
(iv)(E)(2) could be misconstrued as over-
riding the rules for negative adjustments to
a group’s tentative taxable income in the
case of deconsolidating transactions sub-
ject to §1.163(j)-1(b)(1)(iv)(A)(3). Under
this erroneous interpretation, if a sale or
other disposition resulted in a deconsoli-
dation, the “lesser of” computation would
apply solely with respect to the member
stock that was sold, even though the de-
consolidation rules in §1.163(j)-1(b)(1)
(iv)(A)(3) would treat the transaction as
a disposition of all of the departing mem-
ber’s stock. Thus, the “lesser of” compu-
tation would not reflect the full amount of
gain recognized upon the complete dispo-
sition of the departing member’s stock.
The Treasury Department and the IRS
did not intend the “lesser of” rule in pro-
posed §1.163(j)-1(b)(1)(iv)(E)(2) to over-
ride the rules for deconsolidating transac-
tions. The regulations under section 163(j)
generally treat a consolidated group as a
single entity; thus, the rules for decon-
solidations in §1.163(j)-1(b)(1)(iv)(A)(3)
treat the date of a member’s deconsolida-
tion as the appropriate time to make ad-
justments to tentative taxable income with
regard to all of that member’s stock. Thus,
the final regulations clarify §1.163(j)-1(b)
(1)(iv)(A)(3) to provide that any transac-
tion in which a member leaves a consoli-
dated group is treated as a taxable disposi-
tion of all stock of the departing member
held by any member of the consolidated
group for purposes of §1.163(j)-1(b)(1)(ii)
(C) and (D) and §1.163(j)-1(b)(1)(iv)(B),
(E)(1), and (E)(2), unless the transaction
is described in §1.1502-13(j)(5)(i).
A commenter also suggested that non-
recognition transactions in which a mem-
ber leaves a consolidated group should not
be treated as a “sale or other disposition”
for purposes of the negative adjustments
in §1.163(j)-1(b)(1)(ii)(C) and (D) and
proposed §1.163(j)-1(b)(1)(iv)(B) and
(E). The final regulations do not accept
this comment because, under the sin-
gle-entity theory of consolidated groups in
the section 163(j) regulations, such nega-
tive adjustments should be made when a
member deconsolidates, regardless of the
form of the deconsolidation transaction,
other than in a whole-group acquisition
described in §1.1502-13(j)(5)(i). In other
words, because the section 163(j) regula-
tions generally treat a consolidated group
as a unified taxpayer, any adjustments to
ATI related to property should occur when
the item of property leaves the group. This
result should be consistent whether the
property is disposed of directly by a group
member or whether the property leaves
the group upon the deconsolidation of a
member.
The Treasury Department and the IRS
also received a comment that the gain
prong of the proposed “lesser of” com-
putation could yield unintended results
for certain nonrecognition transactions.
Under T.D. 9905, dispositions are treated
as “sales or other dispositions” for pur-
poses of the negative adjustments under
§1.163(j)-1(b)(1)(ii)(C) through (E) unless
an express exception applies. As previous-
ly discussed in this part III.A.3.a of this
Summary of Comments and Explanation
of Revisions section, T.D. 9905 provides
exceptions for section 381 transactions
and whole-group acquisitions. However,
T.D. 9905 does not provide an exception
to “sale or other disposition” treatment for
other nonrecognition transactions, such as

February 1, 2021 584 Bulletin No. 2021–5
transactions to which section 351 or sec-
tion 721 applies.
The commenter noted that the “lesser
of” computations in proposed §1.163(j)-
1(b)(1)(iv)(B) and (E) could be construed
to suggest that a taxpayer would have no
negative adjustment under these provisions
if the taxpayer transferred an asset in a
transaction to which section 351 or section
721 applies. The Treasury Department and
the IRS did not intend the proposed “less-
er of” computations to create additional
exceptions to “sale or other disposition”
treatment for purposes of the negative ad-
justments required under §1.163(j)-1(b)(1)
(ii)(C) through (E). Thus, the final regula-
tions clarify that the disposition of proper-
ty, member stock, or partnership interests
in a transaction other than a deconsolida-
tion (the treatment of which is addressed in
§1.163(j)-1(b)(1)(iv)(A)(3)) that is a non-
recognition transaction other than a section
381 transaction is treated as a taxable dis-
position for purposes of the gain prong of
the “lesser of” computation.
b. Section 1.163(j)-1(b)(1)(iv)(C)
As noted in part III.A.1.b of this Sum-
mary of Comments and Explanation of
Revisions section, the successor asset rules
in §1.163(j)-1(b)(1)(iv)(C) apply to certain
intercompany transactions. For example,
assume that S (a member of the P group)
acquires a depreciable asset and fully de-
preciates the asset under section 168(k). P
then contributes its S stock to S1 (another
member of the P group) in exchange for
S1 stock in a transaction to which section
351 applies. In this case, the S1 stock is a
successor asset to the S stock. Moreover,
if P sells its S1 stock to a third party in a
transaction that causes both S1 and S to
deconsolidate, the transaction is treated as
a taxable disposition of both the S1 stock
and the S stock for purposes of §§1.163(j)-
1(b)(1)(ii)(C) and (D) and 1.163(j)-1(b)(1)
(iv)(B) and (E). See §1.163(j)-1(b)(1)(iv)
(A)(3). In that case, both the actual sale
of the S1 stock and the disposition of the
S stock on its deconsolidation pursuant to
§1.163(j)-1(b)(1)(iv)(A)(3) could produce
negative adjustments to ATI. Application
of the anti-duplication rule in §1.163(j)-
1(b)(1)(iv)(D) effectively would mean that
the total subtraction from ATI would equal
the greater of the two stock gains (if any).
One commenter agreed with this read-
ing of the regulations but suggested that
an example would be helpful to clarify
the interaction of these multiple rules. The
Treasury Department and the IRS agree
with this suggestion, and the final regula-
tions include an example illustrating the
operation of these rules.
c. Section 1.163(j)-1(b)(1)(iv)(D)
Commenters have stated that the an-
ti-duplication rule in §1.163(j)-1(b)(1)(iv)
(D)(2) is unclear, does not properly sup-
port the example in that paragraph, and
does not take into account the exception
to the deconsolidation rule in §1.163(j)-
1(b)(1)(iv)(A)(3). For example, a com-
menter stated that it is unclear whether the
operative rule, which does not reference
§1.163(j)-1(b)(1)(ii)(C), actually supports
the conclusion in the example, which ref-
erences §1.163(j)-1(b)(1)(ii)(C). Another
commenter requested clarification that
the anti-duplication rule in §1.163(j)-1(b)
(1)(iv)(D)(2) does not apply to a whole-
group acquisition, which is not treated as a
“sale or other disposition” for purposes of
§1.163(j)-1(b)(1)(ii)(C) through (E). See
§1.163(j)-1(b)(1)(iv)(A)(3).
The Treasury Department and the IRS
agree with these comments and have re-
vised §1.163(j)-1(b)(1)(iv)(D)(2) to clar-
ify the application of this provision. The
Treasury Department and the IRS also
have clarified the application of §1.163(j)-
1(b)(1)(iv)(D)(1), including by clarifying
that the paragraph contains two separate
rules, rather than one rule and one exam-
ple.
A commenter also requested examples
illustrating the application of the anti-du-
plication rule in §1.163(j)-1(b)(1)(iv)(D)
when the taxpayer’s negative adjustment
under the “lesser of” computation is based
on gain recognized rather than on depreci-
ation deductions taken during the EBIT-
DA period. The final regulations add an
example to §1.163(j)-1(b)(1)(viii) to illus-
trate the application of this rule.
B. Dividends from Regulated Investment
Company (RIC) Shares
If a RIC has certain items of income
or gain, part 1 of subchapter M and oth-
er Code provisions provide rules under
which a RIC may pay dividends that a
shareholder in the RIC may treat in the
same manner (or a similar manner) as the
shareholder would treat the underlying
item of income or gain if the sharehold-
er realized it directly. Like the pream-
ble to the 2020 Proposed Regulations,
this preamble refers to this treatment as
“conduit treatment.” The 2020 Proposed
Regulations provide rules under which a
RIC that earns BII may pay section 163(j)
interest dividends. The total amount of a
RIC’s section 163(j) interest dividends for
a taxable year is limited to the excess of
the RIC’s BII for the taxable year over the
sum of the RIC’s BIE for the taxable year
and the RIC’s other deductions for the
taxable year that are properly allocable to
the RIC’s BII. The 2020 Proposed Regu-
lations provide that a RIC shareholder that
receives a section 163(j) interest dividend
may treat the dividend as interest income
for purposes of section 163(j), subject to
holding period requirements and other
limitations. The Treasury Department and
the IRS received one comment request-
ing that the proposed rules providing this
treatment be finalized. These final regula-
tions adopt those proposed rules.
A few commenters requested that con-
duit treatment be extended to funds other
than RICs, such as foreign regulated in-
vestment funds and foreign money market
funds, so that investors in those funds may
treat earnings from those funds as inter-
est income to the extent the earnings can
be traced to interest income of the funds.
These final regulations do not adopt these
recommendations. The Treasury Depart-
ment and the IRS received similar rec-
ommendations in response to the 2018
Proposed Regulations, and they were not
adopted in T.D. 9905. As explained in the
preamble to T.D. 9905, there are signifi-
cant differences between the rules govern-
ing income inclusions in respect of passive
foreign investment companies (PFICs),
such as foreign money market funds, and
RICs. These significant differences would
require a different mechanical approach if
conduit treatment were extended to PFICs
and present additional policy consider-
ations. The Treasury Department and the
IRS continue to study this comment and
these issues.
Another commenter requested that
conduit treatment be extended to allow

Bulletin No. 2021–5 585 February 1, 2021
shareholders in real estate investment
trusts (REITs) to treat REIT dividends
as interest income, to the extent that the
income earned by the REIT is interest in-
come. The Treasury Department and the
IRS continue to consider this comment.
IV. Comments on and Changes to
Proposed §1.163(j)-6: Application of
the Business Interest Expense Deduction
Limitations to Partnerships and
Subchapter S Corporations
A. Overview
Section 1.163(j)-6 provides rules for
applying section 163(j) to partnerships,
S corporations and their owners. As de-
scribed in this part IV of the Summary
of Explanation of Revisions section, the
Treasury Department and the IRS contin-
ue to study aspects of proposed §1.163(j)-
6. Accordingly, the final regulations re-
serve on §§1.163(j)-6(e)(6) (partnership
deductions capitalized by a partner), (h)
(4) (partner basis adjustments upon liqui-
dating distributions), (h)(5) (partnership
basis adjustments upon partner disposi-
tions), (j) (tiered partnerships), and (l)(4)
(iv) (S corporation deductions capitalized
by an S corporation shareholder). These
paragraphs of the 2020 Proposed Regu-
lations are retained in proposed form and
may be relied on to the extent provided
in the Applicability Dates section of this
preamble.
B. Trading Partnerships
The 2020 Proposed Regulations ad-
dressed the application of section 163(j)
to partnerships engaged in a trade or busi-
ness activity of trading personal property
(including marketable securities) for the
account of owners of interests in the ac-
tivity, as described in §1.469-1T(e)(6)
(trading partnership). Specifically, the
2020 Proposed Regulations included a
rule requiring a partnership engaged in
a trading activity (i.e., trade or business
activities described in section 163(d)(5)
(A)(ii) and illustrated in Revenue Ruling
2008-12, 2008-1 C.B. 520 (March 10,
2008)) to bifurcate its interest expense
from the trading activity between partners
that are passive investors (taxpayers that
do not materially participate in the activ-
ity within the meaning of section 469) in
the trading activity and all other partners,
and subject only the portion of the interest
expense that is allocable to the non-pas-
sive investors to limitation under section
163(j) at the partnership level. The por-
tion of interest expense from the trading
activity allocable to passive investors is
subject to limitation under section 163(d)
at the partner level, as provided in section
163(d)(5)(A)(ii). Accordingly, proposed
§1.163(j)-1(c)(1) and (2) include rules
applicable to trading partnerships that
modify the definitions of BII and BIE to
effectuate this bifurcation.
In addition, proposed §1.163(j)-6(d)(4)
requires that a trading partnership bifur-
cate all of its other items of income, gain,
loss and deduction from its trading activi-
ty between partners that are passive inves-
tors and all other partners. The portion of
the partnership’s other items of income,
gain, loss or deduction from its trading
activity properly allocable to the passive
investors in the partnership will not be
taken into account at the partnership lev-
el as items from a trade or business for
purposes of applying section 163(j) at the
partnership level. Instead, all such part-
nership items properly allocable to pas-
sive investors will be treated as items from
an investment activity of the partnership,
for purposes of sections 163(j) and 163(d).
As stated in the preamble to 2020 Pro-
posed Regulations, this approach, in order
to be effective, presumes that a trading
partnership generally will possess knowl-
edge regarding whether its individual
partners are passive investors in its trading
activity. Because no rules currently exist
requiring a partner to inform the part-
nership whether the partner has grouped
activities of the trading partnership with
other activities of the partner outside of
the partnership, the 2020 Proposed Reg-
ulations include a revision to the section
469 activity grouping rules to provide that
any activity described in section 163(d)(5)
(A)(ii) may not be grouped with any other
activity of the partner, including any other
activity described in section 163(d)(5)(A)
(ii).
In response to the decision to bifurcate
interest expenses from a trading activity,
one commenter stated that the bifurcation
approach was inconsistent with section
163(j)(5). According to the comment, the
statute does not support the partnership
having BIE for some partners and invest-
ment interest expense for others. Rather,
once a partnership determines that it is
investment interest expense that same in-
terest expense cannot also be BIE of the
partnership. The commenter read section
163(j) to mean that if a partnership is en-
gaged in a trade or business that is not a
passive activity and with respect to which
certain owners do not materially partici-
pate, then the interest expense allocable to
the partnership’s trade or business is in-
vestment interest and section 163(j) does
not apply to any of the interest expense.
Alternatively, the commenter recom-
mended that, to the extent the Treasury
Department and the IRS determine that
materially participating partners should be
subject to limitation under either section
163(d) or section 163(j), a rule similar to
that for corporate partners should be ad-
opted. Under such a rule, a trading partner-
ship would treat all of its interest expense
as investment interest expense at the part-
nership level with respect to all of its part-
ners, and the interest expense allocable to
a non-passive investor would be recharac-
terized as BIE by such non-passive inves-
tor. This approach, according to the com-
menter, would achieve a similar result as
the proposed bifurcation approach while
eliminating the administrative complexi-
ties associated with a partnership having
to determine whether each of its partners
is materially participating.
As stated in the preamble to the 2020
Proposed Regulations, the Treasury De-
partment and the IRS considered treating
all interest expense of a trading partner-
ship as investment interest expense but
concluded that it was inconsistent with
the intent of section 163(j) to limit BIE
of a partnership. The commenter’s alter-
native approach also is inconsistent with
the statute because it ignores the fact
that the trading partnership is engaged in
trade or business and, therefore, any BIE
should be subject to section 163(j). Such
an approach would further diverge from
the application of section 163(j), partic-
ularly with respect to business interest
carryforwards. Partnership BIE that is
limited under section 163(j)(4) is carried
forward by the partner as EBIE and is not
treated as paid or accrued in succeeding
taxable years until the partner receives

February 1, 2021 586 Bulletin No. 2021–5
ETI from the same partnership. Under
the commenter’s approach, the partner, if
subject to section 163(j), would treat the
interest expense as paid or accrued in the
succeeding tax year under section 163(j)
(2) without requiring an allocation of ETI
or excess BII (EBII) from the partnership.
The bifurcation approach in the 2020
Proposed Regulations, and in these final
regulations, preserves the partnership-lev-
el application of section 163(j) for those
partners who are non-passive investors in
the trade or business of the partnership as
well as the carryover rules applicable at
the partner-level.
Another commenter suggested an alter-
native under which section 163(j) would
be applied at the partnership level and any
EBIE would be allocated to the partners.
Any direct or indirect partner that is a
non-passive investor in the partnership’s
trading activity would continue to apply
the rules of section 163(j) to the EBIE re-
ceived from the partnership. For partners
who did not materially participate in the
partnership’s trading activity, any allo-
cated EBIE from the partnership would
be fully deductible subject to any part-
ner-level section 163(d) limitation. Under
this approach, any EBIE received by a
passive investor would be treated as paid
or accrued in the current year and not sub-
ject to the carryover rules under section
163(j)(4)(B). The Treasury Department
and the IRS do not adopt this comment as
the approach is inconsistent with the stat-
utory language and intent of section 163(j)
(5) because the second sentence of section
163(j)(5) specifically states that BIE shall
not include investment interest expense.
Several commenters opposed the re-
vision of the grouping rule under section
469 to prohibit the grouping of trading ac-
tivities. Proposed §1.469-4(d)(6) provides
that a trading activity described in section
163(d)(5)(A)(ii) may not be grouped with
any other activity of the taxpayer, includ-
ing another trading activity. One com-
menter observed that such a rule would
discourage trading funds from using mul-
tiple partnerships because it may result in
partners never being able to demonstrate
material participation in the trading activi-
ty under the 500 hour test or any other ma-
terial participation test (i.e., §1.469-5T(a))
for any one partnership, even though the
partner would materially participate in a
properly grouped activity. Another ac-
knowledged the administrative burden
associated with partnerships evaluating
the activities of their passive partners but
highlighted that partnerships were already
required to collect details about partner’s
tax status in similar situations. A third
suggested that the grouping rule could
be modified to permit a partner to group
activities provided the partner provides
sufficient information to the partnership
to enable it to identify the taxpayer as a
materially participating partner.
The Treasury Department and the IRS
do not adopt these recommendations be-
cause the rules under section 469 ade-
quately address these concerns. Activity
under section 469 is broadly defined to be
a trade or business under section 162 and
the rules further provide for grouping by a
partnership or S corporation. As addressed
previously, for the bifurcation method to
be effective, modification of the section
469 grouping rules is necessary to avoid
potential abuse and to allow the trading
partnership to presume that an individual
partner is a passive investor in the trading
activity based solely on the partnership’s
understanding as to the lack of work per-
formed in the trading activity. Additional-
ly, if grouping were allowed, then passive
partners could group their other trade or
business activities, in which they materi-
ally participate, with their trading activity
in order to become a material participant
as to the trading activity, thus, avoiding
the section 163(d) limit at the partner lev-
el. The final regulations clarify that this
grouping rule applies only to individuals,
estates, trusts, closely held C corporations,
and personal service corporations that may
directly or indirectly own interests in trad-
ing activities described in §1.469-1T(e)(6)
and subject to section 163(d)(5)(ii).
One commenter observed that the pro-
posed regulations do not discuss a tiered
partnership structure with respect to the
material participation rules. The Treasury
Department and the IRS determined that
such a rule is not needed. The bifurca-
tion approach in proposed §1.163(j)-1(c)
(1) and (2) applies where interest income
or expense is allocable to one or more
partners that do not materially partici-
pate (within the meaning of section 469),
as described in section 163(d)(5)(A)(ii).
Thus, in a tiered structure where interest is
not allocable to one or more partners that
do not materially participate, the rules in
§1.163(j)-6(c)(1) and (2) do not apply and
the interest expense is subject to the rules
under section 163(j)(4).
The same commenter recommended
the final regulations provide that if a part-
ner that has EBIE ceases to materially par-
ticipate in a later taxable year, the EBIE
would be allowed in a later year subject
to any section 163(d) limitation; and con-
versely, if a passive investor partner has
a section 163(d) investment carryover and
then materially participates in a later tax-
able year, the 163(d) carryover would be
allowed subject to any partner-level sec-
tion 163(j) limitation. In light of concerns
with partners shifting between participat-
ing and not participating in the trading
activity in order to unsuspend EBIE, the
Treasury Department and the IRS deter-
mined that such a rule is not warranted.
One commenter requested transition
relief for trading partnerships that may
have relied on the statement contained in
the preamble to the 2018 Proposed Regu-
lations that the BIE of the partnership al-
locable to trading activity will be subject
to section 163(j) at the entity level, even
if the interest expense is later subject to
limitation under section 163(d) at the in-
dividual partner level. Partnerships that
relied on the 2018 Proposed Regulations
may have allocated EBIE to partners who
do not materially participate in the trading
activity of the partnership. Under the final
regulations, partnerships carrying on trad-
ing activities do not allocate ETI or EBII
from trading activities to their partners
who do not materially participate in those
activities. Rather, any interest expense and
all other items from such activities allo-
cable to these partners will be treated as
items derived from an investment activi-
ty of the partnership. As a result, passive
investors that were previously allocated
EBIE from the trading partnership gen-
erally will not be allocated any ETI or
EBII from that partnership in future years
against which they can offset the EBIE.
The Treasury Department and the IRS
agree that relief should be accorded to
partners of trading partnerships that do
not materially participate in the trading
activity and that relied on the statement in
the preamble to the 2018 Proposed Reg-
ulations. Accordingly, a transition rule is

Bulletin No. 2021–5 587 February 1, 2021
provided in the final regulations to permit
passive investors in a partnership engaged
in a trading activity to deduct EBIE allo-
cated to them from the partnership in any
taxable year ending prior to the effective
date of the final regulations without regard
to the amount of ETI or EBII that may be
allocated by the partnership to the partner
in the first taxable year ending on or af-
ter the effective date of these final regu-
lations.
For purposes of this transition rule, any
EBIE that is no longer subject to disallow-
ance under section 163(j) solely as a result
of this transition rule will not be subject
to limitation or disallowance under sec-
tion 163(d). In such case, the partnership
treated the interest expense as business
interest expense for purposes of calcu-
lating its limitation under section 163(j).
The treatment of interest expense by the
partnership as BIE in prior years is not af-
fected by this transition rule. Accordingly,
the rule in section 163(j)(5) that interest
expense cannot be treated as both BIE and
investment interest expense would still ap-
ply, and the BIE of the partnership cannot
be treated as investment interest expense
of the partner in future years.
The commenter also observed that a
corporate partner is never subject to sec-
tion 163(d) regardless of material partici-
pation and requested clarification whether
section 163(j) applies to a trading partner-
ship’s corporate partner at the partner or
partnership level. The Treasury Depart-
ment and the IRS have determined that
the regulations as proposed adequately
addressed this situation. Generally, a cor-
porate partner is not a passive investor
subject to section 163(d)(5)(A)(ii); there-
fore, the rules under proposed §1.163(j)-
6(c) would not apply.
In the 2020 Proposed Regulations, the
Treasury Department and the IRS request-
ed comments regarding whether similar
rules should be adopted with respect to
S corporations that also may be involved
in trading activities, and whether such
rules would be compatible with subchap-
ter S. One commenter recommended that
the final regulations provide that an S cor-
poration engaged in a trading activity be
required to bifurcate its interest expense
between shareholders who materially par-
ticipate in the trading activity and share-
holders who do not materially participate
and apply section 163(j) to the former and
section 163(d) to the latter at the S corpo-
ration level.
The Treasury Department and the IRS
appreciate this recommendation but, as
acknowledged by the commenter, the im-
plementation of such a rule would require
different allocations of S corporation in-
come and other items among shareholders
of the S corporation. Unlike partnerships,
S corporations must allocate items pro
rata to the shareholders, in accordance
with their respective percentages of stock
ownership in the corporation. See gener-
ally section 1377(a)(1). Therefore, with
regard to S corporations, the Treasury
Department and the IRS have determined
that (i) section 163(d) should continue to
be applied at the shareholder level, and (ii)
as provided by section 163(j)(4)(A) and
(D), section 163(j) should continue to be
applied at the S corporation level. Conse-
quently, the final regulations do not incor-
porate the commenter’s recommendation.
C. Treatment of Business Interest Income
and Business Interest Expense with
Respect to Lending Transactions Between
a Partnership and a Partner (Self-Charged
Lending Transactions)
The 2020 Proposed Regulations pro-
vide that, in the case of a self-charged lend-
ing transaction between a lending partner
and a borrowing partnership in which the
lending partner owns a direct interest, any
BIE of the borrowing partnership attrib-
utable to a self-charged lending transac-
tion is BIE of the borrowing partnership
for purposes of proposed §1.163(j)-6(n).
However, to the extent the lending part-
ner receives interest income attributable
to the self-charged lending transaction and
also is allocated EBIE from the borrow-
ing partnership in the same taxable year,
the lending partner may treat such interest
income as an allocation of EBII from the
borrowing partnership in that taxable year,
but only to the extent of the lending part-
ner’s allocation of EBIE from the borrow-
ing partnership in the same taxable year.
To prevent the potential double counting
of BII, the lending partner includes inter-
est income re-characterized as EBII only
once when calculating the lending part-
ner’s own section 163(j) limitation. In
cases where the lending partner is not a C
corporation, to the extent that any inter-
est income exceeds the lending partner’s
allocation of EBIE from the borrowing
partnership for the taxable year, and such
interest income otherwise would be prop-
erly treated as investment income of the
lending partner for purposes of section
163(d) for that year, such excess amount
of interest income will continue to be
treated as investment income of the lend-
ing partner for that year for purposes of
section 163(d).
One commenter generally support-
ed the approach for self-charged lend-
ing transactions provided in the 2020
Proposed Regulations and expected that
many taxpayers may benefit from this
rule. However, the commenter noted that
the rule applies only to self-charged lend-
ing transactions where the lending part-
ners directly own interests in the borrow-
ing partnerships and stated that this rule is
too narrow. The commenter recommended
that the rule be broadened to include loans
to a partnership by other members in the
same consolidated group as a corporate
partner. In addition, the commenter rec-
ommended that the rule for self-charged
lending transactions should be expanded
to include lending partners in upper-tier
partnerships who make loans to lower-tier
partnerships. The commenter stated that in
both cases, the interest expense would ul-
timately flow up to the same taxpayer that
recognizes the interest income.
The Treasury Department and the
IRS have determined that the rule for
self-charged lending transactions should
be adopted in the final regulations with-
out change. With respect to the recom-
mendation that the self-charged lending
rule should apply to indirect lenders in
tiered-partnership situations, the Treasury
Department and the IRS concluded that
adopting a rule to allow interest income of
a partner in an upper-tier partnership that
lent money to a lower-tier partnership to
offset EBIE that may be suspended in a
lower-tier partnership would add undue
complexity to these rules, and such rules
would likely become more difficult to ad-
minister, particularly with respect to large
and complex multi-tiered entity structures.
With respect to the recommendation to ex-
tend the rule to apply to corporate partners
where the lender is a member of the same
consolidated group of corporations, the

February 1, 2021 588 Bulletin No. 2021–5
Treasury Department and the IRS contin-
ue to consider whether this would be ap-
propriate for inclusion in future guidance.
The Treasury Department and the IRS are
also considering additional guidance that
would limit the application of the self-
charged interest rule to a lender that is
subject to tax under section 511, due to the
special rules that apply to the calculation
of unrelated business taxable income un-
der section 512. See §1.512(a)-6.
The Treasury Department and the IRS
solicited comments in the 2020 Proposed
Regulations regarding whether the rule
for self-charged lending transactions be-
tween partnerships and lending partners
(or a similar rule) should apply to, lending
transactions between S corporations and
lending shareholders. No comments were
received in response to this solicitation.
The pro rata allocation requirements ap-
plicable to S corporations make adopting
rules similar to those provided for part-
nership self-charged lending transactions
difficult to apply and could potentially
impact the eligibility requirements under
subchapter S. Accordingly, the final regu-
lations do not provide such a rule.
D. CARES Act Partnership Rules
The 2020 Proposed Regulations pro-
vide special rules for partners and part-
nerships for taxable years beginning in
2019 or 2020 under section 163(j)(10)
as enacted by the CARES Act. Proposed
§1.163(j)-6(g)(4) provides that 50 percent
of any EBIE allocated to a partner for any
taxable year beginning in 2019 is treated
as BIE paid or accrued by the partner in
the partner’s first taxable year beginning
in 2020 (referred to in the 2020 Proposed
Regulations as §1.163(j)-6(g)(4) business
interest expense). The amount that is treat-
ed as BIE paid or accrued by the partner
in the partner’s 2020 taxable year is not
subject to a section 163(j) limitation at the
partner level. The 2020 Proposed Reg-
ulations further provide that if a partner
disposes of its interest in the partnership
in the partnership’s 2019 or 2020 taxable
year, the amount treated as BIE paid or
accrued by the partner under proposed
§1.163(j)-6(g)(4) is deductible by the
partner and thus does not result in a ba-
sis increase under §1.163(j)-6(h)(3). The
2020 Proposed Regulations state that a
taxpayer may elect to not have §1.163(j)-
6(g)(4) apply, and provide two examples
illustrating these rules in §§1.163(j)-6(o)
(35) and (o)(36). The Treasury Depart-
ment and the IRS specifically requested
comments on these proposed rules and on
whether further guidance was necessary.
One commenter agreed with the ap-
proach taken in the 2020 Proposed Reg-
ulations, but requested that the final reg-
ulations clarify that an election out of
the 50 percent EBIE rule is made by a
partner with respect to each partnership
in which the partner holds an interest.
The commenter stated that partners may
have different reasons to elect out of the
50 percent EBIE rule and that by allow-
ing partners to make the election out with
respect to each partnership, partners will
have greater flexibility in managing their
tax consequences.
The Treasury Department and the IRS
agree with this comment. Thus, the final
regulations clarify that partners may elect
out of the 50 percent EBIE rule on a part-
nership by partnership basis.
Another commenter requested confir-
mation with respect to an aspect of the
example in §1.163(j)-6(o)(36). In the ex-
ample, the partner is allocated EBIE in
2018 and 2019 and sells its partnership
interest in 2019. The commenter request-
ed confirmation that the partner would not
deduct 50 percent of the EBIE since the
sale of the partnership interest occurred in
2019, resulting in a gain/loss recognition
event during the 2019 taxable year, and
there would be no basis in the partnership
for the partner to deduct 50 percent of the
2019 EBIE.
The Treasury Department and the IRS
believe that the example, as drafted in the
proposed regulations, represents a correct
interpretation of the regulations and are
therefore finalizing the example without
change. However, these final regulations
clarify that §1.163(j)-6(g)(4) business in-
terest expense can be deducted by the dis-
posing partner except to the extent that the
business interest expense is negative sec-
tion 163(j) expense as defined in §1.163(j)-
6(h)(1) immediately before the disposi-
tion. Under the example in §1.163(j)-6(o)
(36), the partner treats 50 percent of 2019
EBIE ($10 x 50%) as §1.163(j)-6(g)
(4) business interest expense. Section
1.163(j)-6(g)(4) provides that if a partner
disposes of a partnership interest in the
partnership’s 2019 or 2020 taxable year,
the partner can deduct the §1.163(j)-6(g)
(4) business interest expense and there is
no basis increase under §1.163(j)-6(h)(3)
for this amount. Thus, unless the partner
elects out of the 50 percent EBIE rule, the
partner would have a $25 loss (instead of
a $30 loss) from the sale of its partnership
interest in 2019 and $5 of deductible BIE
that is not subject to a section 163(j) lim-
itation at the partner level.
The Treasury Department and the
IRS received one comment on proposed
§1.163(j)-6(d)(5). This commenter stated
that the proposed regulations disregard the
“11-step approach” in §1.163(j)-6(f)(2),
and instead point to different mechanics
of a tiered partnership allocation rule un-
der proposed §1.163(j)-6(j)(9). The com-
menter recommended additional guidance
and examples on the application of the
proposed regulations to non-tiered part-
nerships and partnerships that historically
allocate all items pro rata.
In light of this comment, and in light
of the fact that the tiered partnership
rules in the proposed regulations are not
being finalized at this time, the Treasury
Department and the IRS believe that a
simpler method for a partnership to take
into account 2019 ATI in 2020 is war-
ranted. Therefore, these final regulations
prescribe a simplified method that applies
when a partnership uses its 2019 section
704 income, gain, loss, and deduction
amounts in determining its 2020 allocable
ATI and include an illustrative example.
V. Comments on and Changes to
Proposed §1.163(j)-7: Application
of the Section 163(j) Limitation to
Foreign Corporations and United States
Shareholders
A. Overview
Section 1.163(j)-7 provides rules for
applying section 163(j) to relevant for-
eign corporations and their United States
shareholders (U.S. shareholders).
As described in this part V of the
Summary of Comments and Explanation
of Revisions section, the Treasury De-
partment and the IRS continue to study
aspects of proposed §1.163(j)-7. Ac-
cordingly, the final regulations reserve

Bulletin No. 2021–5 589 February 1, 2021
on §1.163(j)-7(c)(2)(iii) (treating a CFC
group as single C corporation for purpos-
es of allocations to an excepted trade or
business) and (iv) (treating a CFC group
as single taxpayer for purposes of treating
amounts as interest), (f)(2) (ordering rule
when a CFC group member has ECI), and
(j) (computation of ATI of certain United
States shareholders of applicable CFCs),
and related definitions in §1.163(j)-7(k).
These paragraphs of the 2020 Proposed
Regulations are retained in proposed form
and may be relied on to the extent provid-
ed in the Applicability Dates section.
B. Negative Adjusted Taxable Income of
CFC Group Members
Proposed §1.163(j)-7(c) provided rules
for applying section 163(j) to CFC group
members. Proposed §1.163(j)-7(c)(2)(i)
provided that a single section 163(j) lim-
itation is computed for a specified period
of a CFC group based on the sum of the
current-year business interest expense,
disallowed BIE carryforwards, BII, floor
plan financing interest expense, and ATI
of each CFC group member. For this pur-
pose, the ATI and other items of a CFC
group member were generally comput-
ed on a separate-entity basis. Proposed
§1.163(j)-7(c)(2)(i).
Under the general rule of §1.163(j)-
1(b)(1)(vii), ATI of a taxpayer cannot be
less than zero (no-negative ATI rule). Two
comments were received regarding the ap-
plication of the no-negative ATI rule with
respect to CFC groups and CFC group
members. One of the comments stated that
it is unclear how the rule applies to CFC
group members. Both comments asserted
that the no-negative ATI rule should ap-
ply with respect to the CFC group, rather
than each separate CFC group member. As
a result, the ATI of a CFC group would
generally be reduced by the negative
ATI of CFC group members, if any. One
comment noted that consolidated groups
have a single ATI amount, which takes
into account losses of consolidated group
members. Another comment noted that, if
negative ATI of CFC group members is
not taken into account, CFC group mem-
bers could be required to deduct BIE in a
taxable year in which the sum of the CFC
group members’ tested losses exceed the
sum of their tested income; the comment
questioned whether this result is appro-
priate, noting that it would often be more
beneficial to carry forward the disallowed
BIE to the subsequent taxable year in light
of the fact that tested losses cannot be car-
ried forward to subsequent taxable years.
The Treasury Department and the IRS
agree that the ATI of CFC group mem-
bers should take into account amounts
less than zero for purposes of determining
the ATI of a CFC group. Accordingly, the
final regulations provide that the no-neg-
ative ATI rule applies with respect to the
ATI of a CFC group, rather than a CFC
group member.
C. Transactions Between CFC Group
Members
In general, intragroup transactions are
taken into account for purposes of com-
puting a CFC group’s section 163(j) lim-
itation. However, proposed §1.163(j)-7(c)
(2)(ii) provided an anti-abuse rule that
disregarded an intragroup transaction be-
tween CFC group members if a principal
purpose of entering into the transaction
was to affect the CFC group’s or a CFC
group member’s section 163(j) limita-
tion by increasing or decreasing the CFC
group or a CFC group member’s ATI.
Some comments requested a broader rule
that would permit taxpayers to elect an-
nually to disregard BII and BIE between
CFC group members for purposes of ap-
plying section 163(j). The comments as-
serted that this election would reduce the
compliance burden on taxpayers.
The final regulations do not provide an
election to disregard intragroup BII and
BIE. The effect of the requested election
would be to allow a deduction for all intra-
group BIE and to cause the section 163(j)
limitation applicable to other BIE (that is,
BIE with respect to debt that is not be-
tween members of a CFC group) to be de-
termined without regard to intragroup BII.
Although the requested election would not
affect the total amount of deductible BIE
within the CFC group, it would change the
location of the deduction within the CFC
group (that is, the CFC group member for
which a deduction is allowed). Moving a
BIE deduction from one CFC group mem-
ber to another may have significant Feder-
al income tax consequences. For example,
the location of a CFC group’s interest de-
duction can affect the amount of a CFC
group member’s subpart F income and
tested income (or tested loss) and, there-
fore, the amount of a U.S. shareholder’s
income inclusion under section 951(a) or
951A(a), respectively. Thus, the requested
election could be used to inappropriately
manipulate the impact of BIE deductions
within a CFC group.
However, the final regulations expand
the anti-abuse rule so that it may apply not
only to certain intragroup transactions that
affect ATI but also to intragroup transac-
tions entered into with a principal purpose
of affecting a CFC group or a CFC group
member’s section 163(j) limitation by in-
creasing the CFC group or a CFC group
member’s BII. This rule is intended to pre-
vent taxpayers from artificially increasing
the total amount of BII and BIE within a
CFC group for a specified period in order
to shift disallowed BIE from one CFC
group member to another or change the
timing of deductions of BIE. For example,
a payment of BIE by a payor CFC group
member to a payee CFC group member
will generally result in an equal increase
in the CFC group’s section 163(j) limita-
tion (and therefore the amount of deduct-
ible BIE) as a result of the increase in the
CFC group’s BII. However, the increase
in the CFC group’s section 163(j) lim-
itation is not necessarily allocated to the
payor. Instead, under the ordering rules of
§1.163(j)-7(c)(3), the additional section
163(j) limitation would be allocated first
to the payee to the extent it has BIE, and
then may be allocated to other CFC group
members. This type of transaction would
be subject to the anti-abuse rule if it was
entered into with a principal purpose of in-
creasing the amount of BIE deductible by
other CFC group members.
D. High-Tax Exceptions
1. Application of section 163(j) to
Controlled Foreign Corporations with
high-taxed income
One comment suggested that the Trea-
sury Department and the IRS consider a
special rule for the application of section
163(j) to CFC group members that are
subject to the subpart F high-tax exception
under §1.954-1(d) or the GILTI high-tax
exclusion under §1.951A-2(c)(7) (togeth-

February 1, 2021 590 Bulletin No. 2021–5
er, high-tax exceptions). For example, the
comment suggested a multi-step approach
under which section 163(j) would first be
applied to CFC group members on a sepa-
rate-entity basis for the purpose of apply-
ing the high-tax exceptions, and then ATI
and BIE of CFC group members subject to
the high-tax exceptions could be exclud-
ed in computing the CFC group’s section
163(j) limitation.
The Treasury Department and the IRS
have determined that applying section
163(j) first to each CFC group member on
a separate-entity basis, then applying the
high-tax exceptions, and then reapplying
section 163(j) to a CFC group by exclud-
ing income eligible for the high-tax ex-
ceptions, would significantly increase the
administrative and compliance burdens
of section 163(j) and therefore reduce the
benefits of making a CFC group election.
Furthermore, such an approach would be
inconsistent with the general concept and
purpose of a consolidated approach to
the CFC group election; for example, it
would increase the relevance of the lo-
cation of intragroup debt and ATI within
a CFC group and could inappropriately
enhance the effective foreign tax rate of
such income. Accordingly, the final reg-
ulations do not adopt this recommenda-
tion.
2. Disallowed business interest
expense carryforwards and the high-tax
exceptions
Section 163(j) and the section 163(j)
regulations generally apply to determine
the deductibility of BIE of a relevant for-
eign corporation (which includes an appli-
cable CFC) in the same manner as those
provisions apply to determine the deduct-
ibility of BIE of a domestic C corporation.
Section 1.163(j)-7(b). One comment re-
quested that the Treasury Department and
the IRS confirm that a CFC to which the
high-tax exceptions apply can still have a
disallowed BIE carryforward.
The high-tax exception does not mod-
ify the rules for determining the section
163(j) limitation or the amount of an ap-
plicable CFC’s disallowed BIE carryfor-
ward. See part V.D.1 of this Summary of
Comments and Explanation of Revisions
section. Accordingly, an applicable CFC
may have disallowed BIE carryforwards
if the applicable CFC is subject to a high-
tax exception in the taxable year(s) in
which the disallowed BIE carryforwards
arose.
E. Allocation of CFC Group Items to an
Excepted Trade or Business
Proposed §1.163(j)-7(c)(2)(iii) provid-
ed that, for purposes of allocating items
to an excepted trade or business under
§1.163(j)-10, all CFC group members are
treated as a single C corporation. Simi-
larly, proposed §1.163(j)-7(c)(2)(iv) pro-
vided that, for purposes of determining
whether certain amounts are treated as
interest within the meaning of §1.163(j)-
1(b)(22), all CFC group members are
treated as a single taxpayer. Several com-
ments addressed the method of allocating
items of a CFC group member to an ex-
cepted trade or business under §1.163(j)-
10. The Treasury Department and the IRS
continue to study the proper method for
allocating CFC group members’ items to
an excepted trade or business and when
it is appropriate to treat a CFC group as
a single entity. The Treasury Department
and the IRS may address these issues in
future guidance and will consider the
comments at that time. Accordingly, the
final regulations reserve on §1.163(j)-7(c)
(2)(iii) and (iv).
F. Limitation on Pre-group Disallowed
Business Interest Expense Carryforwards
1. Pre-group disallowed business interest
expense carryforwards attributable to
specified group members
The 2020 Proposed Regulations pro-
vided special rules relating to disallowed
BIE carryforwards of a CFC group mem-
ber that arose in a taxable year before it
joined the CFC group (pre-group disal-
lowed BIE carryforwards). Under pro-
posed §1.163(j)-7(c)(3)(iv)(A)(1), a CFC
group member cannot deduct pre-group
disallowed BIE carryforwards in excess
of the cumulative section 163(j) pre-group
carryforward limitation. This limitation
is determined in a manner similar to the
limitation on the use of carryovers of a
member of a consolidated group arising in
a separate return limitation year (SRLY).
See §1.1502-21(c).
One comment requested that the limita-
tion on pre-group disallowed BIE carry-
forwards be removed, because it increases
the compliance burden on taxpayers and
any potential for loss trafficking could
adequately be addressed by an anti-abuse
rule. Alternatively, if this request is not
adopted, the comment requested that the
limitation on pre-group disallowed BIE
carryforwards not apply to disallowed
BIE carryforwards that arose in a taxable
year in which a CFC group election was
available but prior to the first taxable year
for which the CFC group election was in
effect. The comment asserted that apply-
ing the limitation to such carryforwards is
inappropriate because there is no loss traf-
ficking concern unless a CFC is acquired
from outside the group.
The Treasury Department and the IRS
have determined that it would be inappro-
priate for the limitation on deduction of
pre-group disallowed BIE carryforwards
to be replaced with an anti-abuse rule fo-
cused on loss trafficking. Loss trafficking
concerns may arise anytime the ATI or BII
of one CFC group member is used to al-
low a deduction for BIE of another CFC
group member attributable to a taxable
year before the other CFC group member
joined the CFC group. As a result, the fi-
nal regulations retain the limitation on the
deduction of pre-group disallowed BIE
carryforwards.
2. Application of section 382 to CFCs
joining or leaving a CFC group
As a general matter, the SRLY lim-
itations described in §§1.1502-21(c) and
1.163(j)-5(d) do not apply to a member of
a consolidated group if their application
would result in an overlap with the appli-
cation of section 382 (SRLY overlap rule).
See §§1.1502-21(g)(1) and 1.163(j)-5(f).
One comment requested clarification as to
whether section 382 applies to a CFC that
does not have ECI. The comment generally
supported the limitation on pre-group dis-
allowed BIE carryforwards but suggested
that, if section 382 applies to CFCs, a rule
similar to the SRLY overlap rule should be
adopted to prevent the limitation on pre-
group disallowed BIE carryforwards from
applying to a CFC group member if its ap-
plication would result in an overlap with
the application of section 382.

Bulletin No. 2021–5 591 February 1, 2021
Section 382, by its terms, applies to the
disallowed BIE carryforwards of foreign
corporations regardless of whether they
have ECI. However, the Treasury Depart-
ment and the IRS continue to study cer-
tain aspects of the application of sections
163(j) and 382 to foreign corporations, in-
cluding the possible application of a SRLY
overlap rule to applicable CFCs joining or
leaving a CFC group, as well as the com-
putation of any relevant section 382(a)
limitation. The Treasury Department and
the IRS may address these issues in future
guidance and will consider the comments
at that time.
G. Specified Groups and Specified Group
Members
1. The 80-percent ownership threshold
Proposed §1.163(j)-7(d) provided
rules for determining a specified group
and specified group members. A specified
group includes one or more chains of ap-
plicable CFCs connected through stock
ownership with a specified group parent,
but only if the specified group parent owns
stock meeting the requirements of section
1504(a)(2)(B) (which requires 80 percent
ownership by value) in at least one appli-
cable CFC, and stock meeting the require-
ments of section 1504(a)(2)(B) in each of
the applicable CFCs (except the specified
group parent) is owned by one or more of
the other applicable CFCs or the specified
group parent. Indirect ownership through
a partnership or through a foreign estate or
trust is taken into account for this purpose.
Some comments requested that the
ownership threshold for applying this rule
be reduced to 50 percent, or “more than 50
percent,” in order to make the rule consis-
tent with the ownership rules in sections
957 and 954(d)(3). The comments assert-
ed that a lower threshold would reduce the
compliance burden of applying section
163(j) to CFCs on a separate-entity basis,
would allow joint ventures to be included
in the CFC group, and could prevent tax-
payers from manipulating their ownership
interests in order to break affiliation and
exclude entities from the CFC group. One
comment noted that local regulatory re-
strictions may prevent a U.S. shareholder
from owning 80 percent of the stock in a
CFC.
Another comment requested that the
ownership threshold be reduced to 50
percent with respect to a CFC that has
only one U.S. shareholder. The comment
asserted that, if a CFC has only one U.S.
shareholder, there is no concern of poten-
tially inconsistent treatment by different
shareholders and there would be no need
for additional procedural requirements
(for example, a requirement to provide
notice to other shareholders). Alterna-
tively, the comment suggested that a
specified group parent that is a quali-
fied U.S. person be permitted to elect to
treat a CFC as a CFC group member if
it meets the 50 percent (but not the 80
percent) ownership threshold, even if the
specified group parent is not the sole U.S.
shareholder.
The Treasury Department and the IRS
have determined that it would be inap-
propriate to reduce the specified group
ownership threshold below 80 percent.
The application of section 163(j) to a CFC
group is modeled on the rules for apply-
ing section 163(j) to a U.S. consolidated
group under §1.163(j)-5. Accordingly, the
definition of a specified group is generally
consistent with the definition of an affiliat-
ed group under section 1504. In certain re-
spects, the rules of §1.163(j)-7(c) have the
effect of treating a CFC group as a single
entity for purposes of section 163(j). Such
treatment is not appropriate for CFCs that
do not share at least 80 percent common
ownership, that is, CFCs that are not high-
ly related. Moreover, because one CFC
group member’s ATI and BII can be used
by other CFC group members to deduct
BIE, reducing the specified ownership
threshold would increase the potential for
one CFC group member to disproportion-
ately benefit, or suffer a detriment, from
the attributes of another CFC group mem-
ber even though those CFCs are not highly
related.
As an alternative, one comment re-
quested that a U.S. shareholder be per-
mitted to take into account its pro rata
share of CFC attributes in computing the
CFC group section 163(j) limitation with-
out regard to the percentage of the U.S.
shareholder’s ownership interest. This
approach is not adopted in the final regu-
lations because it would require different
U.S. shareholders to calculate the section
163(j) limitation differently and separate-
ly track disallowed BIE carryforwards
with respect to the same CFC.
2. Clarifications to rules for determining
a specified group and specified group
members
The final regulations make several
clarifying changes to the rules for deter-
mining a specified group and specified
group members. First, the definition of
specified group in §1.163(j)-7(d)(2)(i) is
modified to clarify that a specified group
may exist when a qualified U.S. person
directly owns all of its applicable CFCs
rather than owning one or more chains of
applicable CFCs.
Second, the definition of specified
group member in §1.163(j)-7(d)(3) is
modified to clarify that there must be at
least two applicable CFCs in a specified
group in order for any applicable CFC to
be a specified group member and for a
CFC group election to be available.
Finally, the rule in §1.163(j)-7(d)(2)
(vii) (concerning when a specified group
ceases to exist) is modified to clarify
that references to the common parent in
§1.1502-75(d)(1), (d)(2)(i) through (d)
(2)(ii), and (d)(3)(i) through (d)(3)(iv) are
treated as references to the specified group
parent. This is the case even if the speci-
fied group parent is a qualified U.S. person
and therefore not included in the specified
group.
H. CFC Group Election
1. Timing and revocation of the CFC
group election
Proposed §1.163(j)-7(e) provided
rules and procedures for treating specified
group members as CFC group members
and for determining a CFC group. Pro-
posed §1.163(j)-7(e)(5) provided rules
for making and revoking a CFC group
election. Under the 2020 Proposed Reg-
ulations, a CFC group election could not
be revoked with respect to any specified
period of the specified group that begins
during the 60-month period following the
last day of the first specified period for
which the election was made. Similar-
ly, once revoked, a CFC group election
could not be made again with respect
to any specified period of the specified

February 1, 2021 592 Bulletin No. 2021–5
group that begins during the 60-month
period following the last day of the first
specified period for which the election
was revoked. The preamble to the pro-
posed regulations requested comments
as to whether a specified group that does
not make a CFC group election when it
first comes into existence (or for the first
specified period following 60 days after
the date of publication of the Treasury
decision adopting the 2020 Proposed
Regulations as final in the Federal Reg-
ister) should be precluded from making
the CFC group election for the following
60-month period.
Some comments requested that tax-
payers be permitted to make or revoke the
CFC group election on an annual basis,
due to the difficulty of predicting the ef-
fect of the election five years in advance
(including the potential for changes in fact
or law that could interact adversely with
the CFC group election). The comments
noted that, although the election is favor-
able in most cases, it could have unfavor-
able consequences in some circumstances.
Some comments recommended against
imposing a 60-month waiting period on
specified groups for which a CFC group
election is not made for the first specified
period in which a specified group exists
(or the specified period beginning 60 days
after the regulations are finalized), be-
cause taxpayers may lack the resources or
information to determine whether to make
the election for the first taxable year in
which it is available. Furthermore, some
comments asked for clarification concern-
ing when the 60-month period begins if a
CFC group election is made or revoked
with respect to a prior specified period. Fi-
nally, one comment recommended that the
Treasury Department and the IRS consid-
er providing an exception to the 60-month
rule that would allow a CFC group elec-
tion to be revoked when there is a “change
in control.” The comment did not suggest
a definition of change in control.
The Treasury Department and the IRS
have determined that taxpayers should
not be permitted to revoke the CFC group
election for a specified period beginning
within 60 months after the specified pe-
riod for which it is made or to make the
CFC group election for a specified peri-
od beginning within 60 months after the
specified period for which it is revoked.
The CFC group rules are based in part on
the consolidated return rules, which do not
allow affiliated groups that have elected to
file a consolidated return to discontinue
the filing of a consolidated return without
the consent of the Commissioner (which
generally requires a showing of good
cause). See §1.1502-75(c). In addition, if
a corporation ceases to be a member of a
consolidated group, that corporation gen-
erally is not permitted to rejoin the consol-
idated group before the 61st month begin-
ning after its first taxable year in which it
ceased to be a member of the group. Sec-
tion 1504(a)(3)(A).
Moreover, an annual election would
enable taxpayers to use section 163(j) to
inappropriately control the timing of BIE
deductions. In general, the CFC group
election is intended, in large part, to reduce
taxpayer burden, including compliance
costs and costs that might otherwise be
incurred to restructure the location of debt
within a CFC group solely for purposes of
section 163(j), and to permit allocation of
a CFC group’s section 163(j) limitation to
CFC group members with BIE. The CFC
group election is not intended to allow
taxpayers to select the most favorable re-
sult in every taxable year.
The Treasury Department and the IRS
agree that it is not necessary to impose
the 60-month waiting period on speci-
fied groups that have neither made nor
revoked a CFC group election. Accord-
ingly, the final regulations do not impose
a 60-month waiting period on a specified
group for which a CFC group election
is not made for the first specified period
in which a specified group exists (or the
specified period beginning 60 days af-
ter the regulations are finalized). The fi-
nal regulations provide, consistent with
the 2020 Proposed Regulations, that the
60-month period begins after the last day
of the specified period for which the elec-
tion was made or revoked. See §1.163(j)-
7(e)(5). Therefore, if an election is made
or revoked with respect to a specified pe-
riod, the 60-month period begins to run
on the day after the end of that specified
period. Finally, the Treasury Department
and the IRS continue to study whether an
exemption to the 60-month rule for revok-
ing a CFC group election is appropriate
when the ownership of the CFC group
changes but the specified group continues
and, therefore, the CFC group would also
otherwise continue absent an exemption.
2. Disclosure required for taxable years in
which a CFC group election is in effect
Under the 2020 Proposed Regulations,
a designated U.S. person makes a CFC
group election by attaching a statement to
its relevant Federal income tax or infor-
mation return. Proposed §1.163(j)-7(e)(5)
(iv). However, the 2020 Proposed Regu-
lations did not require a statement to be
filed for taxable years following the tax-
able year for which an election is made.
In order to facilitate ongoing disclosure of
the computation of the CFC group 163(j)
limitation in subsequent taxable years, the
final regulations provide that (in accor-
dance with publications, forms, instruc-
tions, or other guidance) each designated
U.S. person must attach a statement to
its relevant Federal income tax or infor-
mation return for each of its taxable years
that includes the last day of a specified pe-
riod of a specified group for which a CFC
group election is in effect. See §1.163(j)-
7(e)(6). The CFC group election remains
in effect even if the required statement is
not filed.
I. CFC Group Members with Effectively
Connected Income
Proposed §1.163(j)-7(f) provided that
if a CFC group member has income that
is effectively connected with the con-
duct of a U.S. trade or business (ECI),
then ECI items and related attributes of
the CFC group member are not includ-
ed in the calculation of the section 163(j)
limitation of the CFC group or in the
allocation of the limitation among CFC
group members, but are treated as items
of a separate CFC (ECI deemed corpora-
tion) that is not treated as a CFC group
member. A comment requested clarifi-
cation concerning the proper method for
allocating assets between the CFC group
member and the ECI deemed corpora-
tion, which is relevant to the allocation
of BII and BIE to an excepted trade or
business under §1.163(j)-10.
As discussed in part VI of this Sum-
mary of Comments and Explanation of
Revisions section, the Treasury Depart-
ment and the IRS continue to study the

Bulletin No. 2021–5 593 February 1, 2021
application of section 163(j) to foreign
corporations with ECI. The Treasury De-
partment and the IRS may address these
issues in future guidance and will con-
sider the comment at that time. Before
the issuance of such guidance, taxpay-
ers should use a reasonable method for
allocating assets between the CFC group
member and the ECI deemed corpora-
tion. The method must be consistently
applied to all CFC group members and
each specified period of the CFC group
after the first specified period in which it
is applied.
In addition, because the Treasury De-
partment and the IRS continue to study
the application of section 163(j) to foreign
corporations with ECI, the final regula-
tions reserve on §1.163(j)-7(f)(2) (order-
ing rule with §1.163(j)-8 when a CFC
group member has ECI).
J. ATI Computation of an Applicable
CFC
1. Foreign Income Taxes
The 2020 Proposed Regulations pro-
vided that, for purposes of computing the
ATI of a relevant foreign corporation for
a taxable year, tentative taxable income
takes into account a deduction for for-
eign income taxes. Proposed §1.163(j)-
7(g)(3). The preamble to the 2020 Pro-
posed Regulations requested comments
on whether, and the extent to which, the
ATI of a relevant foreign corporation
should be determined without regard to
a deduction for foreign income taxes.
Some comments asserted that all foreign
income taxes, or foreign income taxes
imposed by the country in which a CFC
is organized or a tax resident, should not
be taken into account as a deduction for
purposes of computing a CFC’s ATI. The
comments asserted that not taking into
account a deduction for such foreign in-
come taxes would provide parity between
CFCs and domestic corporations, which
do not deduct Federal income taxes (but
may deduct state and foreign taxes) in de-
termining their ATI.
Other comments noted that, if a domes-
tic corporation elects to claim a foreign tax
credit, the deduction for foreign income
taxes is disallowed under section 275(a)(4)
and is not taken into account in determin-
ing the domestic corporation’s ATI. There-
fore, disregarding a CFC’s deduction for
foreign income taxes would conform the
ATI of a CFC with that of a domestic cor-
poration doing business through a foreign
branch that elects to credit foreign income
taxes. Another comment asserted that for-
eign income taxes should not be deducted
to the extent a CFC’s U.S. shareholders
elect to credit foreign income taxes. Final-
ly, several comments suggested that the
proposed rule penalizes CFCs operating
in high-tax jurisdictions.
The Treasury Department and the IRS
agree that it is appropriate to determine
the ATI of a relevant foreign corporation
without regard to a deduction for for-
eign income taxes that are eligible to be
claimed as a foreign tax credit. Accord-
ingly, the final regulations provide that no
deduction for foreign income taxes (with-
in the meaning of §1.960-1(b)) is taken
into account for purposes of determining
the ATI of a relevant foreign corporation.
Thus, regardless of whether an election is
made to claim a credit for these foreign
income taxes, the foreign income taxes do
not reduce ATI.
2. Anti-abuse rule
Proposed §1.163(j)-7(g)(4) provided
that, if certain conditions are met, when
one specified group member or appli-
cable partnership (specified borrower)
pays interest to another specified group
member or applicable partnership (spec-
ified lender), and the payment is BIE to
the specified borrower and income to the
specified lender, then the ATI of the spec-
ified borrower is increased by the amount
necessary for the BIE of the specified
borrower not to be limited under section
163(j). A partnership is an applicable
partnership if at least 80 percent of the
interests in capital or profits is owned,
in the aggregate, directly or indirectly
through one or more other partnerships,
by specified group members of the same
specified group.
The final regulations provide that, for
purposes of determining whether a part-
nership is an applicable partnership, a
partner’s interests in the profits and cap-
ital of the partnership are determined in
accordance with the rules and principles
of §1.706-1(b)(4)(ii) through (iii).
K. Safe Harbor
Proposed §1.163(j)-7(h) provided a
safe-harbor election for stand-alone
applicable CFCs and CFC groups. If
the safe-harbor election is in effect for a
taxable year of a stand-alone applicable
CFC or specified taxable year of a CFC
group member, no portion of the BIE of
the stand-alone applicable CFC or of
each CFC group member, as applicable,
is disallowed under section 163(j). The
safe-harbor election is intended to reduce
the compliance burden with respect to ap-
plicable CFCs that would not have disal-
lowed BIE if they applied section 163(j)
by allowing taxpayers in general to use
subpart F income and GILTI items in lieu
of ATI. In general, the safe-harbor elec-
tion measures whether BIE is less than
or equal to the sum of 30 percent of the
applicable CFC’s subpart F income and
GILTI (not to exceed the applicable CFC’s
taxable income), taking into account only
amounts attributable to a non-excepted
trade or business.
The preamble to the 2020 Proposed
Regulations requested comments on ap-
propriate modifications, if any, to the
safe-harbor election that would further the
goal of reducing the compliance burden
on stand-alone applicable CFCs and CFC
groups that would not have disallowed
BIE if they applied the section 163(j)
limitation. In this regard, comments re-
quested that the safe harbor be expanded
to cover applicable CFCs and CFC groups
that have BII that is greater than or equal
to BIE. The comments noted that an appli-
cation of section 163(j) would not disal-
low any BIE of an applicable CFC or CFC
group that has net BII.
The Treasury Department and the IRS
agree that it is appropriate for the safe-har-
bor to be expanded as requested because
an application of section 163(j) in this
case would not disallow any BIE. Accord-
ingly, the final regulations provide that a
safe-harbor election may be made with
respect to a stand-alone applicable CFC
or CFC group if its BIE does not exceed
either (i) its BII, or (ii) 30 percent of the
lesser of its eligible amount (in general,
the sum of the applicable CFC’s subpart
F income and GILTI, taking into account
only items properly allocable to a non-ex-
cepted trade or business) or its qualified

February 1, 2021 594 Bulletin No. 2021–5
tentative taxable income (that is, the appli-
cable CFC’s tentative taxable income de-
termined by taking into account only items
properly allocable to a non-excepted trade
or business). Thus, under the final regu-
lations, if either a stand-alone applicable
CFC or a CFC group has BII that is greater
than or equal to its BIE, it is not necessary
to determine its qualified tentative tax-
able income or eligible amount in order to
make the safe-harbor election. However,
consistent with the 2020 Proposed Regu-
lations, the election may not be made for a
CFC group that has pre-group disallowed
BIE carryforwards.
In addition, consistent with the chang-
es described in part V.B of the Summary
of Comments and Explanation of Revi-
sions section (providing that negative
ATI of a CFC group member is taken into
account for purposes of computing the
CFC group’s section 163(j) limitation),
the determination of the eligible amount
of a stand-alone applicable CFC or a
CFC group has been modified to account
for tested losses, if any, of an applicable
CFC. See §1.163(j)-7(h)(3). Rather than
providing a formula for calculating each
component of the eligible amount, the
final regulations rely on existing rules
under sections 951, 951A, 245A (to the
extent provided in section 964(e)(4)),
and 250 to determine the taxable income
a domestic corporation would have had if
it wholly owned the stand-alone applica-
ble CFC or CFC group members and had
no other assets or income. See §1.163(j)-
7(h)(3).
L. Increase in Adjusted Taxable Income
of United States Shareholders
Proposed §1.163(j)-7(j) provided rules
that increase a U.S. shareholder’s ATI by
a portion of its specified deemed inclu-
sions (as defined in §1.163(j)-1(b)(1)(ii)
(G)). Several comments were received on
these rules. The Treasury Department and
the IRS continue to study the method for
determining the portion of the specified
deemed inclusions of a U.S. shareholder
that should increase its ATI. The Treasury
Department and the IRS may address this
issue in future guidance and will consider
the comments at that time. Accordingly,
the final regulations reserve on §1.163(j)-
7(j).
VI. Comments on and Changes to
Proposed §1.163(j)-8: Application of the
Business Interest Deduction Limitation
to Foreign Persons with Effectively
Connected Income
Proposed §1.163(j)-8 provides rules
for applying section 163(j) to a nonresi-
dent alien individual or foreign corpora-
tion with ECI. The Treasury Department
and the IRS continue to study methods of
determining the amount of deductible BIE
and disallowed business interest expense
carryforwards that are allocable to ECI,
such as the ATI ratio defined in proposed
§1.163(j)-8(c)(1)(ii) and the interaction of
proposed §1.163(j)-8 with the tiered part-
nership rules in proposed §1.163(j)-6(j).
The Treasury Department and the IRS an-
ticipate addressing these issues in future
guidance and will consider the comments
at that time. Accordingly, the final regula-
tions continue to reserve on §1.163(j)-8.
VII. Comments on and Changes to
Proposed §1.469-9: Definition of Real
Property Trade or Business
Section 469(c)(7)(C) defines real prop-
erty trade or business by reference to
eleven types of trades or businesses that
are not defined in the statute. The 2020
Proposed Regulations, in response to
questions about the application of section
469(c)(7)(C) to timberlands, provided
definitions for two terms – real property
development and real property redevelop-
ment – to further clarify what constitutes a
real property trade or business.
One commenter questioned why the
preamble to the 2020 Proposed Regula-
tions references the definition of “farm-
ing” in section 464(e), when the term
“farming business” in section 163(j)(7)
(C) is defined by reference to section
263A(e)(4) rather than to section 464(e).
The commenter further noted that a sec-
tion 263A(e)(4) “farming business” ex-
cludes not only timber but also any ever-
green tree which is more than 6 years old
at the time severed from the roots. The
commenter posited that there is no reason
why such trees should be treated different-
ly from timber for section 163(j) purposes.
The Treasury Department and the IRS
have concluded that no change is required
to the definition of real property trade or
business and that the definitions of “real
property development” and “real property
redevelopment” in proposed §1.469-9(b)
(2)(ii)(C) and (D) should be adopted in the
final regulations without change. Howev-
er, it should be noted that §1.469-9(b)(2)
(i)(B) references section 464(e) to exclude
farming activities from the definition of
real property trade or business for pur-
poses of section 469(c)(7)(C). In promul-
gating §1.469-9(b)(2)(i)(B), the Treasury
Department and the IRS determined that
the term “farming” as provided in section
464(e) is the most appropriate definition
for purposes of section 469(c)(7). Section
464(e) generally excludes the cultivation
and harvesting of trees (except those bear-
ing fruit or nuts) from the definition of
“farming.” Accordingly, the Treasury De-
partment and the IRS note that the term
“timberland” as used in §1.469-9(b)(2)
(ii)(C) and (D) includes evergreen trees
(including those described in section
263A(e)(4)). Therefore, to the extent the
evergreen trees may be located on parcels
of land covered by forest, the Treasury
Department and the IRS have concluded
that the business activities of cultivating
and harvesting such evergreen trees may
be properly considered as a component
of a “real property development” or “real
property redevelopment” trade or business
under the final regulations, and no addi-
tional clarification is needed in this regard.
To the extent that any business activities
of cultivating or harvesting evergreen
trees do not explicitly fall within these two
definitions, then such business activities
may otherwise qualify under one or more
of the other terms provided in section
469(c)(7)(C). Providing a definition for
any of the remaining undefined terms in
section 469(c)(7)(C) is beyond the scope
of the final regulations.
VIII. Comments on and Changes to
Proposed §1.163(j)-10
A. Proposed Limitation on Corporate
Look-Through Rules
For purposes of determining the ex-
tent to which a shareholder’s basis in the
stock of a domestic non-consolidated C
corporation or CFC is allocable to an ex-
cepted or non-excepted trade or business
under §1.163(j)-10, §1.163(j)-10(c)(5)(ii)

Bulletin No. 2021–5 595 February 1, 2021
(B) provides several look-through rules
whereby the shareholder “looks through”
to the corporation’s basis in its assets.
The application of these look-through
rules may produce distortive results in
certain situations. For example, assume
Corporation X’s basis in its assets is split
equally between X’s excepted and non-ex-
cepted trades or businesses, and that (as a
result) X has a 50 percent exempt percent-
age applied to its interest expense. How-
ever, rather than operate its excepted trade
or business directly, X operates its ex-
cepted trade or business through a wholly
owned, non-consolidated subsidiary (Cor-
poration Y), and each of X and Y borrows
funds from external lenders. Assuming for
purposes of this example that neither the
anti-avoidance rule in §1.163(j)-2(h) nor
the anti-abuse rule in §1.163(j)-10(c)(8)
applies, Y’s interest expense would not be
subject to the section 163(j) limitation be-
cause Y is engaged solely in an excepted
trade or business. Moreover, a portion of
X’s interest expense also would be alloca-
ble to an excepted trade or business by vir-
tue of the application of the look-through
rule in §1.163(j)-10(c)(5)(ii)(B)(2) to X’s
basis in Y’s stock.
The anti-avoidance rule in §1.163(j)-
2(h) and the anti-abuse rule in §1.163(j)-
10(c)(8) would preclude the foregoing
result in certain circumstances. Howev-
er, proposed §1.163(j)-10(c)(5)(ii)(D)
(2) would modify the look-through rule
for domestic non-consolidated C corpo-
rations and CFCs to limit the potentially
distortive effect of this look-through rule
on tiered structures in situations to which
the anti-avoidance and anti-abuse rules
do not apply. More specifically, proposed
§1.163(j)-10(c)(5)(ii)(D)(2) would mod-
ify the look-through rule for non-con-
solidated C corporations to provide that,
for purposes of determining a taxpayer’s
basis in its assets used in excepted and
non-excepted trades or businesses, any
such corporation whose stock is being
looked through may not itself apply the
look-through rule (Limited Look-Through
Rule).
For example, P wholly and directly
owns S1, which wholly and directly owns
S2. Each of these entities is a non-consol-
idated C corporation to which the small
business exemption does not apply. In de-
termining the extent to which its interest
expense is subject to the section 163(j)
limitation, S1 may look through the stock
of S2 for purposes of allocating S1’s ba-
sis in its S2 stock between excepted and
non-excepted trades or businesses. How-
ever, in determining the extent to which
P’s interest expense is subject to the sec-
tion 163(j) limitation, S1 may not look
through the stock of S2 for purposes of al-
locating P’s basis in its S1 stock between
excepted and non-excepted trades or busi-
nesses.
Several commenters objected to the
Limited Look-Through Rule. One com-
menter stated that the Limited Look-
Through Rule should not be finalized
because it would penalize taxpayers that
incur debt at the holding company level
but hold excepted trade or business assets
through tiers of non-consolidated sub-
sidiaries (such as CFCs) for non-tax rea-
sons. The commenter contended that this
result is especially distortive in regulated
industries, such as utilities, in which debt
financing at the operating-entity level may
be limited or prohibited by regulators. An-
other commenter noted that the Limited
Look-Through Rule potentially conflicts
with the single C corporation approach
for CFCs under proposed §1.163(j)-7(c)
(2)(iii).
The Treasury Department and the IRS
remain concerned that application of the
look-through rules in §1.163(j)-10 to
non-consolidated C corporations may pro-
duce distortive results in certain situations.
However, as stated in the preamble to the
2020 Proposed Regulations, the Treasury
Department and the IRS are aware that
taxpayers are organized into multi-tiered
structures for legitimate, non-tax reasons
and that it may be commercially difficult
or impossible for taxpayers to limit or re-
duce the number of tiers in many cases.
The Treasury Department and the IRS
have therefore determined that such multi-
tiered structures should be able to apply the
look through rules in §1.163(j)-10. How-
ever, the Treasury Department and the IRS
have also determined that the application
of the look through rules in §1.163(j)-10
is inappropriate in cases where a principal
purpose of a multi-tiered structure is to
benefit from distortion under those rules.
Thus, the final regulations replace
the Limited Look-Through Rule with an
anti-abuse rule providing that, for pur-
poses of applying the look-through rules
in §1.163(j)-10(c)(5)(ii)(B) and (C) to a
non-consolidated C corporation (upper-ti-
er entity), that upper-tier entity may not
apply those look-through rules to a low-
er-tier non-consolidated C corporation if a
principal purpose for borrowing funds at
the upper-tier entity level or adding an up-
per-tier or lower-tier entity to the owner-
ship structure is increasing the amount of
the taxpayer’s basis allocable to excepted
trades or businesses.
For example, P wholly and directly
owns S1 (the upper-tier entity), which
wholly and directly owns S2. Each of S1
and S2 is a non-consolidated C corpora-
tion to which the small business exemp-
tion does not apply, and S2 is engaged in
an excepted trade or business. With a prin-
cipal purpose of increasing the amount
of its basis allocable to excepted trades
or businesses, P has S1 (rather than S2)
borrow funds from a third party. S1 may
not look through the stock of S2 (and may
not apply the asset basis look-through rule
described in §1.163(j)-10(c)(5)(ii)(B)(2)
(iv)) for purposes of P’s allocation of its
basis in its S1 stock between excepted
and non-excepted trades or businesses; in-
stead, S1 must treat its stock in S2 as an
asset used in a non-excepted trade or busi-
ness for that purpose. However, S1 may
look through the stock of S2 for purpos-
es of S1’s allocation of its basis in its S2
stock between excepted and non-excepted
trades or businesses.
B. 80-Percent Ownership Threshold in
§1.163(j)-10(c)(7)(i)
A commenter recommended eliminat-
ing the 80-percent ownership threshold
in §1.163(j)-10(c)(7)(i) for applying the
look-through rules in §1.163(j)-10(c)(5)
(ii) to non-consolidated C corporations.
More specifically, the commenter recom-
mended providing that interest expense
allocable to an equity interest in an entity
engaged in an electing real property trade
or business (RPTOB) be treated as allocat-
ed to an electing RPTOB to the extent the
assets of that entity are attributable to an
electing RPTOB, regardless of the level of
the equity interest. The commenter stated
that, because a less-than-80-percent inter-
est in a subsidiary corporation is treated as
allocable to a “trade or business” for pur-

February 1, 2021 596 Bulletin No. 2021–5
poses of the section 163(j) limitation, it is
appropriate to treat the stock of that corpo-
ration as allocable to an electing RPTOB
if the subsidiary corporation is an electing
RPTOB, without regard to an ownership
threshold.
As stated in the preamble to the 2018
Proposed Regulations, the Treasury De-
partment and the IRS have determined
that non-consolidated entities generally
should not be aggregated for purposes
of applying the section 163(j) limitation.
Moreover, as stated in the preamble to
T.D. 9905, the Treasury Department and
the IRS have determined that an 80-per-
cent ownership threshold is appropriate
for domestic non-consolidated C corpo-
rations because, unlike a partnership, a
corporation generally is respected as an
entity separate from its owner(s) for tax
purposes and, unlike a partnership or an
S corporation, a C corporation is not taxed
as a flow-through entity. Thus, the final
regulations do not accept the commenter’s
recommendation.
C. Application of Look-Through Rules to
Small Businesses
Section 1.163(j)-10(c)(5)(ii)(D) pro-
vides that a taxpayer may not apply the
look-through rules in §1.163(j)-10(c)(5)
(ii) to a partnership, S corporation, or
non-consolidated C corporation that is
eligible for the small business exemption
under section 163(j)(3) and §1.163(j)-
2(d)(1), unless that entity elects under
§1.163(j)-9 for a trade or business to be
an electing RPTOB or an electing farm-
ing business. Under §1.163(j)-9(b)(2)(i),
an exempt small business entity that con-
ducts a RPTOB may make a “protective
election” for its RPTOB to be an excepted
trade or business.
A commenter noted that, if a taxpayer
indirectly holds an interest in an electing
RPTOB through an exempt upper-tier part-
nership that does not conduct an excepted
trade or business, the taxpayer would be
ineligible to allocate the taxpayer’s inter-
est expense to the electing RPTOB under
T.D. 9905. To ensure that the owners of
an exempt small business entity are treat-
ed consistently regardless of the entity’s
overall capital structure, the commenter
recommended either (i) allowing the own-
ers of an exempt small business entity to
apply the look-through rules without the
need for a “protective election” to be an
excepted trade or business, or (ii) allow-
ing the small business entity to elect to opt
into the look-through rules.
The Treasury Department and the IRS
appreciate the comments received on the
application of the look-through rules to
small businesses. These comments con-
cern provisions in T.D. 9905 that were not
revised in the 2020 Proposed Regulations,
and the Treasury Department and the IRS
have determined that addressing these
comments would exceed the scope of the
final regulations. However, the Treasury
Department and the IRS will continue to
consider these comments for purposes of
potential future guidance.
D. Alternative to Asset Basis Allocation
A commenter recommended amending
§1.163(j)-10 to permit taxpayers to use a
fair market value allocation method when
determining allocations of BIE for pur-
poses of section 163(j). To discourage tax-
payers from shifting allocation methods,
the commenter recommended that a fair
market value allocation election be irrevo-
cable absent consent from the IRS.
As explained in the preamble to T.D.
9905, disputes between taxpayers and the
IRS over the fair market value of an as-
set are a common and costly occurrence.
Moreover, in the TCJA, Congress repealed
the use of fair market value in the appor-
tionment of interest expense under section
864 of the Code (see section 14502(a) of
the TCJA). As noted in the preamble to
T.D. 9905, Congress stated that the ability
to elect to allocate interest expense under
section 864 on the basis of fair market val-
ue of assets has led to inappropriate results
and needless complexity. For these and
other reasons, the Treasury Department
and the IRS continue to believe that allo-
cating interest expense based on relative
amounts of asset basis is more appropri-
ate than a regime based on the relative fair
market value of assets. Thus, the final reg-
ulations do not accept this comment.
Applicability Dates
These final regulations apply to tax-
able years beginning on or after March
22, 2021. See additional discussion in part
VI of the Special Analyses addressing the
Congressional Review Act.
Some provisions regarding the choice
to apply the final regulations to taxable
years beginning before the applicability
date have changed from the 2020 Pro-
posed Regulations. Commenters noted
that these provisions in the 2020 Proposed
Regulations were complicated. More
specifically, in the 2020 Proposed Regu-
lations, retroactive application of certain
provisions requires application of all of
the section 163(j) regulations contained in
T.D. 9905, some or all of the provisions in
these final regulations, and other specified
provisions. Additionally, most provisions
had to be applied to subsequent taxable
years once applied for a taxable year (sub-
sequent year application). As provided in
this section, to simplify the applicability
date provisions and provide certainty to
taxpayers, these final regulations, except
as otherwise described later in this Appli-
cability Dates section, require taxpayers
choosing to apply the final regulations to a
taxable year beginning before the applica-
bility date to apply the section 163(j) regu-
lations contained in T.D. 9905 as modified
by these final regulations, along with other
specified provisions, and require subse-
quent year application.
Except for §§1.163-15 and 1.1256(e)-
2, pursuant to section 7805(b)(7), taxpay-
ers and their related parties, within the
meaning of sections 267(b) (determined
without regard to section 267(c)(3)) and
707(b)(1), may choose to apply the rules
of these final regulations to a taxable year
beginning after December 31, 2017,
1
and
before March 22, 2021, provided that they
consistently apply the section 163(j) regu-
lations contained in T.D. 9905 as modified
1
Under the 2020 Proposed Regulations, for purposes of determining applicability dates, the term “related party” has the meaning provided in sections 267(b) and 707(b)(1). Section 267(c)(3)
broadens the scope of related parties under section 267(b) by potentially treating individual partners in a partnership as related to a corporation owned by the partnership, even if the individual
partners own only a small interest in the partnership. The Treasury Department and the IRS have determined that this broad scope is unnecessary in this context and may impede the ability
of certain taxpayers to choose to apply the regulations to pre-applicability taxable years. Accordingly, under these final regulations, for purposes of determining applicability dates, the term
“related party” is determined without regard to section 267(c)(3).

Bulletin No. 2021–5 597 February 1, 2021
by these final regulations and, if appli-
cable, §§1.263A-9, 1.263A-15, 1.381(c)
(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6,
1.382-7, 1.383-0, 1.383-1,1.469-9, 1,469-
11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-90, 1.1502-91
through 1.1502-99 (to the extent they ef-
fectuate the rules of §§1.382-2, 1.382-5,
1.382-6, and 1.383-1), and 1.1504-4 con-
tained in T.D. 9905 as modified by these
final regulations to that taxable year and
each subsequent taxable year.
Pursuant to section 7805(b)(7), tax-
payers and their related parties, within the
meaning of sections 267(b) (determined
without regard to section 267(c)(3)) and
707(b)(1), may apply the provisions of
§1.163-15 or 1.1256(e)-2 of the final reg-
ulations for a taxable year beginning after
December 31, 2017, and before March 22,
2021, provided that they consistently ap-
ply the rules in §1.163-15 or 1.1256(e)-2,
as applicable, to that taxable year and each
subsequent taxable year.
Alternatively, taxpayers and their relat-
ed parties, within the meaning of sections
267(b) (determined without regard to sec-
tion 267(c)(3)) and 707(b)(1), may rely
on the rules in the 2020 Proposed Regu-
lations to the extent provided in the 2020
Proposed Regulations.
To the extent that a rule in the 2020
Proposed Regulations is not finalized in
these final regulations, taxpayers and their
related parties, within the meaning of sec-
tions 267(b) (determined without regard
to section 267(c)(3)) and 707(b)(1), may
rely on that rule for a taxable year begin-
ning on or after March 22, 2021, provid-
ed that they consistently follow all of the
rules in the 2020 Proposed Regulations
that are not being finalized to that taxable
year and each subsequent taxable year be-
ginning on or before the date the Treasury
decision adopting that rule as final is ap-
plicable or other guidance regarding con-
tinued reliance is issued.
Statement of Availability of IRS
Documents
The IRS Notices, Revenue Rulings,
and Revenue Procedures cited in this doc-
ument are published in the Internal Reve-
nue Bulletin (or Cumulative Bulletin) and
are available from the Superintendent of
Documents, U.S. Government Publish-
ing Office, Washington, DC 20402, or by
visiting the IRS website at http://www.irs.
gov.
Special Analyses
I. Regulatory Planning and Review –
Economic Analysis
Executive Orders 13771, 13563, and
12866 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to se-
lect regulatory approaches that maximize
net benefits, including potential economic,
environmental, public health and safety
effects, distributive impacts, and equi-
ty. Executive Order 13563 emphasizes
the importance of quantifying both costs
and benefits, reducing costs, harmonizing
rules, and promoting flexibility. For pur-
poses of E.O. 13771 this rule is regulatory.
These final regulations have been des-
ignated by the Office of Information and
Regulatory Affairs (OIRA) as subject to
review under Executive Order 12866 pur-
suant to the Memorandum of Agreement
(MOA, April 11, 2018) between the Trea-
sury Department and the Office of Man-
agement and Budget (OMB) regarding
review of tax regulations. OIRA has des-
ignated these regulations as economically
significant under section 1(c) of the MOA.
Accordingly, the OMB has reviewed these
regulations.
A. Need for the final regulations
The Tax Cuts and Jobs Act (TCJA)
substantially modified the statutory rules
of section 163(j) to limit the amount of net
business interest expense that can be de-
ducted in the current taxable year. Because
this limitation on deduction for business
interest expense is relatively new, taxpay-
ers would benefit from regulations that
explain key terms and calculations. The
Treasury Department and the IRS pub-
lished proposed regulations in December
2018 (2018 Proposed Regulations) and
published final regulations in September
2020 (T.D. 9905) to finalize most sec-
tions of the 2018 Proposed Regulations.
Concurrently with the publication of T.D.
9905, the Treasury Department and the
IRS published proposed regulations (2020
Proposed Regulations) to provide addi-
tional section 163(j) limitation guidance
to T.D. 9905 in response to certain com-
ments to the 2018 Proposed Regulations.
The final regulations are needed to bring
clarity to instances where the meaning of
the statute was unclear and to respond to
comments received on the 2020 Proposed
Regulations.
B. Background and Overview
Section 163(j), substantially revised by
the TCJA, provides a set of statutory rules
that impose a limitation on the amount of
business interest expense that a taxpayer
may deduct for Federal tax purposes. This
limitation does not apply to businesses
with gross receipts of $25 million or less
(inflation adjusted). This provision has the
general effect of putting debt-financed in-
vestment by businesses on a more equal
footing with equity-financed investment,
a treatment that Congress believed would
lead to a more efficient capital structure
for firms. See Senate Budget Explanation
of the Bill as Passed by SFC (2017-11-20)
at pp. 163-4. Subsequently, the Corona-
virus Aid, Relief, and Economic Security
Act (CARES Act) amended section 163(j)
to provide special rules relating to the ATI
limitation for taxable years beginning in
2019 or 2020.
C. Economic Analysis
1. Baseline
In this analysis, the Treasury Depart-
ment and the IRS assess the economic
effects of the final regulations relative to
a no-action baseline reflecting anticipated
Federal income tax-related behavior in the
absence of the final regulations.
2. Summary of Economic Effects
The final regulations provide certainty
and clarity to taxpayers regarding terms
and calculations that are contained in sec-
tion 163(j), which was substantially mod-
ified by TCJA. In the absence of this clar-
ity, the likelihood that different taxpayers
would interpret the rules regarding the
deductibility of business interest expense
(BIE) differently would be exacerbated.
In general, overall economic performance

February 1, 2021 598 Bulletin No. 2021–5
is enhanced when businesses face more
uniform signals about tax treatment. Cer-
tainty and clarity over tax treatment also
reduce compliance costs for taxpayers.
For those situations where taxpayers
would generally adopt similar interpre-
tations of the statute even in the absence
of guidance, the final regulations provide
value by helping to ensure that those inter-
pretations are consistent with the purpose
of the statute. For example, the final reg-
ulations may specify a tax treatment that
few or no taxpayers would adopt in the
absence of specific guidance.
The Treasury Department and the IRS
project that the final regulations will have
an annual economic effect greater than
$100 million ($2020) relative to the no-ac-
tion baseline. This determination is based
on the substantial volume of business in-
terest payments in the economy
2
and the
general responsiveness of business invest-
ment to effective tax rates,
3
one compo-
nent of which is the deductibility of inter-
est expense. Based on these two factors,
even modest changes in the deductibility
of interest payments (and in the certainty
of that deductibility) provided by the final
regulations, relative to the no-action base-
line, can be expected to have annual ef-
fects greater than $100 million. This claim
is particularly likely to hold for the first set
of general section 163(j) guidance that is
promulgated following major legislation,
such as TCJA, and for other major guid-
ance, which the Treasury Department and
the IRS have determined includes the final
regulations.
Regarding the nature of the economic
effects, the Treasury Department and the
IRS project that the final regulations will
increase investment in the United States
and increase the proportion that is debt-fi-
nanced, relative to the no-action baseline.
They have further determined that these ef-
fects are consistent with the intent and pur-
pose of the statute. Because the final regu-
lations are projected to lead to a decrease in
Federal tax revenue relative to the no-ac-
tion baseline, there may be an increase in
the Federal deficit relative to the no-action
baseline. This may lead to a decrease in in-
vestment by taxpayers not directly affected
by these final regulations, relative to the
no-action baseline. This effect should be
weighed against the enhanced efficiency
arising from the clarity and enhanced con-
sistency with the intent and purpose of the
statute provided by these regulations. The
Treasury Department and the IRS have de-
termined that the final regulations provide a
net benefit to the U.S. economy relative to
the no-action baseline.
The Treasury Department and the IRS
have not undertaken more precise quanti-
tative estimates of these effects because
many of the definitions and calculations
under section 163(j) are new and many
of the economic decisions that are impli-
cated by these final regulations involve
highly specific taxpayer circumstances.
The Treasury Department and the IRS do
not have readily available data or models
to estimate with reasonable precision the
types and volume of different financing
arrangements that taxpayers might under-
take under the final regulations versus the
no-action baseline.
In the absence of such quantitative es-
timates, the Treasury Department and the
IRS have undertaken a qualitative analysis
of the economic effects of the final reg-
ulations relative to the no-action baseline
and relative to alternative regulatory ap-
proaches. This analysis is presented in
Part I.C.3 of this Special Analyses.
No comments on the economic analy-
sis of the 2020 Proposed Regulations were
received.
3. Economic Effects of Specific
Provisions
a. Definition of Interest
T.D. 9905 set forth several categories
of amounts and transactions that generate
interest for purposes of section 163(j). The
final regulations provide further guidance
on the definition of interest relevant to the
calculation of interest expense and interest
income. In particular, the final regulations
provide rules under which the dividends
paid by a regulated investment company
(RIC) that earns net business interest in-
come (BII) (referred to as section 163(j)
interest dividends) are to be treated as in-
terest income by the RIC’s shareholders.
That is, under the final regulations, certain
interest income earned by the RIC and
paid to a shareholder as a dividend is treat-
ed as if the shareholder earned the interest
income directly for purposes of section
163(j).
These final regulations clarify that re-
ported dividends paid by RICs can include
designations of BII for the purposes of the
section 163(j) limitation. This clarifica-
tion makes clear that investment through
RICs is treated, for purposes of the section
163(j) limitation, similarly to investment
through other possible debt instruments.
To the extent that taxpayers believed, in
the absence of the final regulations, that
dividends paid by RICs are not treated as
BII for the purposes of the section 163(j)
limitation, then taxpayers may respond to
the final regulations by increasing invest-
ment in RICs. The Treasury Department
and the IRS have determined that this
treatment is consistent with the intent and
purpose of the statute.
Affected Taxpayers. The Treasury De-
partment and the IRS have determined
that the rules regarding section 163(j)
interest dividends will potentially affect
approximately 10,000 RICs. The Treasury
Department and the IRS do not have read-
ily available data on the number of RIC
shareholders that would receive section
163(j) interest dividends that the share-
holder could treat as BII for purposes of
the shareholder’s section 163(j) limita-
tion. They further do not have data on the
volume of dividends that would be eligi-
ble for this treatment.
b. Provisions related to Partnerships
i. Trading Partnerships
Section 163(j) limits the deductibility
of interest expense at the partnership lev-
el. The final regulations address comment-
er concerns about the interaction between
this section 163(j) limitation and the sec-
tion 163(d) partner level limitation on in-
terest expense that existed prior to TJCA.
Under logic described in the preamble to
the 2018 Proposed Regulations, section
163(j) limitations would apply at the part-
nership level while section 163(d) limita-
2
Interest deductions in tax year 2013 for corporations, partnerships, and sole proprietorships were approximately $800 billion.
3
See E. Zwick and J. Mahon, “Tax Policy and Heterogeneous Investment Behavior,” at American Economic Review 2017, 107(1): 217-48 and articles cited therein.

Bulletin No. 2021–5 599 February 1, 2021
tions would apply at the partner level and
these tests would be applied independent-
ly. Commenters suggested and the Trea-
sury Department and the IRS have agreed
that the correct interpretation of the statute
is to exempt interest expense that is limit-
ed at the partner level by section 163(d)
from the partnership-level section 163(j)
limitation in accordance with the language
of section 163(j)(5).
The final regulations provide that inter-
est expense at the partnership level that is
allocated to non-materially participating
partners subject to section 163(d) is not in-
cluded in the section 163(j) limitation cal-
culation of the partnership. Generally, the
section 163(d) limitation is more generous
than the section 163(j) limitation. Relative
to the 2018 Proposed Regulations, this
change may encourage these partners to
incur additional interest expense because
they will be less likely to be limited in
their ability to use it to offset other in-
come. Commenters argued that exempting
from section 163(j) any interest expense
allocated to non-materially participating
partners subject to section 163(d) will
treat this interest expense in the same way
as the interest expense generated through
separately managed accounts, which are
not subject to section 163(j) limitations.
The Treasury Department and the IRS
project that the final regulations will result
in additional investment in trading part-
nerships and generally higher levels of
debt in any given trading partnership rela-
tive to the 2018 Proposed Regulations. Be-
cause investments in trading partnerships
may be viewed as economically similar
to investments in separately managed ac-
counts arrangements, they further project
that the final regulations, by making the
tax treatments of these two arrangements
generally similar, will improve U.S. eco-
nomic performance relative to the no-ac-
tion baseline.
Number of Affected Taxpayers. The
Treasury Department and the IRS have
determined that the rules regarding trad-
ing partnerships will potentially affect
approximately 275,000 partnerships, not
including their partners. This number
was reached by determining, using data
for the 2017 taxable year, the number of
Form 1065 and Form 1065-B filers that
(1) completed Schedule B to Form 1065
and marked box b, c, or d in question 1 to
denote limited partnership, limited liabil-
ity company, or limited liability partner-
ship status; and (2) have a North American
Industry Classification System (NAICS)
code starting with 5231 (securities and
commodity contracts intermediation and
brokerage), 5232 (securities and com-
modity exchanges), 5239 (other financial
investment activities), or 5259 (other in-
vestment pools and funds).
Additionally, the Treasury Department
and the IRS have determined that the rules
regarding publicly traded partnerships
will potentially affect approximately 80
partnerships, not including their partners.
This number was reached by determining,
using data for the 2017 taxable year, the
number of Form 1065 and 1065-B filers
with gross receipts exceeding $25 mil-
lion that answered “yes” to question 5 on
Schedule B to Form 1065 denoting that the
entity is a publicly traded partnership. The
Treasury Department and the IRS do not
have readily available data on the number
of filers that are tax shelters that are poten-
tially affected by these provisions.
ii. Self-charged Lending
The 2018 Proposed Regulations re-
quested comments on the treatment of
lending transactions between a partner-
ship and a partner (self-charged lending
transactions). Suppose that a partnership
receives a loan from a partner and allo-
cates the resulting interest expense to that
partner. Prior to TCJA, the interest income
and interest expense from this loan would
net precisely to zero on the lending part-
ner’s tax return. Under section 163(j) as
revised by TCJA, however, the partner-
ship’s interest expense deduction may
now be limited. Therefore, in absence of
specific regulatory guidance, the lend-
ing partner may receive interest income
from the partnership accompanied by
less-than-fully-offsetting interest expense.
Instead, the lending partner would receive
excess business interest expense (EBIE),
which would not be available to offset his
personal interest income. This outcome
has the effect of increasing the cost of
lending transactions between partners and
their partnerships relative to otherwise
similar financing arrangements.
To avoid this outcome, the final regu-
lations treat the lending partner’s interest
income from the loan as excess business
interest income (EBII) from the partner-
ship, but only to the extent of the partner’s
share of any EBIE from the partnership for
the taxable year. This allows the interest
income from the loan to be offset by the
EBIE. The business interest expense (that
is, BIE) of the partnership attributable to
the lending transaction will thus be treated
as BIE of the partnership for purposes of
applying section 163(j) to the partnership.
The Treasury Department and the IRS
expect that the final regulations will lead a
higher proportion of self-charged lending
transactions in partnership financing, rel-
ative to the no-action baseline. In a self-
charged lending transaction, the lending
partner is on both sides of the transaction.
It is the lender and, through the partner-
ship, the borrower. Because of this, debt
from self-charged lending transactions is
generally viewed as less risky than tra-
ditional debt, as both the lender and the
borrower are incentivized to repay the
loan without default. Therefore, the Trea-
sury Department and the IRS believe that
the better policy choice is to not subject
self-charged lending transactions to sec-
tion 163(j). The Treasury Department
and the IRS further project that the final
regulations will increase the proportion of
partnership financing that is debt-financed
relative to the no-action baseline. The
Treasury Department and the IRS have
determined that these effects are consis-
tent with the intent and purpose of the
statute.
Number of Affected Taxpayers. The
Treasury Department and the IRS do not
have readily available data to determine
the number of taxpayers affected by rules
regarding self-charged interest because no
reporting modules currently connect these
payments by and from partnerships.
c. Provisions related to Controlled
Foreign Corporations (CFCs)
i. How to Apply Section 163(j) when
CFCs have shared ownership
T.D. 9905 clarified that section 163(j)
and the section 163(j) regulations general-
ly apply to determine the deductibility of
a CFC’s BIE for tax purposes in the same
manner as these provisions apply to a do-
mestic corporation. The final regulations

February 1, 2021 600 Bulletin No. 2021–5
provide additional rules and guidance as
to how section 163(j) applies to CFCs,
including when CFCs have shared own-
ership and are eligible to be members of
CFC groups.
The Treasury Department and the IRS
considered three options with respect to
the application of section 163(j) to CFC
groups. The first option was to apply the
163(j) limitation to CFCs on a stand-
alone basis, regardless of whether CFCs
have shared ownership. However, if sec-
tion 163(j) were applied on a stand-alone
basis, business interest deductions of in-
dividual CFCs might be limited by sec-
tion 163(j) even when, if calculated on a
group basis, business interest deductions
would not be limited. Taxpayers could
restructure or “self-help” to mitigate the
effects of the section 163(j) limitation.
Such an option would lead to restruc-
turing costs for the taxpayer (relative to
the third option, described later) with no
corresponding economically productive
activity.
The second option, which was pro-
posed in the 2018 Proposed Regulations,
was to allow an election to treat related
CFCs in a similar manner as partnerships
with respect to their U.S. shareholders.
Under this option, while the section 163(j)
rules would still be computed at the in-
dividual CFC level, the business interest
expense of each CFC group member that
was subject to section 163(j) was limit-
ed to its share of the net business interest
expense of the CFC group, and the “ex-
cess taxable income” of a CFC could be
passed up from lower-tier CFCs to up-
per-tier CFCs and U.S. shareholders in the
same group. Excess taxable income is the
amount of income by which a CFC’s ATI
exceeds the threshold amount of ATI be-
low which there would be disallowed BIE.
Comments to the 2018 Proposed Reg-
ulations suggested that computing a sec-
tion 163(j) limitation for each CFC and
rolling up CFC excess taxable income
would be burdensome for taxpayers,
especially since some multinational or-
ganizations have hundreds of CFCs. In
addition, comments noted that the ability
to pass up excess taxable income would
encourage multinational organizations
to restructure such that CFCs with low
interest payments and high ATI are low-
er down the ownership chain and CFCs
with high interest payments and low ATI
are higher up in the chain of ownership.
Similar to the first option, this restruc-
turing would impose costs on taxpayers
without any corresponding productive
economic activity.
The third option, which is adopted by
the Treasury Department and the IRS in
the final regulations, was to allow taxpay-
ers to elect to apply the section 163(j) rules
to CFC groups on an aggregate basis, sim-
ilar to the rules applicable to U.S. consol-
idated groups. This option was suggested
by many comments and is the approach
taken in the final regulations. Under this
option, a single section 163(j) limitation
is computed for a CFC group by summing
the items necessary for this computation
(for example, current-year BIE and ATI)
across all CFC group members. The CFC
group’s limitation is then allocated to each
CFC member using allocation rules simi-
lar to those that apply to U.S. consolidated
groups.
The choice to use the consolidated
approach versus the stand-alone entity
approach may affect the amount of inter-
est that can be deducted. The amount of
interest that can be deducted may affect
the amount of subpart F income and test-
ed income for purposes of determining
the amount of inclusions under sections
951 and 951A. However, the consolidat-
ed approach applies only for purposes of
computing the section 163(j) limitation
and not for purposes of applying any oth-
er Code provision, such as section 951 or
951A.
This option reduces the compliance
burden on taxpayers in comparison to
applying the section 163(j) rules on an
individual CFC basis and calculating the
excess taxable income to be passed up
from lower-tier CFCs to higher-tier CFCs.
In comparison to the first and second
options, this option also removes the in-
centive for taxpayers to undertake costly
restructuring, since the location of inter-
est payments and ATI among CFC group
members will not affect the interest disal-
lowance for the group. The Treasury De-
partment and the IRS have not estimated
this difference in compliance costs be-
cause they do not have readily available
data or models to do so.
The final regulations also set out a
number of rules to govern membership in
a CFC group. These rules specify which
CFCs can be members of the same CFC
group, how CFCs with U.S. effectively
connected income (ECI) should be treat-
ed, and the timing for making or revoking
a CFC group election. These rules provide
clarity and certainty to taxpayers regard-
ing the CFC group election for section
163(j). In the absence of these regulations,
taxpayers may make financing decisions
or undertake restructuring based on dif-
ferential interpretations of the appropriate
tax treatment, an outcome that is generally
inefficient relative to decisions based on
the more uniform interpretation provided
by the final regulations.
Number of Affected Taxpayers. The
set of taxpayers affected by this rule in-
cludes any taxpayer with ownership in a
CFC that is a member of a CFC group
that has average gross receipts over a
three-year period in excess of $25 mil-
lion. The Treasury Department and the
IRS estimate that there are approximately
7,500 taxpayers with two or more CFCs
based on counts of e-filed tax returns for
tax years 2015-2017. This estimate in-
cludes C corporations, S corporations,
partnerships, and individuals with CFC
ownership.
ii. Foreign income taxes and ATI of a
CFC
The 2020 Proposed Regulations pro-
vided that the ATI of a CFC is determined
by taking into account a deduction for
foreign income taxes. The preamble to
the 2020 Proposed Regulations requested
comments on whether, and the extent to
which, the ATI of a CFC should be de-
termined without regard to a deduction
for foreign income taxes. The final regu-
lations provide that the ATI of a CFC is
determined without regard to a deduction
for foreign income taxes that are eligible
to be claimed as a foreign tax credit. Thus,
regardless of whether an election is made
to claim a credit for these foreign income
taxes, the foreign income taxes do not re-
duce ATI.
The Treasury Department and the IRS
considered three options, based on com-
ments received, in determining the extent
to which foreign income taxes paid by a
CFC should be taken into account in de-
termining its ATI. The first option would

Bulletin No. 2021–5 601 February 1, 2021
not take into account a deduction for for-
eign income taxes imposed by the nation-
al government of the country in which a
CFC is organized or a tax resident, but
would take into account a deduction for
taxes imposed by sub-national levels of
government. This would result in treating
a CFC in an analogous manner to a do-
mestic corporation, which does not deduct
Federal income taxes (but may deduct
state and foreign taxes) in determining its
ATI. However, this option would result in
the ATI of a CFC being determined in a
different manner than the ATI of a domes-
tic corporation doing business through a
foreign branch that elects to credit foreign
income taxes (as discussed in the next
option). Furthermore, this option would
increase (relative to the next option) the
administrative and compliance burdens
of taxpayers required to determine which
foreign income taxes paid by a CFC are
imposed by a national government and
which are imposed by sub-national levels
of government.
The second option considered would
not take into account foreign income taxes
for which an election is made to claim a
foreign tax credit. This option would con-
form the ATI of a CFC with that of a do-
mestic corporation doing business through
a foreign branch. If a domestic corporation
doing business through a foreign branch
elects to claim a foreign tax credit, the de-
duction for foreign income taxes is disal-
lowed under section 275(a)(4) and is not
taken into account in determining the do-
mestic corporation’s ATI. However, unlike
a foreign branch that has a single owner, a
CFC may have multiple shareholders. Be-
cause the election to credit foreign income
taxes is made at the shareholder-level, this
option would require a CFC to determine
which of its shareholders elects to credit
foreign income taxes, thereby increasing
the administrative and compliance bur-
dens. Furthermore, some shareholders of
a CFC may elect to credit foreign income
taxes, while other shareholders of the
CFC may not elect or may not be eligi-
ble to elect a credit (for example, because
the shareholder is a foreign corporation).
Since the section 163(j) limitation is de-
termined at the CFC-level, rather than on
a shareholder-by-shareholder basis, this
option could result in one shareholder be-
ing affected by the election of an unrelated
shareholder of the same CFC, an outcome
that would generally lead to economically
inefficient decision-making.
The third option, which is adopted by
the Treasury Department and the IRS in
the final regulations, does not take into
account a deduction for foreign income
taxes that are eligible to be claimed as a
foreign tax credit for purposes of calculat-
ing a CFC’s ATI, regardless of whether the
CFC’s U.S. shareholders have made an
election to claim a foreign tax credit. Rel-
ative to the first and second options, this
option minimizes the administrative and
compliance burden of determining ATI
of a CFC, and also results in the greatest
amount of ATI and section 163(j) limita-
tion. In addition, this option does not treat
CFCs located in high-tax countries differ-
ently than CFCs located in low-tax coun-
tries. Otherwise similar CFCs will have
similar ATIs regardless of their foreign in-
come taxes. In this way, the rule does not
penalize U.S. shareholders of CFCs with
high foreign taxes.
Number of Affected Taxpayers. The
population of affected taxpayers includes
any taxpayer that is a U.S. shareholder of
a CFC. The Treasury Department and the
IRS estimate that there are approximately
10,000 to 11,000 affected taxpayers based
on a count of e-filed tax returns for tax
years 2015-2017. These counts include C
corporations, S corporations, partnerships,
and individuals with CFC ownership that
meet a $25 million three-year average
gross receipts threshold. The Treasury De-
partment and the IRS do not have readily
available data on the number of filers that
are tax shelters that are potentially affect-
ed by these provisions.
d. Election to use 2019 ATI to determine
2020 section 163(j) limitation for
consolidated groups
The final regulations provide that if a
taxpayer filing as a consolidated group
elects to substitute its 2019 ATI for its
2020 ATI, that group can use the con-
solidated group ATI for the 2019 taxable
year, even if membership of the consoli-
dated group changed in the 2020 taxable
year. For example, suppose consolidated
group C has three members in the 2019
taxable year, P, the common parent of
the consolidated group, and S1 and S2,
which are both wholly owned by P. In
the 2019 taxable year, each member of
consolidated group C had $100 of ATI
on a stand-alone basis, and that consol-
idated group C had $300 of ATI. In the
2020 taxable year, consolidated group C
sells all of the stock of S2 and acquires
all of the stock of a new member, S3. In
the 2019 taxable year, S3 had $50 in ATI
on a stand-alone basis. Under the final
regulations, consolidated group C may
elect to use $300 in ATI from 2019 as a
substitute for its ATI in the 2020 taxable
year.
The Treasury Department and the IRS
considered as an alternative basing the
2019 ATI on the membership of the con-
solidated group in the 2020 taxable year.
In the example in the previous paragraph,
this approach would subtract out the $100
in ATI from S2 and add the $50 in ATI
from S3, for a total of $250 in 2019 ATI
that could potentially be substituted for
2020 ATI for consolidated group C. This
approach would add burden to taxpayers
relative to the final regulations by requir-
ing additional calculations and tracking of
ATI on a member-by-member basis to de-
termine the amount of 2019 ATI that can
be used in the 2020 taxable year without
providing any general economic benefit.
In addition, the 2019 tax year will have
closed for most taxpayers by the time the
final regulations will be published. This
implies that a final rule based on the con-
solidated group composition in the 2019
taxable year to calculate the amount of
2019 ATI that can be used in the 2020 tax-
able year will, relative to the alternative
approach of using the composition in the
2020 taxable year, reduce the incentive
for taxpayers to engage in costly merg-
ers, acquisitions, or divestures to achieve
a favorable tax result for those taxpayers
for whom the 2020 taxable year has not
closed by the time the final regulations are
published.
Number of Affected Taxpayers. The
Treasury Department and the IRS estimate
that approximately 34,000 corporate tax-
payers filed a consolidated group tax re-
turn for tax year 2017. This represents an
upper-bound of the number of taxpayers
affected by the final rule as not all con-
solidated groups would need to calculate
the amount of section 163(j) interest lim-
itation in tax years 2019 and 2020.

February 1, 2021 602 Bulletin No. 2021–5
II. Paperwork Reduction Act
The collection of information in the
final regulations has been submitted to
the OMB for review in accordance with
the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)) (PRA). An agency may
not conduct or sponsor, and a person is not
required to respond to, a collection of in-
formation unless it displays a valid OMB
control number.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
return information are confidential, as re-
quired by section 6103 of the Code.
iv. Collections of Information
The collections of information subject
to the PRA in the final regulations are
in §§1.163(j)-6(d)(5), 1.163(j)-6(g)(4),
1.163(j)-7(e)(5)(iv), 1.163(j)-7(e)(6), and
1.163(j)-7(h)(5).
The collections of information in
§§1.163(j)-6(d)(5) and 1.163(j)-6(g)(4)
are required to make two elections relating
to changes made to section 163(j) by the
CARES Act. The election under §1.163(j)-
6(d)(5) is for a passthrough taxpayer to use
the taxpayer’s ATI for the last taxable year
beginning in 2019 as its ATI for any taxable
year beginning in 2020, in accordance with
section 163(j)(10)(B). The election under
§1.163(j)-6(g)(4) relates to EBIE of a part-
nership for any taxable year beginning in
2019 that is allocated to a partner. Section
163(j)(10)(A)(ii)(II) provides that, unless
the partner elects out, in 2020, the partner
treats 50 percent of the EBIE as not subject
to the section 163(j) limitation. If the part-
ner elects out, the partner treats all EBIE
as subject to the same limitations as other
EBIE allocated to the partner.
Revenue Procedure 2020-22 describes
the time and manner for making these
elections. For both elections, taxpayers
make the election by timely filing a Fed-
eral income tax return or Form 1065, in-
cluding extensions, an amended Federal
income tax return, amended Form 1065,
or administrative adjustment request, as
applicable. More specifically, taxpayers
complete the Form 8990, “Limitation on
Business Interest Expense under Sec-
tion 163(j),” using the taxpayer’s 2019
ATI and/or not applying the rule in sec-
tion 163(j)(10)(ii)(II), as applicable. No
formal statements are required to make
these elections. Accordingly, the report-
ing burden associated with the collections
of information in §§1.163(j)-6(d)(5) and
1.163(j)-6(g)(4) will be reflected in the
IRS Form 8990 PRA Submissions (OMB
control number 1545-0123).
The collections of information in
§1.163(j)-7 are required for taxpayers
(1) to make or revoke an election under
§1.163(j)-7(e)(5)(iv) to apply section
163(j) to a CFC group (CFC group elec-
tion) and to file an annual information
statement to demonstrate how the CFC
group calculated its section 163(j) limita-
tion under §1.163(j)-7(e)(6) (annual infor-
mation statement), or (2) to make an annu-
al election to exempt a CFC or CFC group
from the section 163(j) limitation under
§1.163(j)-7(h)(5) (safe-harbor election).
The CFC group election or revocation of
the CFC group election are made by at-
taching a statement to the US sharehold-
er’s annual return. Similarly, the annual
information statement must be attached to
the US shareholder’s annual return. The
CFC group election remains in place until
revoked and may not be revoked for any
period beginning before 60 months fol-
lowing the period for which it is initially
made. The safe-harbor election is made on
an annual basis.
Under §1.964-1(c)(3)(i), to make an
election on behalf of a foreign corpora-
tion, the controlling domestic sharehold-
er provides a statement with its return
and notice of the election to the minority
shareholders under §1.964-1(c)(3)(ii) and
(iii). See also §1.952-2(b)-(c). These col-
lections are necessary to ensure that the
election is properly effectuated, and that
taxpayers properly report the amount of
interest that is potentially subject to the
limitation.
B. Future Modifications to Forms to
Collect Information
At this time, the Treasury Department
and the IRS are considering modifica-
tions to the Form 8990, “Limitation on
Business Interest Expense IRC 163(j),”
with regard to the elections under section
163(j)(10) regarding the election under
§§1.163(j)-6(d)(5) and 1.163(j)-6(g)(4),
the CFC group election, annual informa-
tion statement, and safe-harbor election.
Any modifications to Form 8990 would
not be effective until the form cycle for
the 2021 taxable year. For the PRA, the
reporting burden of Form 8990 is asso-
ciated with OMB control number 1545-
0123. In the 2018 Proposed Regulations,
Form 8990 was estimated to be required
by fewer than 92,500 taxpayers.
If an additional information collection
requirement is imposed through these
regulations in the future, for purposes of
the PRA, any reporting burden associated
with these regulations will be reflected in
the aggregated burden estimates and the
OMB control numbers for general income
tax forms or the Form 8990, “Limitation
on Business Interest Expense Under Sec-
tion 163(j)”.
The forms are available on the IRS website at:
Form
OMB NumberIRS Website LinkStatus
Form 10401545-0074https://www.irs.gov/pub/irs-pdf/f1040.pdf
(Instructions: https://www.irs.gov/pub/irs-
pdf/i1040gi.pdf)
Published in the Federal Register on
10/30/2020. Public comment period ends
12/29/2020.
Link: https://www.federalregister.gov/documents/2020/10/30/2020-24139/proposed-extension-of-informa-
tion-collection-request-submitted-for-public-comment-comment-request

Bulletin No. 2021–5 603 February 1, 2021
Form
OMB NumberIRS Website LinkStatus
Form 11201545-0123https://www.irs.gov/pub/irs-pdf/f1120.pdf
(Instructions: https://www.irs.gov/pub/irs-
pdf/i1120.pdf)
Published in the Federal Register on
11/3/2020. Public comment period ends
January 4, 2021.
Form 1120Shttps://www.irs.gov/pub/irs-pdf/f1120s.pdf
(Instructions: https://www.irs.gov/pub/irs-
pdf/i1120s.pdf)
Form 1065https://www.irs.gov/pub/irs-pdf/f1065.pdf
(Instructions: https://www.irs.gov/pub/irs-
pdf/i1065.pdf)
Form 1120-REIThttps://www.irs.gov/pub/irs-pdf/
f1120rei—2018.pdf (Instructions: https://
www.irs.gov/pub/irs-pdf/i1120rei.pdf)
Form 8990https://www.irs.gov/pub/irs-pdf/f8990_ac-
cessible.pdf (Instructions: https://www.irs.
gov/pub/irs-pdf/i8990.pdf)
Link: https://www.federalregister.org/documents/2020/11/03/2020-24251/proposed-collection-comment-re-
quest-for-forms-1065-1066-1120-1120-c-1120-f-1120-h-1120-nd-1120-s
In addition, when available, drafts
of IRS forms are posted for comment at
https://apps.irs.gov/app/picklist/list/draft-
TaxForms.htm. IRS forms are available
at https://www.irs.gov/forms-instructions.
Forms will not be finalized until after they
have been approved by OMB under the
PRA.
C. Burden Estimates
The following estimates for the col-
lections of information in the final reg-
ulations are based on the most recently
available Statistics of Income (SOI) tax
data.
For the collection of income in
§1.163(j)-6(d)(5), where a passthrough
taxpayer elects to use the taxpayer’s ATI
for the last taxable beginning in 2019 as
the taxpayer’s ATI for any taxable year
beginning in 2020, the most recently
available 2017 SOI tax data indicates that,
on the high end, the estimated number of
respondents is 49,202. This number was
determined by examining, for the 2017 tax
year, Form 1065 and Form 1120-S filers
with greater than $26 million in gross re-
ceipts that have reported interest expense,
and do not have an NAICS code that is as-
sociated with a trade or business that nor-
mally would be excepted from the section
163(j) limitation.
For the collection of information un-
der §1.163(j)-6(g)(4), in which a partner
elects out of treating 50 percent of any
EBIE allocated to the partner in 2019
as not subject to a limitation in 2020,
the Treasury Department and the IRS
estimate that only taxpayers that ac-
tively want to reduce their deductions
will make this election. The applica-
tion of the base erosion minimum tax
under section 59A depends, in part, on
the amount of a taxpayer’s deductions.
Accordingly, the Treasury Department
and the IRS estimate that taxpayers that
are subject to both the base erosion min-
imum tax under section 59A and sec-
tion 163(j) are the potential filers of this
election. Using the 2017 SOI tax data,
the Treasury Department estimates that
1,182 firms will make the election. This
estimate was determined by examining
three criteria: first, the number of tax-
payers subject to section 59A, namely, C
corporations with at least $500,000,000
in gross receipts, second, the portion
of those taxpayers that do not have an
NAICS code associated with a trade or
business that is generally not subject
to the section 163(j) limitation (2211
(electric power generation, transmis-
sion and distribution), 2212 (natural
gas distribution), 2213 (water, sewage
and other systems), 111 or 112 (farm-
ing), 531 (real property)), and, third, the
portion of taxpayers satisfying the first
two criteria that received a Form K-1,
“Partner’s Share of Income, Deductions,
Credits, etc.”
The reporting burdens associated with
the information collections in §§1.163(j)-
6(d)(5) and 1.163(j)-6(g)(4) are included
in the aggregated burden estimates for
OMB control numbers 1545-0074 in the
case of individual filers and 1545-0123 in
the case of business filers. The overall bur-
den estimates associated with those OMB
control numbers are aggregate amounts
that relate to the entire package of forms
associated with the applicable OMB con-
trol number and will in the future include,
but not isolate, the estimated burden of the
tax forms that will be created or revised
as a result of the information collections
in these regulations. No burden esti-
mates specific to §§1.163(j)-6(d)(5) and
1.163(j)-6(g)(4) of the final regulations
are currently available.
The Treasury Department and the IRS
request comments on all aspects of the
forms that reflect the information collec-
tion burdens related to the final regula-
tions, including estimates for how much
time it would take to comply with the pa-
perwork burdens related to the forms de-
scribed and ways for the IRS to minimize
the paperwork burden.

February 1, 2021 604 Bulletin No. 2021–5
For the collections of information
in §1.163(j)-7, namely the CFC group
election and annual statement, and the
safe-harbor election, and the correspond-
ing notice under §1.964-1(c)(3)(iii), the
most recently available 2017 SOI tax
data indicates that, on the high end, the
estimated number of respondents is 4,980
firms. This number was determined by
examining, for the 2017 tax year, Form
1040, Form 1120, Form 1120-S, and
Form 1065 filers with greater than $26
million in gross receipts that filed a Form
5471, Information Return of U.S. Per-
sons With Respect to Certain Foreign
Corporations, where an interest expense
amount was reported on Schedule C of
the Form 5471.
The estimated number of respondents
that could be subject to the collection
of information for the CFC group or
safe-harbor election is 4,980. The esti-
mated annual burden per respondent/re-
cordkeeper varies from 0 to 30 minutes,
depending on individual circumstances,
with an estimated average of 15 minutes.
The estimated total annual reporting and/
or recordkeeping burden is 1,245 hours
(4,980 respondents * 15 minutes). The
estimated annual cost burden to respon-
dents is $95 per hour. Accordingly, we
expect the total annual cost burden for
the CFC group election and safe-harbor
election statements to be $118,275 (4,980
* .25 * $95).
III. Regulatory Flexibility Act
It is hereby certified that the final regu-
lations will not have a significant econom-
ic impact on a substantial number of small
entities.
This certification can be made because
the Treasury Department and the IRS have
determined that the number of small en-
tities that are affected as a result of the
regulations is not significant. These rules
do not disincentivize taxpayers from their
operations, and any burden imposed is not
significant because the cost of implement-
ing the rules, if any, is low.
As discussed in the 2018 Proposed
Regulations, section 163(j) provides ex-
ceptions for which many small entities will
qualify. First, under section 163(j)(3), the
limitation does not apply to any taxpay-
er, other than a tax shelter under section
448(a)(3), which meets the gross receipts
test under section 448(c) for any taxable
year. A taxpayer meets the gross receipts
test under section 448(c) if the taxpayer
has average annual gross receipts for the
3-taxable year period ending with the tax-
able year that precedes the current taxable
year that do not exceed $26,000,000. The
gross receipts threshold is indexed annu-
ally for inflation. Because of this thresh-
old, the Treasury Department and the IRS
project that entities with 3-year average
gross receipts below $26 million will not
be affected by these regulations except in
rare cases.
Section 163(j) provides that certain
trades or businesses are not subject to the
limitation, including the trade or busi-
ness of performing services as an em-
ployee, electing real property trades or
businesses, electing farming businesses,
and certain utilities as defined in section
163(j)(7)(A)(iv). Under the 2018 Pro-
posed Regulations, taxpayers that oth-
erwise qualified as real property trades
or businesses or farming businesses that
satisfied the small business exemption in
section 448(c) were not eligible to make
an election to be an electing real prop-
erty trade or business or electing farm-
ing business. Under T.D. 9905, however,
those taxpayers are eligible to make an
election to be an electing real proper-
ty trade or business or electing farming
business. Additionally, T.D. 9905 pro-
vides that certain utilities not otherwise
excepted from the limitation can elect
for a portion of their non-excepted utility
trade or business to be excepted from the
limitation. Any economic impact on any
small entities as a result of the require-
ments in the final regulations, not just the
requirements that impose a PRA burden,
is not expected to be significant because
the cost of implementing the rules, if any,
is low.
The Treasury Department and the IRS
do not have readily available data on the
number of filers that are tax shelters, as
defined in section 448(a)(3), that are po-
tentially affected by these provisions. As
described in more detail earlier in this
preamble, the final regulations cover
several topics, including, but not limited
to, self-charged interest, the treatment of
section 163(j) in relation to trader funds,
the impact of section 163(j) on publicly
traded partnerships, and the application
of section 163(j) to United States share-
holders of controlled foreign corpora-
tions.
The Treasury Department and the IRS
do not have readily available data to de-
termine the number of taxpayers affected
by rules regarding self-charged interest
because no reporting modules current-
ly connect these payments by and from
partnerships. Additionally, the Treasury
Department and the IRS do not have read-
ily available data to determine the number
of taxpayers affected by rules regarding
debt proceeds distributed from a taxpayer
account or from cash. However, the rules
do not impose a significant paperwork or
implementation cost burden on taxpay-
ers. Under Notice 89-35, taxpayers have
been required to maintain books and re-
cords to properly report the tax treatment
of interest. The rules in §1.163-15 are a
finalization of the rules in section VI of
Notice 89-35, which extends the period
in §1.163-8T(c)(4)(iii)(B) from 15 to 30
days to determine whether debt proceeds
have been distributed from a particular
account.
As shown in the following table, the
Treasury Department and the IRS es-
timate that approximately 276 trading
partnerships will be affected by these
rules. The table was calculated using data
for the 2018 taxable year, the number of
Form 1065 and Form 1065-B filers, with
more than $26 million in gross receipts
but less than the amount considered to be
a small entity for purposes of this Reg-
ulatory Flexibility Act analysis, that (1)
completed Schedule B to Form 1065 and
marked box b, c, or d in question 1 to de-
note limited partnership, limited liability
company or limited liability partnership
status; and (2) have a North American
Industry Classification System (NAICS)
code starting with 5231 (securities and
commodity contracts intermediation and
brokerage), 5232 (securities and com-
modity exchanges), 5239 (other financial
investment activities) or 5259 (other in-
vestment pools and funds).

Bulletin No. 2021–5 605 February 1, 2021
Form 1065 and 1065-B Filers + NAICS Codes + Gross Receipts Range + Schedule B, Question 1 Box b, c, or d Marked
NAICS Code (description)
Gross Receipts RangeSchedule B, Question 1
Box b, c or d
5231 (securities and commodity contracts intermediation
and brokerage)
>$26M but not more than $41.5M22
5232 (securities and commodity exchanges)
>$26M but not more than $41.5M0
6239 (other financial investment activities)
>$26M but not more than $41.5M242
5259 (other investment pools and funds)>$26M but not more than $35M12
TOTAL276
Additionally, the Treasury Depart-
ment and the IRS have determined that
the rules regarding publicly traded part-
nerships might affect approximately 71
taxpayers. This number was reached by
determining, using data for the 2018 tax-
able year, the number of Form 1065 and
1065-B filers with gross receipts exceed-
ing $25 million that answered “yes” to
question 5 on Schedule B to Form 1065
denoting that the entity is a publicly trad-
ed partnership.
As noted earlier, the final regulations
do not impose any new collection of in-
formation on these entities. These final
regulations actually assist small entities
in meeting their filing obligations by pro-
viding definitive advice on which they can
rely.
For the section 163(j)(10) elections
for passthrough taxpayers under final
§§1.163(j)-6(d)(5) and 1.163(j)-6(g)
(4), most small taxpayers do not need to
make the elections because, as discussed
above, they are not subject to the section
163(j) limitation. For small taxpayers
that are subject to the limitation, the cost
to implement the election is low. Pursu-
ant to Revenue Procedure 2020-22, these
passthrough taxpayers simply complete
the Form 8990 as if the election has been
made. Accordingly, the burden of comply-
ing with the elections, if needed, is no dif-
ferent than for taxpayers who do not make
the elections.
The persons potentially subject to fi-
nal §1.163(j)-7 are U.S. shareholders of
one or more CFCs for which BIE is re-
ported, and that (1) have average annual
gross receipts for the 3-taxable year peri-
od ending with the taxable year that pre-
cedes the current taxable year exceeding
$26,000,000, and (2) want to make the
CFC group election or safe-harbor elec-
tion. Section 1.163(j)-7 of the final regu-
lations requires such taxpayers to attach a
statement to their return providing basic
information regarding the CFC group or
standalone CFC.
As discussed in the PRA section of this
preamble, the reporting burden for both
statements is estimated at 0 to 30 minutes,
depending on individual circumstances,
with an estimated average of 15 minutes
for all affected entities, regardless of size.
The estimated monetized burden for com-
pliance is $95 per hour.
Accordingly, the Secretary certifies
that the rule will not have a significant
economic impact on a substantial number
of small entities.
Pursuant to section 7805(f), the no-
tice of proposed rulemaking preceding
this final rule was submitted to the Chief
Counsel for the Office of Advocacy of the
Small Business Administration for com-
ment on its impact on small business. No
comments on the notice were received
from the Chief Counsel for the Office of
Advocacy of the Small Business Admin-
istration.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 requires that agencies
assess anticipated costs and benefits and
take certain other actions before issuing a
final rule that includes any Federal man-
date that may result in expenditures in any
one year by a state, local, or tribal govern-
ment, in the aggregate, or by the private
sector, of $100 million in 1995 dollars,
updated annually for inflation. These fi-
nal regulations do not include any Federal
mandate that may result in expenditures
by state, local, or tribal governments,
or by the private sector in excess of that
threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes sub-
stantial, direct compliance costs on state
and local governments, and is not required
by statute, or preempts state law, unless
the agency meets the consultation and
funding requirements of section 6 of the
Executive Order. These final regulations
do not have federalism implications and
do not impose substantial direct compli-
ance costs on state and local governments
or preempt state law within the meaning
of the Executive Order.
VI. Congressional Review Act
The Administrator of OIRA has deter-
mined that this is a major rule for purpos-
es of the Congressional Review Act (5
U.S.C. 801 et seq.) (CRA). Under section
801(3) of the CRA, a major rule takes ef-
fect 60 days after the rule is published in
the Federal Register.
Notwithstanding this requirement, sec-
tion 808(2) of the CRA allows agencies to
dispense with the requirements of section
801 when the agency for good cause finds
that such procedure would be impractica-
ble, unnecessary, or contrary to the pub-
lic interest and the rule shall take effect
at such time as the agency promulgating
the rule determines. Pursuant to section
808(2) of the CRA, the Treasury Depart-
ment and the IRS find, for good cause,
that a 60-day delay in the effective date

February 1, 2021 606 Bulletin No. 2021–5
is unnecessary and contrary to the public
interest.
These final regulations resolve am-
biguity with respect to the statute and
certain aspects of the 2020 Proposed
Regulations, prevent abuse through the
application of several anti-abuse rules,
and grant taxpayer relief that would not
be available based solely on the statute.
Following the amendments to section
163(j) by the TCJA, the Treasury De-
partment and the IRS published the pro-
posed regulations to provide certainty to
taxpayers. In particular, as demonstrated
by the wide variety of public comments
in response to the proposed regulations
received after the publication of the final
regulations, taxpayers continue to express
uncertainty regarding the proper applica-
tion of the statutory rules and the final
regulations under section 163(j). This
uncertainty extends to the application of
a number of important temporary pro-
visions in section 163(j) enacted as part
of the CARES Act that were intended to
provide relief for taxpayers impacted by
COVID-19. The final regulations provide
rules that are relevant to the application
of these taxpayer-favorable provisions.
Certainty with respect to these temporary
provisions is essential so that taxpayers
can accurately model the impact of these
provisions on their liquidity in order to
make timely informed business decisions
during the limited periods in which these
provisions are in place. Furthermore, in
order to make informed business deci-
sions, taxpayers will need to consider
the potentially complex interaction of
these temporary provisions, and section
163(j) more generally, with other Code
provisions (for example, sections 59A,
172, and 250), which further heightens
the need for prompt guidance. Consis-
tent with Executive Order 13924 (May
19, 2020), the Treasury Department and
the IRS have therefore determined that
an expedited effective date of the final
regulations would “give businesses...
the confidence they need to re-open by
providing guidance on what the law re-
quires.” 85 FR 31353-4. Accordingly, the
Treasury Department and the IRS have
determined that the rules in this Treasury
decision will take effect on the date it is
filed with the Office of the Federal Reg-
ister for public inspection.
Drafting Information
The principal authors of these regu-
lations are Susie Bird, Charlie Gorham,
Nathaniel Kupferman, Jaime Park, Sophia
Wang, and James Williford (Income Tax
& Accounting), Vishal Amin, Brian Choi,
Jacob Moore, Adrienne M. Mikolashek,
and William Kostak (Passthroughs and
Special Industries), Azeka J. Abramoff
and Raphael J. Cohen (International),
Russell G. Jones and John B. Lovelace
(Corporate), and William Blanchard, Mi-
chael Chin, Steven Harrison, and Pamela
Lew (Financial Institutions & Products).
Other personnel from the Treasury De-
partment and the IRS participated in their
development.
Statement of Availability of IRS
Documents
IRS Revenue Procedures, Revenue
Rulings notices, and other guidance cit-
ed in this document are published in the
Internal Revenue Bulletin (or Cumulative
Bulletin) and are available from the Su-
perintendent of Documents, U.S. Govern-
ment Publishing Office, Washington, DC
20402, or by visiting the IRS website at
https://www.irs.gov.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amend-
ed as follows:
PART 1 – INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.163-15 is added to
read as follows:
§1.163-15 Debt Proceeds Distributed
from Any Taxpayer Account or from
Cash.
(a) In general. Regardless of para-
graphs (c)(4) and (5) of §1.163-8T, in
the case of debt proceeds deposited in
an account, a taxpayer that is applying
§1.163-8T or §1.163-14 may treat any ex-
penditure made from any account of the
taxpayer, or from cash, within 30 days
before or 30 days after debt proceeds are
deposited in any account of the taxpayer
as made from such proceeds to the extent
thereof. Similarly, in the case of debt pro-
ceeds received in cash, a taxpayer that is
applying §1.163-8T or §1.163-14 may
treat any expenditure made from any ac-
count of the taxpayer, or from cash, within
30 days before or 30 days after debt pro-
ceeds are received in cash as made from
such proceeds to the extent thereof. For
purposes of this section, terms used have
the same meaning as in §1.163-8T(c)(4)
and (5).
(b) Applicability date. This section
applies to taxable years beginning on or
after March 22, 2021. However, taxpay-
ers and their related parties, within the
meaning of sections 267(b) (determined
without regard to section 267(c)(3)) and
707(b)(1), may choose to apply the rules
in this section to a taxable year beginning
after December 31, 2017, and before
March 22, 2021, provided that those tax-
payers and their related parties consis-
tently apply all of the rules in this section
to that taxable year and each subsequent
taxable year.
Par. 3. Section 1.163(j)-0 is amended
by:
1. Adding entries for §§ 1.163(j)-1(b)
(1)(iv)(A)(4) and 1.163(j)-1(b)(1)(iv)(B)
(1) and (2).
2. Revising the entry for §1.163(j)-1(b)
(1)(iv)(C).
3. Adding entries for §1.163(j)-1(b)(1)
(iv)(E) through (G).
4. Revising the entries for §1.163(j)-
1(b)(22)(iii)(F) and (b)(35).
5. Adding entries for §§1.163(j)-1(c)
(4), 1.163(j)-2(b)(3)(i) through (iv), and
1.163(j)-2(d)(3).
6. Revising the entries for §§1.163(j)-
2(k) and 1.163(j)-6(c)(1) through (3).
7. Adding entries for §§1.163(j)-6(c)
(4), 1.163(j)-6(d)(3) through (5), 1.163(j)-
6(e)(5) and (6), 1.163(j)-6(f)(1)(iii),
1.163(j)-6(g)(4), and 1.163(j)-6(l)(4)(iv).
8. Revising the entries for §§1.163(j)-
6(n) and (p), 1.163(j)-7(c) through (f) and
(h) through (m).
9. Adding entries for §1.163(j)-7(g)(3)
and (4).

Bulletin No. 2021–5 607 February 1, 2021
10. Revising the entries for §§1.163(j)-
10(c)(5)(ii)(D) and 1.163(j)-10(f).
The revisions and additions read as fol-
lows:
§1.163(j)-0 Table of Contents.
* * * * *
§1.163(j)-1 Definitions.
* * * * *
(b) * * *
(1) * * *
(iv) * * *
(A) * * *
(4) Nonrecognition transactions.
(B) * * *
(1) In general.
(2) Application of the alternative com-
putation method.
(C) Successor rules.
(1) Successor assets.
(2) Successor entities.
* * * * *
(E) Alternative computation method.
(1) Alternative computation method for
property dispositions.
(2) Alternative computation meth-
od for dispositions of member stock.
(3) Alternative computation method for
dispositions of partnership interests.
(F) Cap on negative adjustments.
(1) In general.
(2) Example.
(G) Treatment of depreciation, amorti-
zation, or depletion capitalized under sec-
tion 263A.
* * * * *
(22) * * *
(iii) * * *
(F) Section 163(j) interest dividends.
(1) In general.
(2) Limitation on amount treated as in-
terest income.
(3) Conduit amounts.
(4) Holding period.
(5) Exception to holding period re-
quirement for money market funds and
certain regularly declared dividends.
* * * * *
(35) Section 163(j) interest dividend.
(i) In general.
(ii) Reduction in the case of excess re-
ported amounts.
(iii) Allocation of excess reported
amount.
(A) In general.
(B) Special rule for noncalendar year
RICs.
(iv) Definitions.
(A) Reported section 163(j) interest
dividend amount.
(B) Excess reported amount.
(C) Aggregate reported amount.
(D) Post-December reported amount.
(E) Excess section 163(j) interest in-
come.
(v) Example.
* * * * *
(c) * * *
* * * * *
(4) Paragraphs (b)(1)(iv)(A)(2) through
(4), (B) through (G), (b)(22)(iii)(F), and
(b)(35).
§1.163(j)-2 Deduction for business
interest expense limited.
* * * * *
(b) * * *
(3) * * *
(i) In general.
(ii) Short taxable years.
(iii) Transactions to which section 381
applies.
(iv) Consolidated groups.
* * * * *
(d) * * *
(3) Determining a syndicate’s loss
amount.
* * * * *
(k) Applicability dates.
(1) In general.
(2) Paragraphs (b)(3)(iii), (b)(3)(iv),
and (d)(3).
* * * * *
§1.163(j)-6 Application of the
business interest deduction limitation
to partnerships and subchapter S
Corporations
* * * * *
(c) * * *
(1) Modification of business interest
income for partnerships.
(2) Modification of business interest
expense for partnerships.
(3) Transition rule.
(4) Character of business interest ex-
pense.
(d) * * *
(3) Section 743(b) adjustments and
publicly traded partnerships.
(4) Modification of adjusted taxable in-
come for partnerships.
(5) Election to use 2019 adjusted tax-
able income for taxable years beginning
in 2020.
(e) * * *
(5) Partner basis items, remedial items,
and publicly traded partnerships.
(6) [Reserved].
(f) * * *
(1) * * *
(iii) Exception applicable to publicly
traded partnerships.
* * * * *
(g) * * *
(4) Special rule for taxable years begin-
ning in 2019 and 2020.
* * * * *
(l) * * *
(4) * * *
(iv) [Reserved].
* * * * *
(n) Treatment of self-charged lending
transactions between partnerships and
partners.
(o) * * *
(p) Applicability dates.
(1) In general.
(2) Paragraphs (c)(1) and (2), (d)(3)
through (5), (e)(5), (f)(1)(iii), (g)(4), (n),
and (o)(24) through (29), and (34) through
(36).
§1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
* * * * *
(c) Application of section 163(j) to
CFC group members of a CFC group.
(1) Scope.
(2) Calculation of section 163(j) lim-
itation for a CFC group for a specified
period.
(i) In general.
(ii) Certain transactions between CFC
group members disregarded.
(iii) [Reserved]
(iv) [Reserved]
(3) Deduction of business interest ex-
pense.
(i) CFC group business interest ex-
pense.
(A) In general.
(B) Modifications to relevant terms.

February 1, 2021 608 Bulletin No. 2021–5
(ii) Carryforwards treated as attribut-
able to the same taxable year.
(iii) Multiple specified taxable years
of a CFC group member with respect to a
specified period.
(iv) Limitation on pre-group disal-
lowed business interest expense carryfor-
ward.
(A) General rule.
(1) CFC group member pre-group dis-
allowed business interest expense carry-
forward.
(2) Subgrouping.
(3) Transition rule.
(B) Deduction of pre-group disallowed
business interest expense carryforwards.
(4) Currency translation.
(5) Special rule for specified periods
beginning in 2019 or 2020.
(i) 50 percent ATI limitation applies to
a specified period of a CFC group.
(ii) Election to use 2019 ATI applies to
a specified period of a CFC group.
(A) In general.
(B) Specified taxable years that do not
begin in 2020.
(d) Determination of a specified group
and specified group members.
(1) Scope.
(2) Rules for determining a specified
group.
(i) Definition of a specified group.
(ii) Indirect ownership.
(iii) Specified group parent.
(iv) Qualified U.S. person.
(v) Stock.
(vi) Options treated as exercised.
(vii) When a specified group ceases to
exist.
(3) Rules for determining a specified
group member.
(e) Rules and procedures for treating a
specified group as a CFC group.
(1) Scope.
(2) CFC group and CFC group mem-
ber.
(i) CFC group.
(ii) CFC group member.
(3) Duration of a CFC group.
(4) Joining or leaving a CFC group.
(5) Manner of making or revoking a
CFC group election.
(i) In general.
(ii) Revocation by election.
(iii) Timing.
(iv) Election statement.
(v) Effect of prior CFC group election.
(6) Annual information reporting.
(f) Treatment of a CFC group member
that has ECI.
(1) In general.
(2) [Reserved]
(g) * * *
(3) Treatment of certain foreign in-
come taxes.
(4) Anti-abuse rule.
(i) In general.
(ii) ATI adjustment amount.
(A) In general.
(B) Special rule for taxable years or
specified periods beginning in 2019 or
2020.
(iii) Applicable partnership.
(h) Election to apply safe-harbor.
(1) In general.
(2) Eligibility for safe-harbor election.
(i) Stand-alone applicable CFC.
(ii) CFC group.
(iii) Currency translation.
(3) Eligible amount.
(i) Stand-alone applicable CFC.
(ii) CFC group.
(iii) Additional rules for determining
an eligible amount.
(4) Qualified tentative taxable income.
(5) Manner of making a safe-harbor
election.
(i) In general.
(ii) Election statement.
(6) Special rule for taxable years or
specified periods beginning in 2019 or
2020.
(i) - (j) [Reserved]
(k) Definitions.
(1) Applicable partnership.
(2) Applicable specified taxable year.
(3) ATI adjustment amount.
(4) [Reserved]
(5) [Reserved]
(6) CFC group.
(7) CFC group election.
(8) CFC group member.
(9) [Reserved]
(10) Cumulative section 163(j) pre-
group carryforward limitation.
(11) Current group.
(12) Designated U.S. person.
(13) ECI deemed corporation.
(14) Effectively connected income.
(15) Eligible amount.
(16) Former group.
(17) Loss member.
(18) Payment amount.
(19) Pre-group disallowed business in-
terest expense carryforward.
(20) Qualified tentative taxable in-
come.
(21) Qualified U.S. person.
(22) Relevant period.
(23) Safe-harbor election.
(24) Specified borrower.
(25) Specified group.
(26) Specified group member.
(27) Specified group parent.
(28) Specified lender.
(29) Specified period.
(i) In general.
(ii) Short specified period.
(30) Specified taxable year.
(31) Stand-alone applicable CFC.
(32) Stock.
(l) Examples.
(m) Applicability dates.
(1) General applicability date.
(2) Exception.
(3) Early application.
(i) Rules for paragraphs (b) and (g)(1)
and (2) of this section.
(ii) Rules for certain other paragraphs
in this section.
(4) Additional rules that must be ap-
plied consistently.
(5) Election for prior taxable years.
* * * * *
§1.163(j)-10 Allocation of interest
expense, interest income, and other
items of expense and gross income to an
excepted trade or business.
* * * * *
(c) * * *
(5) * * *
(ii) * * *
(D) Limitations on application of look-
through rules.
(1) Inapplicability of look-through rule
to partnerships or non-consolidated C cor-
porations to which the small business ex-
emption applies.
(2) Limitation on application of look-
through rule to C corporations.
* * * * *
(f) Applicability dates.
(1) In general.
(2) Paragraph (c)(5)(ii)(D)(2).
* * * * *
Par. 4. Section 1.163(j)-1 is amended
by:

Bulletin No. 2021–5 609 February 1, 2021
1. In paragraph (b)(1)(iv)(A)(1), add-
ing the text “and paragraphs (b)(1)(iv)(B)
and (E)” after the text “paragraphs (b)(1)
(ii)(C), (D), and (E)”.
2. Revising paragraphs (b)(1)(iv)(A)
(2) and (3).
3. Adding paragraph (b)(1)(iv)(A)(4).
4. Revising paragraphs (b)(1)(iv)(B),
(C), and (D).
5. Adding paragraphs (b)(1)(iv)(E),
(F), and (G).
6. Revising paragraphs (b)(1)(viii)(A)
through (D).
7. Adding paragraph (b)(1)(viii)(E).
8. Adding paragraphs (b)(22)(iii)(F)
and (b)(35).
9. In paragraph (c)(1), removing “para-
graphs (c)(2) and (3)” from the first sen-
tence and adding “paragraphs (c)(2), (3),
and (4)” in its place.
10. Adding paragraph (c)(4).
The revisions and additions read as fol-
lows:
§1.163(j)-1 Definitions.
* * * * *
(b) * * *
(1) * * *
(iv) * * *
(A) * * *
(2) Intercompany transactions. For
purposes of paragraphs (b)(1)(ii)(C) and
(D) and paragraphs (b)(1)(iv)(B) and (b)
(1)(iv)(E)(1) and (2) of this section, the
term sale or other disposition excludes
all intercompany transactions, within the
meaning of §1.1502-13(b)(1)(i), to the
extent necessary to achieve single-entity
taxation of the consolidated group.
(3) Deconsolidations. Notwithstanding
any other rule in this paragraph (b)(1)(iv)
(A), any transaction in which a member
(S) leaves a consolidated group (selling
group), including a section 381(a) trans-
action described in paragraph (b)(1)(iv)
(A)(1) of this section, is treated as a tax-
able disposition of all S stock held by any
member of the selling group for purposes
of paragraphs (b)(1)(ii)(C) and (D) and
paragraphs (b)(1)(iv)(B) and (b)(1)(iv)
(E)(1) and (2) of this section, unless the
transaction is described in §1.1502-13(j)
(5)(i). Following S’s deconsolidation,
any subsequent sales or dispositions of S
stock by the selling group do not trigger
further adjustments under paragraphs (b)
(1)(ii)(C) and (D) and paragraphs (b)(1)
(iv)(B) and (b)(1)(iv)(E)(1) and (2) of this
section. If a transaction is described in
§1.1502-13(j)(5)(i), the transaction is not
treated as a sale or other disposition for
purposes of paragraphs (b)(1)(ii)(C) and
(D) and paragraphs (b)(1)(iv)(B) and (b)
(1)(iv)(E)(1) and (2) of this section. See
also the successor rules in paragraph (b)
(1)(iv)(C) of this section.
(4) Nonrecognition transactions. The
disposition of property, member stock
(other than in a deconsolidation described
in paragraph (b)(1)(iv)(A)(3) of this sec-
tion), or partnership interests in a nonrec-
ognition transaction, other than a section
381(a) transaction described in paragraph
(b)(1)(iv)(A)(1) of this section, is treated
as a taxable disposition of the property,
member stock, or partnership interest dis-
posed of for purposes of paragraph (b)(1)
(iv)(E)(1)(i), (b)(1)(iv)(E)(2)(i), and (b)
(1)(iv)(E)(3)(i) of this section, respective-
ly. For example, if a taxpayer transfers
property to a wholly owned, non-consol-
idated subsidiary, the transfer of the prop-
erty is treated as a taxable disposition for
purposes of paragraph (b)(1)(iv)(E)(1)(i)
of this section notwithstanding the appli-
cation of section 351.
(B) Deductions by members of a con-
solidated group—(1) In general. If para-
graph (b)(1)(ii)(C), (D), or (E) of this sec-
tion applies to adjust the tentative taxable
income of a consolidated group, and if the
consolidated group does not use the alter-
native computation method in paragraph
(b)(1)(iv)(E) of this section, the amount
of the adjustment under paragraph (b)(1)
(ii)(C) of this section equals the greater
of the allowed or allowable depreciation,
amortization, or depletion of the proper-
ty, as provided under section 1016(a)(2),
for the consolidated group for the taxable
years beginning after December 31, 2017,
and before January 1, 2022, with respect
to such property.
(2) Application of the alternative
computation method. If paragraph (b)
(1)(ii)(C), paragraph (b)(1)(ii)(D), or
paragraph (b)(1)(ii)(E) of this section
applies to adjust the tentative taxable in-
come of a consolidated group, and if the
consolidated group uses the alternative
computation method in paragraph (b)(1)
(iv)(E) of this section, the amount of the
adjustment computed under paragraph
(b)(1)(iv)(E)(1)(i), paragraph (b)(1)(iv)
(E)(2)(i), or paragraph (b)(1)(iv)(E)(3)
(i) of this section must take into account
the net gain that would be taken into
account by the consolidated group, in-
cluding from intercompany transactions,
determined by treating the sale or other
disposition as a taxable transaction (see
paragraphs (b)(1)(iv)(A)(3) and (4) of
this section regarding deconsolidations
and certain nonrecognition transactions,
respectively).
(C) Successor rules—(1) Successor as-
sets. This paragraph (b)(1)(iv)(C)(1) ap-
plies if deductions described in paragraph
(b)(1)(ii)(C) of this section are allowed or
allowable to a consolidated group mem-
ber (S) and either the depreciable property
or S’s stock is subsequently transferred
to another member (S1) in an intercom-
pany transaction in which the transferor
receives S1 stock. If this paragraph (b)(1)
(iv)(C)(1) applies, and if the transferor’s
basis in the S1 stock received in the in-
tercompany transaction is determined, in
whole or in part, by reference to its basis
in the depreciable property or the S stock,
the S1 stock received in the intercompany
transaction is treated as a successor asset
for purposes of paragraph (b)(1)(ii)(D)
and (b)(1)(iv)(E)(2) of this section. Thus,
except as otherwise provided in paragraph
(b)(1)(iv)(D) of this section, the subse-
quent disposition of either the S1 stock or
the S stock (or both) may require the ap-
plication of the adjustment rules of para-
graph (b)(1)(ii)(D) or paragraph (b)(1)(iv)
(E)(2) of this section.
(2) Successor entities. The acquiring
corporation in a section 381(a) transaction
to which the exception in paragraph (b)(1)
(iv)(A)(1) of this section applies is treated
as a successor to the distributor or trans-
feror corporation for purposes of para-
graphs (b)(1)(ii)(C) through (E) and (b)(1)
(iv)(B) and (E) of this section. Therefore,
for example, in applying paragraphs (b)(1)
(ii)(C) through (E) and (b)(1)(iv)(B) and
(E) of this section, the acquiring corpora-
tion is treated as succeeding to the allowed
or allowable items of the distributor or
transferor corporation. Similarly, the sur-
viving group in a transaction described in
§1.1502-13(j)(5)(i) to which the exception
in paragraph (b)(1)(iv)(A)(3) of this sec-
tion applies is treated as a successor to the
terminating group for purposes of para-

February 1, 2021 610 Bulletin No. 2021–5
graphs (b)(1)(ii)(C) through (E) and (b)(1)
(iv)(B) and (E) of this section.
(D) Anti-duplication rule—(1) In gen-
eral. The aggregate of the subtractions
from tentative taxable income of a con-
solidated group under paragraphs (b)(1)
(ii)(C) through (E) or paragraphs (b)(1)
(iv)(E)(1) through (3) of this section with
respect to an item of property (including
with regard to dispositions of successor
assets described in paragraph (b)(1)(iv)
(C)(1) of this section) cannot exceed the
aggregate amount of the consolidated
group members’ deductions described in
paragraph (b)(1)(ii)(C) of this section with
respect to such item of property. In addi-
tion, once an item of property is no lon-
ger held by any member of a consolidated
group (whether or not an adjustment to
the tentative taxable income of the group
is made under paragraph (b)(1)(ii)(C) of
this section with respect to the direct or
indirect disposition of that property), no
further adjustment to the group’s tentative
taxable income is made under paragraph
(b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)(2)
of this section in relation to the same prop-
erty with respect to any subsequent stock
disposition.
(2) Adjustments following deconsolida-
tion. If a corporation (S) leaves a consoli-
dated group (Group 1) in a transaction that
requires an adjustment under paragraph
(b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)
(2) of this section, no further adjustment
is required under paragraph (b)(1)(ii)(C)
or (E) or paragraph (b)(1)(iv)(E) of this
section in a separate return year (as de-
fined in §1.1502-1(e)) of S with respect
to depreciation, amortization, or depletion
deductions allowed or allowable to Group
1. See paragraph (b)(1)(iv)(A) of this sec-
tion for special rules regarding the mean-
ing of the term “sale or other disposition”
for purposes of the adjustments required
under paragraphs (b)(1)(ii)(C) through
(E) and paragraphs (b)(1)(iv)(B) and (E)
of this section. For example, assume that
S deconsolidates from Group 1 in a trans-
action not described in §1.1502-13(j)(5)(i)
after holding property for which deprecia-
tion, amortization, or depletion deductions
were allowed or allowable in Group 1. On
the deconsolidation, S and Group 1 would
adjust tentative taxable income with re-
gard to that property. See paragraphs (b)
(1)(iv)(A)(3), (b)(1)(ii)(D), and (b)(1)(iv)
(E)(2) of this section. If, following the de-
consolidation, S sells the property referred
to in the previous sentence, no subtraction
from tentative taxable income is made un-
der paragraph (b)(1)(ii)(C) or paragraph
(b)(1)(iv)(E)(1) of this section during S’s
separate return year with regard to the
amounts included in Group 1. See para-
graphs (b)(1)(iv)(A)(3), (b)(1)(ii)(D), and
(b)(1)(iv)(E)(2) of this section.
(E) Alternative computation method.
If paragraph (b)(1)(ii)(C), (D), or (E)
of this section applies to adjust the ten-
tative taxable income of a taxpayer, the
taxpayer may compute the amount of the
adjustments required by such paragraph
using the formulas in paragraph (b)(1)
(iv)(E)(1), (2), and (3) of this section,
respectively, provided that the taxpayer
applies such formulas to all dispositions
for which an adjustment is required un-
der paragraph (b)(1)(ii)(C), (D), or (E) of
this section. For special rules regarding
the treatment of deconsolidating trans-
actions and nonrecognition transactions,
see paragraph (b)(1)(iv)(A)(3) and (4)
of this section, respectively. For special
rules regarding the application of the for-
mulas in paragraph (b)(1)(iv)(E)(1), (2),
and (3) of this section by consolidated
groups, see paragraph (b)(1)(iv)(B)(2) of
this section.
(1) Alternative computation method for
property dispositions. With respect to the
sale or other disposition of property, the
lesser of:
(i) Any gain recognized on the sale or
other disposition of such property by the
taxpayer (or, if the taxpayer is a member
of a consolidated group, the consolidated
group); and
(ii) The greater of the allowed or al-
lowable depreciation, amortization, or de-
pletion of the property, as provided under
section 1016(a)(2), for the taxpayer (or, if
the taxpayer is a member of a consolidated
group, the consolidated group) for the tax-
able years beginning after December 31,
2017, and before January 1, 2022, with
respect to such property.
(2) Alternative computation method
for dispositions of member stock. With re-
spect to the sale or other disposition by a
member of a consolidated group of stock
of another member for whom deprecia-
tion, amortization, or depletion was al-
lowed or allowable with regard to an item
of property (or stock of any successor to
that member), the lesser of:
(i) Any gain recognized on the sale or
other disposition of such stock; and
(ii) The investment adjustments under
§1.1502-32 with respect to such stock that
are attributable to deductions described
in paragraph (b)(1)(ii)(C) of this section.
The investment adjustments referred to in
this paragraph (b)(1)(iv)(E)(2)(ii) include
investment adjustments replicated in stock
of members that are successor entities.
(3) Alternative computation method for
dispositions of partnership interests. With
respect to the sale or other disposition of
an interest in a partnership, the lesser of:
(i) Any gain recognized on the sale or
other disposition of such interest; and
(ii) The taxpayer’s (or, if the taxpayer
is a consolidated group, the consolidated
group’s) distributive share of deductions
described in paragraph (b)(1)(ii)(C) of
this section with respect to property held
by the partnership at the time of such sale
or other disposition to the extent such
deductions were allowable under section
704(d).
(F) Cap on negative adjustments—(1)
In general. A subtraction from (or nega-
tive adjustment to) tentative taxable in-
come that is required under paragraph (b)
(1)(ii)(C), (D), or (E) or paragraph (b)(1)
(iv)(B) or (E) of this section is reduced
to the extent the taxpayer establishes that
the positive adjustments to tentative tax-
able income under paragraphs (b)(1)(i)
(D) through (F) of this section in a prior
taxable year did not result in an increase
in the amount allowed as a deduction
for business interest expense for such
year. The extent to which the positive
adjustments under paragraphs (b)(1)(i)
(D) through (F) of this section resulted
in an increase in the amount allowed as
a deduction for business interest expense
in a prior taxable year (such amount of
positive adjustments, the negative adjust-
ment cap) is determined after taking into
account all other adjustments to tentative
taxable income under paragraph (b)(1)(i)
and (ii) of this section for that year, as es-
tablished through books and records. The
amount of the negative adjustment cap for
a prior taxable year is reduced in future
taxable years to the extent of negative ad-
justments under paragraphs (b)(1)(ii)(C)
through (E) and paragraphs (b)(1)(iv)(B)

Bulletin No. 2021–5 611 February 1, 2021
and (E) of this section with respect to the
prior taxable year.
(2) Example. A is a calendar-year in-
dividual taxpayer engaged in a trade or
business that is neither an excepted trade
or business nor eligible for the small busi-
ness exemption. A has no disallowed busi-
ness interest expense carryforwards. In
2021, A has $100x of business interest ex-
pense, no business interest income or floor
plan financing interest expense, and $400x
of tentative taxable income. After taking
into account the adjustments to tentative
taxable income under paragraph (b)(1)(i)
and (ii) of this section other than positive
adjustments under paragraphs (b)(1)(i)(D)
through (F) of this section, A has tentative
taxable income of $450x. A increases its
tentative taxable income by $30x (from
$450x to $480x) under paragraph (b)(1)
(i)(D) of this section to reflect $30x of
depreciation deductions with respect to
Asset Y in 2021. Thus, for 2021, A would
have a section 163(j) limitation of $135x
($450x x 30 percent) without regard to
adjustments under paragraphs (b)(1)(i)(D)
through (F) of this section. After the ap-
plication of paragraph (b)(1)(i)(D) of this
section, A has a section 163(j) limitation
of $144x ($480x x 30 percent). In 2022,
A sells Asset Y at a gain of $50x. Under
paragraph (b)(1)(iv)(F)(1) of this section,
A is not required to reduce its tentative
taxable income in 2022 under paragraph
(b)(1)(ii)(C) through (E) or paragraph (b)
(1)(iv)(E) of this section. As established
by A, the $30x addition to tentative tax-
able income under paragraph (b)(1)(i)(D)
of this section resulted in no increase in
the amount allowed as a deduction for
business interest expense in 2021.
(G) Treatment of depreciation, amor-
tization, or depletion capitalized under
section 263A. Paragraphs (b)(1)(ii)(C)
through (E) of this section and this para-
graph (b)(1)(iv) apply with respect to the
sale or other disposition of property to
which paragraph (b)(1)(iii) of this section
applies. For example, if a taxpayer with
depreciable machinery capitalizes the
depreciation into inventory under section
263A, paragraph (b)(1)(ii)(C) or para-
graph (b)(1)(iv)(E) of this section (and, if
the taxpayer is a consolidated group, para-
graph (b)(1)(iv)(B) of this section) applies
upon the disposition of the machinery,
subject to the cap in paragraph (b)(1)(iv)
(F) of this section. Similarly, the successor
asset rules in paragraph (b)(1)(iv)(C)(1) of
this section would apply if the depreciable
machinery subsequently were transferred
to another member (S1) in an intercom-
pany transaction in which the transferor
received S1 stock.
* * * * *
(viii) * * *
(A) Example 1—(1) Facts. In 2021, A purchases
a depreciable asset (Asset X) for $30x and fully de-
preciates Asset X under section 168(k). For the 2021
taxable year, A establishes that its ATI before adding
back depreciation deductions with respect to Asset X
under paragraph (b)(1)(i)(D) of this section is $130x,
and that its ATI after adding back depreciation de-
ductions with respect to Asset X under paragraph (b)
(1)(i)(D) of this section is $160x. A incurs $45x of
business interest expense in 2021. In 2024, A sells
Asset X to an unrelated third party for $25x.
(2) Analysis. A’s section 163(j) limitation for
2021 is $48x ($160x × 30 percent). Thus, all $45x
of A’s business interest expense incurred in 2021 is
deductible in that year. Under paragraph (b)(1)(ii)(C)
of this section, A must subtract $30x from its tenta-
tive taxable income in computing its ATI for its 2024
taxable year. Alternatively, under paragraph (b)(1)
(iv)(E)(1) of this section, A must subtract $25x (the
lesser of $30x or $25x ($25x - $0x)) from its tenta-
tive taxable income in computing its ATI for its 2024
taxable year. However, the negative adjustments un-
der paragraphs (b)(1)(ii)(C) and (b)(1)(iv)(E)(1) of
this section are both subject to the negative adjust-
ment cap in paragraph (b)(1)(iv)(F) of this section.
Under that paragraph, A’s negative adjustment under
either paragraph (b)(1)(ii)(C) or paragraph (b)(1)(iv)
(E)(1) of this section is capped at $20x, or $150x
(the amount of ATI that A needed in order to deduct
all $45x of business interest expense in 2021) minus
$130x (the amount of A’s tentative taxable income in
2021 before adding back any amounts under para-
graph (b)(1)(i)(D) through (F) of this section). As
established by A, the additional $10x ($30x - $20x)
of depreciation deductions that were added back to
tentative taxable income in 2021 under paragraph (b)
(1)(i)(D) of this section did not increase A’s business
interest expense deduction for that year.
(3) Transfer of assets in a nonrecognition trans-
action to which section 381 applies. The facts are
the same as in paragraph (b)(1)(viii)(A)(1) of this
section, except that, rather than sell Asset X to an
unrelated third party in 2024, A merges with and
into an unrelated third party in 2024 in a transaction
described in section 368(a)(1)(A) in which no gain
is recognized. As provided in paragraph (b)(1)(iv)
(A)(1) of this section, the merger transaction is not
treated as a ‘‘sale or other disposition’’ for purposes
of paragraph (b)(1)(ii)(C) or paragraph (b)(1)(iv)(E)
(1) of this section. Thus, no adjustment to tentative
taxable income is required in 2024 under paragraph
(b)(1)(ii)(C) or paragraph (b)(1)(iv)(E)(1) of this
section.
(4) Transfer of assets in a nonrecognition trans-
action to which section 351 applies. The facts are
the same as in paragraph (b)(1)(viii)(A)(1) of this
section, except that, rather than sell Asset X to an
unrelated third party in 2024, A transfers Asset X to
B (A’s wholly owned subsidiary) in 2024 in a trans-
action to which section 351 applies. The section 351
transaction is treated as a “sale or other disposition”
for purposes of paragraphs (b)(1)(ii)(C) and (b)(1)
(iv)(E)(1) of this section, and it is treated as a tax-
able disposition for purposes of paragraph (b)(1)(iv)
(E)(1) of this section. See paragraph (b)(1)(iv)(A)
(1) and (4) of this section. However, the negative
adjustments under paragraphs (b)(1)(ii)(C) and (b)
(1)(iv)(E)(1) of this section are both subject to the
negative adjustment cap in paragraph (b)(1)(iv)(F)
of this section. Thus, A must subtract $20x from its
tentative taxable income in computing its ATI for its
2024 taxable year.
(B) Example 2—(1) Facts. In 2021, S purchas-
es a depreciable asset (Asset Y) for $30x and fully
depreciates Asset Y under section 168(k). P reduc-
es its basis in its S stock by $30x under §1.1502-32
to reflect S’s depreciation deductions with respect
to Asset Y. For the 2021 taxable year, the P group
establishes that its ATI before adding back S’s de-
preciation deductions with respect to Asset Y under
paragraph (b)(1)(i)(D) of this section is $130x, and
that its ATI after adding back S’s depreciation deduc-
tions with respect to Asset Y under paragraph (b)(1)
(i)(D) of this section is $160x. The P group incurs
$45x of business interest expense in 2021. In 2024,
P sells all of its S stock to an unrelated third party at
a gain of $25x.
(2) Analysis. The P group’s section 163(j) lim-
itation for 2021 is $48x ($160x × 30 percent). Thus,
all $45x of the P group’s business interest expense
incurred in 2021 is deductible in that year. Under
paragraph (b)(1)(ii)(D) of this section, the P group
must subtract $30x from its tentative taxable income
in computing its ATI for its 2024 taxable year. Al-
ternatively, under paragraph (b)(1)(iv)(E)(2) of this
section, the P group must subtract $25x (the lesser
of $30x or $25x) from its tentative taxable income in
computing its ATI for its 2024 taxable year. Howev-
er, the negative adjustments under paragraphs (b)(1)
(ii)(D) and (b)(1)(iv)(E)(2) of this section are both
subject to the negative adjustment cap in paragraph
(b)(1)(iv)(F) of this section. Under that paragraph,
the P group’s negative adjustment under either para-
graph (b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)(2) of
this section is capped at $20x, or $150x (the amount
of ATI the P group needed in order to deduct all $45x
of business interest expense in 2021) minus $130x
(the amount of the P group’s tentative taxable in-
come in 2021 before adding back any amounts under
paragraph (b)(1)(i)(D) through (F) of this section).
As established by the P group, the additional $10x
($30x - $20x) of depreciation deductions that were
added back to tentative taxable income in 2021 un-
der paragraph (b)(1)(i)(D) of this section did not in-
crease the P group’s business interest expense deduc-
tion for that year.
(3) Disposition of less than all member stock.
The facts are the same as in paragraph (b)(1)(viii)
(B)(1) of this section, except that, in 2024, P sells
half of its S stock to an unrelated third party. The
results are the same as in paragraph (b)(1)(viii)(B)(2)
of this section. See paragraph (b)(1)(iv)(A)(3) of this
section. Thus, the P group must subtract $20x from
its tentative taxable income in computing its ATI for
its 2024 taxable year. No further adjustment under
paragraphs (b)(1)(ii)(C) and (D) or paragraphs (b)

February 1, 2021 612 Bulletin No. 2021–5
(1)(iv)(E)(1) and (2) of this section is required if P
subsequently sells its remaining S stock or if S sub-
sequently disposes of Asset Y. See paragraphs (b)(1)
(iv)(A)(3) and (b)(1)(iv)(D) of this section.
(4) Intercompany transfer; disposition of succes-
sor assets—(i) Adjustments in 2024. The facts are the
same as in paragraph (b)(1)(viii)(B)(1) of this sec-
tion, except that, rather than sell all of its S stock to
an unrelated third party in 2024, P transfers all of its
S stock to T in 2024 in a transaction to which section
351 applies and, in 2025, P sells all of its T stock to
an unrelated third party at a gain of $40x. As pro-
vided in paragraph (b)(1)(iv)(A)(2) of this section,
P’s intercompany transfer of its S stock to T is not
a ‘‘sale or other disposition’’ for purposes of para-
graph (b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)(2) of
this section. Thus, no adjustment to tentative taxable
income is required in 2024 under paragraph (b)(1)
(ii)(D) or paragraph (b)(1)(iv)(E)(2) of this section.
(ii) Adjustments in 2025. Pursuant to paragraph
(b)(1)(iv)(C)(1) of this section, P’s stock in T is treat-
ed as a successor asset for purposes of paragraph (b)
(1)(ii)(D) and (b)(1)(iv)(E)(2) of this section. More-
over, P’s sale of its T stock causes both T and S to
deconsolidate. Thus, under paragraph (b)(1)(iv)(A)
(3) of this section, the transaction is treated as a tax-
able disposition of all of the T stock and all of the
S stock held by all members of the P group. Under
the anti-duplication rule in paragraph (b)(1)(iv)(D)
of this section, the total amount of gain recognized
for purposes of paragraph (b)(1)(iv)(E)(2)(i) of this
section is $40x, the greater of the gain on the disposi-
tion of the T stock ($40x) or on the disposition of the
S stock ($25x). However, the negative adjustments
under paragraph (b)(1)(iv)(E)(2) of this section are
subject to the negative adjustment cap in paragraph
(b)(1)(iv)(F) of this section. Thus, the P group must
subtract $20x from its tentative taxable income in
computing its ATI for its 2025 taxable year.
(5) Alternative computation and non-deconsol-
idating disposition of member stock. The facts are
the same as in paragraph (b)(1)(viii)(B)(1) of this
section, except that, in 2024, P sells just ten percent
of its S stock to an unrelated third party at a gain of
$2.5x. Under paragraph (b)(1)(iv)(E)(2) of this sec-
tion, the lesser of P’s gain recognized on the sale of
the S stock ($2.5x) and the investment adjustments
under §1.1502-32 with respect to the S stock P sold
($3x) is $2.5x, an amount less than the $20x limita-
tion under paragraph (b)(1)(iv)(F) of this section.
Thus, the P group must subtract $2.5x from its tenta-
tive taxable income in computing its ATI for its 2024
taxable year.
(6) Non-deconsolidating disposition of member
stock followed by asset disposition. The facts are
the same as in paragraph (b)(1)(viii)(B)(5) of this
section, except that, in 2025, S sells Asset Y to an
unrelated third party for a gain of $20x. Under para-
graph (b)(1)(iv)(E)(1) of this section, the amount of
the adjustment in 2025 is the lesser of two amounts.
The first amount is the amount of S’s gain recognized
on the sale of Asset Y ($20x). See paragraph (b)(1)
(iv)(E)(1)(i) of this section. The second amount is
the amount of depreciation with respect to Asset Y
(see paragraph (b)(1)(iv)(E)(1)(ii) of this section),
reduced by the amount of depreciation previously
taken into account in the computation under para-
graph (b)(1)(iv)(E)(2)(ii) of this section ($30x - $3x,
or $27x). See paragraph (b)(1)(iv)(D)(1) of this
section. Thus, the amount of the adjustment under
paragraphs (b)(1)(iv)(D) and (b)(1)(iv)(E)(1) of this
section is $20x. In turn, this amount is subject to the
negative adjustment cap under paragraph (b)(1)(iv)
(F), which, after accounting for the negative adjust-
ment on the earlier sale of S stock in 2024, is $17.5x
($20x - $2.5x). Accordingly, the P group must sub-
tract $17.5x from its tentative taxable income in
computing its ATI for its 2025 taxable year.
(C) Example 3—(1) Facts. The facts are the same
as in paragraph (b)(1)(viii)(B)(1) of this section, ex-
cept that, in 2024, S sells Asset Y to an unrelated
third party for $25x and, in 2025, P sells all of its S
stock to an unrelated third party at a gain of $25x.
(2) Analysis. The results are the same as in para-
graph (b)(1)(viii)(B)(2) of this section. Thus, the P
group must subtract $20x from its tentative taxable
income in computing its ATI for its 2024 taxable
year. P’s sale of all of its S stock in 2025 is a ‘‘sale
or other disposition’’ for purposes of paragraph (b)
(1)(ii)(D) and (b)(1)(iv)(E)(2) of this section. How-
ever, pursuant to paragraph (b)(1)(iv)(D)(1) of this
section, no further adjustment to the P group’s tenta-
tive taxable income is required in 2025 under para-
graph (b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)(2) of
this section.
(3) Disposition of S stock prior to S’s asset dis-
position. The facts are the same as in paragraph (b)
(1)(viii)(C)(1) of this section, except that, in 2024,
P sells all of its S stock to an unrelated third party
at a gain of $25x and, in 2025, S sells Asset Y to
an unrelated third party for $25x. The results are the
same as in paragraph (b)(1)(viii)(B)(2) of this sec-
tion. Thus, the P group must subtract $20x from its
tentative taxable income in computing its ATI for its
2024 taxable year. Pursuant to paragraph (b)(1)(iv)
(D)(2) of this section, no adjustment to the acquiring
group’s tentative taxable income is required in 2025
under paragraph (b)(1)(ii)(C) or paragraph (b)(1)(iv)
(E)(1) of this section.
(4) Deconsolidation of S in nonrecognition trans-
action. The facts are the same as in paragraph (b)(1)
(viii)(C)(3) of this section, except that, rather than
sell all of its S stock to an unrelated third party, P
causes S to merge with and into an unrelated third
party in a transaction described in section 368(a)(1)
(A). As provided in paragraph (b)(1)(iv)(A)(3) of
this section, the merger transaction is treated as a
taxable disposition of all of P’s stock in S for purpos-
es of paragraphs (b)(1)(ii)(D) and (b)(1)(iv)(E)(2) of
this section because S leaves the P group. Thus, the
results are the same as in paragraph (b)(1)(viii)(C)
(3) of this section.
(D) Example 4—(1) Facts. P wholly owns T,
which wholly owns S. In 2021, S purchases a de-
preciable asset (Asset Z) for $30x and fully depre-
ciates Asset Z under section 168(k). T reduces its
basis in its S stock, and P reduces its basis in its T
stock, by $30x under §1.1502-32 to reflect S’s de-
preciation deductions with respect to Asset Z. For
the 2021 taxable year, the P group establishes that its
ATI before adding back S’s depreciation deductions
with respect to Asset Z under paragraph (b)(1)(i)(D)
of this section is $130x, and that its ATI after adding
back S’s depreciation deductions with respect to As-
set Z under paragraph (b)(1)(i)(D) of this section is
$160x. The P group incurs $45x of business interest
expense in 2021. In 2024, T sells all of its S stock to
an unrelated third party at a gain of $25x. In 2025, P
sells all of its T stock to an unrelated third party at a
gain of $40x.
(2) Analysis. The results are the same as in para-
graph (b)(1)(viii)(B)(2) of this section. Thus, the P
group must subtract $20x from its tentative taxable
income in computing its ATI for its 2024 taxable
year. Pursuant to paragraph (b)(1)(iv)(D)(1) of this
section, no negative adjustment to the P group’s
tentative taxable income is required in 2025 under
paragraph (b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)(2)
of this section.
(3) Disposition of T stock in 2024. The facts are
the same as in paragraph (b)(1)(viii)(D)(1) of this
section, except that, in 2024, P sells all of its T stock
to another consolidated group at a gain of $40x and,
in 2025, T sells all of its S stock to an unrelated party
at a gain of $25x. Whereas the transaction described
in paragraph (b)(1)(viii)(B)(4) of this section is treat-
ed as a taxable disposition of both the T stock and
the S stock, only the actual disposition of the T stock
in the transaction described in this paragraph (b)(1)
(viii)(D)(3) is treated as a taxable disposition for
purposes of paragraphs (b)(1)(ii)(D) and (b)(1)(iv)
(E)(2) of this section. See paragraph (b)(1)(iv)(A)
(3) of this section. However, the results are the same
as in paragraph (b)(1)(viii)(B)(2) and (b)(1)(viii)(B)
(4) of this section because of the negative adjustment
cap in paragraph (b)(1)(iv)(F) of this section. Thus,
the P group must subtract $20x from its tentative tax-
able income in computing its ATI for its 2024 taxable
year. Pursuant to paragraph (b)(1)(iv)(D) of this sec-
tion, no negative adjustment to the acquiring group’s
tentative taxable income is required in 2025 under
paragraph (b)(1)(ii)(D) or paragraph (b)(1)(iv)(E)(2)
of this section.
(E) Example 5—(1) Facts. In 2021, A purchases
Assets X and Y for $30x and $80x, respectively, and
fully depreciates each asset under section 168(k).
For the 2021 taxable year, A establishes that its ATI
before adding back depreciation deductions with re-
spect to Assets X and Y under paragraph (b)(1)(i)(D)
of this section is $150x, and that its ATI after adding
back depreciation deductions with respect to Assets
X and Y under paragraph (b)(1)(i)(D) of this section
is $260x. A incurs $75x of business interest expense
in 2021. In 2024, A sells Assets X and Y to an un-
related third party for $40x and $90x, respectively.
(2) Analysis. A’s section 163(j) limitation for
2021 is $78x ($260x × 30 percent). Thus, all $75x
of A’s business interest expense incurred in 2021 is
deductible in that year. Under paragraph (b)(1)(ii)
(C) of this section, A must subtract $110x ($30x +
$80x) from its tentative taxable income in computing
its ATI for its 2024 taxable year. Alternatively, un-
der paragraph (b)(1)(iv)(E)(1) of this section, A must
subtract $30x with respect to Asset X (the lesser of
$30x or $40x ($40x - $0x)), and $80x with respect
to Asset Y (the lesser of $80x or $90x ($90x - $0x)),
from its tentative taxable income in computing its
ATI for its 2024 taxable year. However, the negative
adjustments under paragraphs (b)(1)(ii)(C) and (b)
(1)(iv)(E)(1) of this section are both subject to the
negative adjustment cap in paragraph (b)(1)(iv)(F) of
this section. Under that paragraph, A’s negative ad-
justment in 2024 under either paragraph (b)(1)(ii)(C)
($110x) or paragraph (b)(1)(iv)(E)(1) (also $110x) of

Bulletin No. 2021–5 613 February 1, 2021
this section is limited to $100x. This amount equals
$250x (the amount of ATI that A needed in order to
deduct all $75x of business interest expense in 2021)
minus $150x (the amount of A’s tentative taxable in-
come in 2021 before adding back any amounts under
paragraph (b)(1)(i)(D) through (F) of this section).
As established by A, the additional $10x ($110x -
$100x) of depreciation deductions that were added
back to tentative taxable income in 2021 under para-
graph (b)(1)(i)(D) of this section did not increase A’s
business interest expense deduction for that year.
(3) Sale of assets in different taxable years. The
facts are the same as in paragraph (b)(1)(viii)(E)
(1) of this section, except that A sells Asset Y to an
unrelated third party for $90x in 2025. Under para-
graph (b)(1)(ii)(C) of this section, A must subtract
$30x from its tentative taxable income in computing
its ATI for its 2024 taxable year. Alternatively, un-
der paragraph (b)(1)(iv)(E)(1) of this section, A must
subtract $30x (the lesser of $30x or $40x ($40x -
$0x)) from its tentative taxable income in computing
its ATI for its 2024 taxable year. Because A’s nega-
tive adjustment cap for its 2021 taxable year is $100x
(see paragraph (b)(1)(viii)(E)(2) of this section), A’s
negative adjustment in 2024 of $30x is not reduced
under paragraph (b)(1)(iv)(F) of this section. In
2025, A must subtract $80x from its tentative taxable
income under paragraph (b)(1)(ii)(C) of this section
in computing its ATI. Alternatively, under paragraph
(b)(1)(iv)(E)(1) of this section, A must subtract $80x
(the lesser of $80x or $90x ($90x - $0x)) from its
tentative taxable income in computing its ATI for
its 2025 taxable year. However, the negative adjust-
ments under paragraphs (b)(1)(ii)(C) and (b)(1)(iv)
(E)(1) of this section are both subject to the nega-
tive adjustment cap in paragraph (b)(1)(iv)(F) of this
section. Moreover, A’s negative adjustment cap for
its 2021 taxable year is reduced from $100x to $70x
to reflect A’s $30x negative adjustment in 2024. See
paragraph (b)(1)(iv)(F) of this section. Thus, A’s
negative adjustment for 2025 under either paragraph
(b)(1)(ii)(C) or paragraph (b)(1)(iv)(E)(1) of this
section is reduced from $80x to $70x. As established
by A, the additional $10x ($110x - $100x) of depre-
ciation deductions that were added back to tentative
taxable income in 2021 under paragraph (b)(1)(i)(D)
of this section did not increase A’s business interest
expense deduction for that year.
* * * * *
(22) * * *
(iii) * * *
(F) Section 163(j) interest dividends—
(1) In general. Except as otherwise pro-
vided in this paragraph (b)(22)(iii)(F), a
section 163(j) interest dividend is treated
as interest income.
(2) Limitation on amount treated as
interest income. A shareholder may not
treat any part of a section 163(j) interest
dividend as interest income to the extent
the amount of the section 163(j) interest
dividend exceeds the excess of the amount
of the entire dividend that includes the
section 163(j) interest dividend over the
sum of the conduit amounts other than
interest-related dividends under section
871(k)(1)(C) and section 163(j) interest
dividends that affect the shareholder’s
treatment of that dividend.
(3) Conduit amounts. For purposes of
paragraph (b)(22)(iii)(F)(2) of this sec-
tion, the term conduit amounts means,
with respect to any category of income
(including tax-exempt interest) earned
by a RIC for a taxable year, the amounts
identified by the RIC (generally in a des-
ignation or written report) in connection
with dividends of the RIC for that taxable
year that are subject to a limit determined
by reference to that category of income.
For example, a RIC’s conduit amount with
respect to its net capital gain is the amount
of the RIC’s capital gain dividends under
section 852(b)(3)(C).
(4) Holding period. Except as provid-
ed in paragraph (b)(22)(iii)(F)(5) of this
section, no dividend is treated as interest
income under paragraph (b)(22)(iii)(F)(1)
of this section if the dividend is received
with respect to a share of RIC stock—
(i) That is held by the shareholder for
180 days or less (taking into account the
principles of section 246(c)(3) and (4))
during the 361-day period beginning on
the date which is 180 days before the date
on which the share becomes ex-dividend
with respect to such dividend; or
(ii) To the extent that the shareholder is
under an obligation (whether pursuant to
a short sale or otherwise) to make related
payments with respect to positions in sub-
stantially similar or related property.
(5) Exception to holding period require-
ment for money market funds and certain
regularly declared dividends. Paragraph
(b)(22)(iii)(F)(4)(i) of this section does
not apply to dividends distributed by any
RIC regulated as a money market fund un-
der 17 CFR 270.2a-7 (Rule 2a-7 under the
1940 Act) or to regular dividends paid by
a RIC that declares section 163(j) interest
dividends on a daily basis in an amount
equal to at least 90 percent of its excess
section 163(j) interest income, as defined
in paragraph (b)(35)(iv)(E) of this sec-
tion, and distributes such dividends on a
monthly or more frequent basis.
* * * * *
(35) Section 163(j) interest dividend.
The term section 163(j) interest dividend
means a dividend paid by a RIC for a tax-
able year for which section 852(b) applies
to the RIC, to the extent described in para-
graph (b)(35)(i) or (ii) of this section, as
applicable.
(i) In general. Except as provided in
paragraph (b)(35)(ii) of this section, a sec-
tion 163(j) interest dividend is any divi-
dend, or part of a dividend, that is reported
by the RIC as a section 163(j) interest div-
idend in written statements furnished to its
shareholders.
(ii) Reduction in the case of excess re-
ported amounts. If the aggregate reported
amount with respect to the RIC for the
taxable year exceeds the excess section
163(j) interest income of the RIC for such
taxable year, the section 163(j) interest
dividend is—
(A) The reported section 163(j) interest
dividend amount; reduced by
(B) The excess reported amount that
is allocable to that reported section 163(j)
interest dividend amount.
(iii) Allocation of excess reported
amount—(A) In general. Except as pro-
vided in paragraph (b)(35)(iii)(B) of this
section, the excess reported amount, if
any, that is allocable to the reported sec-
tion 163(j) interest dividend amount is
that portion of the excess reported amount
that bears the same ratio to the excess
reported amount as the reported section
163(j) interest dividend amount bears to
the aggregate reported amount.
(B) Special rule for noncalendar year
RICs. In the case of any taxable year that
does not begin and end in the same cal-
endar year, if the post-December report-
ed amount equals or exceeds the excess
reported amount for that taxable year,
paragraph (b)(35)(iii)(A) of this section
is applied by substituting “post-December
reported amount” for “aggregate reported
amount,” and no excess reported amount
is allocated to any dividend paid on or be-
fore December 31 of such taxable year.
(iv) Definitions. The following defini-
tions apply for purposes of this paragraph
(b)(35):
(A) Reported section 163(j) inter-
est dividend amount. The term reported
section 163(j) interest dividend amount
means the amount of a dividend distri-
bution reported to the RIC’s shareholders
under paragraph (b)(35)(i) of this section
as a section 163(j) interest dividend.
(B) Excess reported amount. The term
excess reported amount means the excess

February 1, 2021 614 Bulletin No. 2021–5
of the aggregate reported amount over the
RIC’s excess section 163(j) interest in-
come for the taxable year.
(C) Aggregate reported amount. The
term aggregate reported amount means
the aggregate amount of dividends report-
ed by the RIC under paragraph (b)(35)(i)
of this section as section 163(j) interest
dividends for the taxable year (including
section 163(j) interest dividends paid after
the close of the taxable year described in
section 855).
(D) Post-December reported amount.
The term post-December reported amount
means the aggregate reported amount
determined by taking into account only
dividends paid after December 31 of the
taxable year.
(E) Excess section 163(j) interest in-
come. The term excess section 163(j) in-
terest income means, with respect to a tax-
able year of a RIC, the excess of the RIC’s
business interest income for the taxable
year over the sum of the RIC’s business
interest expense for the taxable year and
the RIC’s other deductions for the tax-
able year that are properly allocable to the
RIC’s business interest income.
(v) Example—(A) Facts. X is a domestic C cor-
poration that has elected to be a RIC. For its taxable
year ending December 31, 2021, X has $100x of
business interest income (all of which is qualified
interest income for purposes of section 871(k)(1)(E))
and $10x of dividend income (all of which is quali-
fied dividend income within the meaning of section
1(h)(11) and would be eligible for the dividends
received deduction under section 243, determined
as described in section 854(b)(3)). X has $10x of
business interest expense and $20x of other deduc-
tions. X has no other items for the taxable year. On
December 31, 2021, X pays a dividend of $80x to
its shareholders, and reports, in written statements to
its shareholders, $71.82x as a section 163(j) interest
dividend; $10x as dividends that may be treated as
qualified dividend income or as dividends eligible
for the dividends received deduction; and $72.73x
as interest-related dividends under section 871(k)(1)
(C). Shareholder A, a domestic C corporation, meets
the holding period requirements in paragraph (b)(22)
(iii)(F)(4) of this section with respect to the stock of
X, and receives a dividend of $8x from X on Decem-
ber 31, 2021.
(B) Analysis. X determines that $18.18x of oth-
er deductions are properly allocable to X’s business
interest income. X’s excess section 163(j) interest
income under paragraph (b)(35)(iv)(E) of this sec-
tion is $71.82x ($100x business interest income
– ($10x business interest expense + $18.18x other
deductions allocated) = $71.82x). Thus, X may re-
port up to $71.82x of its dividends paid on December
31, 2021, as section 163(j) interest dividends to its
shareholders. X may also report up to $10x of its div-
idends paid on December 31, 2021, as dividends that
may be treated as qualified dividend income or as
dividends that are eligible for the dividends received
deduction. X determines that $9.09x of interest ex-
pense and $18.18x of other deductions are properly
allocable to X’s qualified interest income. Therefore,
X may report up to $72.73x of its dividends paid on
December 31, 2021, as interest-related dividends
under section 871(k)(1)(C) ($100x qualified interest
income - $27.27x deductions allocated = $72.73x).
A treats $1x of its $8x dividend as a dividend eligi-
ble for the dividends received deduction and no part
of the dividend as an interest-related dividend under
section 871(k)(1)(C). Therefore, under paragraph (b)
(22)(iii)(F)(2) of this section, A may treat $7x of the
section 163(j) interest dividend as interest income
for purposes of section 163(j) ($8x dividend - $1x
conduit amount = $7x limitation).
* * * * *
(c) * * *
(4) Paragraphs (b)(1)(iv)(A)(2)
through (4), (B) through (G), (b)(22)(iii)
(F), and (b)(35). Paragraphs (b)(1)(iv)(A)
(2) through (4), (b)(1)(iv)(B) through (G),
(b)(22)(iii)(F), and (b)(35) of this section
apply to taxable years beginning on or af-
ter March 22, 2021. Taxpayers and their
related parties, within the meaning of sec-
tions 267(b) (determined without regard
to section 267(c)(3)) and 707(b)(1), may
choose to apply the rules in paragraphs (b)
(1)(iv)(A)(2) through (4), (b)(1)(iv) (B)
through (G), (b)(22)(iii)(F), and (b)(35) of
this section to a taxable year beginning af-
ter December 31, 2017, and before March
22, 2021, provided that those taxpayers
and their related parties consistently apply
all of the rules in the section 163(j) regula-
tions contained in T.D. 9905 (§§1.163(j)-0
through 1.163(j)-11, effective November
13, 2020) as modified by T.D. 9943 (effec-
tive January 13, 2021), and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-
7, 1.383-0, 1.383-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §§1.382-2, 1.382-5, 1.382-6, and 1.383-
1), and 1.1504-4 contained in T.D. 9905,
as modified by T.D. 9943, to that taxable
year and all subsequent taxable years.
Par. 5. Section 1.163(j)-2 is amended
by:
1. Adding paragraphs (b)(3)(iii) and
(iv) and (d)(3).
2. Redesignating paragraph (k) as para-
graph (k)(1).
3. Adding a new subject heading for
paragraph (k).
4. Revising the subject heading of new-
ly redesignated paragraph (k)(1).
5. Adding paragraph (k)(2).
The revisions and additions read as fol-
lows:
§1.163(j)-2 Deduction for business
interest expense limited.
* * * * *
(b) * * *
(3) * * *
(iii) Transactions to which section
381 applies. For purposes of the election
described in paragraph (b)(3)(i) of this
section, and subject to the limitation in
paragraph (b)(3)(ii) of this section, the
2019 ATI of the acquiring corporation in
a transaction to which section 381 applies
equals the amount of the acquiring corpo-
ration’s ATI for its last taxable year begin-
ning in 2019.
(iv) Consolidated groups. For purpos-
es of the election described in paragraph
(b)(3)(i) of this section, and subject to the
limitation in paragraph (b)(3)(ii) of this
section, the 2019 ATI of a consolidated
group equals the amount of the consoli-
dated group’s ATI for its last taxable year
beginning in 2019.
* * * * *
(d) * * *
(3) Determining a syndicate’s loss
amount. For purposes of section 163(j),
losses allocated under section 1256(e)(3)
(B) and §1.448-1T(b)(3) are determined
without regard to section 163(j). See also
§1.1256(e)-2(b).
* * * * *
(k) Applicability dates.
(1) In general.* * *
(2) Paragraphs (b)(3)(iii), (b)(3)(iv),
and (d)(3). Paragraphs (b)(3)(iii) and (iv)
and (d)(3) of this section apply to taxable
years beginning on or after March 22,
2021. However, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) (determined without regard
to section 267(c)(3)) and 707(b)(1), may
choose to apply the rules in paragraphs
(b)(3)(iii), (b)(3)(iv), and (d)(3) of this
section to a taxable year beginning after
December 31, 2017, and before March 22,
2021, provided that those taxpayers and
their related parties consistently apply all
of the rules in paragraphs (b)(3)(iii) and
(iv) of this section and the rules in the sec-

Bulletin No. 2021–5 615 February 1, 2021
tion 163(j) regulations contained in T.D.
9905 (§§1.163(j)-0 through 1.163(j)-11,
effective November 13, 2020) as modified
by T.D. 9943 (effective January 13, 2021),
and, if applicable, §§1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.382-1, 1.382-2,
1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-
1, 1.469-9, 1.469-11, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-5,
1.382-6, and 1.383-1), and 1.1504-4 con-
tained in T.D. 9905 as modified by T.D.
9943, for that taxable year and for each
subsequent taxable year.
Par. 6. Section 1.163(j)-6 is amended
by:
1. Adding paragraphs (c)(1) and (2).
2. Redesignating paragraph (c)(3) as
paragraph (c)(4).
3. Adding new paragraph (c)(3) and
paragraphs (d)(3) through (5) and (e)(5).
4. Adding paragraphs (f)(1)(iii) and (g)
(4).
5. Adding paragraph (n).
6. Adding paragraphs (o)(24) through
(26), reserved paragraphs (o)(27). through
(33), and paragraphs (o)(34) through (36).
7. Redesignating paragraph (p) as para-
graph (p)(1), revising the subject heading
of paragraph (p), and adding a subject
heading for newly designated paragraph
(p)(1).
8. Adding paragraph (p)(2).
The revisions and additions read as fol-
lows:
§1.163(j)-6 Application of the section
163(j) limitation to partnerships and
subchapter S corporations.
* * * * *
(c) * * *
(1) Modification of business interest
income for partnerships. The business in-
terest income of a partnership generally is
determined in accordance with §1.163(j)-
1(b)(4). However, to the extent that inter-
est income of a partnership that is properly
allocable to trades or businesses that are
per se non-passive activities is allocated to
partners that do not materially participate
(within the meaning of section 469), as
described in §1.469-1T(e)(6) and subject
to section 163(d)(5)(A)(ii), such interest
income shall not be considered business
interest income for purposes of determin-
ing the section 163(j) limitation of a part-
nership pursuant to §1.163(j)-2(b). A per
se non-passive activity is an activity that
is not treated as a passive activity for pur-
poses of section 469 regardless of whether
the owners of the activity materially par-
ticipate in the activity.
(2) Modification of business interest
expense for partnerships. The business
interest expense of a partnership gen-
erally is determined in accordance with
§1.163(j)-1(b)(3). However, to the extent
that interest expense of a partnership that
is properly allocable to trades or business-
es that are per se non-passive activities
is allocated to partners that do not ma-
terially participate (within the meaning
of section 469), as described in §1.469-
1T(e)(6) and subject to section 163(d)(5)
(A)(ii), such interest expense shall not
be considered business interest expense
for purposes of determining the section
163(j) limitation of a partnership pursu-
ant to §1.163(j)- 2(b).
(3) Transition rule. With respect to a
partner in a partnership engaged in a trade
or business described in §1.469-1T(e)(6)
and subject to section 163(d)(5)(A)(ii),
if such partner had been allocated EBIE
from the partnership with respect to the
trade or business described in §1.469-
1T(e)(6) and subject to section 163(d)(5)
(A)(ii) in any prior taxable year in which
the partner did not materially participate,
such partner may treat such excess busi-
ness interest expense not previously treat-
ed as paid or accrued under §1.163(j)-6(g)
(2) as paid or accrued by the partner in the
first taxable year ending on or after the ef-
fective date of the final regulations and not
subject to further limitation under section
163(j) or 163(d).
* * * * *
(d) * * *
(3) Section 743(b) adjustments and
publicly traded partnerships. Solely for
purposes of §1.163(j)-6, a publicly traded
partnership, as defined in §1.7704-1, shall
treat the amount of any section 743(b) ad-
justment of a purchaser of a partnership
unit that relates to a remedial item that
the purchaser inherits from the seller as an
offset to the related section 704(c) reme-
dial item. For this purpose, §1.163(j)-6(e)
(2)(ii) applies. See Example 25 in para-
graph (o)(25) of this section.
(4) Modification of adjusted taxable in-
come for partnerships. The adjusted tax-
able income of a partnership generally is
determined in accordance with §1.163(j)-
1(b)(1). However, to the extent that the
items comprising the adjusted taxable in-
come of a partnership that are properly al-
locable to trades or businesses that are per
se non-passive activities are allocated to
partners that do not materially participate
(within the meaning of section 469), as
described in section 163(d)(5)(A)(ii), such
partnership items shall not be considered
adjusted taxable income for purposes of
determining the section 163(j) limitation
of a partnership pursuant to §1.163(j)-
2(b).
(5) Election to use 2019 adjusted tax-
able income for taxable years beginning
in 2020. In the case of any taxable year
beginning in 2020, a partnership may
elect to apply this section by substituting
its adjusted taxable income for the last
taxable year beginning in 2019 for the
adjusted taxable income for such taxable
year (post-election ATI or 2019 ATI).
See §1.163(j)-2(b)(4) for the time and
manner of making or revoking this elec-
tion. An electing partnership determines
each partner’s allocable ATI (as defined
in paragraph (f)(2)(ii) of this section)
by using the partnership’s 2019 section
704 income, gain, loss, and deduction as
though such amounts were recognized by
the partnership in 2020. See Example 34
in paragraph (o)(34) of this section.
(e) * * *
(5) Partner basis items, remedial items,
and publicly traded partnerships. Solely
for purposes of §1.163(j)-6, a publicly
traded partnership, as defined in §1.7704-
1, shall either allocate gain that would oth-
erwise be allocated under section 704(c)
based on a partner’s section 704(b) shar-
ing ratios, or, for purposes of allocating
cost recovery deductions under section
704(c), determine a partner’s remedi-
al items, as defined in §1.163(j)-6(b)(3),
based on an allocation of the partnership’s
asset basis (inside basis) items among its
partners in proportion to their share of cor-
responding section 704(b) items (rather
than applying the traditional method, de-
scribed in §1.704-3(b)). See Example 24
in paragraph (o)(24) of this section.
(f) * * *
(1) * * *

February 1, 2021 616 Bulletin No. 2021–5
(iii) Exception applicable to publicly
traded partnerships. Publicly traded part-
nerships, as defined in §1.7704-1, do not
apply the rules in paragraph (f)(2) of this
section to determine a partner’s share of
section 163(j) excess items. Rather, pub-
licly traded partnerships determine a part-
ner’s share of section 163(j) excess items
by applying the same percentage used to
determine the partner’s share of the cor-
responding section 704(b) items that com-
prise ATI.
* * * * *
(g) * * *
(4) Special rule for taxable years be-
ginning in 2019 and 2020. In the case of
any excess business interest expense of
a partnership for any taxable year begin-
ning in 2019 that is allocated to a partner
under paragraph (f)(2) of this section, 50
percent of such excess business interest
expense (§1.163(j)-6(g)(4) business inter-
est expense) is treated as business interest
expense that, notwithstanding paragraph
(g)(2) of this section, is paid or accrued
by the partner in the partner’s first tax-
able year beginning in 2020. Additional-
ly, §1.163(j)-6(g)(4) business interest ex-
pense is not subject to the section 163(j)
limitation at the level of the partner. For
purposes of paragraph (h)(1) of this sec-
tion, any §1.163(j)-6(g)(4) business in-
terest expense is, similar to deductible
business interest expense, taken into ac-
count before any excess business inter-
est expense. This paragraph applies after
paragraph (n) of this section. If a partner
disposes of a partnership interest in the
partnership’s 2019 or 2020 taxable year,
§1.163(j)-6(g)(4) business interest ex-
pense is deductible by the partner (except
to the extent that the business interest ex-
pense is negative section 163(j) expense
as defined in §1.163(j)-6(h)(1) immediate-
ly prior to the disposition) and thus does
not result in a basis increase under para-
graph (h)(3) of this section. See Example
35 and Example 36 in paragraphs (o)(35)
and (o)(36), respectively, of this section.
A partner may elect to not have this provi-
sion apply with respect to each partnership
interest held by the partner on an interest
by interest basis. The rules and procedures
regarding the time and manner of making,
or revoking, such an election are provided
in Revenue Procedure 2020-22, 2020-18
I.R.B. 745, and may be further modified
through other guidance (see §§601.601(d)
and 601.602 of this chapter).
* * * * *
(n) Treatment of self-charged lending
transactions between partnerships and
partners. In the case of a lending transac-
tion between a partner (lending partner)
and partnership (borrowing partnership)
in which the lending partner owns a di-
rect interest (self-charged lending transac-
tion), any business interest expense of the
borrowing partnership attributable to the
self-charged lending transaction is busi-
ness interest expense of the borrowing
partnership for purposes of this section. If
in a given taxable year the lending part-
ner is allocated excess business interest
expense from the borrowing partnership
and has interest income attributable to the
self-charged lending transaction (interest
income), the lending partner is deemed to
receive an allocation of excess business
interest income from the borrowing part-
nership in such taxable year. The amount
of the lending partner’s deemed allocation
of excess business interest income is the
lesser of such lending partner’s allocation
of excess business interest expense from
the borrowing partnership in such taxable
year or the interest income attributable
to the self-charged lending transaction in
such taxable year. To prevent the double
counting of business interest income, the
lending partner includes interest income
that was treated as excess business in-
terest income pursuant to this paragraph
(n) only once when calculating its own
section 163(j) limitation. To the extent
an amount of interest income received
by a lending partner is attributable to a
self-charged lending transaction, and is
deemed to be an allocation of excess busi-
ness interest income from the borrowing
partnership pursuant to this paragraph (n),
such an amount of interest income will not
be treated as investment income for pur-
poses of section 163(d). In cases where
the lending partner is not a C corporation,
to the extent that any interest income ex-
ceeds the lending partner’s allocation of
excess business interest expense from
the borrowing partnership for the taxable
year, and such interest income otherwise
would be properly treated as investment
income of the lending partner for purposes
of section 163(d) for that year, such excess
amount of interest income will continue
to be treated as investment income of the
lending partner for that year for purposes
of section 163(d). See Example 26 in para-
graph (o)(26) of this section.
(o) * * *
(24) Example 24—(i) Facts. On January 1, 2020,
L and M form LM, a publicly traded partnership (as
defined in §1.7704-1), and agree that each will be
allocated a 50 percent share of all LM items. The
partnership agreement provides that LM will make
allocations under section 704(c) using the remedial
allocation method under §1.704-3(d). L contrib-
utes depreciable property with an adjusted tax basis
of $4,000 and a fair market value of $10,000. The
property is depreciated using the straight-line meth-
od with a 10-year recovery period and has 4 years
remaining on its recovery period. M contributes
$10,000 in cash, which LM uses to purchase land.
Except for the depreciation deductions, LM’s ex-
penses equal its income in each year of the 10 years
commencing with the year LM is formed. LM has a
valid section 754 election in effect.
(ii) Section 163(j) remedial items and partner
basis items. LM sells the asset contributed by L in a
fully taxable transaction at a time when the adjusted
basis of the property is $4,000. Under §1.163(j)-6(e)
(2)(ii), solely for purposes of §1.163(j)-6, the tax
gain of $6,000 is allocated equally between L and M
($3,000 each). To avoid shifting built-in gain to the
non-contributing partner (M) in a manner consistent
with the rule in section 704(c), a remedial deduction
of $3,000 is allocated to M (leaving M with no net
tax gain), and remedial income of $3,000 is allocated
to L (leaving L with total tax gain of $6,000).
(25) Example 25—(i) Facts. The facts are the
same as Example 24 in paragraph (o)(24) of this
section except the property contributed by L had an
adjusted tax basis of zero. For each of the 10 years
following the contribution, there would be $500 of
section 704(c) remedial income allocated to L and
$500 of remedial deductions allocated to M with re-
spect to the contributed asset. A buyer of M’s units
would step into M’s shoes with respect to the $500
of annual remedial deductions. A buyer of L’s units
would step into L’s shoes with respect to the $500
of annual remedial income and would have an an-
nual section 743(b) deduction of $1,000 (net $500
of deductions).
(ii) Analysis. Pursuant to §1.163(j)-6(d)(2)(ii),
solely for purposes of §1.163(j)-6, a buyer of L’s
units immediately after formation of LM would off-
set its $500 annual section 704(c) remedial income
allocation with $500 of annual section 743(b) ad-
justment (leaving the buyer with net $500 of section
743(b) deduction). As a result, such buyer would be
in the same position as a buyer of M’s units. Each
buyer would have net deductions of $500 per year,
which would not affect ATI before 2022.
(26) Example 26—(i) Facts. X and Y are partners
in partnership PRS. In Year 1, PRS had $200 of ex-
cess business interest expense. Pursuant to §1.163(j)-
6(f)(2), PRS allocated $100 of such excess business
interest expense to each of its partners. In Year 2, X
lends $10,000 to PRS and receives $1,000 of inter-
est income for the taxable year (self-charged lending
transaction). X is not in the trade or business of lend-
ing money. The $1,000 of interest expense resulting

Bulletin No. 2021–5 617 February 1, 2021
from this loan is allocable to PRS’s trade or business
assets. As a result, such $1,000 of interest expense is
business interest expense of PRS. X and Y are each
allocated $500 of such business interest expense as
their distributive share of PRS’s business interest ex-
pense for the taxable year. Additionally, in Year 2,
PRS has $3,000 of ATI. PRS allocates the items com-
prising its $3,000 of ATI $0 to X and $3,000 to Y.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $900 ($3,000 x 30 percent). Thus,
PRS has $900 of deductible business interest ex-
pense, $100 of excess business interest expense, $0
of excess taxable income, and $0 of excess business
interest income. Pursuant to §1.163(j)-6(f)(2), $400
of X’s allocation of business interest expense is treat-
ed as deductible business interest expense, $100 of
X’s allocation of business interest expense is treated
as excess business interest expense, and $500 of Y’s
allocation of business interest expense is treated as
deductible business interest expense.
(iii) Lending partner. Pursuant to §1.163(j)-6(n),
X treats $100 of its $1,000 of interest income as ex-
cess business interest income allocated from PRS in
Year 2. Because X is deemed to have been allocated
$100 of excess business interest income from PRS,
and excess business interest expense from a partner-
ship is treated as paid or accrued by a partner to the
extent excess business interest income is allocated
from such partnership to a partner, X treats its $100
allocation of excess business interest expense from
PRS in Year 2 as business interest expense paid or
accrued in Year 2. X, in computing its limit under
section 163(j), has $100 of business interest income
($100 deemed allocation of excess business interest
income from PRS in Year 2) and $100 of business
interest expense ($100 allocation of excess business
interest expense treated as paid or accrued in Year 2).
Thus, X’s $100 of business interest expense is de-
ductible business interest expense. At the end of Year
2, X has $100 of excess business interest expense
from PRS ($100 from Year 1). X treats $900 of its
$1,000 of interest income as investment income for
purposes of section 163(d).
(27) – (33) [Reserved]
(34) Example 34—(i) Facts. X and Y are equal
partners in partnership PRS. Further, X and Y share
the profits of PRS equally. In 2019, PRS had ATI of
$100. Additionally, in 2019, PRS had $100 of section
704(b) income which was allocated $50 to X and $50
to Y (PRS did not have any section 704(c) income in
2019). In 2020, PRS’s only items of income, gain,
loss or deduction was $1 of trade or business income,
which it allocated to X pursuant to section 704(c).
(ii) Partnership-level. In 2020, PRS makes the
election described in §1.163(j)-6(d)(5) to use its
2019 ATI in 2020. As a result, PRS has $100 of ATI
in 2020. PRS does not have any business interest
expense. Therefore, PRS has $100 of excess taxable
income in 2020.
(iii) Partner-level allocations. PRS allocates its
$100 of excess taxable income to X and Y pursuant
to §1.163(j)-6(f)(2). To determine each partner’s
share of the $100 of excess taxable income, PRS
must determine each partner’s allocable ATI (as de-
fined in §1.163(j)-6(f)(2)(ii)). Because PRS made the
election described in §1.163(j)-6(d)(5), PRS must
determine the allocable ATI of each of its partners
pursuant to paragraph (d)(5). Specifically, PRS de-
termines each partner’s share of allocable ATI based
on PRS’s 2019 section 704 income, gain, loss, and
deduction. PRS had $100 of section 704(b) income
in 2019 which was allocated $50 to X and $50 to Y.
Therefore, in 2020, X and Y are both allocated $50
of excess taxable income (50% x $100).
(35) Example 35—(i) Facts. X, a partner in part-
nership PRS, was allocated $20 of excess business
interest expense from PRS in 2018 and $10 of excess
business interest expense from PRS in 2019. In 2020,
PRS allocated $16 of excess taxable income to X.
(ii) Analysis. X treats 50 percent of its $10 of ex-
cess business interest expense allocated from PRS in
2019 as §1.163(j)-6(g)(4) business interest expense.
Thus, $5 of §1.163(j)-6(g)(4) business interest ex-
pense is treated as paid or accrued by X in 2020 and
is not subject to the section 163(j) limitation at X’s
level. Because X was allocated $16 of excess taxable
income from PRS in 2020, X treats $16 of its $25 of
excess business interest expense as business interest
expense paid or accrued pursuant to §1.163(j)-6(g)
(2). X, in computing its limit under section 163(j)
in 2020, has $16 of ATI (as a result of its allocation
of $16 of excess taxable income from PRS), $0 of
business interest income, and $16 of business inter-
est expense ($16 of excess business interest expense
treated as paid or accrued in 2020). Pursuant to
§1.163(j)-2(b)(2)(i), X’s section 163(j) limit in 2020
is $8 ($16 x 50 percent). Thus, X has $8 of busi-
ness interest expense that is deductible under section
163(j). The $8 of X’s business interest expense not
allowed as a deduction ($16 business interest ex-
pense subject to section 163(j), less $8 section 163(j)
limit) is treated as business interest expense paid or
accrued by X in 2021. At the end of 2020, X has $9
of excess business interest expense from PRS ($20
from 2018, plus $10 from 2019, less $5 treated as
paid or accrued pursuant to §1.163(j)-6(g)(4), less
$16 treated as paid or accrued pursuant to §1.163(j)-
6(g)(2)).
(36) Example 36—(i) Facts. X is a partner in
partnership PRS. At the beginning of 2018, X’s out-
side basis in PRS was $100. X was allocated $20 of
excess business interest expense from PRS in 2018
and $10 of excess business interest expense from
PRS in 2019. X sold its PRS interest in 2019 for $70.
(ii) Analysis. X treats 50 percent of its $10 of ex-
cess business interest expense allocated from PRS in
2019 as §1.163(j)-6(g)(4) business interest expense.
Thus, $5 of §1.163(j)-6(g)(4) business interest ex-
pense is treated as paid or accrued by X in 2020 and
is not subject to the section 163(j) limitation at X’s
level. Pursuant to paragraph (h)(3) of this section,
immediately before the disposition, X increases the
basis of its PRS interest from $70 to $95 (add back
of $20 of EBIE from 2018 and $5 of remaining EBIE
from 2019). Thus, X has a $25 section 741 loss rec-
ognized on the sale ($70 - $95).
(p) Applicability dates.
(1) In general.* * *
(2) Paragraphs (c)(1) and (2), (d)
(3) through (5), (e)(5), (f)(1)(iii), (g)(4),
(n), and (o)(24) through (29), and (34)
through (36). Paragraphs (c)(1) and (2),
(d)(3) through (5), (e)(5), (f)(1)(iii), (g)
(4), (n), and (o)(24) through (29), and
(34) through (36) of this section apply to
taxable years beginning on or after March
22, 2021. However, taxpayers and their
related parties, within the meaning of sec-
tions 267(b) (determined without regard
to section 267(c)(3)) and 707(b)(1), may
choose to apply the rules in paragraphs
(c)(1) and (2), (d)(3) through (5), (e)(5),
(f)(1)(iii), (g)(4), (n), and (o)(24) through
(29), and (34) through (36) to a taxable
year beginning after December 31, 2017,
and before March 22, 2021, provided that
those taxpayers and their related parties
consistently apply all of the rules in T.D.
9905 (§§1.163(j)-0 through 1.163(j)-11,
effective November 13, 2020) as modified
by T.D. 9943 (effective January 13, 2021),
and, if applicable, §§1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.382-1, 1.382-2,
1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-
1, 1.469-9, 1.469-11, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-5,
1.382-6, and 1.383-1), and 1.1504-4 con-
tained in T.D. 9905 as modified by T.D.
9943, for that taxable year and for each
subsequent taxable year.
Par. 7. Section 1.163(j)-7 is amended
by revising paragraph (a), adding para-
graphs (c) through (f), (g)(3) and (4), (h),
(k), and (l), and revising paragraph (m) to
read as follows:
§1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
(a) Overview. This section provides
rules for the application of section 163(j)
to relevant foreign corporations and Unit-
ed States shareholders of relevant foreign
corporations. Paragraph (b) of this section
provides the general rule regarding the
application of section 163(j) to a relevant
foreign corporation. Paragraph (c) of this
section provides rules for applying sec-
tion 163(j) to CFC group members of a
CFC group. Paragraph (d) of this section
provides rules for determining a specified
group and specified group members. Para-
graph (e) of this section provides rules and
procedures for treating a specified group
member as a CFC group member and for
determining a CFC group. Paragraph (f)
of this section provides rules regarding

February 1, 2021 618 Bulletin No. 2021–5
the treatment of a CFC group member that
has ECI. Paragraph (g) of this section pro-
vides rules concerning the computation of
ATI of an applicable CFC. Paragraph (h)
of this section provides a safe harbor that
exempts certain stand-alone applicable
CFCs and CFC groups from the applica-
tion of section 163(j) for a taxable year.
Paragraphs (i) and (j) of this section are
reserved. Paragraph (k) of this section
provides definitions that apply for purpos-
es of this section (see also §1.163(j)-1 for
additional definitions). Paragraph (l) of
this section provides examples illustrating
the application of this section.
* * * * *
(c) Application of section 163(j) to
CFC group members of a CFC group—
(1) Scope. This paragraph (c) provides
rules for applying section 163(j) to a
CFC group and a CFC group member.
Paragraph (c)(2) of this section provides
rules for computing a single section
163(j) limitation for a specified peri-
od of a CFC group. Paragraph (c)(3) of
this section provides rules for allocating
a CFC group’s section 163(j) limitation
to CFC group members for specified tax-
able years. Paragraph (c)(4) of this sec-
tion provides currency translation rules.
Paragraph (c)(5) of this section provides
special rules for specified periods begin-
ning in 2019 or 2020.
(2) Calculation of section 163(j) lim-
itation for a CFC group for a specified
period—(i) In general. A single section
163(j) limitation is computed for a spec-
ified period of a CFC group. For purposes
of applying section 163(j) and the section
163(j) regulations, the current-year busi-
ness interest expense, disallowed business
interest expense carryforwards, business
interest income, floor plan financing inter-
est expense, and ATI of a CFC group for
a specified period equal the sums of each
CFC group member’s respective amounts
for its specified taxable year with respect
to the specified period. A CFC group
member’s current-year business interest
expense, business interest income, floor
plan financing interest expense, and ATI
for a specified taxable year are generally
determined on a separate-company basis.
For purposes of determining the ATI of a
CFC group, §1.163(j)-1(b)(1)(vii) (pro-
viding that ATI cannot be less than zero)
applies with respect to the ATI of the CFC
group but not the ATI of any CFC group
member.
(ii) Certain transactions between CFC
group members disregarded. Any trans-
action between CFC group members of a
CFC group that is entered into with a prin-
cipal purpose of affecting a CFC group
or a CFC group member’s section 163(j)
limitation by increasing or decreasing a
CFC group or a CFC group member’s ATI
or business interest income for a specified
taxable year is disregarded for purposes
of applying section 163(j) and the section
163(j) regulations.
(3) Deduction of business interest ex-
pense—(i) CFC group business inter-
est expense—(A) In general. The extent
to which a CFC group member’s cur-
rent-year business interest expense and
disallowed business interest expense car-
ryforwards for a specified taxable year
that ends with or within a specified period
may be deducted under section 163(j) is
determined under the rules and principles
of §1.163(j)-5(a)(2) and (b)(3)(ii), subject
to the modifications described in para-
graph (c)(3)(i)(B) of this section.
(B) Modifications to relevant terms.
For purposes of paragraph (c)(3)(i)(A)
of this section, the rules and principles of
§1.163(j)-5(b)(3)(ii) are applied by—
(1) Replacing “§1.163(j)-4(d)(2)” in
§1.163(j)-5(a)(2)(ii) with “§1.163(j)-7(c)
(2)(i)”;
(2) Replacing the term “allocable share
of the consolidated group’s remaining
section 163(j) limitation” with “allocable
share of the CFC group’s remaining sec-
tion 163(j) limitation”;
(3) Replacing the terms “consolidated
group” and “group” with “CFC group”;
(4) Replacing the term “consolidated
group’s remaining section 163(j) limita-
tion” with “CFC group’s remaining sec-
tion 163(j) limitation”;
(5) Replacing the term “consolidated
return year” with “specified period”;
(6) Replacing the term “current year”
or “current-year” with “current specified
period” or “specified taxable year with re-
spect to the current specified period,” as
the context requires;
(7) Replacing the term “member” with
“CFC group member”; and
(8) Replacing the term “taxable year”
with “specified taxable year with respect
to a specified period.”
(ii) Carryforwards treated as attribut-
able to the same taxable year. For purpos-
es of applying the principles of §1.163(j)-
5(b)(3)(ii), as required under paragraph
(c)(3)(i) of this section, CFC group mem-
bers’ disallowed business interest expense
carryforwards that arose in specified tax-
able years with respect to the same speci-
fied period are treated as disallowed busi-
ness interest expense carryforwards from
taxable years ending on the same date and
are deducted on a pro rata basis, under
the principles of §1.163(j)-5(b)(3)(ii)(C)
(3), pursuant to paragraph (c)(3)(i) of this
section.
(iii) Multiple specified taxable years
of a CFC group member with respect to a
specified period. If a CFC group member
has more than one specified taxable year
(each year, an applicable specified taxable
year) with respect to a single specified pe-
riod of a CFC group, then all the applica-
ble specified taxable years are taken into
account for purposes of applying the prin-
ciples of §1.163(j)-5(b)(3)(ii), as required
under paragraph (c)(3)(i) of this section,
with respect to the specified period. The
portion of the section 163(j) limitation
allocable to disallowed business interest
expense carryforwards of the CFC group
member that arose in taxable years before
the first applicable specified taxable year
is prorated among the applicable specified
taxable years in proportion to the number
of days in each applicable specified tax-
able year.
(iv) Limitation on pre-group disallowed
business interest expense carryforward—
(A) General rule—(1) CFC group mem-
ber pre-group disallowed business inter-
est expense carryforward. This paragraph
(c)(3)(iv) applies to pre-group disallowed
business interest expense carryforwards
of a CFC group member. The amount of
the pre-group disallowed business interest
expense carryforwards described in the
preceding sentence that may be includ-
ed in any CFC group member’s business
interest expense deduction for any speci-
fied taxable year under this paragraph (c)
(3) may not exceed the aggregate section
163(j) limitation for all specified periods
of the CFC group, determined by refer-
ence only to the CFC group member’s
items of income, gain, deduction, and loss,
and reduced (including below zero) by the
CFC group member’s business interest

Bulletin No. 2021–5 619 February 1, 2021
expense (including disallowed business
interest expense carryforwards) taken into
account as a deduction by the CFC group
member in all specified taxable years in
which the CFC group member has con-
tinuously been a CFC group member of
the CFC group (cumulative section 163(j)
pre-group carryforward limitation).
(2) Subgrouping. In the case of a pre-
group disallowed business interest ex-
pense carryforward, a pre-group subgroup
is composed of the CFC group member
with the pre-group disallowed business
interest expense carryforward (the loss
member) and each other CFC group mem-
ber of the loss member’s CFC group (the
current group) that was a member of the
CFC group in which the pre-group disal-
lowed business interest expense carryfor-
ward arose and joined the specified group
of the current group at the same time as
the loss member. A CFC group member
that is a member of a pre-group subgroup
remains a member of the pre-group sub-
group until its first taxable year during
which it ceases to be a member of the
same specified group as the loss mem-
ber. For purposes of this paragraph (c),
the rules and principles of §1.163(j)-5(d)
(1)(B) apply to a pre-group subgroup as
if the pre-group subgroup were a SRLY
subgroup.
(3) Transition rule. Solely for purpos-
es of paragraph (c)(3)(iv)(A)(2) of this
section, a CFC group includes a group of
applicable CFCs for which a CFC group
election was made under guidance under
section 163(j) published on December 28,
2018. Therefore, if the requirements of
paragraph (c)(3)(iv)(A)(2) of this section
are satisfied, a group of applicable CFCs
described in the preceding sentence may
be treated as a pre-group subgroup.
(B) Deduction of pre-group disallowed
business interest expense carryforwards.
Notwithstanding paragraph (c)(3)(iv)(A)
(1) of this section, pre-group disallowed
business interest expense carryforwards
are available for deduction by a CFC group
member in its specified taxable year only
to the extent the CFC group has remaining
section 163(j) limitation for the specified
period after the deduction of current-year
business interest expense and disallowed
business interest expense carryforwards
from earlier taxable years that are per-
mitted to be deducted in specified taxable
years of CFC group members with respect
to the specified period. See paragraph (c)
(3)(i) of this section and §1.163(j)-5(b)(3)
(ii)(A). Pre-group disallowed business in-
terest expense carryforwards are deducted
on a pro rata basis (under the principles
of paragraph (c)(3)(i) of this section and
§1.163(j)-5(b)(3)(ii)(C)(4)) with other
disallowed business interest expense car-
ryforwards from taxable years ending on
the same date.
(4) Currency translation. For purpos-
es of applying this paragraph (c), items
of a CFC group member are translated
into a single currency for the CFC group
and back to the functional currency of the
CFC group member using the average ex-
change rate for the CFC group member’s
specified taxable year. The single currency
for the CFC group may be the U.S. dollar
or the functional currency of a plurality of
the CFC group members.
(5) Special rule for specified periods
beginning in 2019 or 2020—(i) 50 per-
cent ATI limitation applies to a specified
period of a CFC group. In the case of a
CFC group, §1.163(j)-2(b)(2) (includ-
ing the election under §1.163(j)-2(b)(2)
(ii)) applies to a specified period of the
CFC group beginning in 2019 or 2020,
rather than to a specified taxable year of
a CFC group member. An election under
§1.163(j)-2(b)(2)(ii) for a specified pe-
riod of a CFC group is not effective un-
less made by each designated U.S. per-
son. Except as otherwise provided in this
paragraph (c)(5)(i), the election is made
in accordance with Revenue Procedure
2020-22, 2020-18 I.R.B. 745. For purpos-
es of applying §1.964-1(c), the election
is treated as if made for each CFC group
member.
(ii) Election to use 2019 ATI applies to
a specified period of a CFC group—(A)
In general. In the case of a CFC group, for
purposes of applying paragraph (c)(2) of
this section, an election under §1.163(j)-
2(b)(3)(i) is made for a specified period of
a CFC group beginning in 2020 and ap-
plies to the specified taxable years of each
CFC group member with respect to such
specified period, taking into account the
application of paragraph (c)(5)(ii)(B) of
this section. The election under §1.163(j)-
2(b)(3)(i) does not apply to any specified
taxable year of a CFC group member oth-
er than those described in the preceding
sentence. An election under §1.163(j)-
2(b)(3)(i) for a specified period of a CFC
group is not effective unless made by each
designated U.S. person. Except as other-
wise provided in this paragraph (c)(5)(ii)
(A), the election is made in accordance
with Revenue Procedure 2020-22, 2020-
18 I.R.B. 745. For purposes of applying
§1.964-1(c), the election is treated as if
made for each CFC group member.
(B) Specified taxable years that do not
begin in 2020. If a specified taxable year
of a CFC group member with respect to
the specified period described in para-
graph (c)(5)(ii)(A) of this section begins
in 2019, then, for purposes of applying
paragraph (c)(2) of this section, §1.163(j)-
2(b)(3) is applied to such specified taxable
year by substituting “2018” for “2019”
and “2019” for “2020.” If a specified tax-
able year of a CFC group member with
respect to the specified period described
in paragraph (c)(5)(ii)(A) of this section
begins in 2021, then, for purposes of ap-
plying paragraph (c)(2) of this section,
§1.163(j)-2(b)(3) is applied to such spec-
ified taxable year by substituting “2020”
for “2019” and “2021” for “2020.”
(d) Determination of a specified group
and specified group members—(1) Scope.
This paragraph (d) provides rules for de-
termining a specified group and specified
group members. Paragraph (d)(2) of this
section provides rules for determining a
specified group. Paragraph (d)(3) of this
section provides rules for determining
specified group members.
(2) Rules for determining a specified
group—(i) Definition of a specified group.
Subject to paragraph (d)(2)(ii) of this sec-
tion, the term specified group means one
or more applicable CFCs or chains of ap-
plicable CFCs connected through stock
ownership with a specified group parent
(which is included in the specified group
only if it is an applicable CFC), but only
if—
(A) The specified group parent owns
directly or indirectly stock meeting the re-
quirements of section 1504(a)(2)(B) in at
least one applicable CFC; and
(B) Stock meeting the requirements of
section 1504(a)(2)(B) in each of the ap-
plicable CFCs (except the specified group
parent) is owned directly or indirectly by
one or more of the other applicable CFCs
or the specified group parent.

February 1, 2021 620 Bulletin No. 2021–5
(ii) Indirect ownership. For purpos-
es of applying paragraph (d)(2)(i) of this
section, stock is owned indirectly only if
it is owned under section 318(a)(2)(A)
through a partnership or under section
318(a)(2)(A) or (B) through an estate or
trust not described in section 7701(a)(30).
(iii) Specified group parent. The term
specified group parent means a qualified
U.S. person or an applicable CFC.
(iv) Qualified U.S. person. The term
qualified U.S. person means a United
States person described in section 7701(a)
(30)(A) or (C). For purposes of this para-
graph (d), members of a consolidated
group that file (or that are required to file)
a consolidated U.S. Federal income tax
return are treated as a single qualified U.S
person and individuals described in sec-
tion 7701(a)(30)(A) whose filing status is
married filing jointly are treated as a sin-
gle qualified U.S. person.
(v) Stock. For purposes of this para-
graph (d)(2), the term stock has the same
meaning as “stock” in section 1504 (with-
out regard to §1.1504-4, except as provid-
ed in paragraph (d)(2)(vi) of this section)
and all shares of stock within a single
class are considered to have the same val-
ue. Thus, control premiums and minority
and blockage discounts within a single
class are not taken into account.
(vi) Options treated as exercised. For
purposes of this paragraph (d)(2), options
that are reasonably certain to be exercised,
as determined under §1.1504-4(g), are
treated as exercised. For purposes of this
paragraph (d)(2)(vi), options include call
options, warrants, convertible obligations,
put options, and any other instrument
treated as an option under §1.1504-4(d),
determined by replacing the term “a prin-
cipal purpose of avoiding the application
of section 1504 and this section” with “a
principal purpose of avoiding the applica-
tion of section 163(j).”
(vii) When a specified group ceases to
exist. The principles of §1.1502-75(d)(1),
(d)(2)(i) and (ii), and (d)(3)(i) through (iv)
apply for purposes of determining when a
specified group ceases to exist. Solely for
purposes of applying these principles, ref-
erences to the common parent are treated
as references to the specified group parent
and each applicable CFC that is treated as
a specified group member for a taxable
year with respect to a specified period
is treated as affiliated with the specified
group parent from the beginning to the
end of the specified period, without regard
to the beginning or end of its taxable year.
(3) Rules for determining a specified
group member. If two or more applicable
CFCs are included in a specified group on
the last day of a taxable year of each appli-
cable CFC that ends with or within a spec-
ified period, then each applicable CFC is
a specified group member with respect to
the specified period for its entire taxable
year ending with or within the specified
period. If only one applicable CFC is in-
cluded in a specified group on the last day
of its taxable year that ends with or within
the specified period, it is not a specified
group member. If an applicable CFC has
multiple taxable years that end with or
within a specified period, this paragraph
(d)(3) is applied separately to each taxable
year to determine if the applicable CFC is
a specified group member for such taxable
year.
(e) Rules and procedures for treating
a specified group as a CFC group—(1)
Scope. This paragraph (e) provides rules
and procedures for treating a specified
group member as a CFC group member
and for determining a CFC group for pur-
poses of applying section 163(j) and the
section 163(j) regulations.
(2) CFC group and CFC group mem-
ber—(i) CFC group. The term CFC group
means, with respect to a specified period,
all CFC group members for their specified
taxable years.
(ii) CFC group member. The term CFC
group member means, with respect to a
specified taxable year and a specified pe-
riod, a specified group member of a speci-
fied group for which a CFC group election
is in effect. However, notwithstanding the
prior sentence, a specified group member
is not treated as a CFC group member for
a taxable year of the specified group mem-
ber beginning before January 1, 2018.
(3) Duration of a CFC group. A CFC
group continues until the CFC group
election is revoked, or there is no lon-
ger a specified period with respect to the
specified group. A failure to provide the
information described in paragraph (e)(6)
of this section does not terminate a CFC
group election.
(4) Joining or leaving a CFC group.
If an applicable CFC becomes a speci-
fied group member for a specified taxable
year with respect to a specified period of
a specified group for which a CFC group
election is in effect, the CFC group elec-
tion applies to the applicable CFC and the
applicable CFC becomes a CFC group
member. If an applicable CFC ceases to be
a specified group member for a specified
taxable year with respect to a specified pe-
riod of a specified group for which a CFC
group election is in effect, the CFC group
election terminates solely with respect to
the applicable CFC.
(5) Manner of making or revoking a
CFC group election—(i) In general. An
election is made or revoked under this
paragraph (e)(5) (CFC group election)
with respect to a specified period of a
specified group. A CFC group election re-
mains in effect for each specified period of
the specified group until revoked. A CFC
group election that is in effect with respect
to a specified period of a specified group
applies to each specified group member
for its specified taxable year that ends with
or within the specified period. The making
or revoking of a CFC group election is not
effective unless made or revoked by each
designated U.S. person.
(ii) Revocation by election. A CFC
group election cannot be revoked with
respect to any specified period beginning
before 60 months following the last day of
the specified period for which the election
was made. Once a CFC group election has
been revoked, a new CFC group election
cannot be made with respect to any spec-
ified period beginning before 60 months
following the last day of the specified pe-
riod for which the election was revoked.
(iii) Timing. A CFC group election
must be made or revoked with respect to
a specified period of a specified group no
later than the due date (taking into account
extensions, if any) of the original Federal
income tax return for the taxable year of
each designated U.S. person in which or
with which the specified period ends.
(iv) Election statement. To make or re-
voke a CFC group election for a specified
period of a specified group, each desig-
nated U.S. person must attach a state-
ment to its relevant Federal income tax
or information return in accordance with
publications, forms, instructions, or oth-
er guidance. The statement must include
the name and taxpayer identification

Bulletin No. 2021–5 621 February 1, 2021
number of all designated U.S. persons,
a statement that the CFC group election
is being made or revoked, as applicable,
the specified period for which the CFC
group election is being made or revoked,
and the name of each CFC group member
and its specified taxable year with respect
to the specified period. The statement
must be filed in the manner prescribed in
publications, forms, instructions, or other
guidance.
(v) Effect of prior CFC group election.
A CFC group election is made solely pur-
suant to the provisions of this paragraph
(e)(5), without regard to whether a CFC
group election described in guidance un-
der section 163(j) published on December
28, 2018, was in effect.
(6) Annual information reporting.
Each designated U.S. person must attach
a statement to its relevant Federal income
tax or information return for each taxable
year in which a CFC group election is in
effect that contains information concern-
ing the computation of the CFC group’s
section 163(j) limitation and the applica-
tion of paragraph (c)(3) of this section to
the CFC group in accordance with pub-
lications, forms, instructions, or other
guidance.
(f) Treatment of a CFC group member
that has ECI—(1) In general. If a CFC
group member has ECI in its specified
taxable year, then for purposes of section
163(j) and the section 163(j) regulations—
(i) The items, disallowed business in-
terest expense carryforwards, and other
attributes of the CFC group member that
are ECI are treated as items, disallowed
business interest expense carryforwards,
and attributes of a separate applicable
CFC (such deemed corporation, an ECI
deemed corporation) that has the same
taxable year and shareholders as the appli-
cable CFC; and
(ii) The ECI deemed corporation is not
treated as a specified group member for
the specified taxable year.
(2) [Reserved].
(g) * * *
(3) Treatment of certain foreign income
taxes. For purposes of computing the ATI
of a relevant foreign corporation for a
taxable year, no deduction is taken into
account for any foreign income tax (as
defined in §1.960-1(b), but substituting
the phrase “relevant foreign corporation”
for the phrase “controlled foreign corpo-
ration”).
(4) Anti-abuse rule—(i) In general. If
a specified group member of a specified
group or an applicable partnership (speci-
fied lender) includes an amount (payment
amount) in income and such amount is at-
tributable to business interest expense in-
curred by another specified group member
or an applicable partnership of the speci-
fied group (specified borrower) during its
taxable year, then the ATI of the specified
borrower for the taxable year is increased
by the ATI adjustment amount if—
(A) The business interest expense is in-
curred with a principal purpose of reduc-
ing the Federal income tax liability of any
United States shareholder of a specified
group member (including over other tax-
able years);
(B) Absent the application of this
paragraph (g)(4), the effect of the speci-
fied borrower treating all or part of the
payment amount as disallowed business
interest expense would be to reduce the
Federal income tax liability of any Unit-
ed States shareholder of a specified group
member; and
(C) Either no CFC group election is in
effect with respect to the specified group
or the specified borrower is an applicable
partnership.
(ii) ATI adjustment amount—(A) In
general. For purposes of this paragraph
(g)(4), the term ATI adjustment amount
means, with respect to a specified borrow-
er and a taxable year, the product of 3 1/3
and the lesser of the payment amount or
the disallowed business interest expense,
computed without regard to this paragraph
(g)(4).
(B) Special rule for taxable years
or specified periods beginning in 2019
or 2020. For any taxable year of an ap-
plicable CFC or specified taxable year
of a CFC group member with respect to
a specified period for which the section
163(j) limitation is determined based, in
part, on 50 percent of ATI, in accordance
with §1.163(j)-2(b)(2), paragraph (g)(4)
(ii)(A) of this section is applied by substi-
tuting “2” for “3 1/3.”
(iii) Applicable partnership. For pur-
poses of this paragraph (g)(4), the term
applicable partnership means, with re-
spect to a specified group, a partnership in
which at least 80 percent of the interests
in profits or capital is owned, directly or
indirectly through one or more other part-
nerships, by specified group members of
the specified group. For purposes of this
paragraph (g)(4)(iii), a partner’s interest in
the profits of a partnership is determined
in accordance with the rules and princi-
ples of §1.706-1(b)(4)(ii) and a partner’s
interest in the capital of a partnership is
determined in accordance with the rules
and principles of §1.706-1(b)(4)(iii).
(h) Election to apply safe-harbor—(1)
In general. If an election to apply this
paragraph (h)(1) (safe-harbor election) is
in effect with respect to a taxable year of a
stand-alone applicable CFC or a specified
taxable year of a CFC group member, as
applicable, then, for such year, no portion
of the applicable CFC’s business interest
expense is disallowed under the section
163(j) limitation. This paragraph (h) does
not apply to excess business interest ex-
pense, as described in §1.163(j)-6(f)(2),
until the taxable year in which it is treated
as paid or accrued by an applicable CFC
under §1.163(j)-6(g)(2)(i). Furthermore,
excess business interest expense is not
taken into account for purposes of deter-
mining whether the safe-harbor election
is available for a stand-alone applicable
CFC or a CFC group until the taxable year
in which it is treated as paid or accrued by
an applicable CFC under §1.163(j)-6(g)
(2)(i).
(2) Eligibility for safe-harbor elec-
tion—(i) Stand-alone applicable CFC.
The safe-harbor election may be made for
the taxable year of a stand-alone applica-
ble CFC only if, for the taxable year, the
business interest expense of the applicable
CFC is less than or equal to either—
(A) The business interest income of the
applicable CFC; or
(B) 30 percent of the lesser of the eligi-
ble amount or the qualified tentative tax-
able income of the applicable CFC.
(ii) CFC group. The safe-harbor elec-
tion may be made for the specified period
of a CFC group only if, for the specified
period, no CFC group member has any
pre-group disallowed business interest
expense carryforward and the business in-
terest expense of the CFC group for the
specified period is less than or equal to
either—
(A) The business interest income of the
CFC group; or

February 1, 2021 622 Bulletin No. 2021–5
(B) 30 percent of the lesser of the eligi-
ble amount or the qualified tentative tax-
able income of the CFC group.
(iii) Currency translation. For purposes
of applying this paragraph (h), BII, BIE,
and qualified tentative taxable income of
a stand-alone applicable CFC or a CFC
group must be determined using the U.S.
dollar. If BII, BIE, or any items of income,
gain, deduction, or loss that are taken into
account in computing qualified tentative
taxable income are maintained in a cur-
rency other than the U.S. dollar, then those
items must be translated into the U.S. dol-
lar using the average exchange rate for the
taxable year or the specified taxable year,
as applicable.
(3) Eligible amount—(i) Stand-alone
applicable CFC. The eligible amount of a
stand-alone applicable CFC for a taxable
year is the sum of the amounts a domestic
corporation would include in gross income
under sections 951(a)(1)(A) and 951A(a),
reduced by any deductions that would be
allowed under section 245A (by reason of
section 964(e)(4)) or section 250(a)(1)(B)
(i), determined as if the domestic corpo-
ration has a taxable year that ends on the
last date of the taxable year of the stand-
alone applicable CFC, it wholly owns the
stand-alone applicable CFC throughout
the CFC’s taxable year, it does not own
any assets other than stock in the stand-
alone applicable CFC, and it has no other
items of income, gain, deduction, or loss.
(ii) CFC group. The eligible amount
of a CFC group for a specified period is
the sum of the amounts a domestic cor-
poration would include in gross income
under sections 951(a)(1)(A) and 951A(a),
reduced by any deductions that would be
allowed under section 245A (by reason
of section 964(e)(4)) or section 250(a)
(1)(B)(i), determined as if the domestic
corporation has a taxable year that is the
specified period, it wholly owns each CFC
group member throughout the CFC group
member’s specified taxable year, it does
not own any assets other than stock in the
CFC group members, and it has no other
items of income, gain, deduction, or loss.
(iii) Additional rules for determining
an eligible amount. For purposes of para-
graphs (h)(3)(i) and (ii) of this section,
the amounts that would be included in
gross income of a United States share-
holder under sections 951(a)(1)(A) and
951A(a), and any corresponding deduc-
tions that would be allowed under section
245A (by reason of section 964(e)(4)) or
section 250(a)(1)(B)(i), are determined
by taking into account any elections that
are made with respect to the applicable
CFC(s), including under §1.954-1(d)(5)
(relating to the subpart F high-tax excep-
tion) and §1.951A-2(c)(7)(viii) (relating
to the GILTI high-tax exclusion). These
amounts are also determined without re-
gard to any section 163(j) limitation on
business interest expense and without
regard to any disallowed business inter-
est expense carryovers. In addition, those
amounts are determined by only taking in
account items of the applicable CFC(s)
that are properly allocable to a non-ex-
cepted trade or business under §1.163(j)-
10.
(4) Qualified tentative taxable income.
The term qualified tentative taxable in-
come means, with respect to a taxable year
of a stand-alone applicable CFC, the ap-
plicable CFC’s tentative taxable income,
and with respect to a specified period of
a CFC group, the sum of each CFC group
member’s tentative taxable income for the
specified taxable year; provided that for
purposes of this paragraph (h)(4), tenta-
tive taxable income is determined by tak-
ing into account only items properly allo-
cable to a non-excepted trade or business
under §1.163(j)-10.
(5) Manner of making a safe-harbor
election—(i) In general. A safe-harbor
election is an annual election made under
this paragraph (h)(5) with respect to a tax-
able year of a stand-alone applicable CFC
or with respect to a specified period of a
CFC group. A safe-harbor election that is
made with respect to a specified period of
a CFC group is effective with respect to
each CFC group member for its specified
taxable year. A safe-harbor election is only
effective if made by each designated U.S.
person with respect to a stand-alone appli-
cable CFC or a CFC group. A safe-harbor
election is made with respect to a taxable
year of a stand-alone applicable CFC, or
a specified period of a CFC group, no lat-
er than the due date (taking into account
extensions, if any) of the original Federal
income tax return for the taxable year of
each designated U.S. person, respectively,
in which or with which the taxable year
of the stand-alone applicable CFC ends
or the specified period of the CFC group
ends.
(ii) Election statement. To make a
safe-harbor election, each designated
U.S. person must attach to its relevant
Federal income tax return or information
return a statement that includes the name
and taxpayer identification number of all
designated U.S. persons, a statement that
a safe-harbor election is being made pur-
suant to §1.163(j)-7(h) and a calculation
that substantiates that the requirements
for making the election are satisfied, and
the taxable year of the stand-alone ap-
plicable CFC or the specified period of
the CFC group, as applicable, for which
the safe-harbor election is being made in
accordance with publications, forms, in-
structions, or other guidance. In the case
of a CFC group, the statement must also
include the name of each CFC group
member and its specified taxable year that
ends with or within the specified period
for which the safe-harbor election is being
made. The statement must be filed in the
manner prescribed in publications, forms,
instructions, or other guidance.
(6) Special rule for taxable years or
specified periods beginning in 2019 or
2020. In the case of a stand-alone appli-
cable CFC, for any taxable year beginning
in 2019 or 2020, paragraph (h)(2)(i) of
this section is applied by substituting “50
percent” for “30 percent.” In the case of a
CFC group, for any specified period be-
ginning in 2019 or 2020, paragraph (h)(2)
(ii)(A) of this section is applied by substi-
tuting “50 percent” for “30 percent.”
* * * * *
(k) Definitions. The following defini-
tions apply for purposes of this section.
(1) Applicable partnership. The term
applicable partnership has the meaning
provided in paragraph (g)(4)(iii) of this
section.
(2) Applicable specified taxable year.
The term applicable specified taxable year
has the meaning provided in paragraph (c)
(3)(iii) of this section.
(3) ATI adjustment amount. The term
ATI adjustment amount has the meaning
provided in paragraph (g)(4)(ii) of this
section.
(4) - (5) [Reserved].
(6) CFC group. The term CFC group
has the meaning provided in paragraph (e)
(2)(i) of this section.

Bulletin No. 2021–5 623 February 1, 2021
(7) CFC group election. The term CFC
group election means the election de-
scribed in paragraph (e)(5) of this section.
(8) CFC group member. The term CFC
group member has the meaning provided
in paragraph (e)(2)(ii) of this section.
(9) [Reserved].
(10) Cumulative section 163(j) pre-
group carryforward limitation. The term
cumulative section 163(j) pre-group car-
ryforward limitation has the meaning pro-
vided in paragraph (c)(3)(iv)(A)(1) of this
section.
(11) Current group. The term current
group has the meaning provided in para-
graph (c)(3)(iv)(A)(2) of this section.
(12) Designated U.S. person. The term
designated U.S. person means—
(i) With respect to a stand-alone ap-
plicable CFC, each controlling domestic
shareholder, as defined in §1.964-1(c)(5)
(i) of the applicable CFC; or
(ii) With respect to a specified group,
the specified group parent, if the specified
group parent is a qualified U.S. person, or
each controlling domestic shareholder, as
defined in §1.964-1(c)(5)(i), of the spec-
ified group parent, if the specified group
parent is an applicable CFC.
(13) ECI deemed corporation. The
term ECI deemed corporation has the
meaning provided in paragraph (f)(1)(i) of
this section.
(14) Effectively connected income.
The term effectively connected income (or
ECI) means income or gain that is ECI,
as defined in §1.884-1(d)(1)(iii), and de-
duction or loss that is allocable to, ECI, as
defined in §1.884-1(d)(1)(iii).
(15) Eligible amount. The term eligible
amount has the meaning provided in para-
graph (h)(3)(i) of this section.
(16) Former group. The term former
group has the meaning provided in para-
graph (c)(3)(iv)(A)(2) of this section.
(17) Loss member. The term loss mem-
ber has the meaning provided in paragraph
(c)(3)(iv)(A)(2) of this section.
(18) Payment amount. The term pay-
ment amount has the meaning provided in
paragraph (g)(4)(i) of this section.
(19) Pre-group disallowed business
interest expense carryforward. The term
pre-group disallowed business interest
expense carryforward means, with respect
to a CFC group member and a specified
taxable year, any disallowed business in-
terest expense carryforward of the CFC
group member that arose in a taxable year
during which the CFC group member (or
its predecessor) was not a CFC group
member of the CFC group.
(20) Qualified tentative taxable in-
come. The term qualified tentative taxable
income has the meaning provided in para-
graph (h)(4) of this section.
(21) Qualified U.S. person. The term
qualified U.S. person has the meaning
provided in paragraph (d)(2)(iv) of this
section.
(22) Relevant period. The term rele-
vant period has the meaning provided in
paragraph (c)(3)(iv)(A)(2) of this section.
(23) Safe-harbor election. The term
safe-harbor election has the meaning pro-
vided in paragraph (h)(1) of this section.
(24) Specified borrower. The term
specified borrower has the meaning pro-
vided in paragraph (g)(4)(i) of this sec-
tion.
(25) Specified group. The term spec-
ified group has the meaning provided in
paragraph (d)(2)(i) of this section.
(26) Specified group member. The term
specified group member has the meaning
provided in paragraph (d)(3) of this sec-
tion.
(27) Specified group parent. The term
specified group parent has the meaning
provided in paragraph (d)(2)(iii) of this
section.
(28) Specified lender. The term spec-
ified lender has the meaning provided in
paragraph (g)(4)(i) of this section.
(29) Specified period—(i) In general.
Except as otherwise provided in para-
graph (k)(29)(ii) of this section, the term
specified period means, with respect to a
specified group—
(A) If the specified group parent is a
qualified U.S. person, the period ending
on the last day of the taxable year of the
specified group parent and beginning on
the first day after the last day of the speci-
fied group’s immediately preceding spec-
ified period; or
(B) If the specified group parent is an
applicable CFC, the period ending on the
last day of the specified group parent’s
required year described in section 898(c)
(1), without regard to section 898(c)(2),
and beginning on the first day after the last
day of the specified group’s immediately
preceding specified period.
(ii) Short specified period. A specified
period begins no earlier than the first date
on which a specified group exists. A spec-
ified period ends on the date a specified
group ceases to exist under paragraph (d)
(2)(vii) of this section. If the last day of
a specified period, as determined under
paragraph (k)(29)(i) of this section, chang-
es, and, but for this paragraph (k)(29)(ii),
the change in the last day of the specified
period would result in the specified period
being longer than 12 months, the speci-
fied period ends on the date on which the
specified period would have ended had the
change not occurred.
(30) Specified taxable year. The term
specified taxable year means, with respect
to an applicable CFC that is a specified
group member of a specified group and a
specified period, a taxable year of the ap-
plicable CFC that ends with or within the
specified period.
(31) Stand-alone applicable CFC. The
term stand-alone applicable CFC means
any applicable CFC that is not a specified
group member.
(32) Stock. The term stock has the
meaning provided in paragraph (d)(2)(v)
of this section.
(l) Examples. The following examples
illustrate the application of this section.
For each example, unless otherwise stat-
ed, no exemptions from the application
of section 163(j) are available, no foreign
corporation has ECI, and all relevant tax-
able years and specified periods begin af-
ter December 31, 2020.
(1) Example 1. Specified taxable years included
in specified period of a specified group—(i) Facts.
As of June 30, Year 1, USP, a domestic corporation,
owns 60 percent of the common stock of FP, which
owns all of the stock of FC1, FC2, and FC3. The re-
maining 40 percent of the common stock of FP is
owned by an unrelated foreign corporation. FP has
a single class of stock. FP acquired the stock of FC3
from an unrelated person on March 22, Year 1. The
acquisition did not result in a change in FC3’s tax-
able year or a close of its taxable year. USP’s inter-
est in FP and FP’s interest in FC1 and FC2 has been
the same for several years. USP has a taxable year
ending June 30, Year 1, which is not a short taxable
year. Each of FP, FC1, FC2, and FC3 are applicable
CFCs. Pursuant to section 898(c)(2), FP and FC1
have taxable years ending May 31, Year 1. Pursu-
ant to section 898(c)(1), FC2 and FC3 have taxable
years ending June 30, Year 1.
(ii) Analysis—(A) Determining a specified group
and specified period of the specified group. Pursu-
ant to paragraph (d) of this section, FP, FC1, FC2,
and FC3 are members of a specified group, and FP
is the specified group parent. Because the specified

February 1, 2021 624 Bulletin No. 2021–5
group parent, FP, is an applicable CFC, the specified
period of the specified group is the period ending on
June 30, Year 1, which is the last day of FP’s required
year described in section 898(c)(1), without regard
to section 898(c)(2), and beginning on July 1, Year
0, which is the first day following the last day of the
specified group’s immediately preceding specified
period (June 30, Year 0). See paragraph (k)(29)(i)(B)
of this section.
(B) Determining the specified taxable years
with respect to the specified period. Pursuant to
paragraph (d)(3) of this section, because each of
FP and FC1 are included in the specified group on
the last day of their taxable years ending May 31,
Year 1, and such taxable years end with or with-
in the specified period ending June 30, Year 1, FP
and FC1 are specified group members with respect
to the specified period ending June 30, Year 1, for
their entire taxable years ending May 31, Year 1,
and those taxable years are specified taxable years.
Similarly, because each of FC2 and FC3 are includ-
ed in the specified group on the last day of their tax-
able years ending June 30, Year 1, and such taxable
years end with or within the specified period ending
June 30, Year 1, FC2 and FC3 are specified group
members with respect to the specified period ending
June 30, Year 1, for their entire taxable years ending
June 30, Year 1, and those taxable years are speci-
fied taxable years. The fact that FC3 was acquired
on March 22, Year 1, does not prevent FC3 from
being a specified group member with respect to the
specified period for the portion of its specified tax-
able year before March 22, Year 1.
(2) Example 2. CFC groups—(i) Facts. The facts
are the same as in Example 1 in paragraph (l)(1)(i)
of this section except that, in addition, a CFC group
election is in place with respect to the specified peri-
od ending June 30, Year 1.
(ii) Analysis. Because a CFC group election is in
place for the specified period ending June 30, Year
1, pursuant to paragraph (e)(2)(ii) of this section,
each specified group member is a CFC group mem-
ber with respect to its specified taxable year ending
with or within the specified period. Accordingly, FP,
FC1, FC2, and FC3 are CFC group members with
respect to the specified period ending June 30, Year
1, for their specified taxable years ending May 31,
Year 1, and June 30, Year 1, respectively. Pursuant to
paragraph (e)(2)(i) of this section, the CFC group for
the specified period ending June 30, Year 1, consists
of FP, FC1, FC2, and FC3 for their specified taxable
years ending May 31, Year 1, and June 30, Year 1,
respectively. Pursuant to paragraph (c)(2) of this sec-
tion, a single section 163(j) limitation is computed
for the specified period ending June 30, Year 1. That
section 163(j) calculation will include FP and FC1’s
specified taxable years ending May 31, Year 1, and
FC2 and FC3’s specified taxable years ending June
30, Year 1.
(3) Example 3. Application of anti-abuse rule—
(i) Facts. USP, a domestic corporation, owns all
of the stock of CFC1 and CFC2. Thus, USP is the
specified group parent of a specified group, the
specified group members of which are CFC1 and
CFC2. USP has a calendar year taxable year. All
specified group members also have a calendar year
taxable year and a functional currency of the U.S.
dollar. CFC1 is organized in, and a tax resident of,
a jurisdiction that imposes no tax on certain types
of income, including interest income. With respect
to Year 1, USP expects to pay no residual U.S. tax
on its income inclusion under section 951A(a)
(GILTI inclusion amount) and expects to have un-
used foreign tax credits in the category described
in section 904(d)(1)(A). A CFC group election is
not in effect for Year 1. With a principal purpose
of reducing USP’s Federal income tax liability in
subsequent taxable years, on January 1, Year 1,
CFC1 loans $100x to CFC2. On December 31,
Year 1, CFC2 pays interest of $10x to CFC1 and re-
pays the principal of $100x. Absent the application
of paragraph (g)(4)(i) of this section, all $10x of
CFC2’s interest expense would be disallowed busi-
ness interest expense and, therefore, CFC2 would
have $10x of disallowed business interest expense
carryforward to Year 2. In Year 2, CFC2 disposes of
one of its businesses at a substantial gain that gives
rise to tested income (within the meaning of section
951A(c)(2)(A) and §1.951A-2(b)(1)). As a result of
the gain being included in the ATI of CFC2, absent
the application of paragraph (g)(4)(i) of this sec-
tion, CFC2 would be allowed to deduct the entire
$10x of disallowed business interest expense car-
ryforward and therefore reduce the amount of its
tested income. Also, USP would pay residual U.S.
tax on its GILTI inclusion amount in Year 2, with-
out regard to the application of paragraph (g)(4)(i)
of this section.
(ii) Analysis. The $10x of business interest ex-
pense paid in Year 1 is a payment amount described
in paragraph (g)(4)(i) of this section because it is be-
tween specified group members, CFC1 and CFC2.
Furthermore, the requirements of paragraphs (g)(4)
(i)(A), (B), and (C) of this section are satisfied be-
cause the $10x of business interest expense is in-
curred with a principal purpose of reducing USP’s
Federal income tax liability; absent the application
of paragraph (g)(4)(i) of this section, the effect of
CFC2 treating the $10x of business interest expense
as disallowed business interest expense in Year 1
would be to reduce USP’s Federal income tax li-
ability in Year 2; and no CFC group election is in
effect with respect to the specified group in Year 1.
Because the requirements of paragraphs (g)(4)(i)
(A), (B), and (C) of this section are satisfied, CFC2’s
ATI for Year 1 is increased by the ATI adjustment
amount, or $33.33x, which is the amount equal to
3 1/3 multiplied by $10x (the lesser of the payment
amount of $10x and the disallowed business interest
expense of $10x). As a result, the $10x of business
interest expense is not disallowed business interest
expense of CFC2 in Year 1, and therefore does not
give rise to a disallowed business interest expense
carryforward to Year 2.
(m) Applicability dates—(1) General
applicability date. Except as provided in
paragraph (m)(2) of this section, this sec-
tion applies for a taxable year of a foreign
corporation beginning on or after Novem-
ber 13, 2020.
(2) Exception. Paragraphs (a), (c)(1),
(c)(2)(i) and (ii), and (c)(3) through (5),
(d), (e), (f)(1), (g)(3) and (4), (h), and (k)
(1) through (3), (6) through (8), and (10)
through (32) of this section apply for a
taxable year of a foreign corporation be-
ginning on or after March 22, 2021.
(3) Early application—(i) Rules for
paragraphs (b) and (g)(1) and (2) of
this section. Taxpayers and their related
parties, within the meaning of sections
267(b) (determined without regard to
section 267(c)(3)) and 707(b)(1), may
choose to apply the rules in paragraphs
(b) and (g)(1) and (2) of this section for
a taxable year beginning after Decem-
ber 31, 2017, and before November 13,
2020, provided that those taxpayers and
their related parties consistently apply
all of those rules and the rules described
in paragraph (m)(4) of this section for
that taxable year. If a taxpayer and its
related parties apply the rules described
in paragraph (m)(4) of this section, as
contained in T.D. 9905 (§§1.163(j)-0
through 1.163(j)-11, effective November
13, 2020), they will be considered as ap-
plying the rules described in paragraph
(m)(4) of this section for purposes of this
paragraph (m)(3)(i).
(ii) Rules for certain other paragraphs
in this section. Taxpayers and their relat-
ed parties, within the meaning of sections
267(b) (determined without regard to sec-
tion 267(c)(3)) and 707(b)(1), may choose
to apply the rules in paragraphs (a), (c)(1),
(c)(2)(i) and (ii), and (c)(3) through (5),
(d), (e), (f)(1), (g)(3) and (4), (h), and (k)
(1) through (3), (6) through (8), and (10)
through (32) of this section for a taxable
year beginning after December 31, 2017,
and before March 22, 2021, provided that
those taxpayers and their related parties
consistently apply all of those rules and the
rules described in paragraph (m)(4) of this
section for that taxable year and for each
subsequent taxable year. If a taxpayer and
its related parties apply the rules described
in paragraph (m)(4) of this section, as con-
tained in T.D. 9905 (§§1.163(j)-0 through
1.163(j)-11, effective November 13, 2020)
as modified by T.D. 9943 (effective Janu-
ary 13, 2021),they will be considered as
applying the rules described in paragraph
(m)(4) of this section for purposes of this
paragraph (m)(3)(ii).
(4) Additional rules that must be ap-
plied consistently. The rules described
in this paragraph (m)(4) are the section
163(j) regulations and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-1,

Bulletin No. 2021–5 625 February 1, 2021
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-
7, 1.383-0, 1.383-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §§1.382-2, 1.382-5, 1.382-6, and 1.383-
1) and 1.1504-4.
(5) Election for prior taxable years
and specified periods. Notwithstanding
paragraph (e)(5)(iii) or (h)(5)(i) of this
section, in the case of a specified period
of a specified group or a taxable year of a
stand-alone applicable CFC that ends with
or within a taxable year of a designated
U.S. person ending before November 13,
2020, a CFC group election or a safe-har-
bor election may be made on an amend-
ed Federal income tax return filed on or
before the due date (taking into account
extensions, if any) of the original Federal
income tax return for the first taxable year
of each designated U.S. person ending on
or after November 13, 2020.
Par. 8. Section 1.163(j)-10 is amended
by:
1. Redesignating paragraph (c)(5)(ii)
(D) as paragraph (c)(5)(ii)(D)(1).
2. Adding a subject heading for para-
graph (c)(5)(ii)(D).
3. Adding paragraph (c)(5)(ii)(D)(2).
4. Redesignating paragraph (f) as para-
graph (f)(1).
5. Adding a subject heading for para-
graph (f).
6. Revising the subject heading for re-
designated paragraph (f)(1).
7. Adding paragraph (f)(2).
The revisions and additions read as fol-
lows:
§1.163(j)-10 Allocation of interest
expense, interest income, and other
items of expense and gross income to an
excepted trade or business.
* * * * *
(c) * * *
(5) * * *
(ii) * * *
(D) Limitations on application of look-
through rules. * * *
(2) Limitation on application of look-
through rule to C corporations. Except
as provided in §1.163(j)-9(h)(4)(iii) and
(iv) (for a REIT or a partnership making
the election under §1.163(j)-9(h)(1) or
(7), respectively), for purposes of apply-
ing the look-through rules in paragraph
(c)(5)(ii)(B) and (C) of this section to
a non-consolidated C corporation (up-
per-tier entity), that upper-tier entity may
not apply these look-through rules to a
lower-tier non-consolidated C corpora-
tion if a principal purpose for borrow-
ing funds at the upper-tier entity level or
adding an upper-tier or lower-tier entity
to the ownership structure is increasing
the amount of the taxpayer’s basis allo-
cable to excepted trades or businesses.
For example, P wholly and directly owns
S1 (the upper-tier entity), which wholly
and directly owns S2. Each of S1 and
S2 is a non-consolidated C corporation
to which the small business exemption
does not apply, and S2 is engaged in an
excepted trade or business. With a princi-
pal purpose of increasing the amount of
basis allocable to its excepted trades or
businesses, P has S1 (rather than S2) bor-
row funds from a third party. S1 may not
look through the stock of S2 (and may
not apply the asset basis look-through
rule described in paragraph (c)(5)(ii)(B)
(2)(iv) of this section) for purposes of P’s
allocation of its basis in its S1 stock be-
tween excepted and non-excepted trades
or businesses; instead, S1 must treat its
stock in S2 as an asset used in a non-ex-
cepted trade or business for that purpose.
However, S1 may look through the stock
of S2 for purposes of S1’s allocation of
its basis in its S2 stock between excepted
and non-excepted trades or businesses.
* * * * *
(f) Applicability dates.
(1) In general. * * *
(2) Paragraph (c)(5)(ii)(D)(2). The
rules contained in paragraph (c)(5)(ii)(D)
(2) of this section apply for taxable years
beginning on or after March 22, 2021.
However, taxpayers may choose to apply
the rules in paragraph (c)(5)(ii)(D)(2) of
this section to a taxable year beginning
after December 31, 2017, and before
March 22, 2021, provided that those tax-
payers and their related parties consis-
tently apply all of the rules in the section
163(j) regulations as contained in T.D.
9905 (§§1.163(j)-0 through 1.163(j)-11,
effective November 13, 2020) as modi-
fied by T.D. 9943 (effective January 13,
2021), and, if applicable, §§1.263A-
9, 1.263A-15, 1.381(c)(20)-1, 1.382-
1, 1.382-2, 1.382-5, 1.382-6, 1.383-0,
1.383-1, 1.469-9, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-
13, 1.1502-21, 1.1502-79, 1.1502-91
through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-
5, 1.382-6, and 1.383-1), and 1.1504-4
contained in T.D. 9905 as modified by
T.D. 9943, to that taxable year and each
subsequent taxable year.
Par. 9. Section 1.469-4 is amended by
adding paragraph (d)(6) to read as follows:
§1.469-4 Definition of activity.
* * * * *
(d) * * *
(6) Activities described in section
163(d)(5)(A)(ii). With respect to any tax-
payer that is an individual, trust, estate,
closely held C corporation or personal
service corporation, an activity described
in §1.469-1T(e)(6) and subject to section
163(d)(5)(A)(ii) that involves the con-
duct of a trade or business which is not a
passive activity of the taxpayer and with
respect to which the taxpayer does not
materially participate may not be grouped
with any other activity or activities of the
taxpayer, including any other activity de-
scribed in §1.469-1T(e)(6) and subject to
section 163(d)(5)(A)(ii).
* * * * *
Par. 10. Section 1.469-9 is amended by
adding paragraphs (b)(2)(ii)(A) and (B) to
read as follows:
§1.469-9 Rules for certain rental real
estate activities.
* * * * *
(b) * * *
(2) * * *
(ii) * * *
(A) Real property development. The
term real property development means
the maintenance and improvement of
raw land to make the land suitable for
subdivision, further development, or
construction of residential or commercial
buildings, or to establish, cultivate, main-
tain or improve timberlands (that is, land
covered by timber-producing forest).
Improvement of land may include any
clearing (such as through the mechani-
cal separation and removal of boulders,
rocks, brush, brushwood, and underbrush

February 1, 2021 626 Bulletin No. 2021–5
from the land); excavation and gradation
work; diversion or redirection of creeks,
streams, rivers, or other sources or bod-
ies of water; and the installation of roads
(including highways, streets, roads, pub-
lic sidewalks, and bridges), utility lines,
sewer and drainage systems, and any oth-
er infrastructure that may be necessary
for subdivision, further development, or
construction of residential or commercial
buildings, or for the establishment, cul-
tivation, maintenance or improvement of
timberlands.
(B) Real property redevelopment. The
term real property redevelopment means
the demolition, deconstruction, separa-
tion, and removal of existing buildings,
landscaping, and infrastructure on a par-
cel of land to return the land to a raw con-
dition or otherwise prepare the land for
new development or construction, or for
the establishment and cultivation of new
timberlands.
* * * * *
Par. 11. Section 1.469-11 is amended
by revising paragraphs (a)(1) and (4) to
read as follows:
§1.469-11 Applicability date and
transition rules.
(a) * * *
(1) The rules contained in §§1.469-1,
1.469-1T, 1.469-2, 1.469-2T, 1.469-3,
1.469-3T, 1.469-4, but not §1.469-4(d)(6),
1.469-5 and 1.469-5T, apply for taxable
years ending after May 10, 1992. The rules
contained in §1.469-4(d)(6) apply for tax-
able years beginning on or after March 22,
2021. However, taxpayers and their relat-
ed parties, within the meaning of sections
267(b) (determined without regard to sec-
tion 267(c)(3)) and 707(b)(1), may choose
to apply the rules in §1.469-4(d)(6) to a
taxable year beginning after December
31, 2017, and before March 22, 2021,
provided that those taxpayers and their
related parties consistently apply all of
the rules in the section 163(j) regulations
as contained in T.D. 9905 (§§1.163(j)-0
through 1.163(j)-11, effective November
13, 2020) as modified by T.D. 9943 (effec-
tive January 13, 2021), and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.383-
0, 1.383-1, 1.469-9, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate
the rules of §§1.382-2, 1.382-5, 1.382-6,
and 1.383-1), and 1.1504-4 contained in
T.D. 9905 as modified by T.D. 9943, to
that taxable year and each subsequent tax-
able year.
* * * * *
(4) The rules contained in §1.469-9(b)
(2), other than paragraphs (b)(2)(ii)(A)
and (B), apply to taxable years beginning
on or after November 13, 2020. Section
1.469-9(b)(2)(ii)(A) and (B) applies to
taxable years beginning on or after March
22, 2021. However, taxpayers and their
related parties, within the meaning of sec-
tions 267(b) (determined without regard
to section 267(c)(3)) and 707(b)(1), may
choose to apply the rules in §1.469-9(b)
(2), other than paragraphs (b)(2)(ii)(A)
and (B), to a taxable year beginning af-
ter December 31, 2017, and on or before
November 13, 2020 and may choose to
apply the rules in §1.469-9(b)(2)(ii)(A)
and (B) to taxable years beginning after
December 31, 2017, and before March 22,
2021, provided that those taxpayers and
their related parties consistently apply all
of the rules in the section 163(j) regula-
tions contained in T.D. 9905 (§§1.163(j)-0
through 1.163(j)-11, effective November
13, 2020) as modified by T.D. 9943 (effec-
tive January 13, 2021), and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.383-
0, 1.383-1, 1.469-9, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate
the rules of §§1.382-2, 1.382-5, 1.382-6,
and 1.383-1), and 1.1504-4, contained in
T.D. 9905 as modified by T.D. 9943, to
that taxable year and each subsequent tax-
able year.
* * * * *
Par. 12. Section 1.1256(e)-2 is added to
read as follows:
§1.1256(e)-2 Special rules for syndicates.
(a) Allocation of losses. For purposes
of section 1256(e)(3), syndicate means
any partnership or other entity (other than
a corporation that is not an S corporation)
if more than 35 percent of the losses of
such entity during the taxable year are al-
located to limited partners or limited en-
trepreneurs (within the meaning of section
461(k)(4)).
(b) Determination of loss amount.
For purposes of section 1256(e)(3), the
amount of losses to be allocated under
paragraph (a) of this section is calculated
without regard to section 163(j).
(c) Example. The following example illustrates
the rules in this section:
(1) Facts. Entity is an S corporation that is equal-
ly owned by individuals A and B. A provides all of
the goods and services provided by Entity. B provid-
ed all of the capital for Entity but does not participate
in Entity’s business. For the current taxable year,
Entity has gross receipts of $5,000,000, non-inter-
est expenses of $4,500,000, and interest expense of
$600,000.
(2) Analysis. Under paragraph (b) of this section,
Entity has a net loss of $100,000 ($5,000,000 minus
$5,100,000) for the current taxable year. One half
(50 percent) of this loss is allocated to B, a limited
owner. Therefore, for the current taxable year, Entity
is a syndicate within the meaning of section 1256(e)
(3)(B).
(d) Applicability date. This section
applies to taxable years beginning on or
after March 22, 2021. However, taxpay-
ers and their related parties, within the
meaning of sections 267(b) (determined
without regard to section 267(c)(3)) and
707(b)(1), may choose to apply the rules
in this section for a taxable year begin-
ning after December 31, 2017, and before
March 22, 2021, provided that those tax-
payers and their related parties consis-
tently apply all of the rules of this section
to that taxable year and each subsequent
taxable year.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: December 30, 2020.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on Jan-
uary 13, 2021, 4:15 p.m., and published in the issue
of the Federal Register for January 19, 2020, 85 F.R.
5496)

Bulletin No. 2021–5 627 February 1, 2021
26 CFR 1.1061-0: Table of contents; 26 CFR
1.1061-1; 26 CFR 1.1061-2; 26 CFR 1.1061-3; 26
CFR 1.1061-4; 26 CFR 1.1061-5; 26 CFR 1.1061-6
T.D. 9945
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Guidance under Section
1061
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations that provide guidance under
section 1061 of the Internal Revenue Code
(Code). Section 1061 recharacterizes cer-
tain net long-term capital gains of a partner
that holds one or more applicable partner-
ship interests as short-term capital gains.
An applicable partnership interest is an in-
terest in a partnership that is transferred to
or held by a taxpayer, directly or indirect-
ly, in connection with the performance of
substantial services by the taxpayer, or any
other related person, in any applicable trade
or business. These final regulations also
amend existing regulations on holding pe-
riods to clarify the holding period of a part-
ner’s interest in a partnership that includes
in whole or in part an applicable partner-
ship interest and/or a profits interest. These
regulations affect taxpayers who directly or
indirectly hold applicable partnership in-
terests in partnerships and the passthrough
entities through which the applicable part-
nership interest is held.
DATES: Effective date: These regulations
are effective on January 13, 2021.
Applicability date: For dates of applica-
bility, see §§1.702-1(g), 1.704-3(f), 1.1061-
1(b), 1.1061-2(c), 1.1061-3(f), 1.1061-4(d),
1.1061-5(g), 1.1061-6(e), and 1.1223-3(g).
FOR FURTHER INFORMATION CON-
TACT: Kara K. Altman or Sonia K. Kothari
at (202) 317-6850 or Wendy L. Kribell at
(202) 317-5279 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regulations
under section 1061 of the Code to amend
the Income Tax Regulations (26 CFR part
1). Section 1061 was added to the Code on
December 22, 2017, by section 13309 of
Public Law 115-97, 131 Stat. 2054 (2017),
commonly referred to as the Tax Cuts and
Jobs Act (TCJA). Section 1061 applies to
taxable years beginning after December 31,
2017. Section 1061 recharacterizes certain
net long-term capital gain with respect to
applicable partnership interests (APIs) as
short-term capital gain.
On August 14, 2020, the Department of
the Treasury (Treasury Department) and
the IRS published a notice of proposed
rulemaking (REG-107213-18) in the Fed-
eral Register (85 FR 49754) containing
proposed regulations under sections 702,
704, 1061, and 1223 of the Code (pro-
posed regulations). The Treasury Depart-
ment and the IRS received written and
electronic comments responding to the
proposed regulations. No public hearing
was requested or held. All comments are
available at www.regulations.gov or upon
request. After full consideration of all
comments timely received, this Treasury
decision adopts the proposed regulations
with modifications in response to the
comments as described in the Summary of
Comments and Explanation of Revisions
section of this preamble.
Summary of Comments and
Explanation of Revisions
Most of the comments addressing the
proposed regulations are summarized in
this Summary of Comments and Expla-
nation of Revisions. However, non-sub-
stantive comments or comments merely
summarizing or interpreting the proposed
regulations, recommending statutory re-
visions, or addressing provisions outside
the scope of these final regulations are not
discussed in this preamble.
The final regulations retain the struc-
ture of the proposed regulations, with cer-
tain revisions. Section 1.1061-1 provides
definitions of the terms used in §§1.1061-
1 through 1.1061-6 of these final regula-
tions (Section 1061 Regulations or final
regulations). Section 1.1061-2 provides
rules and examples regarding APIs and
applicable trades or businesses (ATBs).
Section 1.1061-3 provides guidance on
the exceptions to the definition of an API,
including the capital interest exception.
Section 1.1061-4 provides guidance on
the computation of the Recharacterization
Amount and gives computation examples.
Section 1.1061-5 provides guidance re-
garding the application of section 1061(d)
to transfers to certain related parties. Sec-
tion 1.1061-6 provides reporting rules.
Because the application of section 1061
requires a clear determination of the hold-
ing period of a partnership interest that
is, in whole or in part, an API, the final
regulations also provide clarifying amend-
ments to §1.1223-3. Additional clarify-
ing amendments to §§1.702-1(a)(2) and
1.704-3(e) are also provided.
Part I of this Summary of Comments
and Explanation of Revisions provides
an overview of the statutory provisions
and defined terms used in the proposed
and final regulations. Part II describes the
comments received and revisions made
in response to those comments with re-
spect to the following four areas of the
proposed regulations: (1) the capital in-
terest exception; (2) the treatment of cap-
ital interests acquired with loan proceeds;
(3) the Lookthrough Rule for certain API
dispositions; and (4) transfers of APIs to
Section 1061(d) Related Persons. Part III
discusses additional comments received
and revisions made in other areas of the
proposed regulations. Part IV summariz-
es comments received on issues related to
section 1061 that are beyond the scope of
the regulations and are under study. Part V
discusses applicability dates for the final
regulations. In addition to the revisions
made in response to comments, clarifying
changes have been made throughout the
final regulations.
I. Overview and Defined Terms
A. Section 1061(a): Recharacterization
Amount, Owner Taxpayer, and Related
Concepts
1. Recharacterization Amount
Section 1061(a) recharacterizes as
short-term capital gain the difference be-

February 1, 2021 628 Bulletin No. 2021–5
tween a taxpayer’s net long-term capital
gain with respect to one or more APIs and
the taxpayer’s net long-term capital gain
with respect to these APIs if paragraphs
(3) and (4) of section 1222, which define
the terms long-term capital gain and long-
term capital loss, respectively, for purpos-
es of subtitle A of the Code, are applied
using a three-year holding period instead
of a one-year holding period. The regula-
tions refer to this difference as the Rechar-
acterization Amount. This recharacteriza-
tion is made regardless of any election in
effect under section 83(b).
2. Owner Taxpayers and Passthrough
Entities
The regulations provide that the person
who is subject to Federal income tax on
the Recharacterization Amount is required
to calculate such amounts and refer to this
person as the Owner Taxpayer. Although
an API can be held directly by an Owner
Taxpayer, it also may be held indirectly
through one or more passthrough entities
(Passthrough Entities). A Passthrough
Entity may be a partnership, trust, es-
tate, S corporation, or a passive foreign
investment company (PFIC) with respect
to which the shareholder has a qualified
electing fund (QEF) election in effect.
An API Holder is any person who holds
an API. The regulations provide a frame-
work for determining the Recharacteriza-
tion Amount when an API is held through
one or more tiers of Passthrough Entities
(tiered structure).
3. Gains and Losses Subject to Section
1061
Section 1061(a) applies to a taxpayer’s
net long-term capital gain with respect to
one or more APIs held during the taxable
year. The regulations provide that the de-
termination of a taxpayer’s net long-term
capital gain with respect to the taxpayer’s
APIs held during the taxable year includes
the taxpayer’s combined net distributive
share of long-term capital gain or loss
from all APIs held during the taxable
year and the Owner Taxpayer’s long-term
capital gain and loss from the disposition
of any APIs during the taxable year. The
regulations generally refer to long-term
capital gains and losses recognized with
respect to an API as API Gains and Loss-
es. However, API Gains and Losses do not
include long-term capital gain determined
under sections 1231 and 1256, qualified
dividends described in section 1(h)(11)
(B), and any other capital gain that is char-
acterized as long-term or short-term with-
out regard to the holding period rules in
section 1222, such as capital gain charac-
terized under the identified mixed straddle
rules described in section 1092(b).
Unrealized API Gains and Losses
means, with respect to a Passthrough Enti-
ty’s assets, all unrealized capital gains and
losses that would be realized if those as-
sets were disposed of for fair market value
in a taxable transaction and allocated to an
API Holder with respect to its API, tak-
ing into account the principles of section
704(c). In a tiered structure, API Gains
and Losses and Unrealized API Gains and
Losses retain their character as API Gains
and Losses as they are allocated through
the tiers.
B. Section 1061(c)(1): Definition of an
Applicable Partnership Interest
Section 1061(c)(1) provides that an
API is a partnership interest held by, or
transferred to, a taxpayer, directly or indi-
rectly, in connection with the performance
of substantial services by the taxpayer, or
by any other related person, in any ATB.
For this purpose, the regulations define a
Related Person as a person or entity who
is treated as related to another person or
entity under section 707(b) or 267(b).
Both section 1061(c)(1) and the regula-
tions provide that an API does not include
certain partnership interests held by em-
ployees of entities that are not engaged in
an ATB.
The regulations provide that an API
means any interest in a partnership which,
directly or indirectly, is transferred to
(or is held by) an Owner Taxpayer or
Passthrough Taxpayer in connection with
the performance of substantial services by
the Owner Taxpayer or by a Passthrough
Taxpayer, or by a Related Person, includ-
ing services performed as an employee,
in any ATB unless an exception applies.
There may be one or more Passthrough
Entities between the partnership that orig-
inally issued the API and the Passthrough
Entity in which the Owner Taxpayer
holds its indirect interest in the API. Each
Passthrough Entity in the tiered structure
is treated as holding an API under the reg-
ulations, that is, each Passthrough Entity
is an API Holder as is the Owner Taxpay-
er. An API Holder may be an individual,
partnership, trust, estate, S corporation (as
defined in section 1361(a)(1)), or a PFIC
with respect to which the shareholder has
a QEF election in effect under section
1295.
Section 1061(c)(1), similar to sec-
tion 1061(a), uses the term “taxpayer.”
The proposed regulations provide that an
Owner Taxpayer is the taxpayer for pur-
poses of section 1061(a). The regulations
further provide that the reference to “tax-
payer” in section 1061(c)(1) also includes
a Passthrough Taxpayer. A Passthrough
Taxpayer is a Passthrough Entity that is
treated as a taxpayer for the purpose of de-
termining the existence of an API, regard-
less of whether such Passthrough Taxpay-
er itself is subject to Federal income tax.
Generally, if an interest in a partnership
is transferred to a Passthrough Taxpayer
in connection with the performance of its
own services, the services of its owners,
or the services of persons related to either
such Passthrough Taxpayer or its owners,
the interest is an API as to the Passthrough
Taxpayer. The Passthrough Taxpayer’s
ultimate owners will be treated as Owner
Taxpayers, unless otherwise excepted.
A partnership interest is an API if it was
transferred in connection with the perfor-
mance of substantial services. The regu-
lations presume that services are substan-
tial with respect to a partnership interest
transferred in connection with services.
This presumption is based on the assump-
tion, for purposes of section 1061, that the
parties have economically equated the ser-
vices performed or to be performed with
the potential value of the partnership in-
terest transferred. The regulations provide
that, subject to certain exceptions, once a
partnership interest is an API, it remains
an API and never loses its API character.
C. Section 1061(c)(2): Definition of an
Applicable Trade or Business
Under section 1061, for an interest in a
partnership to be an API, the interest must
be held or transferred in connection with
the performance of substantial services

Bulletin No. 2021–5 629 February 1, 2021
in an ATB. An ATB is defined in section
1061(c)(2) as any activity conducted on a
regular, continuous, and substantial basis
consisting, in whole or in part, of raising
or returning capital, and either (i) invest-
ing in (or disposing of) specified assets
(or identifying specified assets for such
investing or disposition), or (ii) develop-
ing specified assets. The regulations refer
to these actions, respectively, as Raising
or Returning Capital Actions and Invest-
ing or Developing Actions (collectively,
Specified Actions). The regulations pro-
vide that an activity is conducted on a
regular, continuous, and substantial basis
if it meets the ATB Activity Test. The ATB
Activity Test is met if the total level of ac-
tivity (conducted in one or more entities)
meets the level of activity required to es-
tablish a trade or business for purposes of
section 162.
In applying the ATB Activity Test, the
regulations provide that it is not necessary
for both Raising or Returning Capital Ac-
tions and Investing or Developing Actions
to occur in a single taxable year. In that
regard, the combined Specified Actions
are considered together to determine if the
ATB Activity Test is met.
Section 1061(c)(3) provides that spec-
ified assets (Specified Assets) are securi-
ties, as defined in section 475(c)(2) (with-
out regard to the last sentence thereof),
commodities, as defined in section 475(e)
(2), real estate held for rental or invest-
ment, cash or cash equivalents, options or
derivative contracts with respect to any of
the foregoing, and an interest in a partner-
ship to the extent of the partnership’s pro-
portionate interest in any of the foregoing.
The definition of Specified Assets in the
regulations generally tracks the statutory
language. It also includes an option or de-
rivative contract on a partnership interest
to the extent that the partnership interest
represents an interest in other Specified
Assets.
D. Section 1061(c)(4) and Other
Exceptions to API Treatment
Section 1061 includes four exceptions
to the treatment of a profits interest as an
API and the regulations add an additional
exception.
First, the statutory definition of an API
in section 1061(c)(1) excludes an interest
held by a person who is employed by an-
other entity that is conducting a trade or
business (other than an ATB) and provides
services only to such other entity.
Second, section 1061(c)(4)(A) pro-
vides that an API does not include any in-
terest in a partnership directly or indirect-
ly held by a corporation. The regulations
provide that the term “corporation” for
purposes of section 1061(c)(4)(A) does
not include an S corporation for which an
election under section 1362(a) is in effect
or a PFIC with respect to which the share-
holder has a QEF election under section
1295 in effect.
Third, section 1061(c)(4)(B) provides
that an API does not include a capital in-
terest which provides a right to share in
partnership capital commensurate with
(i) the amount of capital contributed (de-
termined at the time of receipt of such
partnership interest), or (ii) the value of
such interest subject to tax under section
83 upon the receipt or vesting of such
interest (the capital interest exception).
The regulations provide that long-term
capital gains and losses with respect to
an API Holder’s capital investment in a
Passthrough Entity, referred to as Capital
Interest Gains and Losses (which can in-
clude allocations and disposition amounts
meeting the requirements), are not subject
to recharacterization under section 1061.
As explained in more detail in Part II.A.
of this Summary of Comments and Expla-
nation of Revisions, to meet this excep-
tion to API treatment, the proposed regu-
lations require allocations to API Holders
(or Passthrough Entities that hold an API
in a lower-tier Passthrough Entity) to be
made in the same manner as to certain oth-
er partners. The final regulations provide
a revised and simplified rule that looks
to whether allocations are commensurate
with capital contributed.
Fourth, section 1061(b) provides that
to the extent provided by the Secretary,
section 1061 will not apply to income or
gain attributable to any asset not held for
portfolio investment on behalf of third
party investors.
Finally, the regulations provide that an
interest in a partnership that was an API in
the hands of the seller will not be treated
as an API in the hands of the purchaser if
the interest is acquired by a bona fide pur-
chaser who (i) does not provide services
in the Relevant ATB to which the acquired
interest relates, (ii) is unrelated to any ser-
vice provider, and (iii) acquired the inter-
est for fair market value.
E. Section 1061(d): Transfer of API to a
Section 1061(d) Related Person
Section 1061(d)(1) provides that if a
taxpayer transfers an API, directly or in-
directly, to a related person described in
section 1061(d)(2), the taxpayer must
include in gross income (as short term
capital gain) the excess of so much of the
taxpayer’s long term capital gains with re-
spect to such interest for the taxable year
attributable to the sale or exchange of any
asset held for not more than 3 years as is
allocable to such interest over any amount
treated as short term capital gain under
section 1061(a).
A related person for purposes of sec-
tion 1061(d)(2) (a Section 1061(d) Relat-
ed Person) is defined more narrowly than
a related person for purposes of section
1061(c)(1) and includes only members of
the taxpayer’s family within the meaning
of section 318(a)(1), the taxpayer’s col-
leagues (those who provided services in
the ATB during certain time periods) and,
under the regulations, a Passthrough Enti-
ty to the extent that a member of the tax-
payer’s family or a colleague is an owner.
F. Section 1061(e): Reporting
Section 1061(e) provides that the Sec-
retary “shall require such reporting (at the
time and in the manner prescribed by the
Secretary) as is necessary to carry out the
purposes of [section 1061].” The regula-
tions set forth the reporting requirements
and include rules for providing informa-
tion required to compute the Recharac-
terization Amount when there is a tiered
structure.
G. Regulatory Authority
Section 1061(f) provides that the Secre-
tary “shall issue such regulations or other
guidance as is necessary or appropriate to
carry out the purposes of [section 1061].”
The legislative history indicates that such
guidance is to address the prevention of
abuse of the purposes of the provision.
See H.R. Conf. Rep. No. 115-466 at 422

February 1, 2021 630 Bulletin No. 2021–5
(2017) (Conference Report); see also Joint
Committee on Taxation, General Explana-
tion of Public Law 115-97, JCS-1-18, at
203 (2017) (Blue Book). The Conference
Report and the Blue Book also state that
the guidance is to address the application
of the provision to tiered structures of en-
tities. See id.
II. Primary Changes to the Proposed
Regulations
The majority of comments received on
the proposed regulations relate to four ar-
eas: (1) the capital interest exception; (2)
the treatment of capital interests acquired
with loan proceeds; (3) the Lookthrough
Rule for certain API dispositions; and
(4) transfers of APIs to Section 1061(d)
Related Persons. After considering these
comments, the Treasury Department and
the IRS have determined that changes in
approach are required for each of these
sections of the final regulations. The re-
mainder of this section generally describes
the comments received in these areas and
the changes made in response. While all
comments timely received were consid-
ered, comments are not described in detail
to the extent that the ancillary concerns
raised by the commenter were resolved by
the changes made to the final regulations.
A. Capital Interest Exception
Section 1061(c)(4)(B) provides that an
API does not include certain capital inter-
ests. The proposed regulations implement
the capital interest exception by excepting
from recharacterization long-term capital
gains and losses that represent a return
on an API Holder’s capital invested in a
Passthrough Entity. The proposed regu-
lations refer to these amounts as Capital
Interest Gains and Losses, and include
in that definition Capital Interest Alloca-
tions, Passthrough Interest Capital Allo-
cations, and Capital Interest Disposition
Amounts that meet the requirements of
proposed §1.1061-3(c)(3) through (6).
The majority of comments received
regarding the capital interest exception
suggested that the rules in the proposed
regulations are too rigid and do not reflect
many common business arrangements,
resulting in many capital interest holders
being denied eligibility for the exception.
Commenters described a variety of con-
cerns, detailed in this Part II.A.
The final regulations provide a revised
and simplified rule that looks to whether
allocations are commensurate with capital
contributed. An allocation will be consid-
ered a Capital Interest Allocation if the al-
location to the API Holder with respect to
its capital interest is determined and cal-
culated in a similar manner to the alloca-
tions with respect to capital interests held
by similarly situated Unrelated Non-Ser-
vice Partners who have made significant
aggregate capital contributions.
1. Capital Interest Allocations, In General
Proposed §1.1061-3(c)(3) provides that
for an allocation to be treated as a Capital
Interest Allocation or a Passthrough Inter-
est Capital Allocation, the allocation must
be one made in the same manner to all part-
ners. As described further in part II.A.2. of
this Summary of Comments and Explana-
tion of Provisions, proposed §1.1061-3(c)
(4) further provides, in part, that Capital
Interest Allocations are allocations of
long-term capital gain or loss make to an
API Holder and to Unrelated Non-Service
Partners based on their respective capital
account balances where the Unrelated
Non-Service Partners have a significant
aggregate capital account balance equal
to five percent or more of the aggregate
capital account balance of the partnership
are the time the allocations are made. The
proposed regulations also indicate that in
general, an allocation will be deemed to
satisfy the “same manner” requirement
if, under the partnership agreement, the
allocation is based on the relative capital
accounts of the partners (or Passthrough
Entity owners) who are receiving the al-
location in question and the terms, prior-
ity, type and level of risk, rate of return,
and rights to cash or property distributions
during the partnership’s operations and on
liquidation are the same. Allocations to an
API Holder may be subordinated to allo-
cations to Unrelated Non-Service Partners
or reduced by the cost of services provid-
ed by such API Holder or a Related Per-
son. Under proposed §1.1061-3(c)(3)(ii),
in the case of a partnership that maintains
capital accounts under §1.704-1(b)(2)(iv),
the allocation must be tested based on that
partner’s capital account. In the case of a
Passthrough Entity that is not a partner-
ship (or a partnership that does not main-
tain capital accounts under §1.704-1(b)(2)
(iv)), if the Passthrough Entity maintains
and determines accounts for its owners
using principles similar to those provided
under §1.704-1(b)(2)(iv), those accounts
will be treated as a capital account for pur-
poses of the proposed regulations.
Several commenters noted that requir-
ing allocations be made in accordance
with partners’ overall section 704(b) cap-
ital accounts in a fund does not comport
with the commercial reality of how most
venture capital, private equity funds, and
hedge funds make their allocations, and
would preclude API Holders from ever
utilizing the capital interest exception.
One commenter noted that many bona fide
partnerships use targeted allocations and
questioned whether it is fair to exclude
partnerships that do not maintain section
704(b) capital or similar accounts from the
capital interest exception when those capi-
tal accounts lack economic significance in
the business arrangement. The commenter
asked the same question about partner-
ships that maintain capital accounts using
generally accepted accounting principles
(GAAP).
Several commenters objected to
the “same manner” requirement on the
grounds that it did not properly implement
section 1061(c)(4)(B), which provides, in
part, that an API “shall not include any cap-
ital interest in the partnership which pro-
vides the taxpayer with a right to share in
partnership capital commensurate with...
the amount of capital contributed” by such
partner. Commenters explained that while
fund managers may earn an economic re-
turn on both their capital investment and
their APIs, they generally do not have the
same economic rights with respect to their
capital investment that the limited part-
ners in the fund have with respect to their
capital investment. For example, com-
menters indicated that an API Holder may
be entitled to tax distributions, may have
different allocations of expenses, may be
subject to regulatory allocations (for ex-
ample, minimum gain chargeback, as de-
scribed in §1.704-2), and may have differ-
ent withdrawal or liquidity rights, which
might be more or less favorable than those
provided to Unrelated Non-Service Part-
ners. Commenters indicated there could

Bulletin No. 2021–5 631 February 1, 2021
be varying liquidity rights between Un-
related Non-Service Partners and noted
that API Holders’ capital may be subject
to more risk than Unrelated Non-Service
Partners’ capital in that API Holders may
bear the first risk of loss. In the case of
hedge funds, commenters noted that lim-
ited partners may invest at different times
and, as such, earn a return that may not
be comparable to other limited partners’
returns.
In addition, several commenters ex-
plained that economic rights and alloca-
tions in private equity and venture capital
funds are frequently determined and made
on a deal-by-deal basis, including alloca-
tions made in a tiered structure by an API
Holder that is a Passthrough Entity, and
that funds may have multiple classes of
interests with different rights and obliga-
tions, meaning that economic rights and
allocations are rarely, if ever, aligned with
respect to all partners based on the part-
ners’ section 704(b) capital accounts.
For the aforementioned reasons, sev-
eral commenters recommended that the
“same manner” requirement be elimi-
nated and replaced with a rule that per-
mits distributions and allocations to an
API Holder, who contributes capital to a
fund, to be “commensurate” with capital
contributed by Unrelated Non-Service
partners. Similarly, one commenter sug-
gested that the only requirement be that
an allocation to an API Holder be calcu-
lated and determined in a similar manner
as the allocations to similarly situated
Unrelated Non-Service Partners. Several
commenters suggested that funds should
be able to establish that they satisfied the
“commensurate” standard using any rea-
sonable method.
Commenters also recommended that
the scope of the term “cost of services”
as used in the proposed regulations be
further explained, noting that situations
where API Holders’ capital investments
are not subject to management fees, while
other investors’ interests are subject to
management fees, should not prevent the
API Holders’ capital interests from qual-
ifying for the capital interest exception.
Commenters recommended that the final
regulations clarify the meaning of the
term “cost of services” and specify that an
API Holder’s capital investment that is not
subject to incentive payments or to man-
agement fees may still be eligible for the
capital interest exception.
Because private equity and hedge funds
operate differently, commenters suggested
that there should be separate rules, tai-
lored to each structure, with respect to the
capital interest exception. The comment-
ers alluded to the notion that, although pri-
vate equity and hedge funds each operate
within a certain blueprint, there are many
variations.
The Treasury Department and the IRS
generally agree with commenters that un-
der the test in the proposed regulations,
it might be difficult for some common
business arrangements to meet the cap-
ital interest exception and that a partner
comparison, based on capital contributed
rather than the partners’ section 704(b)
capital accounts, would be more accu-
rate in determining whether an interest
qualifies for the capital interest exception.
Accordingly, the final regulations provide
that Capital Interest Allocations must be
commensurate with capital contributed
in order to qualify for the capital interest
exception. The final regulations replace
the requirement that allocations be made
to all partners in the same manner with a
requirement that an allocation to an API
Holder with respect to its capital interest
must be determined and calculated in a
similar manner as the allocations with re-
spect to capital interests held by similarly
situated Unrelated Non-Service Partners
who have made significant aggregate
capital contributions. In this regard, the
allocations and distribution rights with
respect to API Holders’ capital interests
and the capital interests of Unrelated
Non-Service Partners who have made
significant aggregate capital contributions
must be reasonably consistent. The similar
manner test may be applied on an invest-
ment-by-investment basis or on the basis
of allocations made to a particular class of
interests. The final regulations retain the
factors used in the proposed regulations to
determine whether allocations and distri-
bution rights are made in a similar manner
among partners: the amount and timing of
capital contributed, the rate of return on
capital contributed, the terms, priority, the
type and level of risk associated with cap-
ital contributed, and the rights to cash or
property distributions during the partner-
ship’s operations and on liquidation. The
final regulations maintain the rule that an
allocation to an API Holder will not fail
to qualify solely because the allocation is
subordinated to allocations made to Unre-
lated Non-Service Partners or because an
allocation to an API Holder is not reduced
by the cost of services provided by the API
Holder or a Related Person to the partner-
ship. The final regulations also clarify the
meaning of cost of services for this pur-
pose. The fact that API Holders are not
charged management fees on their capital
or that their capital is not subject to allo-
cations of API items will not prevent the
API Holder’s capital interest from being
eligible for the capital interest exception.
Similarly, an allocation to an API Holder
will not fail if an API Holder has a right to
receive tax distributions while Unrelated
Non-Service Partners do not have such a
right, where such distributions are treated
as advances against future distributions.
The final regulations extend these con-
cepts to allocations made through tiered
structures. The final regulations remove
the terms Passthrough Capital Allocation,
Passthrough Interest Capital Allocation,
and Passthrough Interest Direct Invest-
ment Allocation, and instead provide
that an allocation made to a Passthrough
Entity that holds an API in a lower-tier
Passthrough Entity will be considered a
Capital Interest Allocation if made in ac-
cordance with the principles applicable in
determining Capital Interest Allocations.
Under the final regulations, Capital Inter-
est Allocations retain their character when
allocated to an upper-tier partnership so
long as they are allocated among the part-
ners in the upper-tier partnership with re-
spect to such partners’ capital interests in
a manner that is respected under section
704(b) (taking the principles of section
704(c) into account).
Because the revised rules provide suffi-
cient flexibility for all structures, the final
regulations do not adopt the suggestion to
provide a separate set of rules for private
equity and hedge funds. The Treasury De-
partment and the IRS continue to study
other issues raised by the commenters,
including the application of the similar
manner requirement to S corporations and
the application of the capital interest ex-
ception to co-invest vehicles.
The Treasury Department and the IRS
request any additional comments on the

February 1, 2021 632 Bulletin No. 2021–5
application of the capital interest excep-
tion in the final regulations.
2. Unrelated Non-Service Partner
Requirement
As discussed in the prior section, pro-
posed §1.1061-3(c)(4) provides additional
guidance on Capital Interest Allocations.
Under the proposed regulations, Capi-
tal Interest Allocations are allocations of
long-term capital gain or loss made under
the partnership agreement to an API Hold-
er and to Unrelated Non-Service Partners
based on their respective capital accounts
and which meet other requirements. Un-
related Non-Service Partners are defined
in proposed §1.1061-1(a) as partners who
have not provided services to the Rele-
vant ATB and who are not, and have nev-
er been, related to any API Holder in the
partnership or any person who provides,
or has provided, services in the Relevant
ATB. Proposed §1.1061-3(c)(4) specifies
that Capital Interest Allocations must be
made in the same manner to API Holders
and to Unrelated Non-Service Partners
with a significant aggregate capital ac-
count balance (defined as five percent or
more of the aggregate capital account bal-
ance of the partnership at the time the allo-
cations are made). Proposed §1.1061-3(c)
(4)(iii) provides that the allocations to the
API Holder and the Unrelated Non-Ser-
vice Partners must be clearly identified
both under the partnership agreement and
on the partnership’s books and records as
separate and apart from allocations made
to the API Holder with respect to its API.
The partnership agreement and the part-
nership books and records must also clear-
ly demonstrate that the requirements for
an allocation to be considered a Capital
Interest Allocation have been met.
For allocations made on a deal-by-deal
or class-by-class basis, commenters noted
that it is unclear if the requirement that al-
locations be made in the same manner to
API Holders and Unrelated Non-Service
Partners with a significant aggregate cap-
ital account balance applies to each deal
or class, or if it applies only to a fund gen-
erally. One commenter suggested that as
an alternative to a strict percentage test,
funds should also be able to satisfy the
test by establishing that the return on a
class of equity was determined at arm’s
length. Another commenter noted that a
specific number or percentage of Unrelat-
ed Non-Service Partners must comprise
the test group to prevent easy avoidance
of the statute but questioned whether the
five percent threshold for the test group is
the appropriate threshold. The commenter
also asked for clarification on the effect of
the rule in proposed §1.1061-3(c)(3)(ii)
(C) that a capital account, for these pur-
poses, does not include the contribution
of amounts attributable to loans made by
other partners or the partnership when
comparing the allocations made to API
Holders and Unrelated Non-Service Part-
ners.
One commenter stated that many funds
would be unable to meet the requirement
that allocations to the API Holder and the
Unrelated Non-Service Partners be clear-
ly identified in the partnership agreement
because their agreements use liquidating
distributions to govern an API Holder’s
rights with respect to its API rather than
allocations. The commenter recommend-
ed that the requirement be considered sat-
isfied if the distribution provision clearly
identified capital interest distributions
separate and apart from distributions with
respect to APIs. Several other commenters
suggested that the rule requiring the allo-
cations to be clearly identified both under
the partnership agreement and on the part-
nership’s books and records be disjunc-
tive, that is, that the allocations be clear-
ly demarcated in either the partnership
agreement or on the partnership’s books
and records. Commenters noted that in or-
der to meet the partnership agreement re-
porting requirement, a fund would have to
update its partnership agreements, which
could be done only by negotiating with the
Unrelated Non-Service Partners. Initiating
those negotiations could cause partners to
want to negotiate other partnership items,
which could take time and alter the agree-
ments. These commenters thus suggested
grandfathering existing partnership agree-
ments or providing a transition period for
funds to update their agreements to com-
ply with this requirement.
The final regulations retain the require-
ment that Capital Interest Allocations to
an API Holder be compared to Capital
Interest Allocations made to Unrelated
Non-Service Partners, as well as the re-
quirement that Capital Interest Alloca-
tions be made to Unrelated Non-Service
Partners with a significant capital account
balance, including the five percent thresh-
old. The Treasury Department and the IRS
considered a number of alternatives and
determined that the five percent thresh-
old adequately insures that there is a sig-
nificant comparison to meet the statutory
exception that an API does not include a
capital interest which provides the API
Holder with a right to share in partnership
capital commensurate with the amount of
capital contributed. In accordance with
the provision that the similar manner test
in the final regulations may be applied on
an investment-by-investment or class-by-
class basis, the final regulations specify
that the Unrelated Non-Service Partner
requirement can also be applied on an
investment-by-investment basis, or on a
class-by-class basis. The final regulations
move the definition of Capital Interest Al-
locations to the definition section of the fi-
nal regulations but retain the requirement
that allocations with respect to, and corre-
sponding to, contributed capital be clear-
ly identified under both the partnership
agreement and in the partnership’s books
and records as separate and apart from al-
locations made to the API Holder with re-
spect to its API, and specify that the books
and records must be contemporaneous.
Documenting the allocations in the part-
nership agreement and in contemporane-
ous books and records is a necessary cor-
ollary to the rule requiring Capital Interest
Allocations to be made in a similar man-
ner between API Holders and Unrelated
Non-Service Partners with a significant
interest, because it shows that the part-
nership’s Unrelated Non-Service Partners
considered these allocations a valid return
on their contributed capital.
The final regulations do not include a
rule that would grandfather existing part-
nership agreements or provide a transition
period for partnerships to update their
agreements. Because the final regulations
more closely align the capital interest ex-
ception to standard industry practice, the
number of partnership agreements that
will need to be amended is reduced. Al-
locations made to an API Holder that do
not meet the requirements of these final
regulations will not be considered Capital
Interest Allocations. Finally, due to the re-
visions made to the capital interest excep-

Bulletin No. 2021–5 633 February 1, 2021
tion in these final regulations, the Treasury
and the IRS have determined that it is not
necessary to clarify the effect that the rule
disregarding contributions made with the
proceeds of loans by other partners or by
the partnership has on the comparison of
the allocation made to API Holders and
Unrelated Non-Service Partners.
3. Capital Interest Disposition Amounts
If an owner disposes of an interest in
a Passthrough Entity that is composed of
a capital interest and an API, proposed
§1.1061-3(c)(6) provides a mechanism
for the owner to determine the portion of
long-term capital gain or loss recognized
on the disposition that is treated as a Cap-
ital Interest Disposition Amount and thus,
a Capital Interest Gain or Loss.
The final regulations clarify the deter-
mination of an API Holder’s Capital In-
terest Disposition Amount when the API
Holder transfers a Passthrough Entity in-
terest that is comprised of both an API and
a capital interest at a gain and would be
allocated only capital loss as a Capital In-
terest Allocation if all of the assets of the
Passthrough Entity had been sold for their
fair market value in a fully taxable trans-
action immediately before the interest
transfer. In such an instance, the final reg-
ulations provide that all of the long-term
capital gain attributable to the interest
transfer is API Gain. Conversely, if such
API Holder recognizes long-term capital
loss on the transfer of a Passthrough En-
tity interest and would be allocated only
capital gain as a Capital Interest Alloca-
tion if all of the assets of the Passthrough
Entity had been sold for their fair market
value in a fully taxable transaction im-
mediately before the interest transfer, the
final regulations provide that all of the
long-term capital loss attributable to the
interest transfer is API Loss. The final
regulations provide additional rules where
a transferred Passthrough Entity interest
results in a gain and the transferor would
have been allocated both Capital Inter-
est Gain and API Gain as well as where
a transferred Passthrough Entity interest
results in a loss and the transferor would
have been allocated both Capital Interest
Loss and API Loss. In such instances, a
fraction is used to determine the portion of
the transferred interest gain or loss char-
acterized as a Capital Interest Disposition
Amount.
Commenters noted a concern that Ex-
ample 5 in proposed regulation §1.1061-
3(c)(7)(v), did not adequately address
basis proration upon a partial interest
sale where a partner holds a partnership
interest comprised of both an API and a
capital interest. Specifically, one com-
menter noted that Example 5’s reliance on
the equitable apportionment approach of
§1.61-6(a) could lead to a situation where
the characterization of the gain or loss at-
tributable to the sale of a portion of the
partner’s partnership interest differs from
the characterization of that partner’s dis-
tributive share of asset gain or loss if all of
the assets of the Passthrough Entity were
sold for their fair market value in a fully
taxable transaction. Another commenter
suggested applying the specific identifica-
tion rules in §1.1223-3 applicable to pub-
licly traded partnership units to transfers
of private interests. These commenters
noted that because the issue illustrated in
Example 5 has ramifications beyond sec-
tion 1061, further study should occur be-
fore proceeding with the position stated in
Example 5.
The Treasury Department and the IRS
continue to study the issue noted with
respect to Example 5 and have removed
the example in the interim as many of the
concerns raised on the sale of a partial
partnership interest extend beyond section
1061.
4. Unrealized API Gains and Losses
Proposed §1.1061-1(a) defines Unre-
alized API Gains and Losses as all unre-
alized capital gains and losses, including
both short-term and long-term, that would
be allocated to an API Holder with respect
to its API if all relevant assets were dis-
posed of for fair market value in a taxable
transaction on the relevant date. Proposed
§1.1061-2(a)(1)(ii) provides rules for the
treatment of Unrealized API Gains and
Losses, including the requirement to de-
termine Unrealized API Gains and Losses
in tiered structures. Proposed §1.1061-
3(c)(3)(iii) provides that Capital Interest
Allocations and Passthrough Interest Cap-
ital Allocations do not include amounts
treated as API Gains and Losses or Unre-
alized API Gains and Losses.
A commenter stated that the require-
ment to determine Unrealized API Gains
and Losses in tiered structures is not rea-
sonable because an upper-tier Passthrough
Entity would not be able to require every
uncontrolled lower-tier Passthrough Enti-
ty in the chain to revalue its assets under
the principles of §1.704-1(b)(2)(iv)(f).
The commenter recommended that the
mandatory section 1061 revaluation rules
be eliminated. The commenter requested
instead that the existing rules for revalua-
tions under the section 704(b) and 704(c)
regulations govern Unrealized API Gains
and Losses. Alternatively, the commenter
suggested that anti-abuse regulations be
written to address revaluations in chains
of controlled tiered partnerships.
The final regulations remove the man-
datory revaluation rules and adopt the
commenter’s suggestion that Unrealized
API Gains and Losses be determined ac-
cording to the existing rules governing
unrealized gains and losses, including
section 704(c) principles. Accordingly,
the final regulations provide that the term
Unrealized API Gains and Losses means,
with respect to a Passthrough Entity’s as-
sets, all unrealized capital gains and losses
that would be (i) realized if those assets
were disposed of for fair market value in
a taxable transaction on the relevant date,
and (ii) allocated to an API Holder with
respect to its API, taking into account the
principles of section 704(c).
Because the proposed regulations pro-
vide that Capital Interest Allocations are
made based on partners’ relative section
704(b) capital accounts, several com-
menters questioned whether Unrealized
API Gains and Losses that are reflected
in an API Holder’s capital account could
generate Capital Interest Allocations, in-
cluding book Capital Interest Allocations,
before these amounts are recognized.
Commenters explained that these issues
are particularly relevant for hedge funds
and described their operations and incen-
tive structure. When an API Holder in a
hedge fund receives incentive allocations
with respect to the API, its capital account
is increased by the amount of the incentive
allocation, and Unrelated Non-Service
Partners’ capital accounts are decreased.
This increase is coupled with allocations
of taxable income and gain and also al-
locations of unrealized gain (reverse

February 1, 2021 634 Bulletin No. 2021–5
section 704(c) allocations). Commenters
also requested additional guidance on the
treatment of realized and unrealized gains
from an API which are contributed to, or
reinvested in, a partnership.
The final regulations continue to pro-
vide that Unrealized API Gains and Loss-
es are not included in Capital Interest
Gains and Losses. In response to com-
ments, the final regulations clarify that if
an API Holder is allocated API Gain by a
Passthrough Entity, to the extent that an
amount equal to the API Gain is reinvest-
ed in Passthrough Entity by the API Hold-
er (either as the result of an actual distri-
bution and recontribution of the API Gain
amount or the retention of the API Gain
amount by the Passthrough Entity), the
amount will be treated as a contribution to
the Passthrough Entity for a capital inter-
est that may produce Capital Interest Allo-
cations for the API Holder, provided such
allocations otherwise meet the require-
ments to be a Capital Interest Allocation.
B. Capital contributions made with the
proceeds of partnership or partner loans.
Proposed §1.1061-3(c)(3)(ii)(C) pro-
vides that for purposes of proposed
§§1.1061-1 through 1.1061-6, a capital
account does not include the contribution
of amounts directly or indirectly attribut-
able to any loan or other advance made or
guaranteed, directly or indirectly, by any
other partner, the partnership, or a Related
Person with respect to any other partner or
the partnership. Repayments on the loan
are included in capital accounts as those
amounts are paid by the partner, provided
that the loan is not repaid with the pro-
ceeds of another similarly sourced loan.
Id.
Several commenters criticized this
treatment, suggesting that the exclusion of
these amounts from the partner’s capital
account inhibits common and reasonable
business practices, and creates barriers
to entry for service partners, particularly
those who are less represented based on
age, gender, or race or do not have ready
access to capital. One commenter noted
that it is typical for fund managers to ei-
ther extend loans to their employees, or to
guarantee loans issued to such employees
by third parties, so that employees may
invest in the manager’s own investment
funds. Similarly, another commenter stat-
ed that the proposed regulations would
introduce a substantial impediment to
raising capital for commercial real estate
investment by creating a disincentive for
general partners to finance or support the
financing of the participation of its em-
ployees in its commercial real estate in-
vestments. The commenter claimed that
contributions made in this manner are a
significant source of capital available for
real estate investment and also an import-
ant factor in attracting third party capital
because they create an alignment of inter-
est between the limited partners and the
general partner and its employees.
Commenters noted that neither the
statute nor the legislative history indicates
that the use of loan proceeds to make a
capital contribution precludes the interest
from being included in a partner’s capital
account and contended that adding such
a rule is not justified by the commensu-
rate with capital statutory language of the
capital interest exception. To the contrary,
commenters argued that the authors of the
TCJA were familiar with prior proposals
regarding profits interests that contained
exceptions for loaned capital and their
decision not to include such an excep-
tion in section 1061 is an indication that
the choice was intentional. Instead, one
commenter maintained that Congress ad-
dressed any concerns through the rule that
a service provider’s rights with respect
to its contributed capital must match the
rights of other non-service partners with
respect to their shares of contributed cap-
ital.
Some commenters recognized that the
exclusion from capital accounts of contri-
butions attributable to partner or partner-
ship loans is an attempt to control the per-
ceived abuse of limited partners loaning
the general partner of the partnership an
amount of capital that entitles the gener-
al partner to a portion of the partnership’s
profits in order to avoid the application of
section 1061 and fit within the capital in-
terest exception. Commenters noted that
section 1061(f) provides the Secretary
with authority to issue guidance as is nec-
essary or appropriate to carry out the pur-
poses of section 1061 and that the legisla-
tive history indicates that such guidance is
to address the prevention of abuse of the
purposes of the provision.
Other commenters, suggesting that the
policy behind the capital interest excep-
tion is to ensure a partner has capital at
risk to qualify for the exception, acknowl-
edged that there are fact patterns in which
a partner might be considered less at risk.
One commenter pointed to the at-risk lim-
itation on losses under section 465, noting
that a service provider would not be con-
sidered at-risk with respect to contributed
capital that is financed through a loan from
another partner, even if the loan were fully
recourse to the service provider. By con-
trast, a partner is considered at-risk when
an investment is funded by a third-party
loan for which the partner has personal li-
ability. Another commenter noted that the
proposed regulations’ treatment of a capi-
tal interest funded through a loan from the
issuing partnership is consistent with the
treatment of partnership loans under oth-
er areas of Subchapter K. The commenter
pointed out that the contribution of a part-
ner’s own promissory note generally does
not increase the partner’s basis in its part-
nership interest under section 722. Simi-
larly, pursuant to §1.704-1(b)(2)(iv)(d)
(2), the partner’s capital account will be
increased with respect to the promissory
note only when there is a taxable disposi-
tion of the note by the partnership or when
the partner makes principal payments on
such note, provided that the note is not
readily tradable on an established securi-
ties market.
Despite recognizing these concerns
regarding abuse, commenters maintained
that the loan proceeds exclusion should
be eliminated because general income tax
principles, such as those in sections 83 and
7872, are sufficient to determine whether
a loan-financed arrangement should not
qualify for the capital interest exception.
Other commenters suggested that if lim-
itations must be imposed, the rule should
be narrowly tailored, recommending that
only loans that are nonrecourse or lack
substantial security be excluded from the
capital interest exception. Commenters
also suggested that guarantees should not
be treated in the same manner as a loan,
particularly in the context of a recourse
loan or a loan from a third-party bank. An-
other commenter suggested that if the loan
or guarantee operates under normal arms-
length standards, it should be eligible to
support a capital contribution. Another

Bulletin No. 2021–5 635 February 1, 2021
commenter noted that the proposed reg-
ulations are silent on loans that are fully
secured with partnership assets.
The Treasury Department and the IRS
remain concerned that capital contribu-
tions made with the proceeds of loans
made or guaranteed by another partner,
the partnership, or a Related Person with
respect to such partner or partnership
could lead to abuse of the capital interest
exception. Therefore, the final regulations
do not adopt the suggestions to remove the
rule. However, the Treasury Department
and the IRS agree with commenters that
the potential for abuse is reduced when a
loan or advance is made by another part-
ner (or Related Person with respect to such
other partner, other than the partnership) to
an individual service provider if the indi-
vidual service provider is personally liable
for the repayment of such loan or advance.
Accordingly, the final regulations provide
that an allocation will be treated as a Cap-
ital Interest Allocation if the allocation is
attributable to a contribution made by an
individual service provider that, directly
or indirectly, results from, or is attribut-
able to, a loan or advance from another
partner in the partnership (or any Relat-
ed Person with respect to such lending or
advancing partner, other than the partner-
ship) to such individual service provider if
the individual service provider is person-
ally liable for the repayment of such loan
or advance as described in the final regula-
tions. The final regulations apply a similar
approach with respect to loans or advanc-
es made by a partner in the partnership
(or a Related Person to such partner, other
than the partnership) to a wholly owned
entity that is disregarded as separate from
an individual service provider where the
individual service provider that owns such
disregarded entity is personally liable for
the repayment of any borrowed amounts
that are not repaid by the disregarded en-
tity. The final regulations provide that an
individual service provider is personally
liable for the repayment of a loan or ad-
vance made by a partner (or any Related
Person, other than the partnership) if (i)
the loan or advance is fully recourse to the
individual service provider; (ii) the indi-
vidual service provider has no right to re-
imbursement from any other person; and
(iii) the loan or advance is not guaranteed
by any other person. The Treasury Depart-
ment and the IRS continue to study the
treatment of guarantees generally in light
of questions about who the borrower is for
Federal tax purposes.
A commenter noted that the proposed
regulations’ treatment of loans, together
with the section 704(b) capital account
approach being taken with respect to the
capital interest exception, could mean
that a partner who borrows from a relat-
ed person to make even a small portion
of his or her capital contribution might be
denied the capital interest exception with
respect to his or her entire capital interest.
A few commenters recommended that if
the treatment of related party loans is re-
tained in the final regulations, adjustments
should be made to ensure that partners are
able to receive appropriate credit for cap-
ital contributions they make that are not
attributable to loans. Another commenter
stated that the proposed regulations did
not provide a tracing regime to connect
loan proceeds with capital contributions.
One commenter suggested that final reg-
ulations clarify how to treat a partner that
fully funded a capital contribution with
loan proceeds but repaid such amounts
before there was a capital interest allo-
cation, including whether a revaluation
would change the answer. The commenter
recommended that it would be appropri-
ate to treat the partner’s capital account as
funded at the time of actual contribution.
Finally, the commenter recommended
that final regulations include a transition
rule related to related party loans made,
advanced, guaranteed, or repaid before
final regulations are issued. The Trea-
sury Department and the IRS considered
these comments and believe that the con-
cerns raised in them are resolved by the
commensurate with capital approach to
the capital interest exception taken in the
final regulations because this approach
does not rely on a comparison of alloca-
tions based on the partners’ overall section
704(b) capital accounts.
C. Lookthrough Rule for Certain API
Dispositions
Proposed §1.1061-4(b)(9) provides a
limited Lookthrough Rule that may apply
to the sale of an API where capital gain
is recognized and the holding period of
the API is more than three years. In the
case of a disposition of a directly held
API with a holding period of more than
three years, the proposed Lookthrough
Rule applies if the assets of the partner-
ship in which the API is held meet the
Substantially All Test. The Substantially
All Test is met if 80 percent or more of
the assets of the partnership in which the
API is held, based on fair market value,
are assets that would produce capital gain
or loss that is not described in proposed
§1.1061-4(b)(6) if disposed of by the part-
nership, and that have a holding period of
three years or less. In the case of a tiered
structure in which an API Holder holds
its API through one or more Passthrough
Entities, the Lookthrough Rule applies if
the API Holder disposes of a Passthrough
Interest held for more than three years and
recognizes capital gain, and either: (i) the
Passthrough Entity through which the API
is directly or indirectly held has a holding
period in the API that is three years or
less, or (ii) the Passthrough Entity through
which the API is held has a holding period
in the API of more than three years and the
assets of the partnership in which the API
is held meet the Substantially All Test.
The Treasury Department and the IRS
received several comments stating that, al-
though the application of the Lookthrough
Rule for directly-held APIs is reasonable,
the application of the Lookthrough Rule
for indirectly-held APIs is punitive and
imposes an unreasonable and significant
administrative burden. The commenters
recommended that the scope of the Look-
through Rule for indirectly-held APIs be
limited, particularly in the case of indi-
rectly-held APIs where the relevant tax-
payer does not control a partnership that
issued the API. Another commenter ques-
tioned the authority for the Lookthrough
Rule but noted that it is consistent with
partnership tax principles and that the pro-
posed regulation would be easily manipu-
lated without the rule.
Commenters suggested that the pro-
posed regulations be amended in one or
more of the following ways: (i) limit the
Lookthrough Rule to situations in which a
Passthrough Entity controls all of the rel-
evant lower-tier Passthrough Entities (or
only applying it to lower-tier Passthrough
Entities that it controls); (ii) limit the
Lookthrough Rule for indirectly held APIs
to situations in which the API is held by

February 1, 2021 636 Bulletin No. 2021–5
a lower-tier Passthrough Entity for three
years or less; (iii) limit the application
of the Lookthrough Rule to situations in
which assets that produce capital gain or
loss of a type taken into account under
section 1061 are a material amount (great-
er than 50 percent) of the value of the
underlying assets of the partnership; (iv)
eliminate the Substantially All Test in the
context of tiered structures (that is, deter-
mine the applicability of the Substantially
All Test with respect to the assets held by
the partnership whose interest was sold);
(v) amend the Substantially All Test so
that a transferring taxpayer who has held
its interest for more than three years will
be required to look through to the under-
lying assets’ character only if 80 percent
or more of the assets held directly or in-
directly by the Passthrough Entity have a
holding period of three years or less; (vi)
make information reporting related to the
Lookthrough Rule mandatory for partner-
ships and S corporations and for required
PFIC annual information statements re-
gardless of whether a Passthrough Entity
has issued or holds an API; (vii) provide
a de minimis rule by which an upper-tier
partnership holding a five percent or less
interest in the lower-tier partnership would
be allowed to use its holding period in the
lower-tier partnership; and (viii) as a part
of the de minimis rule, not require revalu-
ations of lower-tier partnerships when an
Owner Taxpayer disposes of an upper-ti-
er interest that holds five percent or less
of a lower-tier partnership. A commenter
recommended that the Lookthrough Rule
approach calculations in tiered structures
from the lower-tier entities up, aligning
with the approach to tiered structures else-
where in the proposed regulations, and
allowing the rule to appropriately accom-
modate lower-tier gains from assets whose
sale proceeds are treated as capital gains
without regard to section 1222(3) and (4).
After considering the comments, the
Treasury Department and the IRS agree
that the Lookthrough Rule as proposed
could be difficult for Owner Taxpayers
and Passthrough Entities to apply, partic-
ularly in the context of tiered structures.
However, the Treasury Department and
the IRS remain concerned that taxpayers
could avoid section 1061 by transferring
assets to, and issuing APIs from, existing
partnerships. Accordingly, the final regu-
lations retain the Lookthrough Rule, but
instead of applying the Lookthrough Rule
to the disposition of an API held for more
than three years and where the Substantial-
ly All Test is met, the final regulations lim-
it the application of the Lookthrough Rule
to situations where, at the time of dispo-
sition of an API held for more than three
years, (1) the API would have a holding
period of three years or less if the holding
period of such API were determined by
not including any period prior to the date
that an Unrelated Non-Service Partner is
legally obligated to contribute substantial
money or property directly or indirectly to
the Passthrough Entity to which the API
relates (this rule does not apply to the dis-
position of an API to the extent that the
gain recognized upon the disposition of
the API is attributable to any asset not held
for portfolio investment on behalf of third
party investors); or (2) a transaction or se-
ries of transactions has taken place with
a principal purpose of avoiding poten-
tial gain recharacterization under section
1061(a). The Lookthrough Rule similarly
applies with respect to a Passthrough In-
terest issued by an S corporation or a PFIC
to the extent the Passthrough Interest is
treated as an API. The final regulations
also simplify the method for applying the
Lookthrough Rule.
Commenters also stated that the Look-
through Rule raises a concern that going
concern value in a lower-tier entity might
be subject to ordinary income rates if an
upper-tier partnership interest is sold,
the Lookthrough Rule applies, and the
upper-tier partnership owns a lower-tier
partnership interest. These commenters
recommended that gain associated with
goodwill or enterprise value retain the
holding period of the partnership interest
itself, as opposed to the underlying assets,
and that the Lookthrough Rule apply only
to the gain associated with the hypothet-
ical liquidation of the underlying assets.
The Treasury Department and the IRS
continue to study this issue and may ad-
dress it in future guidance.
One commenter requested clarification
that the phrase “total net capital gain” in
proposed §1.1061-4(b)(9)(ii)(C)(1) refers
to “net long-term capital gain” and that
short- and long-term capital gains and
losses cannot be netted against each other.
The final regulations do not include this
language. The Treasury Department and
the IRS believe that the concerns raised
by the commenter are alleviated by the
simplified Lookthrough Rule adjustment
in the final regulations.
D. Section 1.1061-5: Transfers to Related
Parties
Proposed §1.1061-5(a) provides that
if an Owner Taxpayer transfers any API,
or any Distributed API Property, directly
or indirectly, to a Section 1061(d) Relat-
ed Person, or if a Passthrough Entity in
which an Owner Taxpayer holds an in-
terest, directly or indirectly, transfers an
API to a Section 1061(d) Related Person,
regardless of whether gain is otherwise
recognized on the transfer under the Code,
the Owner Taxpayer must include in gross
income as short-term capital gain, the
excess of: (1) the Owner Taxpayer’s net
long-term capital gain with respect to such
interest for such taxable year determined
as provided in proposed §1.1061-5(c),
over (2) any amount treated as short-term
capital gain under proposed §1.1061-4
with respect to the transfer of such inter-
est (that is, any amount included in the
Owner Taxpayer’s API One Year Disposi-
tion Gain Amount and not in the Owner
Taxpayer’s Three Year Disposition Gain
Amount with respect to the transferred
interest). Proposed §1.1061-5(b) provides
that for purposes of section 1061(d), the
term transfer includes contributions, dis-
tributions, sales and exchanges, and gifts.
Several commenters addressed wheth-
er section 1061(d) should be interpreted
as an acceleration provision or merely a
recharacterization provision. With cer-
tain exceptions, the proposed regulations
require that gain be accelerated on the
transfer of an API to a Section 1061(d)
Related Person, regardless of whether the
transfer is otherwise a taxable transaction
for Federal income taxes or whether gain
is otherwise realized or recognized under
the Code on the transfer. One comment-
er supported this treatment, noting that
section 1061(d)(1) is literally worded as
an income acceleration provision while
acknowledging that others have viewed
the language as a recharacterization pro-
vision, such as section 751(a). Another
commenter noted that neither the text nor
the legislative history shed any light on

Bulletin No. 2021–5 637 February 1, 2021
its purpose and stated that the provision’s
language is susceptible to numerous dif-
ferent readings. The commenter noted that
section 1061(d) could be read as a narrow
recharacterization lookthrough provision
similar to section 751, a recharacteriza-
tion and assignment of income provision
that provides for nonrecognition transfers
and requires the transferor rather than the
transferee to include API Gain when ul-
timately realized, a recharacterization and
acceleration provision, or a proration pro-
vision. The commenter did not provide a
recommendation, but noted that the pro-
posed regulations create many traps for
the unwary. The commenter stated that the
broad definition of transfer in the proposed
regulations combined with the overriding
of nonrecognition treatment could lead to
significant, adverse tax impacts on trans-
ferors as well as otherwise uninvolved,
passive interest holders in a variety of
transactions. The commenter suggested
that the Treasury Department and the IRS
carefully consider whether the effect of
the proposed regulations is appropriate
and aligns with section 1061(d)’s lan-
guage, function, and origins.
Other commenters argued that apply-
ing section 1061(d) to transactions where
gain is not otherwise recognized is incon-
sistent with the statutory language. One
commenter stated that section 1061(d) it-
self does not refer to any nonrecognition
provisions, nor does it contain any express
statement of intent to override nonrec-
ognition treatment. This commenter and
others noted that section 1061(d) operates
by reference to the taxpayer’s long-term
capital gains, which as defined in section
1223(3) include only gains that are rec-
ognized for U.S. Federal income tax pur-
poses. Consequently, these commenters
argued that the statute by its terms does
not apply to situations in which the tax-
payer has no actual long-term capital gain
with respect to such interest. Commenters
also noted that the legislative history does
not provide support for treating section
1061(d) as an acceleration provision. Pre-
vious carried interest provisions included
language that explicitly overrode non-rec-
ognition; section 1061 as enacted contains
no such language.
One commenter stated that it is not
necessary to accelerate gain on the trans-
fer of an API to a Section 1061(d) Related
Person, noting that the API in the hands
of the transferee is still subject to section
1061(a) because an API includes interests
held by or transferred to the taxpayer in
connection with the performance of a sub-
stantial service by the taxpayer or a related
person.
Commenters also raised a variety of
concerns about the proposed regulation’s
definition of transfer. Commenters recom-
mended that the term transfer be further
defined to address potential cases involv-
ing indirect transfers of an API, such as
the admission of new partners into the
partnership, the withdrawal of old part-
ners from the partnership, the transfer of
an employee between teams, or an award
to a high performer. One commenter ex-
plained that, in these circumstances, be-
cause there is no change in the relative
economic position between fund manag-
ers and third-party investors, there should
be no requirement for the fund manager
or employees of the fund manager to rec-
ognize unrealized built-in gain. Com-
menters also recommended that the final
regulations consider whether a forfeiture
of an API is a transfer for purposes of
section 1061(d) but stated that such an
interpretation would be overbroad. One
commenter noted that forfeiture and real-
locations involve circumstances in which
the partners’ legal and economic interests
in the partnership’s Unrealized API Gains
are contingent rather than fixed. Where a
partner’s interest in Unrealized API Gains
is contingent, the commenter argued that
it is not appropriate to tax a partner on a
reduction in that interest under section
1061(d).
Another commenter asked for clarifi-
cation that the distribution of an API by a
direct API Holder to an Owner Taxpayer
(indirect API Holder) would be exempt
from the application of section 1061(d).
The commenter noted that section 1061(a)
would continue to apply to the distribut-
ed API and that this treatment would be
consistent with the rules related to Dis-
tributed API Property in §1.1061-4. Un-
der those rules, a distribution of property
by a Passthrough Entity to an API Holder
is not subject to recharacterization un-
der section 1061 but the Distributed API
Property continues to be subject to section
1061. The commenter argued that this rule
would also treat similarly situated taxpay-
ers the same, rather than treating distribu-
tees of Distributed API Property different-
ly from Owner Taxpayers who receive a
distribution of an API from a partnership.
Another commenter asked for clarifi-
cation that the definition of gift refers to
transfers which are gifts for income tax
purposes (rather than for gift tax purpos-
es). The commenter noted that many com-
mon estate planning techniques involve
transfers of assets to grantor trusts with
the transferor as the grantor and the grant-
or’s family members as beneficiaries of
the trust, and that these types of transfers
often result in a completed gift for gift tax
purposes but do not constitute a transfer of
ownership for income tax purposes.
Commenters also recommended that
the final regulations exclude specific non-
recognition transactions, including (i)
transfers resulting from the death of an
Owner Taxpayer; (ii) gifts to a non-grant-
or trust by an Owner Taxpayer; and (iii)
transfers resulting from a change in tax
status of a grantor trust. One commenter
noted that, in light of section 1061(d)’s
specific reference to section 318(a)(1),
and not to section 318(a)(2), a gift to a
non-grantor trust for the benefit of a tax-
payer’s spouse, children, grandchildren or
parents should not be considered an “indi-
rect transfer” that would trigger the appli-
cation of section 1061(d). The commenter
noted that Congress’s use of the phrase
“directly or indirectly” does not warrant
disturbing the conclusion that a transfer to
a non-grantor trust does not constitute an
acceleration event for purposes of section
1061(d). This commenter suggested in the
alternative that if a transfer to a non-grant-
or trust is an acceleration event for pur-
poses of section 1061(d), only upon a sub-
sequent distribution of the API out of the
non-grantor trust should the acceleration
event occur.
After considering the comments, the
Treasury Department and the IRS have
determined that while section 1061(d)
can reasonably be interpreted as an accel-
eration provision, in the absence of clear
language to the contrary, it is more ap-
propriate to apply section 1061(d) only to
transfers in which long-term capital gain
is recognized under chapter 1 of the Code.
Interpreting section 1061(d) as only a re-
characterization provision is consistent
with the statutory language that looks to

February 1, 2021 638 Bulletin No. 2021–5
so much of the taxpayer’s long-term cap-
ital gain with respect to such interest for
such taxable year as is attributable to the
sale or exchange of any asset held. This
treatment also prevents the acceleration
of gain in the many non-abusive nonrec-
ognition transactions described by com-
menters. Furthermore, it is not necessary
to accelerate gain on the transfers of an
API to a Section 1061(d) Related Person
in a non-taxable transaction because the
API will remain an API in the hands of the
transferee under §1.1061-2(a). Accord-
ingly, the final regulations provide that
the Section 1061(d) Recharacterization
Amount includes only long-term capital
gain that the Owner Taxpayer recognizes
under chapter 1 of the Code upon a trans-
fer through a sale or exchange of an API to
a Section 1061(d) Related Person.
Proposed §1.1061-5(c) provides a for-
mula for calculating the Owner Taxpayer’s
short-term capital gain upon a transfer of
an API to a Section 1061(d) Related Per-
son based upon a hypothetical sale of all
of the partnership’s property in a fully tax-
able transaction. A commenter noted that
because the calculation is not based on the
Recharacterization Amount under a hypo-
thetical liquidation, it includes amounts
excluded from the Recharacterization
Amount, such as capital interest gains and
losses. The commenter recommended that
the formula be amended so that it is based
upon the Recharacterization Amount in a
hypothetical partnership liquidation, and
that the final regulations contain an ex-
ception from taxation for transactions in
which the Owner Taxpayer’s deemed dis-
tributions with respect to the Owner Tax-
payer’s API on a hypothetical liquidation
basis are the same immediately before
and after the transaction (not including
any deemed distributions due to changes
in debt allocations). Another comment-
er suggested that, in order to avoid dou-
ble-counting in a tiered structure, there
should be a cap on the amount that would
be taxed equal to the gain that would be
realized if the directly transferred API
were sold for its fair market value by the
Owner Taxpayer.
Another commenter noted that the
proposed regulations provide that section
1061(d) applies to transfers of APIs by
Passthrough Entities and to transfers of
Distributed API Property by Owner Tax-
payers, but that the rules do not provide
guidance on how to calculate the amount
to be included. The commenter suggested
that, in the case of a transfer of an API by a
Passthrough Entity, the inclusion amount
should be the amount that would be allo-
cated to each of the Passthrough Entity’s
direct or indirect Owner Taxpayers in a
deemed taxable sale of assets by the low-
er-tier entity in which the Passthrough En-
tity holds its API, and that the amounts that
such Passthrough Entity includes in the
API One Year Distributive Share Amount,
but not in the API Three Year Distributive
Share Amount, for each Owner Taxpayer
should be subtracted from the aforemen-
tioned amounts to calculate an Owner
Taxpayer’s recharacterization amount
under section 1061(d). In the case of a
transfer of Distributed API Property by an
Owner Taxpayer, the commenter suggest-
ed that the inclusion amount should be the
amount of long-term capital gain that the
Owner Taxpayer would have recognized
on a taxable sale for cash at the Distribut-
ed API Property’s fair market value.
The Treasury Department and the IRS
appreciate these thoughtful suggestions.
The final regulations have revised and
simplified the computation of the inclu-
sion amount in §1.1061-5(c) and have
added the term Section 1061(d) Rechar-
acterization Amount. The final regulations
provide that, if section 1061(d) applies,
an Owner Taxpayer’s Section 1061(d)
Recharacterization Amount is the Own-
er Taxpayer’s share of the amount of net
long-term capital gain from assets held for
three years or less that would have been
allocated to the Owner Taxpayer with re-
spect to the transferred API if the partner-
ship had sold all of its property in a fully
taxable transaction for cash in an amount
equal to the fair market value of such
property immediately prior to the Owner
Taxpayer’s transfer of the API (or a por-
tion of such gain if only a portion of the
API is transferred).
A commenter requested clarification as
to whether “capital gain recognized” on
an otherwise taxable transfer in proposed
§1.1061-5(c)(2) means that the amount
recharacterized under section 1061(d) in-
cludes only gain that would otherwise be
treated as long-term gain or whether it sets
the total amount of short-term gain on the
transfer. The final regulations provide that
the long-term gain that is recharacterized
to short-term under section 1061(d) is the
lesser of (i) the amount of net long-term
capital gain recognized by the Owner Tax-
payer upon the transfer of such interest, or
(ii) the Section 1061(d) Recharacteriza-
tion Amount as computed under §1.1061-
5(c). Thus, only gain that would otherwise
be treated as long-term gain is recharac-
terized under section 1061(d).
Proposed §1.1061-5(d) provides that
the basis of a transferred API or trans-
ferred Passthrough Interest (in the case
of a transferred Indirect API) is increased
by the additional gain recognized. A com-
menter requested that the rule be revised
to explicitly coordinate with section 743
so that the basis adjustments will be allo-
cated to the assets that result in the gain
recognition. The concerns raised in this
comment are resolved because the final
regulations limit the application of section
1061(d) to transactions in which gain is
recognized.
Another commenter recommended
that the final regulations explicitly ex-
clude amounts that would be subject to
the Capital Interest Exception. The final
regulations do not adopt this comment
because the Capital Interest Exception is
an exception to the definition of an API.
Therefore, such a rule is not needed. Com-
menters also recommended that the final
regulations explicitly exclude amounts
specified in proposed §1.1061-4(b)(6)
(designated as §1.1061-4(b)(7) in the fi-
nal regulations) from the calculation of
the Section 1061(d) Recharacterization
Amount. One commenter noted that the
scope of section 1061(d)(1) is broader
than the tax result that would occur if the
partnership had actually sold all its prop-
erty, noting that neither the statute nor
the proposed regulations exclude section
1231 gains (and other excluded gains such
as those under section 1256) from the Sec-
tion 1061(d) Recharacterization Amount.
Another commenter argued that section
1061(d) should not recharacterize section
1231 gain, stating that while the statuto-
ry language in section 1061(d) provides
arguable authority for including section
1231 gains in the computation of the Sec-
tion 1061(d) Recharacterization Amount,
the approach is hard to justify from a pol-
icy perspective. The commenter argued
that because section 1061(d) is aimed at

Bulletin No. 2021–5 639 February 1, 2021
preventing an API Holder from circum-
venting section 1061(a), the regulations
should not impose on taxpayers a result
under section 1061(d) that is worse than if
section 1061(a) had applied to assets sold
by the partnership. The commenter rec-
ommended that “long-term capital gains”
should be interpreted consistently for
purposes of section 1061(a) and section
1061(d), and that long-term capital gain
recognized with respect to section 1231
assets should not be recharacterized under
either paragraph.
The final regulations adopt these
comments and provide that the Section
1061(d) Recharacterization Amount does
not include amounts not taken into ac-
count for purposes of section 1061 under
§1.1061-4(b)(7).
Proposed §1.1061-5(c)(1) provides
that if an Owner Taxpayer transfers an
Indirect API and is subject to section
1061(d), the computation of the Section
1061(d) Recharacterization Amount must
be applied at the level of any lower-tier
Passthrough Entities. One commenter rec-
ommended that this rule be aligned with
the rules for tiered partnerships elsewhere
in the proposed regulations, such as the
Lookthrough Rule, which explicitly states
that it applies only to the “assets of the
partnership in which the API is held.” A
commenter recommended that the final
regulations clarify whether the transfer of
a distributed asset held, or deemed to be
held, by the partnership for three years or
less is subject to section 1061(d). Another
commenter noted that there is no principled
reason for not applying section 1061(d) in
tiered partnerships to transfers of Distrib-
uted API Property by Passthrough Entities
to Section 1061(d) Related Persons of the
ultimate Owner Taxpayer.
Under the final regulations, the Sec-
tion 1061(d) Recharacterization Amount
is computed by the Owner Taxpayer. The
transfer of a distributed asset held, or
deemed to be held, by a Passthrough Enti-
ty for three years or less is subject to sec-
tion 1061(d). The final regulations clarify
that for purposes of section 1061(d), an
Owner Taxpayer will be treated as trans-
ferring the Owner Taxpayer’s share of any
Indirect API or Distributed API Proper-
ty if the Indirect API or Distributed API
Property is transferred by the API Holder
to a person that is a Section 1061(d) Relat-
ed Person with respect to the Owner Tax-
payer. The final regulations also provide
that the rules for determining the Section
1061(d) Recharacterization Amount also
apply to the transfer of a Passthrough In-
terest issued by an S corporation or PFIC
to the extent the Passthrough Interest is
treated as an API.
Proposed §1.1061-5(e) defines a Sec-
tion 1061(d) Related Person as: (i) a
person that is a member of the taxpay-
er’s family within the meaning of section
318(a)(1); (ii) a person that performed a
service within the current calendar year
or the preceding three calendar years in
a Relevant ATB to the API transferred by
taxpayer; or (iii) a Passthrough Entity to
the extent that a person described in para-
graph (e)(1)(i) or (ii) owns an interest, di-
rectly or indirectly. One commenter rec-
ommended that the definition of Section
1061(d) Related Person be amended to
exclude a Passthrough Entity to the ex-
tent that a member of the taxpayer’s fam-
ily or colleague is an owner, noting that
language is not in the statute and is not
discussed in the legislative history. The
final regulations do not adopt this com-
ment. Section 1061(d)(1) provides that
the inclusion required by section 1061(d)
applies if a taxpayer transfers any API,
directly or indirectly, to a person related
to the taxpayer.
III. Additional Comments Received and
Revisions Made
A. Sections 1.1061-1 and 1.1061-2:
Definitions, Operational Rules, and
Examples
1. Definitions, In General
A commenter expressed the view that
the interrelated new terms and defini-
tions make the proposed regulations dif-
ficult to read and comprehend in some
places. The final regulations largely re-
tain the terms and definitions provided
in §1.1061-1(a) but simplify many of
the computational rules and concepts
used to determine the Recharacterization
Amount and the Section 1061(d) Re-
characterization Amount. The terms and
definitions provide a helpful roadmap to
the regulations and are also needed to
provide Owner Taxpayers, Passthrough
Entities, and the IRS with a common
vocabulary that can be used to describe
the necessary computations and report-
ing requirements. The final regulations
make clarifying changes throughout the
definitions, including providing that a
Passthrough Entity can also be a trust or
estate. Terms have also been added and
removed in accordance with the revi-
sions discussed elsewhere in this Sum-
mary of Comments and Explanation of
Revisions.
A commenter noted that the preamble
to the proposed regulations provides that
“taxpayer” means Owner Taxpayer in
sections 1061(a) and (d), and both Own-
er Taxpayer and Passthrough Taxpayer in
section 1061(c)(1). The commenter fur-
ther noted that the proposed regulations
use the definition of “person” as that term
is generally used under section 7701(a)
(1). The commenter requested that the fi-
nal regulations provide explicit definitions
of “taxpayer” and “person” in each rele-
vant part because the terms have different
meanings in different contexts.
The final regulations do not adopt this
comment because defining taxpayer and
person in different ways in each relevant
section would introduce unnecessary com-
plexity. However, the use of these terms
has been modified in certain places in the
final regulations to alleviate confusion.
2. Operational Rules
a. Definition of API; An API remains an
API
Proposed §1.1061-1(a) provides that
API means any interest in a partnership
which, directly or indirectly, is transferred
to (or is held by) an Owner Taxpayer or
Passthrough Taxpayer in connection with
the performance of substantial services by
the Owner Taxpayer or by a Passthrough
Taxpayer, or by any Related Person, in-
cluding services performed as an employ-
ee, in any ATB unless an exception applies,
and that for purposes of this definition, an
interest in a partnership also includes any
financial instrument or contract, the value
of which is determined in whole or in part
by reference to the partnership (including
the amount of partnership distributions,
the value of partnership assets, or the re-
sults of partnership operations.)

February 1, 2021 640 Bulletin No. 2021–5
A commenter expressed concern that
defining an interest in a partnership to in-
clude a financial instrument or contract,
the value of which is determined in whole
or in part by reference to the partnership,
could include investment management
contracts that provide for a fee based on
the assets of a fund partnership and not a
carried interest or other performance al-
location, creating a risk that the sale of a
management company or indirect sale of
a management contract could be subject
to section 1061. This in turn could cause
the enterprise value of the management
company to be taxed at ordinary income
rates. The commenter recommended that
the definition of API be modified to ex-
clude financial instruments or contracts
that merely reference the value of part-
nership assets or that provide for fee in-
come that is subject to ordinary income
tax treatment.
Because financial instruments can rep-
licate the performance of a partnership
interest, the inclusion of such items in
the definition of an API is necessary for
purposes of implementing section 1061.
Accordingly, the final regulations do not
adopt this comment. As stated in Part IV
of this Summary of Comments and Ex-
planation of Revisions, the Treasury De-
partment and the IRS continue to study
the impact of section 1061 on the taxation
of enterprise value related to the transfer
or exchange of partnership interests and
management contracts.
Proposed §1.1061-2(a)(1)(i) provides
that once a partnership interest qualifies
an API, the partnership interest remains
an API unless and until the requirements
of one of the exceptions to qualification
of a partnership interest as an API are sat-
isfied. A commenter questioned whether
this provision is valid given that it is not
explicit in the statute, but reasoned that
the rule is implicit in the statutory scheme
and is necessary to prevent avoidance of
the statute.
The Treasury Department and the IRS
agree with the commenter that this rule is
implicit in the statutory scheme. Neither
the statute nor the legislative history pro-
vide a time limit or other means of ending
API treatment beyond the exceptions to
qualification as an API. Consequently, no
modifications have been made to §1.1061-
2(a)(1)(i).
b. Presumption that services are
substantial
Proposed §1.1061-2(a)(1)(iv) pro-
vides that if a partnership interest is trans-
ferred to or held by an Owner Taxpayer,
Passthrough Taxpayer, or any Related Per-
son in connection with the performance
of services, the Owner Taxpayer, the
Passthrough Taxpayer, or the Related Per-
son is presumed to have provided substan-
tial services for purposes of section 1061.
Commenters suggested that presuming
all services to be substantial is overbroad
and recommended that the presumption
be removed. In addition, one commenter
recommended the inclusion of non-ex-
clusive safe harbors that service partners
could rely on to determine that partnership
interests they hold or that have been trans-
ferred to them are not in connection with
the performance of substantial services.
Another commenter recommended adding
a means to rebut the presumption that the
services are substantial.
The final regulations retain the pro-
posed rule’s presumption that all services
provided for a partnership interest are sub-
stantial services for purposes of section
1061. However, the Treasury Department
and the IRS will continue to study and
consider possible circumstances under
which the presumption might be rebutted
as well as the possibility of providing safe
harbors for circumstances under which the
presumption will not apply. These consid-
erations may be addressed in future guid-
ance.
c. Application of the ATB Activity Test
i. In general, ATB
Proposed §1.1061-1(a) provides that
applicable trade or business (ATB) means
any activity for which the ATB Activity
Test with respect to Specified Actions is
met, and includes all Specified Actions
taken by Related Persons, including
combining activities occurring in sepa-
rate partnership tiers or entities as one
ATB. Proposed §1.1061-1(a) defines an
Owner Taxpayer as the person subject to
Federal income tax on net gain with re-
spect to an API or an Indirect API during
the taxable year, including an owner of a
Passthrough Taxpayer unless the owner of
the Passthrough Taxpayer is a Passthrough
Entity itself or is excepted under proposed
§1.1061-3(a), (b), or (d).
ii. ATB Activity Test
Proposed §1.1061-2(b)(1) provides
that the ATB Activity Test is satisfied if
Specified Actions are conducted by one or
more Related Persons and the total level
of activity, including the combined activ-
ities of all Related Persons, satisfies the
level of activity that would be required to
establish a trade or business under section
162. Proposed §1.1061-1(a) provides that
Specified Actions means Raising or Re-
turning Capital Actions and Investing or
Developing Actions. Raising or Returning
Capital Actions means actions involving
raising or returning capital but does not
include Investing or Developing Actions.
Investing or Developing Actions means
actions involving either (i) investing in (or
disposing of) Specified Assets (or identi-
fying Specified Assets for such investing
or disposition), or (ii) developing Speci-
fied Assets.
Commenters requested clarification
that joint ventures of a real estate develop-
er involving a single stand-alone project at
a single location will not satisfy the ATB
Activity Test. One of these commenters
recommended that the definition of Rais-
ing or Returning Capital should be refined
so that it includes only raising or return-
ing capital activities in which the busi-
ness earns compensation based on either
capital committed, capital contributed, or
capital invested. Another commenter not-
ed that additional guidance may be need-
ed to make the statute more administrable
because real estate held for rental or in-
vestment is a Specified Asset but holding
the property may not constitute a trade or
business under section 162.
The final regulations do not adopt these
comments. Whether a single project or
raising of capital involves the level of ac-
tivity needed to constitute a trade or busi-
ness under section 162 is dependent on
the facts and circumstances unique to the
project or raising of capital. Furthermore,
guidance under section 162 is beyond the
scope of these regulations.
Example 6 of proposed §1.1061-2(b)
(2)(vi) describes a situation in which A
manages a hardware store that Partnership

Bulletin No. 2021–5 641 February 1, 2021
owns. A is issued a profits interest in Part-
nership in connection with A’s services.
Partnership owns the building in which
the hardware store operates. The example
notes that the building is held by Partner-
ship not for rental or investment, but to
conduct Partnership’s hardware business
and, thus, the building is not a Specified
Asset. The example provides that the part-
nership maintains and manages a certain
amount of working capital for its business,
but notes that working capital is not tak-
en into account for the purpose of deter-
mining whether the ATB Activity Test is
met. A commenter suggested that another
example should be added to analyze how
to apply the ATB Activity Test where the
facts are changed so that the business is
held in a C corporation, the partnership
only holds the C corporation stock, and
the holding partnership is held by an in-
vestment partnership. The commenter
stated that the ATB Activity Test should
not be met by the holding partnership and
the manager should not be an API Holder.
The final regulations do not adopt this
comment. Depending on the specific facts
and circumstances of the situation, the
Treasury and the IRS believe that the ATB
Activity Test could be met by such a hold-
ing partnership and the manager might be
an API Holder.
A commenter requested clarification
regarding what activities occurring in sep-
arate partnership tiers or entities will be
considered combined and treated as one
ATB, and recommended that the regula-
tions be amended to include an example
illustrating how the ATB and API rules
work in this situation. The commenter rec-
ommended that the application of section
1061 be limited to an Owner Taxpayer
solely with respect to partnership interests
that serve as compensation for services
relating to Specified Assets. Another com-
menter requested simplifying safe harbors
for activities conducted in multiple enti-
ties either in the same chain or in a broth-
er-sister chain.
The Treasury Department and the IRS
continue to study these issues and may
consider providing future guidance on
these matters. However, the Treasury De-
partment and the IRS note the definition
of ATB includes any and all activities, no
matter how minimal, conducted by enti-
ties that are Related Persons to each other,
for purposes of determining whether the
ATB Activity Test is met, and if that test is
met, then each such participating entity is
considered to be engaged in an ATB.
Another commenter requested clarifi-
cation that businesses that do not both raise
or return capital and engage in either in-
vestment or development activities do not
satisfy the ATB Activity Test, and that the
regular, continuous, and substantial stan-
dard applies independently to each prong
of the ATB Activity Test. The commenter
suggested that because the proposed regu-
lations aggregate activities of one or more
entities and related parties, the final reg-
ulations should not include the statement
that the fact that either Raising or Return-
ing Capital Actions or Investing or Devel-
oping Actions are only infrequently taken
does not preclude the test from being sat-
isfied if the combined Specified Actions
meet the test. The commenter expressed
concern that this language combined with
the rule that Raising or Returning Capital
Actions and Investing or Developing Ac-
tions are not required to be taken in each
taxable year could cause the activities of a
fund sponsor’s affiliates to satisfy the rais-
ing or returning capital prong with respect
to any of the sponsored funds.
The final regulations do not adopt
this comment. It is necessary for both
the Raising or Returning Capital Actions
and Investing or Developing Actions to
be present for the ATB Activity Test to
be satisfied. The aggregation rule and the
language regarding infrequent actions
are necessary to prevent abuse of section
1061. Without these rules, activities could
be spread among multiple related entities
with the intent of not satisfying the ATB
Activity Test.
iii. Definition of Specified Assets
Proposed §1.1061-1(a) defines Spec-
ified Assets as: (i) securities, including
interests in partnerships qualifying as se-
curities (as defined in section 475(c)(2)
without regard to the last sentence there-
of); (ii) commodities (as defined in section
475(e)(2)); (iii) real estate held for rental
or investment; (iv) cash or cash equiva-
lents; (v) an interest in a partnership to the
extent that the partnership holds Specified
Assets; and, (vi) options or derivative con-
tracts with respect to any of the foregoing.
Commenters requested additional
guidance on the treatment of partnerships
that engage in the production, storage,
transportation, processing, or marketing
of physical commodities in the ordinary
course of business (including hedges with
respect to the commodities). The com-
menters requested that such partnerships
not be treated as engaged in Investing and
Developing Actions as a result of such
activities, and that Specified Assets only
include commodities that are themselves
actually actively traded on an established
financial market, not merely commodities
of the same type as commodities that are
or can be actively traded on an established
financial market.
The final regulations do not adopt this
comment; however, the Treasury Depart-
ment and the IRS continue to study this is-
sue and may address it in future guidance.
Another commenter noted that it is
unclear whether the rule treating a deriva-
tive contract with respect to a partnership
interest as a partnership interest for pur-
poses of applying section 1061 is needed
to appropriately administer section 1061.
The commenter noted that the proposed
regulation’s position regarding such a de-
rivative injects unnecessary complexity
into the tax system, and stated that be-
cause payments made before termination
of a swap are almost always ordinary in-
come, it may not make economic or tax
sense to use such a financial instrument in
lieu of a partnership interest in an attempt
to avoid section 1061.
The final regulations do not adopt this
comment. While the use of a derivative
contract in this circumstance may be rare,
the Treasury and the IRS are concerned
that the potential for abuse exists. Conse-
quently, the treatment of a derivative con-
tract as a partnership interest for purposes
of applying section 1061 is necessary to
prevent the circumvention of, and compli-
ance with, section 1061.
B. Section 1.1061-3: Exceptions to the
Definition of API
1. Corporate Exception
Section 1061(c)(4)(A) provides that
an API “shall not include any interest in
a partnership directly or indirectly held
by a corporation.” In implementing this

February 1, 2021 642 Bulletin No. 2021–5
exception, proposed §1.1061-3(b)(2) pro-
vides that a corporation does not include
an entity for which an election was made
to treat the entity as a Passthrough Enti-
ty, and that therefore, an S corporation
for which an election under 1362(a) is in
effect and a PFIC with respect to which
the shareholder has a QEF election under
section 1295 in effect (such entity is a
QEF with respect to the shareholder), are
not treated as corporations for purposes of
section 1061. One commenter approved of
this decision, noting that section 1061(f)
provides ample authority for excluding
S corporations and PFICs from the term
corporation. The commenter noted that al-
lowing such structures to benefit from the
corporate exception would allow section
1061 to be entirely circumvented. Another
commenter, discussing PFICs subject to
QEF elections, noted that the exclusion of
QEFs from the definition of corporation
for purposes of section 1061 is consistent
with section 1(h)(9) and (h)(10).
One commenter disagreed regarding
authority, noting that the ability to treat
QEFs and S corporations as subject to sec-
tion 1061 is subject to substantial doubt
and contrary to the plain text of the stat-
ute. The commenter also noted that Notice
2018-18, 2018-2 I.R.B. 443, and the pro-
vision’s legislative history offer no reason
why S corporations should, or should not,
qualify for the exception. Another com-
menter said that a legislative clarification
should be sought prior to including a rule
in the final regulations providing that S
corporations are subject to section 1061.
The Treasury Department and the IRS
agree with commenters that the exclusion
of S corporations and QEFs from the cor-
porate exception is necessary to avoid cir-
cumvention of section 1061. Accordingly,
no change has been made to this section
of the final regulations. As explained in
the preamble to the proposed regulations,
section 1061(f) provides that the Secre-
tary has authority to issue regulations or
other guidance as is necessary or appro-
priate to carry out the purposes of section
1061. Both the Conference Report and the
Blue Book further direct the Treasury De-
partment and the IRS to issue regulations
to address the prevention of abuse of the
purposes of the provision. The grant of
authority in section 1061(f) is sufficient
to issue regulations providing that the ex-
ception in section 1061(c)(4)(A) does not
include S corporations and PFICs with
respect to which shareholders have QEF
elections in effect. See also section 1(h)(9)
and (10).
2. Unrelated Purchaser Exception
Proposed §1.1061-3(d) provides that if
a taxpayer acquires an interest in a part-
nership (target partnership) by taxable
purchase for fair market value that, but for
the exception in §1.1061-3(d), would be
an API, the taxpayer will not be treated as
acquiring an API if, immediately before
the purchase (1) the taxpayer is not relat-
ed within the meaning of section 267(b)
or 707(b) to any person who provides ser-
vices in the Relevant ATB, or any service
providers who provide services to or for
the benefit of the target partnership or a
lower-tier partnership in which the target
partnership holds a direct or indirect inter-
est; (2) section 1061(d) does not apply to
the transaction (as provided in §1.1061-5);
and (3) the taxpayer has not provided in
the past, does not then provide, and does
not anticipate providing services in the
future to, or for the benefit of, the target
partnership, directly or indirectly, or any
lower-tier partnership in which the target
partnership holds a direct or indirect inter-
est.
A few commenters stated that the pro-
posed regulations are unclear as to wheth-
er the exception applies only to an API
that is directly acquired or whether it also
applies to an API in which the buyer ac-
quired an indirect interest through an up-
per-tier partnership. One commenter rec-
ommended that final regulations provide
that the exception applies to both APIs
purchased directly as well as an APIs
purchased indirectly, noting that the unre-
lated purchaser might not be able to rely
on Rev. Rul. 87-115, 1987-2 C.B. 163,
to adjust the basis of the underlying fund
assets to prevent the recognition of built-
in gain, as fund sponsors generally do not
make section 754 elections at the fund lev-
el. Further, the commenter suggested that
the final regulations provide that the ex-
ception applies regardless of whether the
lower-tier partnership interest is acquired
after the third-party purchases the interest
in the upper-tier partnership or acquires
the upper-tier partnership interest by con-
tribution. Another commenter suggested
that the exception be extended to interests
in other Passthrough Entities.
The final regulations do not adopt these
comments because of the complexity of
administering the unrelated purchaser ex-
ception through tiers of Passthrough Enti-
ties. The final regulations make non-sub-
stantive clarifying changes to the rule.
The preamble to the proposed regula-
tions provides that the exception does not
apply to an Unrelated Non-Service Part-
ner who becomes a partner by making a
contribution to a Passthrough Entity that
holds an API and in exchange receives an
interest in the Passthrough Entity’s API,
stating that, in this case, allocations to the
Unrelated Non-Service Partner with re-
spect to the API are API Gains and Loss-
es and retain their character as API Gains
and Losses. One commenter noted that
this exception to the unrelated purchaser
exception is not explained in the proposed
regulations’ preamble and suggested that
the exception to the exception is most
likely intended to refer to a situation in
which an investor makes a contribution in
form to an upper-tier partnership, which
then distributes an API with respect to a
lower-tier partnership to the contributing
upper-tier partner. The commenter notes
that these transfers might be a purchase
of the API by the investor from the up-
per-tier partnership. The Treasury
Department and the IRS intend that the
third-party purchaser exception be limit-
ed to API purchases and not apply when a
third party contributes cash or property to
a Passthrough Entity holding an API in a
transaction qualifying for nonrecognition
under section 721(a), or any similar provi-
sion, resulting in the contributor receiving
allocations attributable to the transferee
Passthrough Entity’s API.
C. Section 1.1061-4: Computing the
Recharacterization Amount
1. Computation of the Recharacterization
Amount
Proposed §1.1061-4(a)(1) provides that
the Recharacterization Amount equals the
Owner Taxpayer’s One Year Gain Amount
less the Owner Taxpayer’s Three Year
Gain Amount. The Owner Taxpayer’s One
Year Gain Amount is the sum of the Own-

Bulletin No. 2021–5 643 February 1, 2021
er Taxpayer’s combined net API One Year
Distributive Share Amount from all APIs
held during the taxable year and the Own-
er Taxpayer’s API One Year Disposition
Amount. An Owner’s Taxpayer’s Three
Year Gain Amount is equal to the Owner
Taxpayer’s combined net API Three Year
Distributive Share Amount from all APIs
held during the taxable year and the Own-
er Taxpayer’s API Three Year Disposition
Amount. The API One Year and Three
Year Distributive Share Amounts exclude
Capital Interest Gains and Losses. Capital
Interest Disposition Amounts are not in-
cluded in the computation of the API One
Year and Three Year Disposition Amounts
because they relate to the disposition of a
Capital Interest rather than an API.
Proposed §1.1061-4(a)(3)(i) provides
that the API One Year Distributive Share
Amount equals the API Holder’s distrib-
utive share of net long-term capital gain
from the partnership for the taxable year,
including capital gain or loss on the dis-
position of all or a part of an API, with
respect to the partnership interest held by
the API Holder calculated without the ap-
plication of section 1061 less, to the extent
included in the amount determined under
proposed §1.1061-4(a)(3)(i)(A), the ag-
gregate of amounts that are excluded from
section 1061 under proposed §1.1061-4(b)
(6), the API Holder’s Transition Amount
for the taxable year; and Capital Interest
Gains and Losses as determined under
proposed §1.1061-3(c)(2).
One commenter stated that the defini-
tion of API One Year Distributive Share
Amount does not allow for this amount to
be a loss. For example, if an Owner Tax-
payer holds two APIs and one partnership
allocates the taxpayer a loss and the other
a gain, the loss does not offset the gain be-
cause the API One Year Distributive Share
Amount for the partnership that allocated
the taxpayer a loss will be zero. The com-
menter recommended allowing the API
One Year Distributive Share Amount to be
less than zero. The final regulations adopt
this suggestion by revising the compu-
tation for the API One Year Distributive
Share Amount to include both capital gain
and loss. In addition, the commenter sug-
gested that the final regulations provide
that if each of the API One Year Distrib-
utive Share Amount and the API Three
Year Distributive Share Amount is greater
than zero but the API One Year Distrib-
utive Share Amount is less than the API
Three Year Distributive Share Amount, no
portion of the API One Year Distributive
Share Amount is recharacterized as short-
term capital gain. The final regulations
adopt this suggestion by providing that if
the One Year Gain Amount and the Three
Year Gain Amount are both greater than
zero but the One Year Gain Amount is less
than the Three Year Gain Amount, none
of the One Year Gain Amount is included
in the Recharacterization Amount for the
taxable year. In addition to adopting this
comment, the final regulations make mi-
nor clarifying changes to the computation
rules.
Commenters raised several additional
concerns related to the computation rules.
One commenter recommended that reg-
ulations provide guidance on how losses
limited by section 1211 affect the Rechar-
acterization Amount. Another commenter
noted that the proposed regulations do not
address how net capital gain is comput-
ed or the order of steps in doing so un-
der section 1(h)(1). The commenter stated
that because section 1061(a) recharac-
terizes what would have been long-term
capital gain as short-term capital gain, it
is apparent that section 1061(a) must be
applied somewhere in the process before
the application of section 1(h). Further,
the proposed regulations do not address
§1.1(h)-1, which provides a look-through
rule when a partnership interest is sold,
to determine what portion of the gain on
sale will be treated as collectibles gain or
section 1250 capital gain. The commenter
also noted that, although section 1231 and
section 1256 gains are excluded from sec-
tion 1061 by the proposed regulations, a
sale of a partnership interest holding such
assets is not excluded, and all the gain is
subject to section 1061(a) unless section
751(a) applies. Finally, the commenter
stated that there is no provision in the pro-
posed regulations addressing suspension
of the holding period of an API when an
API owner seeks to obtain a more-than-
three-year holding period without under-
taking additional risk – that is, the hedging
of the API. The commenter recommended
that an express rule be provided, such as
the rule provided in §1.1400Z2(a)-1(b)
for interests in partnerships self-certified
as qualified opportunity funds.
The Treasury Department and the IRS
continue to study the issues raised by
these comments in regard to the computa-
tion rules and may address them in future
guidance.
2. Distributed API Property
Proposed §1.1061-1(a) provides that
Distributed API Property means proper-
ty distributed by a Passthrough Entity to
an API Holder with respect to the API if
the holding period, as determined under
sections 735 and 1223, in the API Hold-
er’s hands is three years or less at the time
of disposition of the property by the API
Holder.
A commenter questioned whether the
Treasury Department and the IRS have
the authority to treat Distributed API
Property as subject to section 1061(a).
The commenter further stated that in or-
der for the rule to be a valid exercise of
regulatory authority, distributed property
for this purpose should exclude proper-
ty that, if sold by the partnership, would
be excluded from section 1061, such as
property that would generate 1231 and
1256 gains.
The final regulations continue to treat
Distributed API Property as subject to
section 1061(a) under the authority of
section 1061(f). However, the Treasury
Department and the IRS agree with the
commenter that long-term capital gain
from the disposition of Distributed API
Property that, if sold by the partnership,
would be excluded from section 1061,
such as 1231 and 1256 gain, qualified
dividends described in section 1(h)(11)
(B), and any other capital gain that is
characterized as long-term or short-term
without regard to the holding period rules
in section 1222, should not be recharac-
terized under section 1061(a). The final
regulations clarify this point by exclud-
ing these items from the calculation of
the API One Year Disposition Amount.
Additionally, because a Passthrough En-
tity does not calculate an API One Year
Disposition Amount, the final regulations
clarify that for purposes of calculating
the API One Year Distributive Share
Amount, an API Holder’s distributive
share of net long-term capital gain from
the partnership includes capital gain or
loss on the disposition of Distributed API

February 1, 2021 644 Bulletin No. 2021–5
Property or all or part of an API by an
API Holder that is a Passthrough Entity.
Another commenter suggested that the
final regulations explicitly provide rules
for the treatment of Distributed API Prop-
erty when the Distributed API Property is
distributed from one Passthrough Entity to
another and the upper-tier entity disposes
of the Distributed API Property. The com-
menter also requested confirmation in the
final regulations that partnerships should
subtract capital gain or loss from proper-
ty that had been Distributed API Property
but no longer is at the time of disposition
when calculating the API One Year Dis-
tributive Share Amount because such gain
is excluded from the calculation of the Re-
characterization Amount.
The final regulations partially adopt
this comment by revising the computa-
tion of the One Year Distributive Share
Amount to explicitly include dispositions
of API Distributed Property by a partner-
ship or other Passthrough Entity. The final
regulations do not adopt the suggestion to
explicitly provide that partnerships should
subtract capital gain or loss from proper-
ty that had been Distributed API Property
but no longer is at the time of disposition
when calculating the API One Year Dis-
tributive Share Amount. The definition of
Distributed API Property provides that it
only applies to property with a holding
period of three years or less on the date of
disposition by an API Holder. Any proper-
ty with a greater than three-year holding
period is therefore not Distributed API
Property. A special rule for Distributed
API Property distributed to an upper-tier
entity by a lower-tier entity is unnecessary
because the definition of API Holder in-
cludes a Passthrough Entity.
Commenters noted that the proposed
regulations are unclear as to how the Dis-
tributed API Property rules apply where
an API Holder owns both a profits interest
and a capital interest in a partnership, and
recommended that the final regulations
clarify that a distribution to a partner is
not Distributed API Property to the ex-
tent that it is distributed with respect to
the portion of the partner’s interest qual-
ifying for the Capital Interest Exception.
One commenter suggested that such guid-
ance should also address how to apply the
recommended rule in the context of tiered
structures.
The Treasury Department and the IRS
continue to study this issue and may ad-
dress it in future guidance.
3. Special Rules for Capital Gain
Dividends from Regulated Investment
Companies (RICs) and Real Estate
Investment Trusts (REITs)
The preamble to the proposed regu-
lations recognizes that long-term capital
gain treatment should be available for
a capital gain dividend paid by a RIC or
REIT to the extent that the capital gain
dividend is attributable to assets held for
more than three years or is attributable to
assets that are not subject to section 1061.
Proposed §1.1061-4(b)(4) facilitates this
treatment by allowing a RIC or REIT to
disclose two additional amounts based on
modified computations of the RIC’s or
REIT’s net capital gain. First, the RIC or
REIT may disclose the amount of the cap-
ital gain dividend that is attributable to the
RIC’s or REIT’s net capital gain exclud-
ing any amounts not taken into account for
purposes of section 1061 under proposed
§1.1061-4(b)(6) from the computation.
Second, the RIC or REIT may disclose the
amount of the capital gain dividend that is
attributable to the RIC’s or REIT’s net cap-
ital gain both (1) excluding any amounts
not taken into account for purposes of sec-
tion 1061 under proposed §1.1061-4(b)(6)
from the computation, and (2) substituting
three years for one year in applying sec-
tion 1222. The proposed regulations allow
a RIC or REIT to disclose these two addi-
tional amounts in writing to its sharehold-
ers with its section 852(b)(3)(C)(i) capital
gain dividend statement or section 857(b)
(3)(B) capital gain dividend notice.
One commenter suggested that it
would be extremely rare for a RIC to have
shareholders for whom this provision is
relevant and stated that requiring this ad-
ditional reporting would be unnecessarily
burdensome as it creates a third type of
capital gain that RICs would need to track
and report. Consequently, the commenter
requested that final regulations continue to
permit, but not require, RICs to report this
information if they have a shareholder for
whom such amounts are relevant. In addi-
tion, the commenter noted that most funds
will not calculate this information at the
time capital gain dividends are reported
on Forms 1099-DIV. The commenter re-
quested that final regulations allow report-
ing on a written statement furnished to the
applicable shareholder on request, without
tying the reporting of such amounts to the
reporting of capital gain dividends.
Another commenter suggested that
RICs and REITs should be permitted to
disclose these additional amounts, upon
request by a shareholder, and report the
One Year Amounts Disclosure and Three
Year Amounts Disclosure (as those terms
are defined in proposed §1.1061-6(c)) un-
til the extended due date of their returns.
The final regulations retain the rules as
proposed but designate them as §1.1061-
4(b)(5). As suggested by these comment-
ers, the final regulations retain the option
to disclose to shareholders the two addi-
tional amounts (that is the final regula-
tions do not make disclosure mandatory).
The final regulations do not adopt the sug-
gestion to allow RICs and REITs to dis-
close these additional amounts only upon
the request of a shareholder because such
treatment may allow a RIC or REIT to
choose to provide information only to cer-
tain shareholders but not to other share-
holders. The Treasury Department and the
IRS continue to study comments suggest-
ing that the disclosure of this information
be separated from the reporting of capital
gain dividends and may issue guidance in
the future. In the interim, the final regula-
tions retain the rule that the disclosures are
to be provided with the section 852(b)(3)
(C)(i) capital gain dividend statement or
section 857(b)(3)(B) capital gain dividend
notice.
4. Computation of the Recharacterization
Amount for Owner Taxpayers with
interests in QEFs
The proposed regulations provide spe-
cial rules for Owner Taxpayers that hold
their APIs indirectly through PFICs for
which they have made a QEF election.
Specifically, under proposed §1.1061-
4(b)(5), the API One and Three Year
Distributive Share Amounts include an
Owner Taxpayer’s section 1293(a)(1) in-
clusions from QEFs, reduced by amounts
that are excluded from section 1061(a) if
the QEF complies with the reporting rules
under §1.1061-6(d). These reporting rules
provide that QEFs may provide informa-

Bulletin No. 2021–5 645 February 1, 2021
tion to allow Owner Taxpayers to com-
pute their Recharacterization Amount. If
a QEF fails to provide such information,
an Owner Taxpayer includes its entire pro
rata share of the QEF’s net capital gain
in its API One Year Distributive Share
Amount and no portion of its pro rata
share of the QEF’s net capital gain is ul-
timately included in its API Three Year
Distributive Share Amount. One com-
menter made several suggestions regard-
ing the computation of an Owner Tax-
payer’s API One Year Distributive Share
Amount and API Three Year Distributive
Share Amount with respect to a QEF’s net
capital gain. Broadly, the commenter ex-
pressed a concern that the corporate-lev-
el capital gain netting rules applicable to
QEFs are not consonant with the require-
ment that the Recharacterization Amount
be computed at the Owner Taxpayer lev-
el. A QEF determines its net capital gain
at the corporate level, and may do so in
one of three ways: first, the QEF may cal-
culate and report the amount of each cat-
egory of long-term capital gain described
in section 1(h) of the Code; second, the
QEF may report its net capital gain for
the year and state that it is subject it to the
highest capital gain rate of tax applicable
to the shareholder; or third, the QEF may
determine its current earnings and prof-
its (E&P) and report the entire amount as
ordinary earnings. Section 1.1293-1(a)
(2). A QEF’s net capital gain is limited
to its current E&P, regardless of how it
computes such amount under §1.1293-
1(a)(2) (QEF E&P limitation). Section
1293(e)(2). The commenter had several
suggestions on how to clarify or improve
the rules under section 1061 applicable to
QEFs.
First, the commenter suggested that the
three year QEF net capital gain provision
was not entirely clear, particularly in re-
gard to the API Three Year Distributive
Share Amount. The commenter recom-
mended that the final regulations clarify
that an Owner Taxpayer includes in its API
Three Year Distributive Share Amount the
same base amount as determined for the
API One Year Distributive Share Amount
(as adjusted to reflect only net long-term
capital gains and losses calculated by sub-
stituting a greater-than-three-year holding
period for a greater-than-one-year holding
period).
The Treasury Department and the IRS
confirm that an Owner Taxpayer’s API
Three Year Distributive Share Amount is
based on the amount computed for its API
One Year Distributive Share Amount and
adjusted to include only items that would
be treated as a long-term gain or loss if
three years were substituted for one year
in paragraphs (3) and (4) of section 1222
if the QEF satisfies certain reporting ob-
ligations. See §1.1061-6(d). However, the
final regulations revise proposed §1.1061-
4(b)(5) (designated as §1.1061-4(b)(6)
in the final regulations) to more precise-
ly identify the inputs for computing an
Owner Taxpayer’s API One and Three
Year Distributive Share Amounts and il-
lustrate an Owner Taxpayer’s API Three
Year Distributive Share Amount compu-
tation with respect to a QEF. Specifical-
ly, §1.1061-4(b)(6)(i) provides that an
Owner Taxpayer’s inclusion under section
1293(a)(1)(B) that is taken into account in
determining the API One Year Distribu-
tive Share Amount with respect to a QEF
is limited to the QEF’s E&P by section
1293(e)(2) and that the section 1293(a)(1)
(B) inclusion may be reduced by the Own-
er Taxpayer’s share of the excess (if any)
of the Capital Interest Gain over Capital
Interest Loss with respect to the QEF as
well as amounts not taken into account
for purposes of section 1061 pursuant to
§1.1061-4(b)(7). In either case, however,
§1.1061-4(b)(6)(i) permits such reduc-
tions only if a QEF has provided an Own-
er Taxpayer with the relevant information
necessary for the Owner Taxpayer to de-
termine those amounts.
Additionally, §1.1061-4(b)(6)(ii) of the
final regulations provides that the minuend
of an Owner Taxpayer’s API Three Year
Distributive Share Amount computation
(under §1.1061-4(a)(3)(ii)) includes its
entire amount determined under §1.1061-
4(b)(6)(i) (one year QEF net capital gain).
The final regulations further provide that
if the QEF does not provide the Owner
Taxpayer with information necessary un-
der §1.1061-6(d) to determine the amount
of its section 1293(a)(1)(B) inclusion (less
any allowed reductions) with respect to
the QEF that would be included in its API
One and Three Year Distributive Share
Amounts, then the entire amount of the
Owner Taxpayer’s one year QEF net cap-
ital gain (less any allowed reductions) is
also included in the subtrahend of its API
Three Year Distributive Share Amount
formula (under §1.1061-4(a)(3)(ii)(A)).
This results in an Owner Taxpayer’s en-
tire section 1293(a)(1)(B) inclusion (less
any allowed reductions) being treated as
short-term capital gain. However, if the
QEF provides the Owner Taxpayer with
the additional necessary information,
then the Owner Taxpayer includes only
the amount of its one year QEF net capi-
tal gain amount that would not be treated
as long-term capital gain substituting a
greater-than-three-year holding period in
applying paragraphs (3) and (4) of section
1222 in the subtrahend of this formula
(under §1.1061-4(a)(3)(ii)(A)). This can
result in a portion of an Owner Taxpay-
er’s section 1293(a)(1)(B) inclusion being
characterized as long-term capital gain
with the balance being treated as short-
term capital gain.
To illustrate, assume an Owner Taxpay-
er owns an interest in a QEF that holds an
API; the Owner Taxpayer owns no other
API directly or indirectly. The QEF gen-
erates both long- and short-term capital
gain in its taxable year, none of which are
amounts described in §1.1061-4(b)(7) or
Capital Interest Gains; the Owner Taxpay-
er’s pro rata share of the QEF’s long-term
capital gain is $100, $70 of which would
not be long-term capital gain if a great-
er-than-three-year holding period were
used in applying paragraphs (3) and (4) of
section 1222, and its share of the QEF’s
short-term capital gain (determined with-
out regard to section 1061) is $15. Before
applying section 1061, under §1.1293-1(a)
(2), the Owner Taxpayer’s pro rata share
of the QEF’s net capital gain is $100. Un-
der §1.1061-4(b)(6)(i), with respect to the
QEF, the Owner Taxpayer’s one year QEF
net capital gain amount, and thus its API
One Year Distributive Share Amount, is
$100. In its API Three Year Distributive
Share Amount computation with respect
to the QEF, this $100 is the minuend (un-
der §1.1061-4(a)(3)(ii)). If the QEF does
not provide the Owner Taxpayer with in-
formation to determine how much of its
pro rata share of the QEF’s net capital gain
would constitute long-term capital gain if
a greater-than-three-year holding period
were used in applying paragraphs (3) and
(4) of section 1222, the Owner Taxpayer
would include all $100 under §1.1061-

February 1, 2021 646 Bulletin No. 2021–5
4(a)(3)(ii)(A) in the subtrahend of its
computation. This results in an API Three
Year Distributive Share Amount of $0
with respect to the QEF (that is: $100 un-
der §1.1061-4(a)(3)(ii) introductory text,
minus $100 under §1.1061-4(a)(3)(ii)(A))
and a Recharacterization Amount of $100
(that is, $100 API One Year Distributive
Share Amount minus $0 API Three Year
Distributive Share Amount). However,
if the QEF does provide the Owner Tax-
payer with this information, the Owner
Taxpayer includes $70 in the subtrahend
of its API Three Year Distributive Share
Amount computation with respect to the
QEF under §1.1061-4(a)(3)(ii)(A). This
results in an API Three Year Distributive
Share Amount of $30 (that is: $100 under
§1.1061-4(a)(3)(ii) introductory text, mi-
nus $70 under §1.1061-4(a)(3)(ii)(A)) and
a $70 Recharacterization Amount (that
is: $100 API One Year Distributive Share
Amount minus $30 API Three Year Dis-
tributive Share Amount).
Additionally, the commenter asked that
the final regulations harmonize the QEF
reporting rules with the reporting rules
applicable to other Passthrough Entities.
Specifically, the commenter requested that
if a QEF does not report relevant informa-
tion, then QEF shareholders that are Own-
er Taxpayers should be able to substanti-
ate amounts included in the API One Year
Distributive Share Amount and Three
Year Distributive Share Amount, as well
as items excluded from section 1061(a),
through alternative means.
The Treasury Department and the IRS
have concluded that, when coupled with
§1.1061-6(d), the QEF reporting rules in
§1.1295-1(g) provide a sufficiently com-
prehensive framework for information
reporting and no additional rule for sec-
tion 1061 is necessary. Under §1.1295-
1(g)(1), for a PFIC to be treated as a QEF
by its shareholders it must provide either
an annual statement including the share-
holder’s pro rata share of the QEF’s net
capital gain for the year or a statement
that it has granted its shareholders access
to its books and records (or other doc-
uments) for the purpose of determining
those amounts; under §1.1295-1(g)(3), the
same information must be reported to in-
direct PFIC shareholders on an intermedi-
ary statement. Under §1.1295-1(g)(2), in
“rare and unusual circumstances,” a PFIC
can provide alternative documentation if
it obtains a private letter ruling from, and
enters into a closing agreement with, the
IRS. In addition to these reporting require-
ments, §1.1061-6(d) permits (but does not
require) a QEF to provide its shareholders
that are Owner Taxpayers with additional
information for the purpose of determin-
ing the Owner Taxpayer’s API One Year
Distributive Share Amount and Three
Year Distributive Share Amount.
The Treasury Department and the
IRS have determined that the reporting
mechanisms under §§1.1295-1(g) and
1.1061-6(d) provide sufficient avenues
for an Owner Taxpayer to obtain infor-
mation from a QEF to determine its API
One Year Distributive Share Amount and
Three Year Distributive Share Amount. A
special rule allowing Owner Taxpayers
to substantiate QEF information through
alternative means for purposes of section
1061 would also run counter to §1.1295-
1(g), which generally requires a QEF, and
not its shareholders, to report information
for purposes of section 1293. As a result,
to reconcile the optional nature of QEF
reporting as compared with reporting re-
quirements of other Passthrough Entities,
the final regulations revise §1.1061-6(b)
(2)(ii) to provide that a Passthrough Entity
from which information is requested must
provide such information, but only to the
extent the information is necessary for the
requesting Passthrough Entity to meet its
reporting and filing requirements under
§1.1061-6. The final regulations also re-
vise §1.1061-6(d) to provide that Owner
Taxpayers are not permitted to separate-
ly substantiate amounts with respect to a
QEF under §1.1061-6(a)(2). Accordingly,
the comments suggesting changes to the
QEF reporting rules under section 1061
are not adopted.
The commenter also suggested that the
final regulations should provide guidance
on how to apportion the QEF E&P lim-
itation for purposes of section 1061. Spe-
cifically, the commenter suggested that
the QEF E&P limitation should be appor-
tioned according to the shareholder’s rel-
ative share of the API One Year Distribu-
tive Share Amount and the API Three Year
Distributive Share Amount with respect to
the QEF. The commenter also suggested
that consideration be given to bypassing
netting at the PFIC level, with guidance
to be provided on how to allocate the QEF
E&P limitation at the Owner Taxpayer
level.
The QEF E&P limitation is imposed
by section 1293(e)(2) and is taken into
account in determining a shareholder’s
pro rata share of the net capital gains of
a QEF that is required to be included in a
shareholder’s income pursuant to section
1293(a)(1). Netting of losses must there-
fore be carried out before determining the
net capital gain of a QEF that is required
to be included by a shareholder. The Trea-
sury Department and the IRS recognize
the complexity regarding apportioning
the QEF E&P limitation for purposes of
section 1061. This issue is particular-
ly acute in light of the different types of
capital gain and loss relevant for purposes
of section 1061 that may be included in
a QEF’s net capital gain, including one-
and three-year capital gains and losses,
and amounts excluded from section 1061
under §1.1061-4(b)(7) or under the capital
interest exception. Further complication
arises from the fact that a loss may arise
either from a QEF’s ordinary business op-
erations, or from one or more of the four
categories listed in the prior sentence.
In this regard, the Treasury Department
and the IRS considered several possible
ways of apportioning the QEF E&P lim-
itation. One possibility would be to adopt
an approach that apportions the QEF E&P
limitation between the relevant types
of capital gains for purposes of section
1061 on a pro rata basis, which the Trea-
sury Department and the IRS determined
would be appropriate in many circum-
stances, though not all. For example, if a
loss arises from a QEF’s ordinary business
operations while its capital gain income is
derived from an API, there may be no di-
rect link between the ordinary loss and the
API-derived capital gain. In such a case
a pro rata approach may be appropriate.
Alternatively, for other circumstances, the
Treasury Department and the IRS consid-
ered apportioning a QEF’s E&P limitation
based on more specific ordering rules. For
example, if a loss were related to one or
more categories of capital gain, allocation
first to those categories might be appropri-
ate. Another possible approach would be
to allocate the loss giving rise to the E&P
limitation in the manner that most close-
ly approximates how an Owner Taxpayer

Bulletin No. 2021–5 647 February 1, 2021
would be permitted to allocate the loss if
the QEF’s gains and losses were derived
directly by the Owner Taxpayer and the
Owner Taxpayer’s income was limited to
otherwise-long-term capital gain income.
In light of the complexity regarding the
different scenarios under which a pro
rata approach or an alternative approach
would be more appropriate, the Treasury
Department and the IRS have determined
that this issue warrants further study and
welcome comments in this regard. Until
the Treasury Department and the IRS is-
sue further guidance on this issue, taxpay-
ers may adopt any reasonable method for
apportioning the QEF E&P limitation for
purposes of section 1061 taking into ac-
count these considerations.
Finally, the commenter requested that
the Treasury Department and the IRS pro-
vide a rule that would identify an Owner
Taxpayer’s distributive share of a QEF’s
net capital gain from a Passthrough En-
tity attributable to the Owner Taxpayer’s
qualifying capital interest and API. The
Treasury Department and the IRS contin-
ue to study this issue and may address it in
future guidance.
5. Items Not Taken Into Account for
Purposes of Section 1061
Proposed §1.1061-4(b)(6) provides
that certain items of long-term capital
gain and loss are excluded from the cal-
culation of the API One Year Distributive
Share Amount and the API Three Year
Distributive Share Amount. Specifically,
long-term capital gain and long-term cap-
ital loss determined under section 1231 or
1256, qualified dividends included in net
capital gain for purposes of section 1(h)
(11)(B), and capital gains or losses that are
characterized as long-term or short-term
without regard to the holding period rules
in section 1222 are excluded from these
calculations.
Two commenters questioned the ex-
clusion of long-term capital gain deter-
mined under section 1231 from rechar-
acterization under section 1061. Those
commenters discussed the discrepancies
in language between section 1061(a)(1)
and 1061(a)(2), noting that only section
1061(a)(2) refers to section 1222. Both
commenters suggested that the treatment
of section 1231 gains in the proposed reg-
ulations is contrary to the statutory text of
section 1061. The first commenter stat-
ed that section 1061(a)(1) applies to net
long-term capital gain and noted that other
portions of section 1061 indicate that it is
supposed to apply to gains that are taxed
at favorable rates for disposition of invest-
ment assets. This commenter argued that
the reference to section 1222 in section
1061(a)(2) can be read as excluding cer-
tain section 1222 gains from the reach of
section 1061(a), rather than limiting sec-
tion 1061(a) to such gains by implication.
The commenter noted that if a determina-
tion is made that section 1061(a) does ap-
ply to section 1231, then regulations need
to address the holding periods of section
1231 and how the netting rules of section
1231 interact with section 1061.
The second commenter suggested that,
under the proposed regulations, the por-
tion of any net section 1231 gains attrib-
utable to APIs could arguably be included
in the amount described in section 1061(a)
(1). The commenter stated that this would
lead to nonsensical results if net section
1231 gains are included in the amount de-
scribed in section 1061(a)(1) but exclud-
ed from the amount described in section
1061(a)(2). Because of the conflicting
statutory language in sections 1061(a)(1)
and 1061(a)(2), the commenter recom-
mended that the treatment of section 1231
gains be reconsidered, suggesting that one
approach would be to include the net 1231
gain attributable to APIs in the section
1061(a) computation after recomputing
this amount by substituting 3 years for 1
year.
In contrast, several commenters sup-
ported the proposed regulation’s treatment
of qualified dividends and long-term cap-
ital gains determined under section 1231
and 1256 as not subject to recharacteriza-
tion under section 1061 and recommended
these provisions be finalized as proposed.
Commenters noted that this treatment
aligns with the clear language of the stat-
ute and is consistent with Congressional
intent. One commenter stated that section
1256 amounts should not be subject to
section 1061(a) because they are not gains
that are taxed at favorable rates that arise
from the disposition of assets. Another
commenter noted that the statutory refer-
ences to section 1223(3) and (4) raise the
question of section 1061’s potential effect
on other Code provisions without regard
to section 1222. The commenter indicated
that some provisions have their own hold-
ing period, such as section 1231, while
others, such as section 1256, just mandate
tax treatment. The commenter stated that
this results in a haphazard inclusion or
exclusion of items from section 1061 and
noted that because the section 1061 legis-
lative history is devoid of guidance on this
issue, the approach taken in the proposed
regulations is reasonable but a technical
correction from Congress would be wel-
come.
The final regulations do not adopt sug-
gestions that section 1231 gain should be
subject to recharacterization under section
1061(a) and maintain the rules in proposed
§1.1061-4(b)(6), which is designated as
1.1061-4(b)(7) in the final regulations.
As stated in the preamble to the proposed
regulations, section 1231 gains and losses
are treated as long-term based on the op-
eration of section 1231, and not by refer-
ence to paragraphs (3) and (4) of section
1222. Similarly, section 1256 provides
for specific character treatment and does
not calculate gain by reference to section
1222. Accordingly, the Treasury Depart-
ment and the IRS have determined that it
is appropriate to exclude these amounts
from both the One Year and Three Year
Gain Amounts. In contrast, because sec-
tion 1061(d)(1) looks to the excess of
long-term capital gains with respect to the
transferred interest to the sale or exchange
of any asset held for not more than three
years as is allocable to such interest over
what is otherwise short-term capital gain
under section 1061(a), and does not ref-
erence section 1222, these amounts are
captured in transactions to which section
1061(d) applies. The final regulations do
not adopt the suggestion to provide guid-
ance on section 1231 holding periods
or netting rules because such guidance
would be beyond the scope of these final
regulations.
One commenter suggested that pro-
posed §1.1061-4(b), which excludes
certain items from the calculation of the
API One Year and Three Year Distribu-
tive Share Amounts, should be modified
to explicitly reference both One Year
Disposition Gains and One Year Distrib-
utive Share Amounts in providing for an
exclusion of section 1231 property from

February 1, 2021 648 Bulletin No. 2021–5
the scope of section 1061. The commenter
suggested that the Treasury Department
and the IRS should also determine wheth-
er a similar modification is appropriate for
the exclusion for section 1256 property.
The final regulations do not adopt this
comment. The API One Year Disposition
Amount includes long-term capital gains
and losses recognized by an Owner Tax-
payer on the disposition of all or a portion
of an API. Pursuant to section 741, the sale
or exchange of a partnership interest, in-
cluding an API, is the sale or exchange of
a capital asset. Accordingly, the character
of the gain is determined with reference to
section 1222. The items listed in §1.1061-
4(b)(7), including section 1231 gain, are
excluded from the calculation of the API
One Year and Three Year Distributive
Share Amounts because they are not de-
termined without regard to section 1222.
Furthermore, asymmetrical tax treatment
occasionally is a result of the difference
between the sale of a partnership interest
and the sale of assets by a partnership.
One commenter noted that under sec-
tion 197(f), acquired goodwill is treated as
depreciable property, thereby causing gain
recognized on the sale of acquired good-
will to be treated as section 1231 gain.
By contrast, self-created goodwill does
not qualify as an amortizable intangible
under section 197; therefore, any gain
recognized on the sale of the self-created
goodwill is not section 1231 gain. Instead,
it is treated as a capital asset giving rise
to capital gain upon a sale or exchange.
Consequently, under the proposed regula-
tions, gain on the sale of acquired good-
will is excluded from the Recharacteri-
zation Amount while gain on the sale of
self-created goodwill is not excluded. The
commenter recommended that in addition
to the exclusion for section 1231 gain, the
regulations should provide that any gain
recognized on the sale of goodwill held in
connection with the conduct of a trade or
business (whether or not determined un-
der section 1231) is also excluded from
the Recharacterization Amount because
there is no evidence Congress intended to
subject self-created goodwill held in con-
nection with a trade or business to section
1061.
The final regulations do not adopt this
comment. The disparate treatment of pur-
chased and self-created goodwill is pre-
scribed by section 197 and nothing in sec-
tion 1061 changes this treatment.
6. Holding Periods
Proposed §1.1061-4(b)(8) clarifies that
the relevant holding period of either an as-
set or an API is determined under all pro-
visions of the Code or regulations that are
relevant to determining whether the asset
or the API has been held for the long-term
capital gain holding period by applying
those provisions as if the holding period
were three years instead of one year. For
this purpose, the relevant holding period
is the direct owner’s holding period in the
asset sold.
The final regulations maintain this rule
as proposed. One commenter requested
clarification that the modification of a
partnership agreement does not itself cre-
ate a new holding period for the API. The
final regulations do not adopt this com-
ment as section 1061 does not generally
change the holding period of an asset.
7. API Holder Transition Amounts and
Partnership Transition Amounts
The proposed regulations provide that
a partnership that was in existence as of
January 1, 2018, could irrevocably elect to
treat all long-term capital gains and losses
recognized from the disposition of all as-
sets held by the partnership for more than
three years as of January 1, 2018, as Part-
nership Transition Amounts. An amount
of long-term gain or loss treated as a Part-
nership Transition Amount and included
in the allocation of long-term capital gains
and losses under sections 702 and 704 to
an API Holder with respect to its interest
in a Passthrough Entity was treated as an
API Holder Transition Amount. API Hold-
er Transition Amounts were not taken into
account for purposes of determining the
Recharacterization Amount. The preamble
to the proposed regulations also requests
comments on whether a transition rule is
needed and whether the Partnership Tran-
sition Amount rules are useful or whether
another approach would be more helpful
in easing transition difficulties.
Several commenters questioned the
need for an elective transition rule. One
commenter noted that while they appre-
ciated the Treasury Department and the
IRS seeking to minimize the burdens
associated with the change in law, they
did not believe the transition rules would
measurably lessen the recordkeeping bur-
den on funds. The commenter also noted
that whether and for whom the transition
rules would be beneficial is unpredictable.
Another commenter recommended that
final regulations include an example illus-
trating, or otherwise better explaining, the
importance of the API Holder Transition
Amount rules, that is, what benefits the
API Holder Transition Amount rules are
intended to confer on taxpayers. No com-
menter provided an example of the poten-
tial applicability of the API Holder Tran-
sition Amount rules. After considering the
comments, the Treasury Department and
the IRS have determined that the Partner-
ship Transition Amount rules are unneces-
sary. Accordingly, the final regulations do
not include these rules.
D. Section 1.1061-6: Reporting
Requirements
Proposed §1.1061-6(a) provides filing
and reporting requirements for Owner
Taxpayers and Passthrough Entities. Pro-
posed §1.1061-6(a)(1) provides that an
Owner Taxpayer must file such informa-
tion with the IRS as the Commissioner
may require in forms, instructions, or other
guidance as is necessary for the Commis-
sioner to determine that the Owner Tax-
payer is in compliance with section 1061
and the regulations. Proposed §1.1061-
6(b)(1) provides that a Passthrough En-
tity must file such information with the
IRS as the Commissioner may require in
forms, instructions, or other guidance as
is necessary for the Commissioner to de-
termine that the Passthrough Entity and its
partners have complied with section 1061
and the regulations and that a Passthrough
Entity that has issued an API must furnish
to the API Holder, including an Owner
Taxpayer, such information at such time
and in such manner as is necessary to de-
termine the One Year Gain Amount and
the Three Year Gain Amount with respect
to the Owner Taxpayer that directly or in-
directly holds the API.
Proposed §1.1061-6(a)(2) provides
that if a Passthrough Entity does not fur-
nish the information that an Owner Tax-
payer needs to determine its Recharac-

Bulletin No. 2021–5 649 February 1, 2021
terization Amount and meet its reporting
requirements, and the Owner Taxpayer is
not able to otherwise substantiate all or a
part of those amounts to the satisfaction
of the Secretary, then (i) the negative ad-
justments under proposed §1.1061-4(a)(3)
(i)(B) necessary to calculate the API One
Year Distributive Share Amount will be
deemed to equal zero, and (ii) the negative
adjustment to the API One Year Distribu-
tive Share Amount for purposes of deter-
mining the API Three Year Distribution
Amount under proposed §1.1061-4(a)(3)
(ii)(B) will be deemed to equal zero.
Proposed §1.1061-6(b)(2) provides
that a Passthrough Entity that holds an
interest in a lower-tier entity and needs
information from the lower-tier entity to
meet its reporting obligations under the
proposed regulations must request such
information from that entity by the later of
the 30th day after the close of the taxable
year to which the information request re-
lates or within 14 days after the date of a
request for information from an upper-tier
Passthrough Entity and the lower-tier en-
tity must respond by the due date (includ-
ing extensions) of the Schedule K-1 for
the taxable year. Proposed §1.1061-6(b)
(2)(vii) provides that a Passthrough Enti-
ty that fails to comply with the reporting
rules in the proposed regulations or as
further required in forms, instructions, or
other guidance will be subject to penalties.
One commenter stated that the report-
ing rules are based on the assumption that
there will be a limited number of indi-
viduals who are in control and who have
access to all relevant factual information.
Consequently, the rules are extensive and
smaller partnerships and non-controlled
partnerships may have difficulty comply-
ing without significant cost and expense.
The commenter suggested this argued in
favor of exempting small partnerships
from these rules.
A few commenters stated that lower-ti-
er passthrough entities are not required to
furnish information until the due date of
their returns and that this deadline does
not permit upper-tier entities sufficient
time to incorporate lower-tier passthrough
entity information into their reporting.
Further, the commenter noted that the
regulations appear to prevent Owner Tax-
payers from excluding anything from the
API One Year Distributive Share Amount
even if only part of the information cannot
be substantiated. The commenter recom-
mended that for groups of non-controlled
entities, the requestor should be allowed
any reasonable approach to substantiate
the information and suggested that issues
from non-compliant tiers should be re-
solved by having the IRS impose failure
to furnish penalties on those tiers. Finally,
the commenter recommended guidance on
how to substantiate unreported amounts.
Several commenters suggested that the
information reporting requirements are
onerous and that denying exclusions from
recharacterization for non-compliance is
too harsh a penalty for Owner Taxpayers
and upper-tier partnerships who are un-
able to secure the necessary information
from lower-tier partnerships, particularly
where an Owner Taxpayer or upper-tier
partnership has no control over whether
the reporting requirements are met by the
lower-tier partnership. One commenter ar-
gued that there is no indication in the stat-
ute or legislative history that this is what
Congress intended. The commenter noted
that the TCJA conference report indicates
that Congress intended section 6031(b)
penalties to apply to a failure to report to
partners and those penalties are sufficient
to deter non-compliance while not acting
to change the character of distributive
share items.
A few commenters noted that the re-
porting requirements will require signif-
icant amendments to partnership agree-
ments and reporting systems. These
commenters requested that the effective
date for the reporting requirements and as-
sociated penalties be delayed until at least
12 months after the year end in which the
regulations are finalized to give funds and
API Holders time to amend their opera-
tions and establish proper information re-
porting systems, particularly in light of the
increased reporting requirements resulting
from partner tax capital account reporting,
Forms K-2 and K-3, the section 163(j)
limitation, and other recent guidance.
One commenter suggested that the
regulations should provide a de minimis
exception to the reporting requirements,
especially in tiered partnership arrange-
ments. The commenter suggested that if a
limited partner owns less than five percent
of a fund, there should be limitations on
reporting requirements to those partners,
arguing that information reporting is cost-
ly in a tiered fund context and the low-
er-tiered funds may not want to dedicate
the resources to provide the proper report-
ing for such small fund interests.
The final regulations do not adopt these
comments. The reporting rules, including
the zero presumptions, are necessary to ef-
fectively administer section 1061 and the
regulations. The Treasury Department and
the IRS note that the amounts required to
be reported under the reporting rules may
be substantiated by any reasonable means
if a Passthrough Entity fails to report the
necessary information to the Owner Tax-
payer. Similarly, a de minimis rule or an
exception for small partnerships would
frustrate Owner Taxpayers’ ability to cor-
rectly determine the Recharacterization
Amount and the IRS’s ability to adminis-
ter the statute. For these reasons, the Trea-
sury Department and the IRS also decline
to provide a delay in the applicability date
for the reporting rules.
The final regulations retain the re-
porting rules as proposed with minor
clarifying changes, including the chang-
es discussed in paragraph III.C.4 of this
preamble with respect to QEF reporting.
In addition, the final regulations provide
that if an Owner Taxpayer requires in-
formation from a Passthrough Entity to
determine the Section 1061(d) Recharac-
terization Amount, the Owner Taxpayer
should request such information from that
entity. The Passthrough Entity is required
to provide the information to the extent
requested by an API Holder and necessary
to determine the Owner Taxpayer’s Sec-
tion 1061(d) Recharacterization Amount.
Finally, the final regulations substitute
“Commissioner” for “Secretary of the
Treasury” in §1.1061-6(a)(2) to avoid any
misperception that any office or bureau
within the Treasury Department other than
the IRS is responsible for examining tax-
payers’ returns.
E. Securities Partnerships
The proposed regulations include an
amendment to §1.704-3(e), which pro-
vides that a method for aggregating gains
and losses by a securities partnership
will not be considered reasonable unless
it takes into account the application of
section 1061. Specifically, the proposed

February 1, 2021 650 Bulletin No. 2021–5
regulations require partnerships that use
the partial or full netting approaches de-
scribed in §1.704-3(e) to establish ac-
counts to track API Holders’ Capital In-
terest Gains and Losses, Unrealized API
Gains and Losses, and API Gains and
Losses. A commenter questioned whether
these rules were necessary, given the like-
lihood of hedge fund managers to leave a
fund before the three-year holding period
expires. Another commenter noted that
funds would need to implement sophisti-
cated tracking mechanisms to distinguish
between Capital Interest Gains and Losses
and API Gains and Losses. The comment-
er thought that such tracing conflicted
with the principles of aggregation provid-
ed by §1.704-3(e).
Another commenter recommended that
the final regulations confirm that part-
nerships can change their section 704(c)
aggregation method in order to address
section 1061 in a manner consistent with
the regulations and that any such change
would not violate the requirement to use
the same aggregation approach once an
approach is adopted. The commenter re-
quested that the final regulations provide
examples illustrating the intended appli-
cation of the creation of separate accounts
for APIs and capital interests.
The final regulations provide a sim-
plified rule in §1.704-3(e) that states that
section 1061 must be taken into account
in applying the aggregation rule for secu-
rities partnerships, but does not provide a
specific method for doing so. The Trea-
sury Department and the IRS continue to
study the comments received on this issue
and may provide additional guidance in
the future.
IV. Additional Areas Under Study
A. Section 1061(b) Exception
Section 1061(b) provides that “[t]o the
extent provided by the Secretary, [section
1061(a)] shall not apply to income or gain
attributable to any asset not held for port-
folio investment on behalf of third party
investors.” The proposed regulations re-
serve with respect to the application of
section 1061(b). The preamble to the pro-
posed regulations states that the Treasury
Department and the IRS generally believe
that the section 1061(b) exception is effec-
tively implemented in the proposed regu-
lations with the exception to section 1061
for Passthrough Interest Direct Invest-
ment Allocations. The preamble further
requested comments on the application of
section 1061(b) and whether the proposed
regulations’ exclusion for Passthrough In-
terest Direct Investment Allocations prop-
erly implements the exception.
One commenter suggested that the
Passthrough Interest Direct Investment
Allocations would exempt certain fami-
ly offices from section 1061(a) but stated
that the exception is too narrow to ac-
count for all types of family offices. The
commenter noted that section 1061(b)
is not intended to cover family offices
managed by a professional investment
manager who is not a family member and
who receives an API because the family
members are third-party investors with
respect to the professional investment
manager. Several commenters suggested
that additional guidance under section
1061(b) is needed for family offices,
management companies, and other part-
nerships that do not hold assets for port-
folio investment on behalf of third-party
investors. One commenter argued that
the Treasury Department and the IRS
should not reserve on section 1061(b)
because carried interests as used in asset
management businesses were the partic-
ular focus of Congress as it contemplated
carried interest proposals.
One commenter noted that it had rec-
ommended prior to the issuance of the
proposed regulations that the authority
under section 1061(b) should be exercised
to confirm that section 1061(a) does not
apply to recharacterize income or gain
attributable to the value of intangibles,
including goodwill, created or used in an
ATB. The commenter recognized that the
Passthrough Interest Direct Investment
Allocation rules in the proposed regu-
lations operate in part to implement an
exception for enterprise value, but rec-
ommended that final regulations should
provide specifically that section 1061(a)
does not apply to recharacterize income
or gain attributable to enterprise value.
Furthermore, the commenter argued that
the enterprise value exception should ap-
ply to allocations through tiers and should
not require allocations in accordance with
partner capital accounts if the intangible
asset it not held for portfolio investment
on behalf of third-party investors.
As discussed in Part II.A. of this Sum-
mary of Comments and Explanation of
Revisions, the final regulations modify the
rules related to the capital interest excep-
tion, including removing the Passthrough
Interest Direct Investment Allocation rules.
As discussed in Part II.C. of this Summa-
ry of Comments and Explanation of Re-
visions, the final regulations provide that
the delayed holding period prong of the
Lookthrough Rule does not apply to the
disposition of an API to the extent that the
gain recognized upon the disposition is at-
tributable to any asset not held for portfolio
investment on behalf of third party inves-
tors. The Treasury Department and the IRS
continue to study the comments regarding
section 1061(b) and may address the appli-
cation of the provision in future guidance,
including whether section 1061(a) applies
to recharacterize income or gain attrib-
utable to enterprise value. The Treasury
Department and the IRS request additional
comments related to section 1061(b).
B. Small Partnerships
In the preamble to the proposed regula-
tions, the Treasury Department and the IRS
requested comments and suggestions on
whether a simplified method for determin-
ing and calculating the API Gain or Loss
should be provided for small partnerships
and if so, the criteria that should be used
to determine which partnerships should
be eligible to use the simplified method.
One commenter stated that a small part-
nership exception is critically important
to the integrity of the entire section 1061
regulatory regime. The commenter also
noted that given the burdensome nature
of the reporting requirements that could
apply to small business taxpayers, a mod-
ification of these requirements for either
“small partnerships” or “small partners”
would appear to be justified. As discussed
in the section on reporting requirements,
a commenter also recommended a de mi-
nimis exception to the reporting require-
ments for passthrough entities in which a
limited partner owns five percent, or less,
of a fund. The Treasury Department and
the IRS continue to study this issue and
may address this in future guidance. The
Treasury Department and the IRS request

Bulletin No. 2021–5 651 February 1, 2021
additional comments and suggestions on
whether a simplified method for determin-
ing and calculating the API Gain or Loss
should be provided for small partnerships
and if so, the criteria that should be used
to determine which partnerships should be
eligible to use the simplified method.
V. Applicability Dates
The final regulations retain the appli-
cability dates as proposed. Accordingly,
the final regulations generally apply to
taxable years of Owner Taxpayers and
Passthrough Entities beginning on or after
January 19, 2021. Section 1.1061-3(b)(2)
(i) applies to taxable years beginning after
December 31, 2017. Section 1.1061-3(b)
(2)(ii) applies to taxable years beginning
after August 14, 2020. An Owner Taxpay-
er or Passthrough Entity may choose to ap-
ply the final regulations in their entirety to
a taxable year beginning after December
31, 2017, provided that they consistently
apply the final regulations in their entirety
to that year and all subsequent years.
With respect to an API in a partnership
with a fiscal year ending after December
31, 2017, section 706 determines the cap-
ital gains and losses the Owner Taxpayer
includes in income with respect to an API
after December 31, 2017. Section 706 pro-
vides that the taxable income of a partner for
a taxable year includes amounts required
by sections 702 and 707(c) with respect to a
partnership based on the income, gain, loss,
deduction, or credit of a partnership for any
taxable year ending within or with the tax-
able year of the partner. Accordingly, if a
calendar year Owner Taxpayer has an API
in a fiscal year partnership whose taxable
year ends after December 31, 2017, section
1061 applies to the Owner Taxpayer’s dis-
tributive share of long-term capital gain or
loss with respect to the API in calendar year
2018 regardless of whether the partnership
disposed of the property giving rise to the
gains and losses in the period prior to Janu-
ary 1, 2018. See §1.706-1(a).
Special Analyses
l. Regulatory Planning and Review–
Economic Analysis
Executive Orders 12866, 13563, and
13771 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to
select regulatory approaches that max-
imize net benefits (including potential
economic, environmental, public health
and safety effects, distributive impacts,
and equity). Executive Order 13563 em-
phasizes the importance of quantifying
both costs and benefits, of reducing costs,
of harmonizing rules, and of promoting
flexibility.
These regulations have been desig-
nated as economically significant under
Executive Order 12866 pursuant to the
Memorandum of Agreement (April 11,
2018) between the Treasury Department
and the Office of Management and Bud-
get (OMB) regarding review of tax regu-
lations.
A. Need for Final Regulations
These final regulations provide cer-
tainty and clarity to taxpayers affect-
ed by statutory changes introduced in
section 1061 by TCJA. The Treasury
Department and the IRS have received
questions and comments regarding the
meaning of various provisions in section
1061 and issues not explicitly addressed
in the statute. The Treasury Department
and the IRS have determined that such
comments warrant the issuance of fur-
ther guidance.
B. Background
Section 1061 of the Internal Revenue
Code (Code), enacted by TCJA, character-
izes certain long-term capital gains recog-
nized with respect to an API as short-term
capital gains. Short-term capital gains are
generally taxed at a higher rate than long-
term capital gains.
Section 1061 defines an API as an inter-
est in a partnership transferred to or held
by the taxpayer in connection with the
performance of substantial services by the
taxpayer, or any other related person, in
any “applicable trade or business” (ATB).
Under section 1061 the term ATB encom-
passes a range of financial service activ-
ities. Specifically, an ATB is any activity
conducted on a regular, continuous, and
substantial basis which consists, in whole
or in part, of raising or returning capital,
and either (i) investing in (or disposing of)
“specified assets” (or identifying specified
assets for such investing or disposition),
or (ii) developing specified assets. “Spec-
ified assets” are certain securities, certain
commodities, real estate held for rental or
investment, cash or cash equivalents, op-
tions or derivative contracts with respect
to any of the foregoing, and an interest in
a partnership to the extent of the partner-
ship’s proportionate interest in any of the
foregoing.
Prior to the TCJA, the Internal Revenue
Code made no distinction between capital
gains allocated to APIs versus other part-
nership interests and partnership assets.
Generally, the required holding period to
obtain the lower long-term capital gains
tax rate was one year for all partnership
interests and partnership capital assets.
Under the new provision, the required
holding period for an API must be greater
than three years to obtain long-term capi-
tal gains treatment.
The Treasury Department and the IRS
previously published proposed regula-
tions under section 1061 (“proposed reg-
ulations”).
C. Overview of the final regulations
The final regulations provide taxpayers
with definitional and computational guid-
ance regarding the application of section
1061. In particular, the final regulations
provide a number of definitions, includ-
ing the term ‘taxpayer’ for the purpose of
determining the existence of an API. Ad-
ditionally, the regulations clarify the rules
for certain exceptions to section 1061, in-
cluding the exception for capital interests,
and provide for an additional exception
for bona fide purchases of APIs by an un-
related party who is not a service provider.
The final regulations also provide rules
for calculating the recharacterized gain
amount.
D. Economic analysis
1. Baseline
In this analysis, the Treasury Depart-
ment and the IRS assess the benefits and
costs of the final regulations relative to a
no-action baseline reflecting anticipated
Federal income tax-related behavior in the
absence of these final regulations.

February 1, 2021 652 Bulletin No. 2021–5
2. Summary of Economic Effects
The final regulations provide certain-
ty and consistency in the application of
section 1061 by providing definitions
and clarifications regarding the statute’s
terms and rules. An economically effi-
cient tax system generally aims to treat
income and expense derived from similar
economic decisions consistently across
taxpayers and activities in order to reduce
incentives for individuals and businesses
to make choices based on tax rather than
market incentives. In the absence of the
guidance provided in these final regula-
tions, taxpayers would bear the burden
of interpreting the statute and the chanc-
es that different taxpayers might interpret
the statute differently would be exacer-
bated. For example, two similarly situat-
ed taxpayers might interpret the statutory
provisions pertaining to the definition of
taxpayer or the capital interest exception
differently, causing one to enter into a
partnership that another comparable tax-
payer might decline because of a different
interpretation of how the income will be
treated under section 1061. If this oppor-
tunity did not go to the more productive
taxpayer, this lack of clarity results in an
economically inefficient pattern of activi-
ty. An economic loss may also arise if all
taxpayers have identical interpretations
of the tax treatment of particular income
streams under the statute but which differ
slightly from the interpretation that Con-
gress intended for these income streams.
In this case, guidance provides value by
bringing economic decisions closer in line
with the intent and purpose of the statute.
The final regulations include multi-
ple substantive changes compared to the
proposed regulations. The Treasury De-
partment and the IRS view these chang-
es as favorable to taxpayers, providing
more flexibility and reducing burden and
complexity. In particular, the final rules
governing the capital interest exception
are more flexible to better accommodate
common business practices, which vary
considerably across industries. Compared
to the proposed regulations, the final reg-
ulations considerably narrow the range
of related party transactions triggering
1061 recharacterization, and the associat-
ed compliance burden. Finally, compared
to the proposed regulations, the Look-
through Rule on the sale of APIs included
in the final regulations is a more narrowly
targeted anti-abuse rule, only imposing a
compliance burden on taxpayers that ap-
pear to have engaged in abusive practices
with the primary aim of avoiding section
1061(a) recharacterization.
The proposed regulations solicited
comments on the economic analysis of the
proposed regulations. No such comments
were received.
3. Economic Analysis of Specific
Provisions
a. Provisions Not Substantially Revised
from the Proposed Regulations
i. Definition of taxpayer
The statute requires taxpayers to make
a number of determinations, including the
determination of the existence of an API,
and the calculation of the section 1061
amount, or amount of long-term gain re-
characterized under section 1061. Howev-
er, the term “taxpayer” is not defined in
either section 1061 or in the Conference
Report. Comments received by the Trea-
sury Department and IRS highlight the
importance of the definition of the term
taxpayer for purposes of section 1061.
Without guidance, taxpayers could use
different approaches to define “taxpayer,”
leading otherwise similar taxpayers to ex-
perience different degrees of complexity,
and to report different recharacterized
amounts.
The final regulations include two defi-
nitions of taxpayer to address the level at
which the determination of the existence
of an API is made and the level at which
the calculation of the section 1061 amount
is made. The final regulations define the
Owner Taxpayer as the person generally
required to pay tax on the gain or loss with
respect to the API. Under the final regu-
lations, the section 1061 calculation is
only performed by the person (the Own-
er Taxpayer) who must pay tax on the
gains and losses recognized with respect
to the API. The final regulations also in-
troduce the term Passthrough Taxpayer.
A Passthrough Taxpayer is an entity that
does not itself generally pay tax on capital
gains but must determine when an API ex-
ists and allocate income, gain, deduction
and loss to its owners. Both the Owner
Taxpayer and the Passthrough Taxpayer
are treated as taxpayers for the purpose of
determining whether an API exists.
The Treasury Department and the IRS
considered and rejected two alternative
approaches to the definition of taxpayer
outlined in received comments, the “ag-
gregate approach” and the “full entity ap-
proach”. Under the aggregate approach, a
partnership is not treated as a taxpayer for
purposes of section 1061. Instead, section
1061 is applied solely to the partners that
are ultimately subject to tax on the part-
nership’s items of capital gain and loss. A
concern with using this approach for the
purpose of determining whether an API
exists is that it could incentivize partners
to use tiered ownership structures to avoid
section 1061 recharacterization. For ex-
ample, an upper tier partnership may re-
ceive an interest in a lower-tier fund in
connection with the upper-tier partner-
ship’s performance of services in an ATB.
Partners of the upper-tier partnership may
contend that they did not receive their in-
terest in the upper-tier partnership in con-
nection with the services performed by
the upper-tier partnership. Stopping such
avoidance strategies would require com-
plex rules and potentially burdensome
reporting requirements when tiered own-
ership structures are involved.
Under the “full entity approach”, the
partnership is treated as a taxpayer for
purposes of both determining the exis-
tence of an API and calculating the section
1061 recharacterization amount. Treating
the partnership as a taxpayer for purposes
of calculating the section 1061 recharac-
terization amount was found to be more
burdensome than the approach taken in
the final regulations for three reasons.
First, using the full entity approach for
determining the section 1061 recharac-
terization amount may lead to increased
recharacterization of gains under section
1061 because individuals would not be
able to net gains and losses across mul-
tiple APIs. Second, the administrative
burden on both the taxpayer and the IRS
would be increased in cases of tiered own-
ership. Under the full entity approach, a
separate section 1061 calculation would
be required at each level at which an API
is held in a tiered partnership structure.
Finally, the full entity approach may add

Bulletin No. 2021–5 653 February 1, 2021
complexity and burden in cases in which
an exception to section 1061 applies, such
as if a corporation is a direct or indirect
partner. Because corporations are exclud-
ed from section 1061, any amount rechar-
acterized at the partnership level would
need to be tracked as it is allocated to
partners to ensure that corporate or other
excepted partners are not subject to the
three-year holding period under section
1061.
The Treasury and the IRS have con-
cluded that the chosen alternative, incor-
porating the concepts of Owner Taxpayer
and Passthrough Taxpayer, is less burden-
some than other alternatives and provides
helpful certainty to taxpayers.
ii. Clarification of the treatment of an API
purchased by an unrelated party
The statute states that capital gain or
loss recognized by a taxpayer on the sale
of an API held for more than one year is
subject to section 1061. The statute also
provides guidance for ongoing treatment
under section 1061 when the API is pur-
chased by, or transferred to, a related par-
ty or another service provider. However,
the statute does not provide guidance for
the taxpayer who purchases an API and
is neither a service provider to the rele-
vant ATB, nor related to the seller of the
API. The final regulations add an excep-
tion to section 1061 and provide that the
term API does not include an interest in
a partnership that would be treated as an
API but is held by a bona fide purchaser
of the interest who does not currently and
has never provided services in the relevant
ATB and who is not related to a person
who provides services currently or has
provided services in the past. By clarify-
ing the treatment of an API that is sold at
arm’s length, the final regulations reduce
uncertainty and compliance burdens for
taxpayers entering into these transac-
tions. The Treasury Department and the
IRS have determined that this exception
is consistent with the purpose of section
1061, which applies to service providers
and persons related to service providers
and which is not meant to apply to bona
fide purchasers of a partnership interest
who do not provide services.
The Treasury Department and the IRS
considered not providing this exception.
However, it was determined that failure to
provide this exception would treat unrelat-
ed purchasers of an API in an inequitable
fashion, and that continued treatment of
the partnership interest as an API would
be inconsistent with the purpose of section
1061 because unrelated purchasers did not
receive their interest in connection with
the performance of substantial services.
b. Provisions Substantially Revised from
the Proposed Regulations
i. Capital interest exception
Section 1061(c)(4)(B) provides that the
definition of an API does not include “any
capital interest in the partnership which
provides the taxpayer with a right to
share in partnership capital commensurate
with—(i) the amount of capital contrib-
uted (determined at the time of receipt of
such partnership interest) or (ii) the value
of the interest included in income under
section 83 upon the receipt or vesting of
such interest.” However, the statute does
not provide guidance on what it means for
a right to share in partnership capital to be
“commensurate” with the amount of capi-
tal contributed.
The final regulations clarify that allo-
cations are deemed commensurate with
capital contributed if, under the partner-
ship agreement, the allocation to an API
Holder is calculated in a similar manner
as the allocations to similarly situated Un-
related Non-Service Partners. This may be
determined on an investment-by-invest-
ment or class-by-class basis. To qualify as
a benchmark for comparison, the Unrelat-
ed Non-Service Partners must hold a sig-
nificant investment, defined as at least five
percent of the partnership. In the absence
of these regulations, taxpayers might face
confusion, along with substantial compli-
ance cost, in calculating their qualifying
capital interest. Further, partners with re-
alized gains would be incentivized to en-
gage in a series of inefficient transactions
in order to minimize tax.
The Treasury Department and the IRS
considered alternative interpretations of
“commensurate with capital contributed.”
In particular, the proposed regulations
provide that an allocation is “commensu-
rate with capital” if the allocation is based
on the relative section 704(b) capital ac-
counts of the partners under the partner-
ship agreement. The proposed regulations
then provide multiple rules for calculating
an API holder’s capital account, including
a rule disallowing unrealized API capital
gains in calculating the API holder’s cap-
ital account, and a rule for determining
the capital account when an API is held
through another partnership. In light of
numerous comments, the Treasury De-
partment and the IRS have determined
that the proposed regulations were too
rigid and were not well suited to the wide
variety of common business practices re-
garding ownership structure, accounting
conventions, and compensation arrange-
ments. Specifically, many partnerships
subject to section 1061 do not maintain
section 704(b) capital accounts. For many
other partnerships, the capital account of
one partner may relate to economic rights
associated with multiple separate invest-
ments held by a partnership, while the
capital account of another partner may re-
late to economic rights associated with a
separate set of investments held by a part-
nership. For these reasons, the Treasury
Department and the IRS have determined
that the section 704(b) capital accounts of
partners provide a poor means of measur-
ing commensurate economic capital inter-
est rights.
The proposed regulations also prohib-
ited use of the capital interest exception
if a capital contribution was funded with
related party loan proceeds. Commenters
noted that it is a common business prac-
tice in industries subject to Section 1061
for employees to require new partners to
make substantial capital contributions,
which are often acquired through a loan.
This arrangement, designed not to avoid
tax but to align the incentives of general
partners and limited partners, would be
unduly penalized under the proposed reg-
ulations, incentivizing firms to choose a
less efficient ownership and governance
structure. The final regulations amend the
rule to allow an individual service provid-
er’s capital contributions to be funded with
loan proceeds from partners and persons
related to partners if the individual service
provider is personally liable for the loan,
meaning the loan is fully recourse to the
individual service provider, the individual
service provider has no right to be reim-
bursed by any person, and no person has

February 1, 2021 654 Bulletin No. 2021–5
guaranteed the individual service’s pro-
vider’s loan. The Treasury Department
and the IRS believe the final rules address
abusive avoidance strategies, while im-
posing less burden on taxpayers engaged
in standard business practices relative to
not allowing any contributions from pro-
ceeds from related part loans to be eligible
for the capital interest exception.
ii. Lookthrough Rule on sale of APIs
Section 1061(a) provides that if one or
more APIs are held by a taxpayer at any
time during the taxable year, the excess
(if any) of (1) the taxpayer’s net long-
term capital gain with respect to such in-
terests for such taxable year, over (2) the
taxpayer’s net long-term capital gain with
respect to such interests for that taxable
year computed by applying paragraphs (3)
and (4) of sections 1222 by substituting
“3 years” for “1 year,” must be treated as
short-term capital gain, notwithstanding
section 83 or any election in effect under
section 83(b). The House Report explains
that section 1061 “imposes a three-year
holding period (not the generally applica-
ble one-year holding period) in the case
of long-term capital gain from applica-
ble partnership interests.” Neither section
1061 nor the Reports, however, explicitly
provides what the relevant holding peri-
od is for purposes of section 1061(a) for
the sale of an API with assets of different
holding periods.
The final regulations include a Look-
through Rule that is triggered if a trans-
action or series of transactions has taken
place with a principal purpose of avoiding
potential gain recharacterization under
section 1061(a). Under this Lookthrough
Rule, all gain not attributable to assets
held for more than three years is subject to
recharacterization under section 1061(a).
Additionally, the Lookthrough Rule ap-
plies if the API disposition would be sub-
ject to Section 1061(a) recharacterization
using a holding period not beginning until
the date that Unrelated Non-Service Part-
ners legally commit to contribute substan-
tial capital to the applicable partnership.
Without this rule, fund managers might
attempt to avoid the recharacterization
of gains by establishing partnerships and
leaving them inactive for three years be-
fore attracting investment from limited
partners, thereby circumventing Section
1061.
The Treasury Department and the IRS
considered and rejected alternative ap-
proaches, including applying a simple
interest approach, an alternative look-
through rule (as provided in the proposed
regulations), and an underlying assets
approach. The simple interest approach
looks solely to the holding period in the
API, regardless of the length of time the
partnership has engaged in substantive
investment. This approach might allow
taxpayers to avoid section 1061 charac-
terization for long-term capital gains on
assets that are not held for the more than
three years by the partnership. This result
would encourage distortive behavior in
investment funds, which might look to
create partnerships for different investors
solely for tax purposes, relative to the ap-
proach adopted in the final regulations.
That is, the partners of that investment
partnership would not be subject to sec-
tion 1061 if they had owned their APIs for
more than three years, irrespective of how
long the investment partnership had been
active and attracting capital from outside
investors.
Alternatively, the underlying asset, or
full lookthrough, approach looks solely to
the holding period in the underlying asset
(or assets) of the partnership, regardless
of whether the underlying asset is sold
by the partnership or the API is sold by
its owner. The underlying asset approach
would be more difficult (and burdensome)
for taxpayers to apply (relative to the pro-
vision provided in the final regulations)
as it would require a determination of the
unrealized gain for each asset held by the
partnership, even in cases in which a rela-
tively small share of assets by value have
a holding period of three years or less.
The proposed regulations included
an alternative lookthrough rule applied
to the sale of an API if 80% or more of
the value of the assets held by the part-
nership at the time of the API disposition
were assets held for three years or less
that would produce capital gain or loss
subject to section 1061 if disposed of by
the partnership. If the lookthrough rule in
the proposed regulations applied, a por-
tion of the capital gain on the disposition
of the API attributable partnership assets
held for three or fewer years would be re-
characterized as short-term capital gain.
This alternative was rejected in the final
regulations because the calculations re-
quired by the proposed lookthrough rule
would impose unnecessary compliance
burden on individual taxpayers selling an
API without any accompanying general
economic benefit. The rules requiring
partnerships to furnish taxpayers with
the relevant information to perform the
calculations would also impose undue
additional burden on the relevant part-
nerships. The lookthrough rule provided
in the final regulations applies in more
limited circumstances, narrowly target-
ing taxpayers that appear to be engaged
in abusive practices to avoid section
1061(a) recharacterization. Therefore,
the final regulations provide helpful
guidance and certainty for taxpayers,
while imposing minimal compliance bur-
den relative to the no-action baseline or
alternative regulatory approaches.
iii. Treatment of API transfers to Related
Parties
Section 1061(d) recharacterizes cer-
tain long-term capital gain as short-term
capital gain when a taxpayer transfers an
API to a related person. While the statute
provides a definition of a related person
and a general description of the recharac-
terization amount, numerous commenters
expressed uncertainty regarding the scope
of transfers subject to section 1061(d),
pointing out that although the statutory
language of section 1061(d) refers to the
transfer of an API, it refers to income in-
clusion associated with an API transfer
that is related to the sale or exchange of
partnership assets held for three years
of less. Based on the statutory language,
commenters expressed the view that sec-
tion 1061(d) transfers should be limited to
taxable transfers.
Although one read of the text of sec-
tion 1061(d) suggests that the provision
can be broadly applied to capture all API
transfers, including gifts and other non-
recognition transfer, the Treasury Depart-
ment and the IRS considered and rejected
applying section 1061(d) to nontaxable
transfers. Applying section 1061(d) to
nontaxable transfers would impose in-
come recognition on gifts including an
API, where no income recognition is im-

Bulletin No. 2021–5 655 February 1, 2021
posed on otherwise similar gifts, creating
a tax disadvantage for gifts including an
API. Instead, the Treasury and the IRS
have determined that the section 1061(d)
statute is better read as a recharacteriza-
tion provision that looks to how much
of the taxpayer’s long-term capital gain
upon the sale of an API is attributable
to the sale or exchange of any asset held
for three years or less and that the pro-
vision’s use of the word “transfer” does
not supersede application of the sale or
exchange requirement in the statute.
II. Paperwork Reduction Act
A. Collection of information in §1.1061-
6(a) on the Owner Taxpayer is on existing
forms
The collection of information in
§1.1061-6(a) requires an Owner Taxpayer
to file such information with the IRS as the
Commissioner may require in forms, in-
structions and other published guidance as
is necessary for the IRS to determine that
the taxpayer has properly complied with
section 1061 and the Section 1061 Regu-
lations. This information is necessary for
the IRS to determine that the Owner Tax-
payer has properly complied with section
1061. In general, the Owner Taxpayer is
an individual and the Owner Taxpayer’s
Recharacterization Amount and Section
1061(d) Recharacterization Amount will
be required to be reported to the IRS as
short-term capital gain on Schedule D,
“Capital Gains and Losses,” of the Form
1040, “U.S. Individual Income Tax Re-
turn.” Less frequently, the Owner Tax-
payer is a trust and the Owner Taxpayer’s
Recharacterization Amount and Section
1061(d) Recharacterization Amount will
be required to be reported to the IRS as
short-term capital gain on Schedule D,
“Capital Gains and Losses,” of the Form
1041, “U.S. Income Tax Return for Es-
tates and Trusts.”
The current status of the Paperwork
Reduction Action submission related to
§1.1061-6(a) is provided in the following
table. The burdens associated with the
collection of information from the Own-
er Taxpayer to comply with section 1061
are included in the aggregate burden es-
timates for Form 1040 under OMB con-
trol number 1545-0074 and Form 1041
under OMB control number 1545-0092.
The overall burden estimates provided in
OMB Control Number 1545-0074 rep-
resents a total estimated burden time, in-
cluding all other related forms and sched-
ules for individuals, of 1.784 billion hours
and total estimated monetized costs of
$31.74 billion (in 2017 dollars). The over-
all burden estimates provided in OMB
Control Number 1545-0092 represents a
total estimated burden time, including all
other forms and schedules for trusts and
estates of 307.8 million hours and total
estimated monetized costs of $9.95 bil-
lion (in 2016 dollars). These amounts are
aggregate amounts that relate to all infor-
mation collections associated with the ap-
plicable OMB control numbers, and will
in the future include, but not isolate, the
estimated burden of Owner Taxpayers as
a result of the information collections in
the regulations. No burden estimates spe-
cific to the final regulations are currently
available. The Treasury Department and
IRS have not estimated the burden, in-
cluding that of any new information col-
lections, related to the requirements un-
der the final regulations. Those estimates
would capture both changes made by the
TCJA and those that arise out of discre-
tionary authority exercised in the regula-
tions. The Treasury Department and the
IRS request comments on all aspects of
information collection burdens related to
the collection of information applicable
to the Owner Taxpayer in these regula-
tions. In addition, when available, drafts
of IRS forms are posted for comment at
www.irs.gov/draftforms.
FormType of Filer
OMB Num-
ber(s)
Status
Form 1040
(Including
Schedule D)
Individual
(NEW Mod-
el)
1545-0074
Published in the Federal Register on 9/30/19. Comment period closed on
11/29/19. 84 FR 51712. Thirty-day notice published on 12/18/19. 84 FR
69458. Approved by the Office of Information and Regulatory Affairs (OIRA)
on 1/30/20.
Form 1041
(Including
Schedule D)
Trusts and
Estates
(Legacy
Model)
1545-0092
Published in the Federal Register on 4/4/2018. 83 FR 14552. Public comment
period closed 6/4/2018. Thirty-day notice published on 9/27/18. 83 FR 48894.
Approved by OIRA on 5/8/19.
B. Collection of information on
Passthrough Entities in §1.1061-6(b) and
(c) on existing forms
1. Passthrough Entities
The collection of information in
§1.1061-6(b) requires a Passthrough
Entity that has issued an API to furnish
to the API Holder, including the Owner
Taxpayer, such information at such time
and in such manner as the Commissioner
may require in forms, instructions, and
other published guidance as is necessary
to determine the One Year Gain amount
and the Three Year Gain Amount with
respect to an Owner Taxpayer. This in-
cludes: (i) the API One Year Distribu-
tive Share Amount and the API Three
Year Distributive Share Amount (as de-
termined under §1.1061-4); (ii) Capital
gains and losses allocated to the API
Holder that are excluded from section
1061 under §1.1061-4(b)(7); (iii) Cap-
ital Interest Gains and Losses allocated
to the API Holder (as determined under
§1.1061-3(c)); (iv) In the case of a dis-

February 1, 2021 656 Bulletin No. 2021–5
position by the API Holder of an inter-
est in the Passthrough Entity during the
taxable year, any information required
by the API Holder to properly take the
disposition into account under section
1061, including information necessary to
apply the Lookthrough Rule and to de-
termine its Capital Interest Disposition
Amount and any information necessary
to determine an Owner Taxpayer’s Sec-
tion 1061(d) Recharacterization Amount.
The regulations seek to minimize the in-
formation that a Passthrough Entity is re-
quired to automatically furnish annually.
In some cases, an upper-tier Passthrough
Entity may be an API Holder in a low-
er-tier Passthrough Entity, and the in-
formation furnished by the lower-tier
Passthrough Entity to the upper-tier
Passthrough Entity may not be sufficient
for the upper-tier Passthrough Entity to
meet its reporting obligations under the
regulations. In this case, the regulations
require the lower-tier Passthrough Entity
to furnish information to the upper-tier
Passthrough Entity if requested. Thus,
if an upper-tier Passthrough Entity in a
tiered entity structure holds an interest
in a lower-tier Passthrough Entity and
it needs information from the lower-tier
Passthrough Entity to comply with its ob-
ligation to furnish information under the
regulations, it must request information
from the lower-tier entity and the low-
er-tier entity must furnish the requested
information. This passing of information
upon request between the tiers of entities
is necessary to minimize the quantity of
information required to be annually fur-
nished by a Passthrough Entity and be-
cause each Passthrough Entity in a tiered
entity arrangement is the only entity that
has access to the information that is re-
quired to be furnished. The collection of
information in the regulations is neces-
sary to ensure that the Owner Taxpayer
receives information sufficient to cor-
rectly calculate its Recharacterization
Amount under section 1061.
2. RICs and REITs
Section 1.1061-6(c) permits a RIC or
a REIT that reports or designates all or a
part of a dividend as a capital gain divi-
dend, to disclose additional information to
their shareholders for purposes of section
1061. The furnishing of this information
may allow a Passthrough Entity to include
a portion of the capital gain dividend in
the API Three Year Distributive Share
amount furnished to API Holders and may
ultimately enable an Owner Taxpayer to
reduce its Recharacterization Amount un-
der the regulations.
3. Table for collections of information in
§1.1061-6(b) and (c)
The collection of information with re-
spect to §1.1061-6(b) and (c) is provided
in the following table. In the case of a
Passthrough Entity that is a partnership,
the information will be required to be
furnished as an attachment to the Sched-
ule K-1, “Partner’s Share of Income,
Deduction, Credit, Etc.” of Form 1065,
“U.S. Return of Partnership Income.” In
the case of a Passthrough Entity that is an
S corporation, the information will be re-
quired to be furnished as an attachment to
the Schedule K-1, “Shareholder’s Share
of Income, Deductions, Credit, Etc.,” of
Form 1120-S, “U.S. Income Tax Return
for an S Corporation.” The burdens asso-
ciated with the collection of information
from the Passthrough Entities will be in-
cluded in the aggregate burden estimates
for the Form 1065 and the Form 1120S
under OMB control number 1545-0123.
The overall burden estimates provid-
ed in OMB Control Number 1545-0123
represents a total estimated burden time,
including all others related forms and
schedules, of 3.344 billion hours and to-
tal estimated monetized costs of $61.558
billion (in 2019 dollars). The burden esti-
mates provided in OMB Control Number
1545-0123 are aggregate amounts that
relate to all information collections asso-
ciated with the applicable OMB control
number, and will in the future include,
but not isolate, the Passthrough Entities’
estimated burden as a result of the infor-
mation collections in the proposed regu-
lations.
In the case of a Passthrough Entity that
is a trust or estate, the information will be
required to be furnished as an attachment
to the Schedule K-1, “Beneficiary’s Share
of Income, Deductions, Credit, Etc.,” of
Form 1041, “U.S. Income Tax Return for
Estates and Trusts.” The burdens associ-
ated with the collection of information
from a Passthrough Entity that is a trust
or estate will be included in the aggregate
burden estimates for the Form 1041 OMB
control number 1545-0092. The overall
burden estimates provided in OMB Con-
trol Number 1545-0092 represents a total
estimated burden time, including all other
forms and schedules for trusts and estates
of 307.8 million hours and total estimated
monetized costs of $9.95 billion (in 2016
dollars). The burden estimates provided
in OMB Control Number 1545-0092 are
aggregate amounts that relate to all in-
formation collections associated with the
applicable OMB control number, and will
in the future include, but not isolate, the
Passthrough Entities’ estimated burden as
a result of the information collections in
the regulations.
In the case of RICs and REITs the in-
formation will be furnished in connection
with the Form 1099-DIV, “Dividends and
Distributions.” The burden estimates as-
sociated with the collection of informa-
tion from RICs and REITs will be includ-
ed in the aggregate burden estimated for
the Form 1099-DIV under OMB Control
Number 1545-0110. The overall burden
estimates provided in OMB Control Num-
ber 1545-0110 represents a total estimat-
ed burden time of 32,119,195 hours and
total estimated monetized costs of $ 1.64
billion (in 2016 dollars). The burden es-
timates provided in OMB Control Num-
ber 1545-0110 relate to all information
collections associated with the applicable
OMB Control Number, and will in the fu-
ture include, but not isolate, the RIC and
REIT estimated burden as a result of the
information collections in the regulations.
The Treasury Department and IRS
have not estimated the burden, including
that of any new information collections,
related to the requirements under the reg-
ulations. Those estimates would capture
both changes made by the TCJA and those
that arise out of the discretionary authority
exercised in the regulations. The Treasury
Department and the IRS request com-
ments on all aspects of information col-
lection burdens related to the collection of
information applicable to the Passthrough
Entities in the regulations. In addition,
when available, drafts of IRS Forms and
the applicable instructions are posted for
comment at https://www.irs.gov/pub/irs-
dft/.

Bulletin No. 2021–5 657 February 1, 2021
Form
Type of
Filer
OMB
Number(s)
Status
Form 1041
(including
Schedule K-1)
Trusts and
Estates
(Legacy
Model)
1545-0092
Published in the Federal Register on 4/4/2018. 83 FR 14552. Public
comment period closed 6/4/2018. Thirty-day notice published on 9/27/18. 83
FR 48894. Approved by OIRA on 5/8/19.
Form 1065
(including
Schedule K-1)
Business
(NEW
Model)
1545-0123
Sixty-day notice published in the Federal Register on 9/30/19. Public
Comment period closed on 11/29/19.
84 FR 51718. Thirty-day notice published in the Federal Register on
12/19/19. Public Comment period closed on 1/21/20. 84 FR 69825.
Approved by OIRA on 1/30/20.
Form 1120S
(Including
Schedule K-1)
Business
(New
Model)
1545-0123
Sixty-day notice published in the Federal Register on 9/30/19. Public
Comment period closed on 11/29/19.
84 FR 51718. Thirty-day notice published in the Federal Register on
12/19/19. Public Comment period closed on 1/21/20. 84 FR 69825.
Approved by OIRA on 1/30/20.
Form 1099-DIV
(Legacy
Model)
1545-0110
Sixty-day notice published in the Federal Register on 9/19/19. Public
comment period closed 11/18/19.
84 FR 49379. Thirty-day notice published in the Federal Register on
12/20/19. 84 FR 70269.
Link: https://www.federal register.gov/documents/2018/05/23/2018-10981/proposed-collection-comment-
request–for –form-1099-div
C. Chart Showing Number of
Respondents Regarding Existing Forms
The following chart shows the estimat-
ed number of returns that are expected to
have attachments providing additional in-
formation with respect to section 1061. As
noted previously, Owner Taxpayers will be
required to provide section 1061 informa-
tion on an attachment to Schedules D for
Forms 1040 and 1041. Passthrough Tax-
payers will be required to report section
1061 on Forms 1041, 1065, and 1120S to
the IRS and to furnish information to their
API Holders on attachments to the respec-
tive K-1s. RICs and REITs may volun-
tarily report additional information at an
attachment to Form 1099-DIV.
Schedule D Form 104020,475
Schedule D Form 10412,275
Schedule K Form 106528,500
Schedule K-1s Form 106557,000
Schedule K Form 1120S1,500
Schedule K-1s Form 11201,000
Form 1099-DIV filed by REITs 836
Form 1099-DIV filed by RICs3,880
D. Voluntary Collection of Information in
§1.1061-6(d) on PFIC shareholder will be
added to existing OMB Control Number
for PFIC Information Retention
Section 1.1061-6(d) permits a PFIC
with respect to which the shareholder is
an API Holder who has a QEF election is
in effect for the taxable year to provide ad-
ditional information to the shareholder to
determine the amount of the shareholder’s
inclusion that would be included in the
API One Year Distributive Share Amount
and the API Three Year Distributive Share
Amount. If the PFIC furnishes this infor-
mation to the shareholder, the sharehold-
er must retain a copy of this information
along with the other information required
to be retained under §1.1295-1(f)(2)(ii).
The burden associated with retaining this
additional information will be includ-

February 1, 2021 658 Bulletin No. 2021–5
ed in the aggregate burden estimates for
§1.1295-1(f) under OMB Control Number
1545-1555. An agency may not conduct
or sponsor, and a person is not required
to respond to, a collection of information
unless it displays a valid control number
assigned by the Office of Management
and Budget.
Books and records related to the col-
lection of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and tax
return information are confidential, as re-
quired by 26 U.S.C. 6103.
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is hereby
certified that these final regulations will
not have a significant economic impact
on a substantial number of small entities
within the meaning of section 601(6) of
the Regulatory Flexibility Act. These reg-
ulations generally only impact investment
funds that have capital gains and losses
that derive from the disposition of assets
that have a holding period of more than
one year but not more than three years. In-
vestment funds are considered small busi-
ness if they have annual average receipts
of $41.5 million or less (13 CFR part 121).
The rule may affect a substantial number
of small entities, but data are not readily
available to assess how many entities will
be affected.
The Treasury Department and the IRS
received no actionable comments on the
impact that the proposed regulations
would have on small entities. Although
certain commenters requested that part-
nerships with an unspecified amount of
limited assets be excepted from the ap-
plication of the statutory rules of section
1061, these commenters did not provide
any data to demonstrate that any burden
would be significant. Similarly, a com-
menter requested an exception to the
reporting requirements for passthrough
entities in which a limited partner owns
5 percent or less of a fund but did not
quantify the burden. In addition, the fi-
nal regulations adopt other comments
that limit the general burden of the reg-
ulations to all entities, including small
entities.
Even if a substantial number of small
entities are affected, the economic impact
of these regulations on small entities is
not significant. The regulations provide
taxpayers with definitional and computa-
tional guidance regarding the application
of section 1061. The impact of the regula-
tions is to impose an additional reporting
obligation that applies only with respect to
the sale of assets held for more than one
year but not more than three years. The
Treasury Department and the IRS recog-
nize that this reporting obligation may
increase, at least to some extent, the tax
preparation burden for affected taxpayers
beyond that imposed by the statute. This
reporting obligation generally will only
apply to a minority of the asset disposi-
tions by an entity. The entity will also
have a reporting obligation in certain cir-
cumstances regarding the disposition of
an API, but the extent of the reporting ob-
ligation depends on the number of assets
disposed by the entity and their holding
periods. The information reported is read-
ily available to taxpayers and reported on
forms already in use beginning with the
2019 taxable year such as Schedule D to
IRS Form 1065. Finally, some taxpayers
may find they need an initial investment
of time to read and understand these regu-
lations at an approximate cost of $95/hour
and an estimated time of ten hours. Ac-
cordingly, the Secretary certifies that these
regulations will not have a significant eco-
nomic impact on a substantial number of
small entities.
Pursuant to section 7805(f), the notice
of proposed rulemaking preceding this
regulation was submitted to the Chief
Counsel for the Office of Advocacy of
the Small Business Administration for
comment on its impact on small business-
es. No comments were received from the
Chief Counsel for the Office of Advocacy
of the Small Business Administration.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 requires that agencies
assess anticipated costs and benefits and
take certain other actions before issuing a
final rule that includes any Federal man-
date that may result in expenditures in any
one year by a state, local, or tribal govern-
ment, in the aggregate, or by the private
sector, of $100 million in 1995 dollars,
updated annually for inflation. This rule
does not include any Federal mandate that
may result in expenditures by state, local,
or tribal governments, or by the private
sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive order. This rule does not
have federalism implications and does
not impose substantial direct compliance
costs on state and local governments or
preempt state law within the meaning of
the Executive order.
VI. Congressional Review Act
The Administrator of the Office of In-
formation and Regulatory Affairs of the
Office of Management and Budget has
determined that this Treasury decision is a
major rule for purposes of the Congressio-
nal Review Act (5 U.S.C. 801 et seq.). Un-
der 5 U.S.C. 801(a)(3), a major rule takes
effect 60 days after the rule is published in
the Federal Register.
Notwithstanding this requirement, 5
U.S.C. 808(2) allows agencies to dispense
with the requirements of 5 U.S.C. 801
when the agency for good cause finds that
such procedure would be impracticable,
unnecessary, or contrary to the public in-
terest and the rule shall take effect at such
time as the agency promulgating the rule
determines. Pursuant to 5 U.S.C. 808(2),
the Treasury Department and the IRS find,
for good cause, that a 60-day delay in the
effective date is contrary to the public in-
terest.
Following the enactment of section
1061 by the TCJA, the Treasury Depart-
ment and the IRS published the proposed
regulations to provide certainty to tax-
payers. In particular, as demonstrated by
the wide variety of public comments in
response to the proposed regulations re-
ceived, taxpayers continue to express un-

Bulletin No. 2021–5 659 February 1, 2021
certainty regarding the proper application
of the statutory rules under section 1061.
This is especially the case for taxpayers in
the trade or business of operating invest-
ment funds, which may be unwilling to
engage in certain commercial transactions
without the additional clarity provided by
these final regulations. Additionally, var-
ious rules contained within these regula-
tions attempt to curb certain abusive trans-
actions designed to avoid the application
of section 1061 and an earlier effective
date is necessary to address these abusive
transactions. Accordingly, the Treasury
Department and the IRS have determined
that the rules in this Treasury decision will
take effect on the date of filing for public
inspection in the Federal Register.
Statement of Availability of IRS
Documents
Notice 2018-18, 2018-2 I.R.B. 443 (in
addition to any other revenue procedures
or revenue rulings, etc. cited in this pre-
amble) is published in the Internal Rev-
enue Bulletin (or Cumulative Bulletin)
and is available from the Superintendent
of Documents, U.S. Government Publish-
ing Office, Washington, DC 20402, or by
visiting the IRS website at http://www.irs.
gov.
Drafting Information
The principal authors of these regula-
tions are Kara K. Altman, Sonia K. Kothari,
and Wendy L. Kribell of the Office of As-
sociate Chief Counsel (Passthroughs and
Special Industries). However, other per-
sonnel from the Treasury Department and
the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Amendment to the Regulations
Accordingly, 26 CFR Part 1 is amend-
ed as follows:
PART 1— INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding entries for
§§1.1061-0, 1.1061-1, 1.1061-2, 1.1061-
3, 1.1061-4, 1.1061-5, and 1.1061-6 in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1061-0 added under 26
U.S.C. 1061(f).
Section 1.1061-1 added under 26
U.S.C. 1061(f).
Section 1.1061-2 added under 26
U.S.C. 1061(f).
Section 1.1061-3 added under 26
U.S.C. 1(h)(9) and 1061(f).
Section 1.1061-4 added under 26
U.S.C. 1061(f).
Section 1.1061-5 added under 26
U.S.C. 1061(f).
Section 1.1061-6 added under 26
U.S.C. 1061(f).
* * * * *
Par. 2. Section 1.702-1 is amended by
adding a sentence at the end of paragraph
(a)(2) and adding paragraph (g) to read as
follows.
§1.702-1 Income and credits of partner.
(a) * * * * *
(2) * * * Each partner subject to sec-
tion 1061 must take into account gains
and losses from sales of capital assets
held for more than one year as provided
in section 1061 and §§1.1061-1 through
1.1061-6.
* * * * *
(g) Applicability date. The last sen-
tence of paragraph (a)(2) of this section
applies for the taxable years beginning on
or after January 19, 2021.
Par. 3. Section 1.704-3 is amended by:
1. In paragraph (e)(3)(vi)(B), remove
the word “and” at the end of the paragraph;
2. Redesignating paragraph (e)(3)(vi)
(C) as paragraph (e)(3)(vi)(D);
3. Adding new paragraph (e)(3)(vi)(C);
and
4. Revising the heading and first sen-
tence of paragraph (f) and adding a sen-
tence to the end of paragraph (f).
The additions and revisions read as fol-
lows:
§1.704-3 Contributed property.
* * * * *
(e) * * *
(3) * * *
(vi) * * *
(C) With respect to any person who
directly or indirectly holds an Applicable
Partnership Interest, as defined in §1.1061-
1(a)(1), take into account the application
of section 1061 with respect to such inter-
est in an appropriate manner; and
* * * * *
(f) Applicability dates. With the excep-
tion of paragraphs (a)(1), (a)(8)(ii) and
(iii), (a)(10) and (11), and (e)(3)(vi)(C)
of this section, and of the last sentence of
paragraph (d)(2) of this section, this sec-
tion applies to properties contributed to a
partnership and to revaluations pursuant
to §1.704-1(b)(2)(iv)(f) or (s) on or after
December 21, 1993.
* * * Paragraph (e)(3)(vi)(C) of this
section applies to taxable years beginning
on or after January 19, 2021.
* * * * *
Par. 4. Sections 1.1061-0 through
1.1061-6 are added before the undesignat-
ed center heading “Changes to Effectuate
F.C.C. Policy” to read as follows:
Sec.
* * * * *
1.1061-0 Table of contents.
1.1061-1 Section 1061 definitions.
1.1061-2 Applicable partnership inter-
ests and applicable trades or businesses.
1.1061-3 Exceptions to the definition
of an API.
1.1061-4 Section 1061 computations.
1.1061-5 Section 1061(d) transfers to
related persons.
1.1061-6 Reporting rules.
* * * * *
§1.1061-0 Table of contents.
This section lists the captions that ap-
pear in §§1.1061-1 through 1.1061-6.
§1.1061-1 Section 1061 definitions.
(a) Definitions.
(b) Applicability date.
§1.1061-2 Applicable partnership
interests and applicable trades or
businesses.
(a) API rules and examples.
(1) Rules.
(i) An API remains an API.
(ii) Application of section 1061 to Un-
realized API Gains and Losses.

February 1, 2021 660 Bulletin No. 2021–5
(iii) API Gains and Losses retain their
character.
(iv) Substantial services by the Owner
Taxpayer, Passthrough Taxpayer or any
Related Person.
(v) Grantor trusts and entities disre-
garded as separate from their owners.
(2) Examples.
(b) Application of the ATB Activity Test.
(1) In general.
(i) Rules for applying the ATB Activity
Test.
(A) Aggregate Specified Actions taken
into account.
(B) Raising or Returning Capital Ac-
tions and Investing or Developing Actions
are not both required to be taken in each
taxable year.
(C) Combined conduct by multiple re-
lated entities taken into account.
(ii) Developing Specified Assets.
(iii) Partnerships.
(2) Examples.
(c) Applicability date.
§1.1061-3 Exceptions to the definition of
an API.
(a) A partnership interest held by an
employee of another entity not conducting
an ATB.
(b) Partnership interest held by a cor-
poration.
(1) In general.
(2) Treatment of interests held by an S
corporation or a qualified electing fund.
(c) Capital Interest Gains and Losses.
(1) In general.
(2) Capital Interest Gains and Losses
defined.
(3) General rules for determining Cap-
ital Interest Allocations.
(i) Commensurate with capital contrib-
uted.
(ii) In a similar manner.
(A) Relevant factors.
(B) Clear identification requirement.
(iii) Reinvestment of API Gain.
(iv) Unrelated Non-Service Partner re-
quirement.
(v) Proceeds of certain loans not taken
into account for Capital Interest Alloca-
tion purposes.
(A) General rule.
(B) Recourse liability.
(vi) Items that are not included in Cap-
ital Interest Allocations.
(4) Capital Interest Disposition
Amounts.
(i) In general.
(ii) Determination of the Capital Inter-
est Disposition Amount.
(5) Capital Interest Allocations made
by a Passthrough Entity that is an API
Holder.
(6) Examples.
(d) Partnership interest acquired by
purchase by an unrelated person.
(1) Acquirer not a Related Person.
(2) Section 1061(d) not applicable.
(3) Acquirer not a service provider.
(e) [Reserved]
(f) Applicability date.
(1) General rule.
(2) Partnership interest held by an S
corporation.
(3) Partnership interest held by a PFIC
with respect to which the shareholder has
a QEF election in effect.
§1.1061-4 Section 1061 computations.
(a) Computations.
(1) Recharacterization Amount.
(2) One Year Gain Amount and Three
Year Gain Amount.
(i) One Year Gain Amount.
(ii) Three Year Gain Amount.
(3) API One Year Distributive Share
Amount and API Three Year Distributive
Share Amount.
(i) API One Year Distributive Share
Amount.
(ii) API Three Year Distributive Share
Amount.
(4) API One Year Disposition Amount
and API Three Year Disposition Amount.
(i) API One Year Disposition Amount.
(ii) API Three Year Disposition
Amount.
(b) Special rules for calculating the
One Year Gain Amount and the Three
Year Gain Amount.
(1) One Year Gain Amount equals zero
or less.
(2) Three Year Gain Amount equals
zero or less.
(3) One Year Gain Amount less than
Three Year Gain Amount.
(4) Installment sale gain.
(5) Special rules for capital gain div-
idends from regulated investment com-
panies (RICs) and real estate investment
trusts (REITs).
(i) API One Year Distributive Share
Amount.
(ii) API Three Year Distributive Share
Amount.
(iii) Loss on sale or exchange of stock.
(6) Pro rata share of qualified electing
fund (QEF) net capital gain.
(i) One year QEF net capital gain.
(ii) Three year QEF net capital gain ad-
justment.
(7) Items not taken into account for
purposes of section 1061.
(8) Holding period determination.
(i) Determination of holding period for
purposes of the Three Year Gain Amount.
(ii) Relevant holding period.
(9) Lookthrough Rule for certain API
dispositions.
(i) Determination that the Lookthrough
Rule applies.
(A) In general.
(B) Determination that the Look-
through Rule applies to the disposition of
a Passthrough Interest.
(ii) Application of the Lookthrough
Rule.
(10) Section 83.
(c) Examples.
(1) Recharacterization rules.
(2) Special rules examples.
(d) Applicability date.
§1.1061-5 Section 1061(d) transfers to
related persons.
(a) In general.
(b) Transfer.
(c) Section 1061(d) Recharacterization
Amount.
(d) Special rules.
(e) Section 1061(d) Related Person.
(f) Examples.
(g) Applicability date.
§1.1061-6 Reporting rules.
(a) Owner Taxpayer filing require-
ments.
(1) In general.
(2) Failure to obtain information.
(b) Passthrough Entity filing require-
ments and reporting.
(1) Requirement to file information
with the IRS and to furnish information to
API Holder.
(2) Requirement to request, furnish,
and file information in tiered structures.

Bulletin No. 2021–5 661 February 1, 2021
(i) Requirement to request information.
(ii) Requirement to furnish and file in-
formation.
(iii) Timing of requesting and furnish-
ing information.
(A) Requesting information.
(B) Furnishing information.
(iv) Manner of requesting information.
(v) Recordkeeping requirement.
(vi) Passthrough Entity is not furnished
information to meet its reporting obliga-
tions under paragraph (b)(1) of this sec-
tion.
(vii) Filing requirements.
(viii) Penalties.
(c) Regulated investment company
(RIC) and real estate investment trust
(REIT) reporting.
(1) Section 1061 disclosures.
(i) One Year Amounts Disclosure.
(ii) Three Year Amounts Disclosure.
(2) Pro rata disclosures.
(3) Report to shareholders.
(d) Qualified electing fund (QEF) re-
porting.
(e) Applicability date.
§1.1061-1 Section 1061 definitions.
(a) Definitions. The following defini-
tions apply solely for purposes of this sec-
tion and §§1.1061-2 through 1.1061-6.
API Gains and Losses are any long-
term capital gains and capital losses with
respect to an API and include:
(i) The API One Year Distributive
Share Amount as defined in §1.1061-4(a)
(3)(i);
(ii) The API Three Year Distributive
Share Amount as defined in §1.1061-4(a)
(3)(ii);
(iii) The API One Year Disposition
Amount as defined in §1.1061-4(a)(4)(i);
(iv) The API Three Year Disposition
Amount as defined in §1.1061-4(a)(4)(ii);
and
(v) Capital gains or losses from the dis-
position of Distributed API Property.
API Holder is a person who holds an
API.
Applicable Partnership Interest (API)
means any interest in a partnership which,
directly or indirectly, is transferred to
(or is held by) an Owner Taxpayer or
Passthrough Taxpayer in connection with
the performance of substantial services by
the Owner Taxpayer or by a Passthrough
Taxpayer, or by any Related Person, in-
cluding services performed as an em-
ployee, in any ATB unless an exception
in §1.1061-3 applies. For purposes of
defining an API under this section and
section 1061 of the Internal Revenue
Code (Code), an interest in a partnership
also includes any financial instrument
or contract, the value of which is deter-
mined in whole or in part by reference
to the partnership (including the amount
of partnership distributions, the value of
partnership assets, or the results of part-
nership operations). An Owner Taxpayer
and a Passthrough Taxpayer can hold an
API directly or indirectly through one or
more Passthrough Entities.
Applicable Trade or Business (ATB)
means any activity for which the ATB
Activity Test with respect to Specified Ac-
tions is met, and includes all Specified Ac-
tions taken by Related Persons, including
combining activities occurring in separate
partnership tiers or entities as one ATB.
ATB Activity Test has the meaning pro-
vided in §1.1061-2(b)(1).
Capital account means a capital ac-
count maintained under §1.704-1(b)(2)
(iv) or similar principles.
Capital Interest Allocations means,
with respect to a partnership, allocations
of long-term capital gain or loss made un-
der the partnership agreement to an API
Holder and to Unrelated Non-Service
Partners based on such partners’ capital
contributed with respect to the partnership
to the extent such allocations otherwise
meet the requirements of §1.1061-3(c).
With respect to other Passthrough Enti-
ties, the principles of this definition apply.
Capital Interest Disposition Amount
has the meaning provided in §1.1061-3(c)
(4).
Capital Interest Gains and Losses has
the meaning provided in §1.1061-3(c)(2).
Distributed API Property means prop-
erty distributed by a Passthrough Entity to
an API Holder with respect to an API if
the holding period, as determined under
sections 735 and 1223, in the API Hold-
er’s hands is three years or less at the time
of disposition of the property by the API
Holder.
Indirect API means an API that is held
through one or more Passthrough Entities.
Investing or Developing Actions means
actions involving either—
(i) Investing in (or disposing of) Spec-
ified Assets (or identifying Specified As-
sets for such investing or disposition); or
(ii) Developing Specified Assets (see
§1.1061-2(b)(1)(ii)).
Lookthrough Rule means the recharac-
terization rule described in §1.1061-4(b)
(9).
One Year Gain Amount has the mean-
ing provided in §1.1061-4(a)(2)(i).
Owner Taxpayer means the person sub-
ject to Federal income tax on net gain with
respect to an API or an Indirect API during
the taxable year, including an owner of a
Passthrough Taxpayer unless the owner of
the Passthrough Taxpayer is a Passthrough
Entity itself or is excepted under §1.1061-
3(a), (b), or (d).
Passthrough Entity means a partner-
ship, trust, estate, S corporation described
in §1.1061-3(b)(2)(i), or passive for-
eign investment company described in
§1.1061-3(b)(2)(ii).
Passthrough Interest means an interest
in a Passthrough Entity that represents in
whole or in part an API.
Passthrough Taxpayer means a
Passthrough Entity that is treated as a tax-
payer for the purpose of determining the
existence of an API.
Raising or Returning Capital Actions
means actions involving raising or return-
ing capital but does not include Investing
or Developing Actions.
Recharacterization Amount has the
meaning provided in §1.1061-4(a)(1).
Related Person means a person or en-
tity who is treated as related to another
person or entity under sections 707(b) or
267(b).
Relevant ATB means the ATB in which
services were provided and in connection
with which an API is held or was trans-
ferred.
Section 1061(d) Recharacterization
Amount has the meaning provided in
§1.1061-5(c).
Section 1061(d) Related Person has the
meaning provided in §1.1061-5(e).
Section 1061 Regulations means the
provisions of this section and §§1.1061-2
through 1.1061-6.
Specified Actions means the combi-
nation of Raising or Returning Capital
Actions and Investing or Developing Ac-
tions.
Specified Assets means—

February 1, 2021 662 Bulletin No. 2021–5
(i) Securities, including interests in
partnerships qualifying as securities (as
defined in section 475(c)(2) without re-
gard to the last sentence thereof);
(ii) Commodities (as defined in section
475(e)(2));
(iii) Real estate held for rental or in-
vestment;
(iv) Cash or cash equivalents; and
(v) An interest in a partnership to the
extent that the partnership holds Specified
Assets. See §1.1061-2(b)(1)(iii).
(vi) Specified Assets include options
or derivative contracts with respect to any
of the items provided in paragraphs (i)
through (v) of this definition.
Three Year Gain Amount has the mean-
ing provided in §1.1061-4(a)(2)(ii).
Unrealized API Gains and Losses
means, with respect to a Passthrough Enti-
ty’s assets, all unrealized capital gains and
losses that would be:
(i) Realized if those assets were dis-
posed of for fair market value in a taxable
transaction on the relevant date; and
(ii) Allocated to an API Holder with
respect to its API, taking into account the
principles of section 704(c).
Unrelated Non-Service Partners means
partners who do not (and did not) provide
services in the Relevant ATB and who are
not (and were not) Related Persons with
respect to any API Holder in the partner-
ship or any person who provides or has
provided services in the Relevant ATB.
(b) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough En-
tities beginning on or after January 19,
2021. An Owner Taxpayer or Passthrough
Entity may choose to apply this section to
a taxable year beginning after December
31, 2017, provided that they consistent-
ly apply the Section 1061 Regulations in
their entirety to that year and all subse-
quent years.
§1.1061-2 Applicable partnership in-
terests and applicable trades or business-
es.
(a) API rules and examples—(1)
Rules—(i) An API remains an API. Once
a partnership interest qualifies as an API,
the partnership interest remains an API
unless and until the requirements of one
of the exceptions to qualification of a
partnership interest as an API, set forth in
§1.1061-3, are satisfied.
(ii) Application of section 1061 to Un-
realized API Gains and Losses. Unreal-
ized API Gains and Losses are API Gains
and Losses subject to section 1061 when
the gains and losses are realized and rec-
ognized. Unrealized API Gains and Loss-
es do not lose their character as such until
they are recognized.
(iii) API Gains and Losses retain their
character. API Gains and Losses retain
their character as API Gains and Losses as
they are allocated from one Passthrough
Entity to another Passthrough Entity and
then to the Owner Taxpayer.
(iv) Substantial services by an Owner
Taxpayer, Passthrough Taxpayer, or any
Related Person. If an interest in a partner-
ship is transferred to or held by an Owner
Taxpayer, Passthrough Taxpayer, or any
Related Person in connection with the
performance of services, the Owner Tax-
payer, the Passthrough Taxpayer, or the
Related Person is presumed to have pro-
vided substantial services for purposes of
section 1061.
(v) Grantor trusts and entities disre-
garded as separate from their owners. A
trust wholly described in subpart E, part
I, subchapter J, chapter 1 of the Internal
Revenue Code (that is, a grantor trust),
a qualified subchapter S subsidiary de-
scribed in section 1361(b)(3), and an en-
tity with a single owner that is treated as
disregarded as an entity separate from its
owner under any provision of the Internal
Revenue Code or any part of 26 CFR (in-
cluding §301.7701-3 of this chapter) are
disregarded for purposes of the Section
1061 Regulations.
(2) Examples. The following examples
illustrate the provisions of this paragraph
(a).
(i) Example 1: API. (A) A is the general partner
of PRS, a partnership, and provides services to PRS.
A is engaged in an ATB as defined in §1.1061-1(a).
PRS transfers a PRS profits interest to A in connec-
tion with A’s performance of substantial services
with respect to PRS’s ATB. A’s interest in PRS is an
API.
(B) After 6 years, A retires and is no longer en-
gaged in an ATB and does not perform any services
with respect to its ATB and with respect to PRS.
However, A retains the API in PRS. PRS continues
to acquire new capital assets and to allocate gain to A
from the disposition of those assets. Under paragraph
(a)(1)(i) of this section, A’s interest in PRS remains
an API after A retires.
(ii) Example 2: Contribution of an API to a
partnership. Individuals A, B, and C each direct-
ly hold APIs in PRS, a partnership. A and B form
a new partnership, GP, and contribute their APIs in
PRS to GP. Following the contribution, each of A
and B holds an Indirect API because each of A and
B now indirectly holds an API in PRS through GP, a
Passthrough Entity. Each of A’s and B’s interests in
GP is a Passthrough Interest because each of A’s and
B’s interest in GP represents an Indirect API.
(iii) Example 3: Passthrough Interest, Indirect
API, Passthrough Taxpayer. Each of A, B, and C
provides services to, and is an equal partner in, GP.
GP is engaged in an ATB as defined in §1.1061-1(a),
is the general partner of PRS, and provides substan-
tial management services to PRS. In connection with
GP’s performance of substantial services in an ATB,
PRS issues a profits interest to GP. Because GP’s
PRS interest was received in connection with GP’s
providing services in an ATB, GP is a Passthrough
Taxpayer and GP’s interest in PRS is an API. Be-
cause A, B, and C are partners in GP, they each hold
a Passthrough Interest in GP and an Indirect API in
PRS. Each of A, B, and C is treated as an Owner Tax-
payer because each is a partner in GP and because
each holds an Indirect API in PRS in connection with
the performance of its services to GP’s ATB.
(iv) Example 4: S corporation, Passthrough In-
terest, Indirect API, and Passthrough Taxpayer. A
owns all of the stock of S Corp, an S corporation.
S Corp is engaged in an ATB, as defined in §1.1061-
1(a). S Corp is the general partner of PRS, a partner-
ship, and provides substantial management services
to PRS. A provides substantial services in S Corp’s
ATB. In connection with S Corp providing substan-
tial services to PRS, PRS issues a profits interest to
S Corp. S Corp’s interest in PRS is its only asset.
Because S Corp’s profits interest in PRS was issued
to S Corp in connection with substantial services in
an ATB, S Corp is a Passthrough Taxpayer and its in-
terest in PRS is an API. Because A is a shareholder in
S Corp, A holds a Passthrough Interest in S Corp and
an Indirect API in PRS as a result of S Corp’s API in
PRS. A is treated as an Owner Taxpayer because A
holds an interest in S Corp, a Passthrough Taxpayer,
and also indirectly holds an API in PRS in connec-
tion with A’s services in S Corp’s ATB.
(v) Example 5: Indirect API, Related Person,
and Passthrough Taxpayer. Each of A, B, and C is
an equal partner in partnership GP, the general part-
ner of PRS. GP’s Specified Actions do not satisfy the
ATB Activity Test under §1.1061-1(a) and as a result,
GP’s actions do not establish an ATB. Management
Company is a Related Person with respect to GP
within the meaning of sections 267(b) and 707(b),
is engaged in an ATB, and provides substantial man-
agement services to PRS that are sufficient to satisfy
the ATB Activity Test. Management Company’s ac-
tions are attributed to GP under paragraphs (a)(1)(iv)
and (b)(1)(i)(C) of this section because Management
Company is a Related Person to GP. In connection
with Management Company’s services to PRS, PRS
issues a profits interest to GP. Because its PRS profits
interest is issued to GP in connection with services
provided by Management Company, a Related Per-
son, GP is a Passthrough Taxpayer and its interest
in PRS is an API. Unless an exception described in
§1.1061-3 applies, because A, B, and C are partners
in GP, they each hold a Passthrough Interest in GP
and an Indirect API in PRS. A, B, and C are treated
as Owner Taxpayers because they hold an interest in
GP, a Passthrough Taxpayer.

Bulletin No. 2021–5 663 February 1, 2021
(b) Application of the ATB Activity
Test—(1) In general. The ATB Activity
Test is satisfied if both Raising and Re-
turning Actions and Investing or Devel-
oping Actions are conducted by an Owner
Taxpayer, Passthrough Taxpayer, or one
or more Related Persons with respect to an
Owner Taxpayer or Passthrough Taxpay-
er, and the total level of activity, includ-
ing the combined activities of all Related
Persons, satisfies the level of activity that
would be required to establish a trade or
business under section 162.
(i) Rules for applying the ATB Activi-
ty Test—(A) Aggregate Specified Actions
taken into account. The determination of
whether the ATB Activity Test is satisfied
is based on the combined activities con-
ducted that qualify as either Raising or
Returning Capital Actions and Investing
or Developing Actions. The fact that ei-
ther Raising or Returning Capital Actions
or Investing or Developing Actions are
only infrequently taken does not preclude
the test from being satisfied if the com-
bined Specified Actions meet the test.
(B) Raising or Returning Capital Ac-
tions and Investing or Developing Ac-
tions are not both required to be taken in
each taxable year. Raising or Returning
Capital Actions and Investing or Devel-
oping Actions are not both required to
be taken in each taxable year in order to
satisfy the ATB Activity Test. For exam-
ple, the ATB Activity Test will be satis-
fied if Investing or Developing Actions
are not taken in the current taxable year,
but sufficient Raising or Returning Cap-
ital Actions are taken in anticipation of
future Investing or Developing Actions.
Additionally, the ATB Activity Test will
be satisfied if no Raising or Returning
Capital Actions are taken in the current
taxable year, but have been taken in a pri-
or taxable year (regardless of whether the
ATB Activity Test was met in the prior
year), and sufficient Investing or Devel-
oping Actions are undertaken by the tax-
payer in the current taxable year.
(C) Combined conduct by multiple
related entities taken into account–(1)
Related Entities. If a Related Person(s)
(within the meaning of §1.1061-1(a))
solely or primarily performs Raising or
Returning Capital Actions and one or
more other Related Person(s) solely or
primarily performs Investing or Develop-
ing Actions, the combination of the activ-
ities performed by these Related Persons
will be taken into account in determining
whether the ATB Activity Test is satisfied.
(2) Actions taken by an agent or dele-
gate. Specified Actions taken by an agent
or a delegate in its capacity as an agent or
a delegate of a principal will be taken into
account by the principal in determining
whether the ATB Activity Test is satisfied
with respect to the principal. These Spec-
ified Actions are also taken into account
in determining whether the ATB Activity
test is satisfied with respect to the agent or
the delegate.
(ii) Developing Specified Assets. De-
veloping Specified Assets takes place if it
is represented to investors, lenders, regu-
lators, or other interested parties that the
value, price, or yield of a portfolio busi-
ness may be enhanced or increased in
connection with choices or actions of a
service provider. Merely exercising vot-
ing rights with respect to shares owned or
similar activities do not amount to devel-
oping Specified Assets.
(iii) Partnerships. Investing or Devel-
oping Actions directly conducted with re-
spect to Specified Assets held by a partner-
ship are counted towards the ATB Activity
Test. Additionally, a portion of the Invest-
ing or Developing Actions conducted with
respect to the interests in a partnership that
holds Specified Assets is counted towards
the ATB Activity Test. This portion is the
value of the partnership’s Specified Assets
over the value of all of the partnership’s
assets. Actions taken to manage a partner-
ship’s working capital will not be taken
into account in determining the portion
of Investing or Developing Actions con-
ducted with respect to the interests in the
partnership.
(2) Examples. The following examples
illustrate the application of the ATB Ac-
tivity Test described in paragraph (b)(1) of
this section.
(i) Example 1: Combined activities of Raising
or Returning Capital Actions and Investing or De-
veloping Actions. During the taxable year, B takes
a small number of actions to raise capital for new
investments. B takes numerous actions to develop
Specified Assets. B’s actions with respect to raising
capital and B’s actions with respect to developing
Specified Assets are combined for the purpose of de-
termining whether the ATB Activity Test is satisfied.
These actions cumulatively rise to the level required
to establish a trade or business under section 162.
Thus, B satisfies the ATB Activity Test.
(ii) Example 2: Combining Specified Actions in
multiple entities. GP, a partnership, conducts Raising
or Returning Capital Actions. Management Compa-
ny, a partnership that is a Related Person to GP, con-
ducts Investing or Developing Actions. When GP’s
and Management Company’s activities are com-
bined, the ATB Activity Test is satisfied. According-
ly, both GP and Management Company are engaged
in an ATB, and services performed by either GP or
Management Company are performed in an ATB un-
der paragraph (b)(1) of this section.
(iii) Example 3: Investing or Developing Actions
taken after Raising or Returning Capital Actions that
do not meet the ATB Activity Test. In year 1, PRS
engaged in Raising or Returning Capital Actions to
fund PRS’s investment in Specified Assets. Howev-
er, PRS’ Specified Actions during year 1 did not sat-
isfy the ATB Activity Test because they did not satis-
fy the level of activity required to establish a trade or
business under section 162. Therefore, PRS was not
engaged in an ATB in year 1. In year 2, PRS engaged
in significant Investing or Developing Actions but
did not engage in any Raising or Returning Capital
Actions. In year 2, PRS’s Investing or Developing
Actions rise to the level required to establish a trade
or business under section 162. Because PRS has cu-
mulatively engaged in both Investing or Developing
Actions and Raising or Returning Capital Actions
and because the Specified Actions rise to the level of
activity required to establish a trade or business un-
der section 162, PRS is engaged in an ATB in year 2.
(iv) Example 4: Raising or Returning Capital Ac-
tions taken in anticipation of Investing or Develop-
ing Actions. In year 1, A only conducted Raising or
Returning Capital Actions. A’s Raising or Returning
Capital Actions were undertaken to raise capital to
invest in Specified Assets with the goal of increasing
their value through Investing or Developing Actions
and rise to the level of activity required to establish
a trade or business under section 162. A did not take
Investing or Developing Actions during the taxable
year. A’s Raising or Returning Capital Actions satisfy
the ATB Activity Test because they were undertaken
in anticipation of also engaging in Investing or De-
veloping Actions. Therefore, the ATB Activity Test
is satisfied, and A is engaged in an ATB in year 1.
(v) Example 5: Attribution of delegate’s actions.
GP is the general partner of PRS. GP is responsible
for providing management services to PRS. GP con-
tracts with Management Company to provide man-
agement services on GP’s behalf to PRS. GP and
Management Company are not Related Persons. The
Specified Actions taken by Management Company
on behalf of GP are attributed to GP for purposes
of the ATB Activity Test because the Management
Company is operating as a delegate of GP. Addition-
ally, those Specified Actions are taken into account
by Management Company for purposes of the ATB
Activity Test and whether it is engaged in an ATB.
(vi) Example 6: ATB Activity Test not satisfied. A
is the manager of a hardware store. Partnership owns
the hardware store, including the building in which
the hardware business is conducted. In connection
with A’s services as the manager of the hardware
store, a profits interest in Partnership is transferred to
A. Partnership’s business involves buying hardware
from wholesale suppliers and selling it to customers.
The hardware is not a Specified Asset. Although real

February 1, 2021 664 Bulletin No. 2021–5
estate is a Specified Asset if it is held for rental or
investment purposes, Partnership holds the building
for the purpose of conducting its hardware business
and not for rental or investment purposes. There-
fore, the building is not a Specified Asset as to Part-
nership. Partnership also maintains and manages a
certain amount of working capital for its business,
but actions with respect to working capital are not
taken into account for the purpose of determining
whether the ATB Activity Test is met. Partnership
is not a Related Person with respect to any person
who takes Specified Actions. Partnership is not en-
gaged in an ATB because the ATB Activity Test is
not satisfied. Although Partnership raises capital, its
Raising or Returning Capital Actions alone do not
satisfy the ATB Activity Test. Further, Partnership
takes no Investing or Developing Actions because it
holds no Specified Assets other than working capital.
Partnership is not in an ATB and the profits interest
transferred to A is not an API.
(c) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough En-
tities beginning on or after January 19,
2021. An Owner Taxpayer or Passthrough
Entity may choose to apply this section to
a taxable year beginning after December
31, 2017, provided that they apply the
Section 1061 Regulations in their entirety
to that year and all subsequent years.
§1.1061-3 Exceptions to the definition of
an API.
(a) A partnership interest held by an
employee of another entity not conduct-
ing an ATB. An API does not include any
interest transferred to a person in connec-
tion with the performance of substantial
services by that person as an employee of
another entity that is conducting a trade or
business (other than an ATB) and the per-
son provides services only to such other
entity.
(b) Partnership interest held by a cor-
poration—(1) In general. An API does
not include any interest directly or indi-
rectly held by a corporation.
(2) Treatment of interests held by an S
corporation or a qualified electing fund.
For purposes of this section, a corpora-
tion does not include an entity for which
an election was made to treat the entity as
a Passthrough Entity. Thus, the following
entities are not treated as corporations for
purposes of section 1061—
(i) An S corporation for which an elec-
tion under section 1362(a) is in effect; and
(ii) A passive foreign investment com-
pany (PFIC) with respect to which the
shareholder has a qualified electing fund
(QEF) election under section 1295 in ef-
fect.
(c) Capital Interest Gains and Loss-
es—(1) In general. Capital Interest Gains
and Losses are not subject to section 1061
and, therefore, are not included in calcu-
lating an Owner Taxpayer’s Recharacter-
ization Amount.
(2) Capital Interest Gains and Losses
defined. For purposes of paragraph (c)(1)
of this section, Capital Interest Gains and
Losses are Capital Interest Allocations that
meet the requirements of paragraph (c)(3)
of this section and Capital Interest Dispo-
sition Amounts that meet the requirements
of paragraph (c)(4) of this section.
(3) General rules for determining Cap-
ital Interest Allocations—(i) Commensu-
rate with capital contributed. An alloca-
tion will be considered a Capital Interest
Allocation if the allocation to the API
Holder with respect to its capital interest
is determined and calculated in a similar
manner as the allocations with respect to
capital interests held by similarly situated
Unrelated Non-Service Partners who have
made significant aggregate capital contri-
butions as described in paragraph (c)(3)
(iv) of this section. For purposes of this
paragraph (c)(3), a capital interest is an
interest that would give the holder a share
of the proceeds if the partnership’s assets
were sold at fair market value at the time
the interest was received and the proceeds
were then distributed in a complete liqui-
dation of the partnership.
(ii) In a similar manner. For purpos-
es of paragraph (c)(3)(i) of this section,
a Capital Interest Allocation to an API
Holder will be treated as made in a sim-
ilar manner if allocations and distribution
rights with respect to the capital contrib-
uted by an API Holder to which the API
Holder’s Capital Interest Allocation re-
lates are reasonably consistent with al-
location and distribution rights with re-
spect to capital contributed by Unrelated
Non-Service Partners where the Unrelated
Non-Service Partner requirement is met.
For purposes of this paragraph (c)(3)(ii),
allocation and distribution rights for an
API Holder that are limited to a particu-
lar class of partnership capital interests or
that are determined with respect to capi-
tal contributions invested in a particular
partnership investment will be considered
as made in a similar manner to alloca-
tions and distribution rights of Unrelated
Non-Service Partners where the Unrelated
Non-Service Partner requirement is met
for the applicable interest class or partner-
ship investment.
(A) Relevant factors. For purposes of
this paragraph (c)(3)(ii), the following
factors are not exclusive, but are relevant
factors in determining whether allocation
and distribution rights with respect to
capital contributed by an API Holder are
reasonably consistent with allocation and
distribution rights of persons meeting the
Unrelated Non-Service Partner require-
ment: the amount and timing of capital
contributed, the rate of return on capital
contributed, the terms, priority, type and
level of risk associated with capital con-
tributed, and the rights to cash or property
distributions during the partnership’s op-
erations and on liquidation. Accordingly,
an allocation to an API Holder will not
fail to qualify solely because the alloca-
tion is subordinated to allocations made to
Unrelated Non-Service Partners, because
an allocation to an API Holder is not re-
duced by the cost of services provided by
the API Holder or a Related Person to the
partnership, where the cost of services
provided includes management fees or
API allocations, or because an API Hold-
er has a right to receive tax distributions
while Unrelated Non-Service Partners do
not, where such distributions are treated as
advances against future distributions.
(B) Clear identification requirement.
For purposes of this paragraph (c)(3)
(ii), allocations will be considered made
in a similar manner only if the alloca-
tions to the API Holder and the Unrelated
Non-Service Partners are allocations with
respect to, and corresponding to, such
partners’ contributed capital that are sep-
arate and apart from allocations made to
the API Holder with respect to its API and
where both the partnership agreement and
the partnership’s contemporaneous books
and records clearly demonstrate that the
requirements of paragraph (c)(3) of this
section have been met.
(iii) Reinvestment of API Gain. If an
API Holder is allocated API Gain by a
Passthrough Entity, to the extent that an
amount equal to the API Gain is reinvest-
ed in the Passthrough Entity by the API
Holder (either as the result of an actual

Bulletin No. 2021–5 665 February 1, 2021
distribution and recontribution of the API
Gain amount or the retention of the API
Gain amount by the Passthrough Entity),
the amount will be treated as a contribu-
tion to the Passthrough Entity for a capital
interest that may produce Capital Interest
Allocations for the API Holder, provided
such allocations meet the requirements of
this paragraph (c)(3).
(iv) Unrelated Non-Service Partner
requirement. For purposes of paragraph
(c)(3) of this section, the Unrelated
Non-Service Partner requirement means
that Unrelated Non-Service Partners must
have made significant aggregate capital
contributions in relation to total capital
contributions of all partners. Unrelated
Non-Service Partners will be treated as
having made significant aggregate capital
contributions provided such partners pos-
sess five percent or more of the aggregate
capital contributed to the partnership at
the time the allocations are made. With
respect to an API Holder with allocation
and distribution rights that are attributable
to a particular interest class or partnership
investment, the Unrelated Non-Service
requirement must be met with respect to
that particular interest class or partnership
investment.
(v) Proceeds of certain loans not tak-
en into account for Capital Interest Allo-
cation purposes—(A) General rule. For
purposes of the Section 1061 Regulations,
an allocation is not a Capital Interest Al-
location to the extent the allocation is at-
tributable to the contribution of an amount
of capital to a partnership that, directly
or indirectly, results from, or is attribut-
able to, any loan or other advance made
or guaranteed, directly or indirectly, by
the partnership, a partner in the partner-
ship, or any Related Person with respect
to such persons, except to the extent a loan
or advance is described in paragraph (c)
(3)(v)(B) of this section. However, the
repayments on a loan described in the
preceding sentence are taken into account
as capital contributed (and may therefore
generate Capital Interest Allocations) as
those amounts are paid by the partner, pro-
vided that the loan is not repaid with the
proceeds of another loan described in the
preceding sentence.
(B) Recourse liability. Paragraph (c)
(3)(v)(A) of this section does not apply
with respect to an allocation attributable
to a contribution made by an individu-
al service provider that, directly or indi-
rectly, results from, or is attributable to,
a loan or advance from another partner
in the partnership (or any Related Person
with respect to such lending or advancing
partner, other than the partnership) to such
individual service provider if the individu-
al service provider is personally liable for
the repayment of such loan or advance. A
contribution made by an individual service
provider includes a contribution made by
an entity that is wholly owned by, and dis-
regarded as separate from, the individual
service provider as described in §1.1061-
2(a)(1)(v), including a contribution attrib-
utable to a loan or advance made to the
disregarded entity by another partner in
the partnership (or any Related Person
with respect to such lending or advancing
partner, other that the partnership) if the
individual service provider is personally
liable for the repayment of any and all
borrowed amounts that are not repaid by
the disregarded entity. For purposes of this
paragraph (c)(3)(v)(B), an individual ser-
vice provider is personally liable for the
repayment of a loan or advance made by a
partner (or any Related Person, other than
the partnership) if—
(1) The loan or advance is fully re-
course to the individual service provider;
(2) The individual service provider has
no right to reimbursement from any other
person; and
(3) The loan or advance is not guaran-
teed by any other person.
(vi) Items that are not included in Cap-
ital Interest Allocations. Capital Interest
Allocations do not include –
(A) Amounts that are treated as API
Gains and Losses and Unrealized API
Gains and Losses; or
(B) Items that are not taken into ac-
count for purposes of section 1061 under
§1.1061-4(b)(7).
(4) Capital Interest Disposition
Amounts—(i) In general. The term Capi-
tal Interest Disposition Amount means the
amount of long-term capital gain or loss
recognized on the sale or disposition of all
or a portion of a Passthrough Interest that
is treated as Capital Interest Gain or Loss.
In general, long-term capital gain or loss
recognized on the sale or disposition of a
Passthrough Interest is deemed to be API
Gain or Loss unless it is determined under
paragraph (c)(4)(ii) of this section to be a
Capital Interest Disposition Amount.
(ii) Determination of the Capital Inter-
est Disposition Amount. If a Passthrough
Interest that includes a right to allocations
of Capital Interest Gains and Losses is dis-
posed of, the amount of long-term capital
gain or loss that is treated as a Capital In-
terest Disposition Amount is determined
under the rules provided in this paragraph
(c)(4)(ii).
(A) First, determine the amount of
long-term capital gain or loss that would
be allocated to the Passthrough Interest
(or the portion of the Passthrough Interest
sold) if all the assets of the Passthrough
Entity (including gain or loss with re-
spect to assets described in §1.1061-4(b)
(7)) were sold for their fair market value
in a fully taxable transaction immediately
before the disposition of the Passthrough
Interest (hypothetical asset sale). For pur-
poses of this paragraph (c)(4)(ii), the as-
sets of the Passthrough Entity include any
assets held by a lower-tier Passthrough
Entity in which the Passthrough Entity has
a direct or indirect interest.
(B) Second, determine the amount from
the hypothetical asset sale that would be
allocated to the Passthrough Interest (or
the portion of the Passthrough Interest
sold) as Capital Interest Allocations under
paragraph (c)(3) of this section.
(C) Third, if the transferor recognized
long-term capital gain upon disposition
of the Passthrough Interest and only net
short-term capital losses, net long-term
capital losses, or both, are allocated to
the Passthrough Interest under paragraph
(c)(4)(ii)(B) of this section from the hy-
pothetical asset sale, all of the long-term
capital gain is API Gain. If the transferor
recognized long-term capital loss on the
disposition of the Passthrough Interest and
only net short-term capital gains, net long-
term capital gains, or both, are allocated to
the Passthrough Interest under paragraph
(c)(4)(ii)(B) of this section, then all the
long-term capital loss is API Loss.
(D) If paragraph (c)(4)(ii)(C) of this
section does not apply and long-term cap-
ital gain is recognized on the disposition
of the Passthrough Interest, the amount of
long-term capital gain that the transferor
of the Passthrough Interest recognizes that
is treated as a Capital Interest Disposition
Amount is determined by multiplying

February 1, 2021 666 Bulletin No. 2021–5
long-term capital gain recognized on the
disposition of the Passthrough Interest
by a fraction, the numerator of which is
the amount of long-term capital gain de-
termined under paragraph (c)(4)(ii)(B)
of this section, and the denominator of
which is the amount of long-term capital
gain determined under paragraph (c)(4)
(ii)(A) of this section, with the percentage
represented by the fraction limited to 100
percent. Alternatively, if paragraph (c)(4)
(ii)(C) of this section does not apply and
long-term capital loss is recognized on the
disposition of the Passthrough Interest, the
amount of long-term capital loss treated as
a Capital Interest Disposition Amount is
determined by multiplying the transferor’s
capital loss by a fraction, the numerator of
which is the amount of long-term capital
loss determined under paragraph (c)(4)(ii)
(B) of this section, and the denominator
of which is the amount of long-term capi-
tal loss determined under paragraph (c)(4)
(ii)(A) of this section, with the percentage
represented by the fraction limited to 100
percent.
(E) In applying this paragraph (c)(4)
(ii), allocations of amounts that are not in-
cluded in determining the amount of long-
term capital gain or loss recognized on the
sale or disposition of the Passthrough In-
terest are not included. See, for example,
section 751(a).
(5) Capital Interest Allocations made by
a Passthrough Entity that is an API Hold-
er. An allocation made to a Passthrough
Entity that holds an API in a lower-tier
Passthrough Entity will be considered a
Capital Interest Allocation if it meets the
principles set forth in paragraphs (c)(3) and
(4) of this section (other than paragraph (c)
(3)(iv) of this section). For purposes of ap-
plying the Capital Interest Allocation rules
in this paragraph (c)(5) to a tiered partner-
ship structure, to the extent that a Capital
Interest Allocation that is made by a low-
er-tier partnership to an upper-tier partner-
ship is properly allocated to the upper-tier
partnership’s partners with respect to their
capital interests in the upper-tier partner-
ship in a manner that is respected under
704(b) (taking into account the principles
of section 704(c)), such allocation is a Cap-
ital Interest Allocation.
(6) Examples. The rules of this para-
graph (c) are illustrated by the following
examples.
(i) Example 1: Capital Interest Allocations—(A)
Facts. Each of A, B, and C contributes $100 to GP
and is an equal partner in GP, a partnership that is
the general partner of PRS, a partnership. The con-
tributions are not attributable to loans or advances
described in paragraph (c)(3)(v)(A) of this section.
PRS’s other partners are Unrelated Non-Service
Partners. Each of GP and PRS makes allocations to
its partners in accordance with its partners’ interests
in that partnership, as described in §1.704-1(b)(3).
GP holds a 20% profits interest in PRS that is an API
that GP received in exchange for providing substan-
tial services to PRS in an ATB. GP’s API is an Indi-
rect API to each of A, B, and C. GP contributes the
$300 of capital contributed by A, B and C to PRS.
GP’s $300 contribution equals 2% of the contribut-
ed capital made by all of PRS’s partners ($15,000).
PRS’s partnership agreement describes its partners’
economic distribution rights with respect to its liq-
uidating proceeds as follows: first, liquidating pro-
ceeds are proportionately distributed to each of GP
and the Unrelated Non-Service Partners equal to the
amount necessary to return each of those partners’
unreturned capital; second, liquidating proceeds are
distributed to GP with respect to its API in PRS; and,
finally, any residual liquidating proceeds are distrib-
uted, proportionately, 98% to the Unrelated Non-Ser-
vice Partners and 2% to GP. During its initial taxable
year, PRS has $10,000 of net capital gain, causing an
increase in PRS’s distributable proceeds of $10,000.
In accordance with the partners’ economic rights as
described in PRS’s partnership agreement, PRS al-
locates $2,160 of net capital gain to GP (a $2,000
API allocation plus $160 ($8,000 ($10,000-$2,000)
x 2%), with respect to GP’s contributed capital) and
$7,840 of net capital gain to the Unrelated Non-Ser-
vice Partners with respect to their contributed capi-
tal. GP allocates $720 ($2,160/3) of this net capital
gain to each of A, B, and C in accordance with their
interests in GP.
(B) PRS’s Capital Interest Allocation
Analysis. Because PRS’s partnership
agreement provides for no differences as
to the amount and timing of capital con-
tributed, the rate of return on capital con-
tributed, the type and level of risk associ-
ated with capital contributed, or the rights
to cash or property distributions during
the PRS’s operations and on liquidation,
the allocations and distribution rights with
respect the capital contributed by GP are
reasonably consistent with the allocation
and distribution rights with respect to cap-
ital contributed by Unrelated Non-Service
Partners. Accordingly, GP’s allocation of
$160 is a Capital Interest Allocation that
is treated as made in a similar manner
as the allocations made to the Unrelated
Non-Service Partners.
(C) GP Capital Interest Allocation Analysis.
GP is allocated $2,160 from PRS, consisting of a
$2,000 API allocation and a $160 Capital Interest
Allocation. The $160 Capital Interest Allocation is
allocated equally to A, B, and C based on their cap-
ital contributions to GP. Therefore, they qualify as
Capital Interest Allocations by GP. See paragraph
(c)(5) of this section. The $2,000 of gain allocated
by PRS’s to GP with respect to GP’s API cannot be
treated as a Capital Interest Allocation by GP and
therefore is subject to section 1061. In summary, A,
B, and C are each allocated $720 of capital gain from
PRS ($2,160/3). Of this amount, $667 is API Gain
($2,000/3) and $53 is a Capital Interest Allocation
($160/3).
(ii) Example 2: Sale of a Passthrough Inter-
est—(A) Facts. In Year 1, A, B, and C form GP, a
partnership. Each of A, B, and C contributes $100 to
GP and is an equal partner in GP. The contributions
are not attributable to loans or advances described
in paragraph (c)(3)(v)(A) of this section. GP invests
the $300 in Asset X in Year 1. GP is also the general
partner of PRS, a partnership. PRS’s other partners
are Unrelated Non-Service Partners. GP holds a 20%
profits interest in PRS that is an API that GP received
in exchange for providing substantial services to
PRS in an ATB. GP’s API is an Indirect API to each
of A, B, and C. Each of GP and PRS makes alloca-
tions to its partners in accordance with its partners’
interests in that partnership, as described in §1.704-
1(b)(3). In Year 3, A sells A’s interest in GP to an
unrelated third party for $800 and recognizes $700
of capital gain on the sale. If PRS had sold its assets
in a hypothetical asset sale as required by paragraph
(c)(4)(ii)(A) of this section and liquidated immedi-
ately before A sold its interest in GP, GP would have
been allocated $1,800 of long-term capital gain with
respect to GP’s API in PRS, and GP would have al-
located $600 of this $1,800 to A. If GP sold Asset X
for its fair market value and liquidated immediately
before A sold its interest in GP, A would have been
allocated $100 of long-term capital gain.
(B) Analysis. GP does not have a capital inter-
est in PRS. Therefore, its allocations from PRS are
allocations with respect to its API which are subject
to section 1061. The total gain allocable to A as a re-
sult of the hypothetical liquidations would be $700.
Under paragraph (c)(4)(ii)(D) of this section, $100
of the $700 of A’s interest sale gain is A’s Capital
Interest Disposition Amount, and is not subject to
section 1061.
(iii) Example 3: Reinvestment of Realized API
Gain. A, B, and C are partners in PRS, a partnership.
At the beginning of Year 1, A is issued an API in PRS
in exchange for providing substantial services to PRS
in an ATB. A has no capital interest in PRS. During
Year 1, PRS’s assets appreciate by $100. At the end of
Year 1, under the terms of its partnership agreement,
if PRS were to sell all of its assets at their fair market
value and distribute the proceeds in a complete liqui-
dation, A would receive $20 with respect to its API.
Thus, at the end of Year 1, A has $20 of Unrealized
API Gain. In Year 2, PRS sells Asset X, an asset that
PRS owned in Year 1, and allocates $8 of the long-
term capital gain to A as API Gain. As a result, $8 of
A’s $20 of Unrealized API Gain becomes API Gain
that is subject to section 1061. A reinvests A’s share of
the proceeds from the Asset X sale in PRS. As a result,
under paragraph (c)(3)(iii) of this section, A has an $8
capital interest in PRS and, provided the requirements
of paragraph (c)(3) of this section are met, A may re-
ceive future Capital Interest Allocations with respect
to the capital interest.
(d) Partnership interest acquired by
purchase by an unrelated person. If a

Bulletin No. 2021–5 667 February 1, 2021
person (acquirer) acquires an interest in a
partnership (target partnership) by taxable
purchase for fair market value that, but for
the exception set forth in this paragraph
(d), would be an API, the transferor of the
interest will be treated as selling an API
but the acquirer will not be treated as ac-
quiring an API if—
(1) Acquirer not a Related Person.
Immediately before the purchase, the ac-
quirer is not a Related Person with respect
to—
(i) Any person who provides services
in the Relevant ATB; or
(ii) Any service providers who provide
services to, or for the benefit of, the target
partnership or a lower-tier partnership in
which the target partnership holds an in-
terest, directly or indirectly.
(2) Section 1061(d) not applicable.
Section 1061(d) does not apply to the
transaction (as provided in §1.1061-5).
(3) Acquirer not a service provider. At
the time of the purchase, the acquirer has
not provided, does not provide, and does
not anticipate providing, services in the
future, to, or for the benefit of, the target
partnership, directly or indirectly, or any
lower-tier partnership in which the target
partnership directly or indirectly holds an
interest.
(e) [Reserved]
(f) Applicability date—(1) Gener-
al rule. Except as provided in para-
graphs (f)(2) and (3) of this section,
the provisions of this section apply to
taxable years of Owner Taxpayers and
Passthrough Entities beginning on or
after January 19, 2021. An Owner Tax-
payer or Passthrough Entity may choose
to apply this section to a taxable year
beginning after December 31, 2017, pro-
vided that they apply the Section 1061
Regulations in their entirety to that year
and all subsequent years.
(2) Partnership interest held by an S
corporation. Paragraph (b)(2)(i) of this
section, which provides that the exception
under section 1061(c)(1) to the definition
of an API does not apply to a partnership
interest held by an S corporation with an
election under section 1362(a) in effect,
applies to taxable years beginning after
December 31, 2017.
(3) Partnership interest held by a PFIC
with respect to which the shareholder has
a QEF election in effect. Paragraph (b)(2)
(ii) of this section, which provides that the
exception under section 1061(c)(1) to the
definition of an API does not apply to a
partnership interest held by a PFIC with
respect to which the shareholder has a
QEF election in effect under section 1295,
applies to taxable years of an Owner Tax-
payer and Passthrough Entity beginning
after August 14, 2020.
§1.1061-4 Section 1061 computations.
(a) Computations—(1) Recharacter-
ization Amount. The Recharacterization
Amount is the amount that an Owner Tax-
payer must treat as short-term capital gain
under section 1061(a). The Recharacteri-
zation Amount equals—
(i) The Owner Taxpayer’s One Year
Gain Amount; less
(ii) The Owner Taxpayer’s Three Year
Gain Amount.
(2) One Year Gain Amount and Three
Year Gain Amount—(i) One Year Gain
Amount. The Owner Taxpayer’s One Year
Gain Amount is the sum of –
(A) The Owner Taxpayer’s combined
net API One Year Distributive Share
Amount from all APIs held during the tax-
able year; and
(B) The Owner Taxpayer’s API One
Year Disposition Amount.
(ii) Three Year Gain Amount. The Own-
er Taxpayer’s Three Year Gain Amount is
the sum of –
(A) The Owner Taxpayer’s combined
net API Three Year Distributive Share
Amount from all APIs held during the tax-
able year; and
(B) The Owner Taxpayer’s API Three
Year Disposition Amount.
(3) API One Year Distributive Share
Amount and API Three Year Distributive
Share Amount—(i) API One Year Distrib-
utive Share Amount. The API One Year
Distributive Share Amount equals—
(A) The API Holder’s distributive
share of net long-term capital gain or loss
from the partnership for the taxable year
(including capital gain or loss on the dis-
position of Distributed API Property by an
API Holder that is a Passthrough Entity or
the disposition of all or a part of an API by
an API Holder that is a Passthrough Enti-
ty), with respect to the partnership interest
held by the API Holder calculated without
the application of section 1061; less
(B) To the extent included in the amount
determined under paragraph (a)(3)(i)(A)
of this section, the aggregate of—
(1) Amounts that are not taken into ac-
count for purposes of section 1061 under
paragraph (b)(7) of this section; and
(2) Capital Interest Gains and Losses as
determined under §1.1061-3(c)(2).
(ii) API Three Year Distributive Share
Amount. The API Three Year Distributive
Share Amount equals the API One Year
Distributive Share Amount, less–
(A) Items included in the API One Year
Distributive Share Amount that would not
be treated as a long-term gain or loss if
three years is substituted for one year in
paragraphs (3) and (4) of section 1222;
and
(B) Any adjustments resulting from
the application of the Lookthrough Rule
under paragraph (b)(9)(ii) of this section
when an API is disposed of by an API
Holder that is a Passthrough Entity.
(4) API One Year Disposition Amount
and API Three Year Disposition Amount—
(i) API One Year Disposition Amount. The
API One Year Disposition Amount is the
combined net amount of—
(A) Long-term capital gains and losses
recognized during the taxable year by an
Owner Taxpayer, including long-term cap-
ital gain computed under the installment
method that is taken into account for the
taxable year, on the disposition of all or a
portion of an API that has been held for
more than one year, including a disposition
to which the Lookthrough Rule applies;
(B) Long-term capital gain and loss
recognized by an Owner Taxpayer due
to a distribution with respect to an API
during the taxable year that is treated un-
der section 731(a) as gain or loss from the
sale or exchange of a partnership interest
held for more than one year; and,
(C) Long-term capital gains and losses
recognized by an Owner Taxpayer on the
disposition of Distributed API Property
(taking into account deemed exchanges
under section 751(b)) during the taxable
year that has a holding period of more than
one year but not more than three years to
the distributee Owner Taxpayer on the
date of disposition, excluding items de-
scribed in paragraph (b)(7) of this section.
(ii) API Three Year Disposition
Amount. The API Three Year Disposition
Amount is the combined net amount of—

February 1, 2021 668 Bulletin No. 2021–5
(A) Long-term capital gains and loss-
es recognized during the taxable year by
an Owner Taxpayer, including long-term
capital gain computed under the install-
ment method that is taken into account for
the taxable year, on the disposition of all
or a portion of an API that has been held
for more than three years and to which the
Lookthrough Rule does not apply;
(B) Long-term capital gains and loss-
es recognized by an Owner Taxpayer on
the disposition during the taxable year of
all or a portion of an API that has been
held for more than three years in a trans-
action to which the Lookthrough Rule in
paragraph (b)(9) of this section applies,
less any adjustments required under the
Lookthrough Rule in paragraph (b)(9)(ii)
of this section; and
(C) Long-term capital gains and losses
recognized on a distribution with respect
to an API during the taxable year that is
treated under sections 731(a) as gain or
loss from the sale or exchange of a part-
nership interest held for more than three
years.
(b) Special rules for calculating the
One Year Gain Amount and the Three
Year Gain Amount—(1) One Year Gain
Amount equals zero or less. If an Owner
Taxpayer’s One Year Gain Amount is zero
or results in a loss, the Recharacterization
Amount for the taxable year is zero and
section 1061(a) does not apply.
(2) Three Year Gain Amount equals
zero or less. If an Owner Taxpayer’s Three
Year Gain Amount is less than or equal to
$0, the Three Year Gain Amount is zero
for purposes of calculating the Recharac-
terization Amount.
(3) One Year Gain Amount less than
Three Year Gain Amount. If the One Year
Gain Amount and the Three Year Gain
Amount are both greater than zero but the
One Year Gain Amount is less than the
Three Year Gain Amount, none of the One
Year Gain Amount is included in the Re-
characterization Amount for the taxable
year.
(4) Installment sale gain. The One Year
Gain Amount under paragraph (a)(2)(i)
of this section and the Three Year Gain
Amount, as determined under paragraph
(a)(2)(ii) of this section include long-term
capital gains from installment sales. This
includes long-term capital gain or loss
recognized with respect to an API after
December 31, 2017, with respect to an in-
stallment sale that occurred on or before
December 31, 2017. The holding period
of the asset upon the date of disposition is
used for purposes of determining whether
capital gain is included in the taxpayer’s
One Year Gain Amount or the Three Year
Gain Amount.
(5) Special rules for capital gain div-
idends from regulated investment com-
panies (RICs) and real estate investment
trusts (REITs)—(i) API One Year Distrib-
utive Share Amount. If a RIC or REIT re-
ports or designates a dividend as a capital
gain dividend and provides the One Year
Amounts Disclosure as defined in §1.1061-
6(c)(1)(i), the amount provided in the One
Year Amounts Disclosure is included in the
calculation of an API One Year Distributive
Share Amount. If the RIC or REIT does not
provide the One Year Amounts Disclosure,
the full amount of the RIC’s or REIT’s cap-
ital gain dividend must be included in the
calculation of an API One Year Distributive
Share Amount.
(ii) API Three Year Distributive Share
Amount. If a RIC or REIT reports or desig-
nates a dividend as a capital gain dividend
and provides the Three Year Amounts Dis-
closure as defined in §1.1061-6(c)(1)(ii),
the amount provided in the Three Year
Amounts Disclosure is used for the calcu-
lation of an API Three Year Distributive
Share amount. If the RIC or REIT does
not provide the Three Year Amounts Dis-
closure, no amount of the RIC’s or REIT’s
capital gain dividend may be used for the
calculation of an API Three Year Distribu-
tive Share Amount.
(iii) Loss on sale or exchange of stock.
If a RIC or REIT provides the Three Year
Amounts Disclosure as provided in para-
graph (b)(5)(ii) of this section, any loss on
the sale or exchange of shares of a RIC or
REIT held for six months or less is treat-
ed as a capital loss on an asset held for
more than three years, to the extent of the
amount of the Three Year Amounts Dis-
closure from that RIC or REIT.
(6) Pro rata share of qualified electing
fund (QEF) net capital gain—(i) One year
QEF net capital gain. The calculation
of an API One Year Distributive Share
Amount includes an Owner Taxpayer’s
inclusion under section 1293(a)(1)(B) as
limited by section 1293(e)(2) with respect
to a passive foreign investment company
(as defined in section 1297(a)) for which
a QEF election (as described in section
1295(a)) is in effect for the taxable year.
The amount of the inclusion may be re-
duced by the amount of long-term capi-
tal gain that is not taken into account for
purposes of section 1061 as provided in
paragraph (b)(7) of this section and may
be reduced by the Owner Taxpayer’s share
of the excess, if any, of the Capital Inter-
est Gain over Capital Interest Loss with
respect to the QEF, provided in each case
that the relevant information is provided
by the QEF. See §1.1061-6 for reporting
rules.
(ii) Three year QEF net capital gain
adjustment. For purposes of calculating
an Owner Taxpayer’s API Three Year Dis-
tributive Share Amount, the entire amount
determined under paragraph (b)(6)(i) of
this section, after any allowed reduction, is
included as an item in paragraph (a)(3)(ii)
(A) of this section unless the QEF provides
information to determine the amount of the
inclusion that would constitute net capi-
tal gain (as defined in §1.1293-1(a)(2), as
limited by section 1293(e)(2)) if the QEF’s
net capital gain for the taxable year were
calculated under section 1222(11) applying
paragraphs (3) and (4) of section 1222 by
substituting three years for one year. If such
information is provided, the amount includ-
ed as an item in paragraph (a)(3)(ii)(A) of
this section is the amount determined un-
der paragraph (b)(6)(i) of this section that
would not be treated as long-term gain if
three years were substituted for one year in
paragraphs (3) and (4) of section 1222. See
§1.1061-6 for reporting rules.
(7) Items not taken into account for
purposes of section 1061. The following
items of long-term capital gain and loss
are excluded from the calculation of the
API One Year Distributive Share Amount
in paragraph (a)(3)(i) of this section and
the API Three Year Distributive Share
Amount in paragraph (a)(3)(ii) of this sec-
tion—
(i) Long-term capital gain and long-
term capital loss determined under section
1231;
(ii) Long-term capital gain and long-
term capital loss determined under section
1256;
(iii) Qualified dividends included in net
capital gain for purposes of section 1(h)
(11)(B); and

Bulletin No. 2021–5 669 February 1, 2021
(iv) Capital gains and losses that are
characterized as long-term or short-term
without regard to the holding period rules
in section 1222, such as certain capital
gains and losses characterized under the
mixed straddle rules described in section
1092(b) and §§1.1092(b)-3T, 1.1092(b)-
4T, and 1.1092(b)-6.
(8) Holding period determination—(i)
Determination of holding period for pur-
poses of the Three Year Gain Amount. For
purposes of computing the Three Year
Gain Amount, the relevant holding period
of either an asset or an API is determined
under all provisions of the Code or reg-
ulations that are relevant to determining
whether the asset or the API has been held
for the long-term capital gain holding pe-
riod by applying those provisions as if the
holding period were three years instead of
one year.
(ii) Relevant holding period. The rele-
vant holding period is the direct owner’s
holding period in the asset sold. Accord-
ingly, for purposes of determining an API
Holder’s Taxpayer’s API One Year Dis-
tributive Share Amount and API Three
Year Distributive Share Amount for the
taxable year under paragraph (a)(3) of
this section, the partnership’s holding pe-
riod in the asset being sold or disposed of
(whether a directly held asset or a partner-
ship interest) is the relevant holding peri-
od for purposes of section 1061.
(9) Lookthrough Rule for certain API
dispositions—(i) Determination that the
Lookthrough Rule applies—(A) In gener-
al. The Lookthrough Rule will apply if, at
the time of disposition of an API held for
more than three years—
(1) The API would have a holding pe-
riod of three years or less if the holding
period of such API were determined by
not including any period before the date
that an Unrelated Non-Service Partner is
legally obligated to contribute substantial
money or property directly or indirectly to
the Passthrough Entity to which the API
relates. This paragraph (b)(9)(i)(A) does
not apply to the disposition of an API to
the extent that the gain recognized upon
the disposition of the API is attributable
to any asset not held for portfolio invest-
ment on behalf of third party investors (as
defined in section 1061(c)(5)). Solely for
the purpose of this paragraph (b)(9)(i)(A),
a substantial legal obligation to contrib-
ute money or property is an obligation to
contribute a value that is at least 5 percent
of the partnership’s total capital contribu-
tions as of the time of the API disposition;
or
(2) A transaction or series of transac-
tions has taken place with a principal pur-
pose of avoiding potential gain recharac-
terization under section 1061(a).
(B) Determination that the Look-
through Rule applies to the disposition
of a Passthrough Interest. Paragraph (b)
(9)(i)(A) of this section similarly applies
with respect to a Passthrough Interest is-
sued by an S corporation or a PFIC to the
extent the Passthrough Interest is treated
as an API.
(ii) Application of the Lookthrough
Rule. If the Lookthrough Rule applies, for
purposes of applying an Owner Taxpay-
er’s Recharacterization Amount, as de-
scribed in paragraph (a) of this section—
(A) The Owner Taxpayer must include
the entire amount of capital gain recog-
nized on the disposition of an API by the
Owner Taxpayer in the Owner Taxpayer’s
API One Year Disposition Amount; and
(B) The Owner Taxpayer must include
in its Three Year Disposition Amount an
amount equal its One Year Disposition
Amount (determined under paragraph (b)
(9)(ii)(A) of this section) reduced by the
Owner Taxpayer’s share of the amount
of any gain, directly or indirectly, from
assets held for three years or less that
would have been allocated to the Owner
Taxpayer (to the extent attributable to the
transferred API) by the partnership if the
partnership had sold all of its property in
a fully taxable transaction for cash in an
amount equal to the fair market value of
such property (taking into account section
7701(g)) immediately prior to the Owner
Taxpayer’s transfer of the API.
(C) In the case of an API disposition by
an API Holder that is a Passthrough Entity
and not an Owner Taxpayer, the principles
set forth in paragraph (b)(9)(ii)(A) of this
section must be applied to determine the
amount to include in the Owner Taxpay-
er’s One Year Distributive Amount and
in paragraph (b)(9)(ii)(B) of this section
to determine the amounts included in the
Owner Taxpayer’s Three Year Distribu-
tive Share Amount.
(10) Section 83. Except with respect to
any portion of the interest that is a capital
interest under §1.1061-3(c), this section
applies regardless of whether an Owner
Taxpayer or Passthrough Entity has made
an election under section 83(b) or included
amounts in gross income under section 83.
(c) Examples—(1) Recharacterization
rules. The rules of paragraph (a) of this
section are illustrated by the following ex-
amples. Unless otherwise stated, all gains
and losses are long-term capital gains and
losses, none of the long-term capital gain
or loss in this section is capital gain or loss
not taken into account for purposes of sec-
tion 1061 under paragraph (b)(7) of this
section, and neither the Lookthrough Rule
nor section 751 is applicable.
(i) Example 1: Determination of API One Year
and Three Year Distributive Share Amounts—(A)
Facts. A holds an API in PRS but has no capital in-
terest in PRS and is not entitled to a Capital Interest
Allocation with respect to PRS. During the taxable
year, PRS allocates to A $20 of long-term capital
gain from the sale of capital asset X (which had been
held by PRS for two years) and $40 of long-term
capital gain from the sale of capital asset Y (which
had held by PRS for five years). A has no other items
of long-term capital gain or loss with respect to its in-
terest in PRS during the taxable year. A has no other
long-term capital gains or losses with respect to any
other API during the taxable year.
(B) Determination of A’s API One Year Distribu-
tive Share Amount. Under paragraph (a)(3)(i) of this
section, A has an API One Year Distributive Share
Amount of $60. This amount is the sum of the $20 of
the long-term capital gain allocated to A from PRS’s
sale of capital asset X and the $40 of long-term cap-
ital gain allocated to A from PRS’s sale of capital
asset Y.
(C) Determination of A’s API Three Year Distrib-
utive Share Amount. (1) Under paragraph (a)(3)(ii)
of this section, A’s API Three Year Distributive Share
Amount is equal to A’s API One Year Distributive
Amount, $60, less the sum of:
(i) The items included in the API One Year Dis-
tributive Share Amount that would not be treated as a
long-term gain or loss if three years is substituted for
one year in paragraphs (3) and (4) of section 1222,
$20; and
(ii) Adjustments resulting from the application of
the Lookthrough Rule under paragraph (b)(9)(ii) of
this section, which under the facts in paragraph (c)
(1)(i)(A) of this section, is inapplicable.
(2) Thus, A’s Three Year API Distributive Share
Amount is $40.
(D) Determination of A’s Recharacterization
Amount. Under paragraph (a)(2)(i) of this section,
A’s One Year Gain amount is equal to A’s API One
Year Distributive Share Amount, $60. A’s Three Year
Gain Amount is equal to A’s API Three Year Distrib-
utive Share Amount, $40. Under paragraph (a)(1) of
this section, A’s Recharacterization Amount is A’s
One Year Gain Amount, minus A’s Three Year Gain
Amount, or $20.
(ii) Example 2: API One Year and Three Year
Disposition Amounts—(A) Facts. During the taxable

February 1, 2021 670 Bulletin No. 2021–5
year, A disposes of an API that A has held for four
years for a $100 gain. Additionally, A sells Distrib-
uted API Property for a $300 gain at a time when A
has a two-year holding period in such property. A has
no other items of long-term capital gain or loss with
respect to any API in the year.
(B) Determination of A’s API One Year and Three
Year Disposition Amounts. Under paragraph (a)(4)(i)
of this section, A’s API One Year Disposition Amount
is $400. This amount is the sum of A’s $300 of long-
term capital gain on A’s disposition of the Distribut-
ed API Property and A’s $100 of long-term capital
gain on the disposition of the API. Under paragraph
(a)(4)(ii) of this section, A’s Three Year Disposition
Amount is $100, which is the amount of long-term
capital gain that A recognized upon disposition of the
API held for more than three years. Under paragraph
(a)(2) of this section, A’s One Year Gain Amount is
$400 and A’s Three Year Gain Amount is $100.
(C) Determination of A’s Recharacterization
Amount. Under paragraph (a)(1) of this section, A’s
Recharacterization Amount is $300, which is the
difference between A’s One Year Gain Amount and
Three Year Gain Amount.
(iii) Example 3: Determination of One Year Gain
Amount, Three Year Gain Amount, and Recharacter-
ization Amount—(A) Facts. A holds an API in each
of PRS1 and PRS2. With respect to PRS1, A’s API
One Year Distributive Share Amount is $100 and
A’s API Three Year Distributive Share Amount is
($200). With respect to PRS2, A’s API One Year Dis-
tributive Share Amount is $600 and A’s API Three
Year Distributive Share Amount is $300. During the
taxable year, A also has an API One Year Disposi-
tion Amount of $200 of gain. A has no other items of
long-term capital gain or loss with respect to an API
for the taxable year.
(B) Determination of A’s One Year Gain Amount.
Under paragraph (a)(2) of this section, A’s One Year
Gain Amount is $900, which is an amount equal to
A’s $100 API One Year Distributive Share Gain from
PRS1 and A’s $600 API One Year Distributive Share
from PRS2 (a combined net API One Year Distribu-
tive Share Amount of $700) plus A’s $200 API One
Year Disposition Amount.
(C) Determination of A’s Three Year Gain
Amount. Under paragraph (a)(2) of this section, A’s
Three Year Gain Amount is $100, which is equal to
A’s combined net API Three Year Distributive Share
Amount for the taxable year (A’s $200 API Three
Year Distributive Share Amount loss from PRS1 plus
A’s API Three Year Distributive Share Amount Gain
of $300 from PRS2). A does not have an API Three
Year Disposition Amount.
(D) Determination of A’s Recharacterization
Amount. Under paragraph (a)(1) of this section, A’s
Recharacterization Amount is $800. (A’s One Year
Gain Amount of $900 less A’s Three Year Gain
Amount of $100).
(2) Special rules examples. The prin-
ciples of paragraph (b) of this section are
illustrated by the following examples.
(i) Example 1: Lookthrough Rule. On July 1,
2021, A and B form partnership PRS. At the time of
PRS’s formation, A agrees to provide substantial ser-
vices to PRS in exchange for a 20% profits interest in
PRS, and B, a partner that is an Unrelated Non-Ser-
vice Partner, contributes $1 million in exchange for
an interest in PRS and PRS immediately uses the
capital to purchase marketable securities. On July
1, 2023, C, another Unrelated Non-Service Partner
becomes legally obligated to contribute capital to
PRS ($75 million) for the purposes of investing in
and developing Specified Assets and is admitted into
PRS. On July 3, 2023, and after C makes a contribu-
tion of $75 million, PRS uses this capital to acquire
stock in portfolio company Z. On July 1, 2025, when
Z has a value of $500 million and the value of the
marketable securities is $2 million, A sells its API
in PRS for $85.2 million. As a result of this sale, the
Lookthrough Rule applies because B’s contribution
was non-substantial under paragraph (b)(9)(i)(A)(1)
of this section. Therefore, A includes $85.2 million
in its API One Year Disposition Amount and under
paragraph (b)(9)(ii)(B) of this section, $200,000
(20% share of $1 million gain in marketable securi-
ties) in its API Three Year Disposition Amount. Ac-
cordingly, under paragraph (a)(1) of this section, A’s
Recharacterization Amount is $85 million.
(ii) Example 2: Installment sale gain. On Decem-
ber 22, 2021, A disposed of A’s API in an installment
sale. At the time of the disposition, A had held its
API for two years. A received a payment with respect
to the installment sale during A’s 2022 taxable year
causing A to recognize $200 of long-term capital
gain. The $200 long-term capital gain recognized
in 2022 is subject to section 1061 because it is rec-
ognized after December 31, 2017. Accordingly, the
$200 of long-term capital gain recognized by A in
2022 is included in A’s API One Year Disposition
Amount. The $200 of long-term capital gain is not
in A’s API Three Year Disposition Amount because
the API was not held for more than three years at the
time of its disposition.
(iii) Example 3: REIT capital gain dividend.
During the taxable year, A holds an API in PRS. PRS
holds an interest in REIT. During the taxable year,
REIT distributes a $1,000 capital gain dividend to
PRS of which 50% is allocable to A’s API. Part of
the capital gain dividend for the year results from
section 1231 gain. In accordance with §1.1061-6(c)
(1)(i), REIT discloses to PRS the One Year Amounts
Disclosure of $400, which is the $1000 capital gain
dividend reduced by the $600 of section 1231 cap-
ital gain dividend included in that amount. Part of
the One Year Amounts Disclosure for the year re-
sults from gain from property held for three years
or less. In accordance with §1.1061-6(c)(1)(ii), REIT
also discloses the Three Year Amounts Disclosure
of $150, which is the $400 One Year Amounts Dis-
closure reduced by the $250 of gain attributable to
property held for three years or less. PRS includes a
$200 gain in determining A’s API One Year Distrib-
utive Share Amount and a $75 gain in determining
A’s API Three Year Distributive Share Amount. See
paragraphs (b)(5)(i) and (ii) of this section.
(d) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough En-
tities beginning on or after January 19,
2021. An Owner Taxpayer or Passthrough
Entity may choose to apply this section to
a taxable year beginning after December
31, 2017, provided that they apply the
Section 1061 Regulations in their entirety
to that year and all subsequent years.
§1.1061-5 Section 1061(d) transfers to
related persons.
(a) In general. If an Owner Taxpay-
er transfers any API or Distributed API
Property, directly or indirectly, to a Sec-
tion 1061(d) Related Person (as defined in
paragraph (e) of this section), the Owner
Taxpayer must include in gross income as
short-term capital gain, an amount equal
to—
(1) The short-term capital gain recog-
nized upon the API transfer without re-
gard to this paragraph (a); and
(2) The lesser of–
(i) The amount of net long-term capital
gain recognized by the Owner Taxpayer
upon the transfer of such interest; or
(ii) The amount treated as short-term
capital gain under paragraph (c) of this
section (Section 1061(d) Recharacteriza-
tion Amount).
(b) Transfer. For purposes of this sec-
tion, the term transfer means a sale or ex-
change in which gain is recognized by the
Owner Taxpayer under chapter 1 of the
Internal Revenue Code.
(c) Section 1061(d) Recharacterization
Amount. To the extent an Owner Taxpayer
recognizes long-term capital gain upon a
transfer of an API to a Section 1061(d) Re-
lated Person, the Owner Taxpayer’s Sec-
tion 1061(d) Recharacterization Amount
is the amount of net long-term capital
gain (excluding amounts not taken into
account for purposes of section 1061 un-
der §1.1061-4(b)(7)) from assets held for
three years or less that would have been
allocated to the Owner Taxpayer (to the
extent attributable to the transferred API)
by the partnership if the partnership had
sold all of its property in a fully taxable
transaction for cash in an amount equal
to the fair market value of such property
(taking into account section 7701(g)) im-
mediately prior to the Owner Taxpayer’s
transfer of the API. If only a portion of
an Owner Taxpayer’s API is transferred,
this paragraph (c) shall apply with respect
to the portion of gain attributable to the
transferred interest.
(d) Special rules. For purposes of this
section, the following rules are applicable.

Bulletin No. 2021–5 671 February 1, 2021
(1) An Owner Taxpayer will be treat-
ed as transferring the Owner Taxpayer’s
share of any Indirect API or Distributed
API Property if the Indirect API or Dis-
tributed API Property is transferred by the
API Holder to a person that is a Section
1061(d) Related Person with respect to the
Owner Taxpayer.
(2) The rules set forth in paragraphs
(a), (b), and (c) of this section apply upon
the transfer of a Passthrough Interest is-
sued by an S corporation or PFIC to the
extent the Passthrough Interest is treated
as an API.
(e) Section 1061(d) Related Person.
For purposes of this section, the term Sec-
tion 1061(d) Related Person means—
(1) A person that is a member of the
taxpayer’s family within the meaning of
section 318(a)(1);
(2) A person that performed a service
within the current calendar year or the pre-
ceding three calendar years in a Relevant
ATB to the API transferred by taxpayer; or
(3) A Passthrough Entity to the extent
that a person described in paragraph (e)
(1) or (2) of this section owns an interest,
directly or indirectly.
(f) Examples. The following examples
illustrate the rules of this section.
(1) Example 1: Transfer to child by gift. A, an
individual, performs services in an ATB and has
held an API in connection with those services for 10
years. The API has a fair market value of $1,000 and
a tax basis of $0, and no debt is associated with the
API. A transfers all of the API to A’s daughter as a
gift. A’s daughter is a section 1061(d) Related Person
but A’s gift is not a transfer as described in paragraph
(b) of this section thus section 1061(d) does not ap-
ply to A’s gift. However, the API remains an API in
the hands of A’s daughter under §1.1061-2(a)(1)(i).
(2) Example 2: Transfer of an API to a partner-
ship owned by Section 1061(d) Related Persons—(i)
Facts. A, B, and C are equal partners in GP, a part-
nership. GP holds only one asset, an API in PRS1
which is an Indirect API as to each A, B, and C. A, B,
and C each provides services in the ATB in connec-
tion with which GP was transferred its API in PRS1.
A and B contribute their interests in GP to PRS2 in a
Section 721(a) exchange for interests in PRS2.
(ii) Application of section 1061(d). Because the
contribution by A and B of their interest in GP to
PRS2 is an exchange in which no gain is recognized
by either A or B, the contribution is not a transfer as
described in paragraph (b) of this section thus section
1061(d) does not apply to A and B’s contribution.
However, the API remains an API in the hands of
PRS2 under §1.1061-2(a)(1)(i).
(3) Example 3: Transfer of an API to a Section
1061(d) Related Person. A holds an API in GP, a
partnership which A has owned for four years. A
transfers the API to a Section 1061(d) Related Per-
son described in paragraph (e) of this section in ex-
change for $100 of cash, resulting in A recognizing
long-term capital gain of $100. Because this is a
transfer described in paragraph (b) of this section,
section 1061(d) applies to the transfer of A’s API and
A must determine its Section 1061(d) Recharacter-
ization Amount under paragraph (c) of this section.
If, immediately prior to A’s transfer of the API, the
partnership had sold all of its assets in a fully taxable
transaction for cash equal of the fair market value of
the assets, A’s share of the net long-term capital gain
(excluding amounts not taken into account for pur-
poses of section 1061 under §1.1061-4(b)(7)) from
assets held for three years or less would have been
$120. Thus, A’s Section 1061(d) Recharacterization
Amount is $120. As a result, A’s $100 long-term cap-
ital gain is recharacterized as short-term capital gain
under paragraph (a) of this section. The API remains
an API in the hands of the Section 1061(d) Related
Person under §1.1061-2(a)(1)(i).
(g) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough En-
tities beginning on or after January 19,
2021. An Owner Taxpayer or Passthrough
Entity may choose to apply this section to
a taxable year beginning after December
31, 2017, provided that they apply the
Section 1061 Regulations in their entirety
to that year and all subsequent years.
§1.1061-6 Reporting rules.
(a) Owner Taxpayer filing require-
ments–(1) In general. An Owner Taxpayer
must file such information with the IRS as
the Commissioner of Internal Revenue or
the Commissioner’s delegate (Commis-
sioner) may require in forms, instructions,
or other guidance as is necessary for the
Commissioner to determine that the Own-
er Taxpayer has properly complied with
section 1061 and the Section 1061 Reg-
ulations. If an Owner Taxpayer requires
information from a Passthrough Entity to
determine the Capital Interest Disposition
Amount or the Section 1061(d) Recharac-
terization Amount, the Owner Taxpayer
must request such information from that
entity.
(2) Failure to obtain information.
Paragraph (b)(1) of this section requires
certain Passthrough Entities to furnish
an Owner Taxpayer with certain amounts
necessary to determine its Recharacteri-
zation Amount and meet its reporting re-
quirements under paragraph (a)(1) of this
section. To the extent that an Owner Tax-
payer is not furnished the information re-
quired to be furnished under paragraph (b)
(1) of this section in such time and in such
manner as required by the Commissioner
and the Owner Taxpayer is not otherwise
able to substantiate all or a part of these
amounts to the satisfaction of the Com-
missioner, then if the information with
respect to the determination of the—
(i) API One Year Distributive Share
Amount under §1.1061-4(a)(3)(i) is not
furnished, the API One Year Distributive
Share Amount will not be reduced by-
(A) Amounts not taken into account for
purposes of section 1061 under §1.1061-
4(b)(7); or
(B) Capital Interest Gains and Losses
as determined under §1.1061-3(c)(2).
(ii) API Three Year Distributive Share
Amount determined under §1.1061-4(a)
(3)(ii) is not furnished, all items included
in the API One Year Distributive Share
Amount are treated as items that would
not be treated as long-term capital gain or
loss, if three years is substituted for one
year in paragraphs (3) and (4) of section
1222.
(b) Passthrough Entity filing require-
ments and reporting—(1) Requirement to
file information with the IRS and to furnish
information to API Holder. A Passthrough
Entity must file such information with the
IRS as the Commissioner may require in
forms, instructions, or other guidance as
is necessary for the Commissioner to de-
termine that it and its partners have com-
plied with section 1061 and the Section
1061 Regulations. A Passthrough Enti-
ty that has issued an API must furnish
to the API Holder, including an Owner
Taxpayer, such information at such time
and in such manner as the Commission-
er may require in forms, instructions, or
other guidance as is necessary to deter-
mine the One Year Gain Amount and the
Three Year Gain Amount with respect to
an Owner Taxpayer that directly or indi-
rectly holds the API. A Passthrough Entity
that has furnished information to the API
Holder must file such information with the
IRS, at such time and in such manner as
the Commissioner may require in forms,
instructions, or other guidance. This infor-
mation includes:
(i) The API One Year Distributive
Share Amount and the API Three Year
Distributive Share Amount (as determined
under §1.1061-4);

February 1, 2021 672 Bulletin No. 2021–5
(ii) Capital gains and losses allocated
to the API Holder that are excluded from
section 1061 under §1.1061-4(b)(7);
(iii) Capital Interest Gains and Loss-
es allocated to the API Holder (as deter-
mined under §1.1061-3(c)); and
(iv) In the case of a disposition by an API
Holder of an interest in the Passthrough
Entity during the taxable year, upon the
request of an API Holder, any information
required by the API Holder to properly
take the disposition into account under
section 1061, including—
(A) Information necessary to apply the
Lookthrough Rule and to determine the
API Holder’s Capital Interest Disposition
Amount; and
(B) Information necessary to determine
an Owner Taxpayer’s Section 1061(d) Re-
characterization Amount.
(2) Requirement to request, furnish,
and file information in tiered structures—
(i) Requirement to request information. If
a Passthrough Entity requires information
to meet its reporting and filing require-
ments under this section (in addition to
any information required to be furnished
to the Passthrough Entity under paragraph
(b)(1) of this section) from a lower-tier
entity in which it holds an interest, the
Passthrough Entity must request such in-
formation from that entity.
(ii) Requirement to furnish and file in-
formation. If information is requested of a
Passthrough Entity under paragraph (b)(2)
(i) of this section, the Passthrough Enti-
ty must furnish the requested information
to the person making the request but only
to the extent the information is necessary
for the requesting Passthrough Entity to
meet its reporting and filing requirements
under this section or is required by the
Commissioner in forms, instructions, or
other guidance. If the person requesting
the information is an API Holder in the
Passthrough Entity, the information is
furnished under paragraph (b)(1) of this
section. If the Passthrough Entity request-
ing the information is not an API Holder,
the Passthrough Entity must furnish the
information to the requesting Passthrough
Entity as required by the Commissioner in
forms, instructions, or other guidance.
(iii) Timing of requesting and furnish-
ing information—(A) Requesting infor-
mation. A Passthrough Entity described in
paragraph (b)(2)(i) of this section must re-
quest information under paragraph (b)(2)
(i) of this section by the later of the 30th
day after the close of the taxable year to
which the information request relates or
14 days after the date of a request for in-
formation from an upper-tier Passthrough
Entity.
(B) Furnishing information—(1) In
general. Except as provided in paragraph
(b)(2)(iii)(B)(2) of this section, requested
information must be furnished by the date
on which the entity is required to furnish
information under section 6031(b) or un-
der section 6037(b), as applicable.
(2) Late requests. Information with
respect to a taxable year that is requested
by an upper-tier Passthrough Entity after
the date that is 14 days prior to the due
date for a lower-tier Passthrough Entity to
furnish and file information under section
6031(b) or section 6037(b), as applicable,
must be furnished and filed in the time and
manner prescribed by forms, instructions
and other guidance.
(iv) Manner of requesting information.
Information may be requested electroni-
cally or in any manner that is agreed to by
the parties.
(v) Recordkeeping requirement. Any
Passthrough Entity receiving a request
for information must retain a copy of the
request and the date received in its books
and records.
(vi) Passthrough Entity is not fur-
nished information to meet its reporting
obligations under paragraph (b)(1) of
this section. If an upper-tier Passthrough
Entity holds an interest in a lower-tier
Passthrough Entity and it is not furnished
the information described in paragraph
(b)(1) of this section, or, alternatively, if
it has not been furnished information af-
ter having properly requested the infor-
mation under this paragraph (b)(2), the
upper-tier Passthrough Entity must take
actions to otherwise determine and sub-
stantiate the missing information. To the
extent that the upper-tier Passthrough En-
tity is not able to otherwise substantiate
and determine the missing information to
the satisfaction of the Commissioner, the
upper-tier Passthrough Entity must treat
these amounts as provided under para-
graph (a)(2) of this section. The upper-tier
Passthrough Entity must provide notice to
the API Holder and the IRS regarding the
application of this paragraph (b)(2) to the
information being reported as required in
forms, instructions, and other guidance.
(vii) Filing requirements. Both the
Passthrough Entity requesting the infor-
mation and the Passthrough Entity fur-
nishing the information must file all infor-
mation with the IRS as the Commissioner
may require in forms, instructions, or oth-
er guidance.
(viii) Penalties. In addition to the re-
quirement in section 1061(e) that the
Secretary shall require reporting (at the
time and in the manner prescribed by the
Secretary) as is necessary to carry out the
purposes of this section, the information
required to be furnished under this para-
graph (b) is also required to be furnished
under sections 6031(b) and 6037(b). Fail-
ure to report as required under this para-
graph (b) will be subject to penalties under
section 6722.
(c) Regulated investment company
(RIC) and real estate investment trust
(REIT) reporting—(1) Section 1061 dis-
closures. A RIC or REIT that reports or
designates a dividend, or part thereof, as a
capital gain dividend, may, in addition to
the information otherwise required to be
furnished to a shareholder, disclose two
amounts for purposes of section 1061—
(i) One Year Amounts Disclosure. The
One Year Amounts Disclosure of a RIC or
REIT is a disclosure by the RIC or REIT
of an amount that is attributable to a com-
putation of the RIC’s or REIT’s net capi-
tal gain excluding capital gain and capital
loss not taken into account for purposes of
section 1061 under §1.1061-4(b)(7). The
aggregate amounts provided in the One
Year Amounts Disclosures with respect
to a taxable year of a RIC or REIT must
equal the lesser of the RIC’s or REIT’s
net capital gain, excluding any capital
gains and capital losses not taken into ac-
count for purposes of section 1061 under
§1.1061-4(b)(7), for the taxable year or
the RIC’s or REIT’s aggregate capital gain
dividends for the taxable year.
(ii) Three Year Amounts Disclosure.
The Three Year Amounts Disclosure of a
RIC or REIT is a disclosure by the RIC
or REIT of an amount that is attributable
to a computation of the RIC’s or REIT’s
One Year Amounts Disclosure substitut-
ing “three years” for “one year” in apply-
ing section 1222. The aggregate amounts
provided in the Three Year Amounts Dis-

Bulletin No. 2021–5 673 February 1, 2021
closures with respect to a taxable year of a
RIC or REIT must equal the lesser of the
aggregate amounts provided in the RIC’s
or REIT’s One Year Amounts Disclosures
substituting “three years” for “one year”
in applying section 1222 for the taxable
year or the RIC’s or REIT’s aggregate
capital gain dividends for the taxable year.
(2) Pro rata disclosures. The One
Year Amounts Disclosure and Three
Year Amounts Disclosure made to each
shareholder of a RIC or REIT must be
proportionate to the share of capital gain
dividends reported or designated to that
shareholder for the taxable year.
(3) Report to shareholders. A RIC or
REIT that provides the section 1061 dis-
closures described in paragraphs (c)(1)(i)
and (ii) of this section must provide those
section 1061 disclosures in writing to its
shareholders with the statement described
in section 852(b)(3)(C)(i) or the notice de-
scribed in section 857(b)(3)(B) in which
the capital gain dividend is reported or
designated.
(d) Qualified electing fund (QEF) re-
porting. A passive foreign investment
company with respect to which the share-
holder has a QEF election (as described in
section 1295(a)) in effect for the taxable
year that determines net capital gain as
provided in §1.1293-1(a)(2)(i)(A), as lim-
ited by section 1293(e)(2), may provide
some or all of the information listed in
paragraph (b)(1) of this section (and any
other relevant information) to its share-
holders to enable API Holders to deter-
mine the amount of their inclusion under
section 1293(a)(1) that would be included
in the API One Year Distributive Share
Amounts and API Three Year Distributive
Share Amounts. To the extent that such in-
formation is not provided, paragraph (a)
(2) of this section will apply except that
Owner Taxpayers are not permitted to
separately substantiate the information.
An API Holder who receives the addition-
al information described in this paragraph
(d) must retain such information as re-
quired by §1.1295-1(f)(2)(ii).
(e) Applicability date. The provisions
of this section apply to taxable years of
Owner Taxpayers and Passthrough En-
tities beginning on or after January 19,
2021. An Owner Taxpayer or Passthrough
Entity may choose to apply this section to
a taxable year beginning after December
31, 2017, provided that they apply the
Section 1061 Regulations in their entirety
to that year and all subsequent years.
Par. 5. Section 1.1223-3 is amended
by:
1. Redesignating paragraph (b)(5) as
paragraph (b)(6);
2. Adding a new paragraph (b)(5);
3. Designating Examples 1 through
8 of paragraph (f) as paragraphs (f)(1)
through (8);
4. Adding paragraphs (f)(9) and (10);
and
5. Revising the heading and adding a
sentence at the end of paragraph (g).
The additions and revision read as fol-
lows:
§1.1223-3 Rules relating to the holding
periods of partnership interests.
* * * * *
(b) * * *
(5) Divided holding period if partner-
ship interest comprises in whole or in part
one or more profits interests—(i) In gen-
eral. If a partnership interest is comprised
in whole or in part of one or more profits
interests (as defined in paragraph (b)(5)(ii)
of this section), then, for purposes of ap-
plying paragraph (b)(1) of this section, the
portion of the holding period to which a
profits interest relates is determined based
on the fair market value of the profits in-
terest upon the disposition of all, or part,
of the interest (and not at the time that the
profits interest is acquired). Paragraph (b)
(1) of this section continues to apply to the
extent that a partner acquires portions of a
partnership interest that are not comprised
of a profits interest and the value of the
profits interest is not included for purpos-
es of determining the value of the entire
partnership interest under paragraph (b)
(1).
(ii) Definition of capital interest and
profits interest. For purposes of this para-
graph (b)(5), a profits interest is a partner-
ship interest other than a capital interest.
A capital interest is an interest that would
give the holder a share of the proceeds if
the partnership’s assets were sold at fair
market value at the time the interest was
received and then the proceeds were dis-
tributed in a complete liquidation of the
partnership. A profits interest, for purpos-
es of this paragraph (b)(5), is received in
connection with the performance of ser-
vices to or for the benefit of a partnership
in a partner capacity or in anticipation of
being a partner, and the receipt of the in-
terest is not treated as a taxable event for
the partner or the partnership under appli-
cable Federal income tax guidance.
* * * * *
(f) * * *
(9) Example 9. On June 1, 2020, GP contributes
$10,000 to PRS for a partnership interest in PRS.
On June 30, 2023, GP receives a 20% interest in the
profits of PRS that is an Applicable Partnership In-
terest (API) as defined in §1.1061-1(a). On June 30,
2025, GP sells its interest in PRS for $30,000. At the
time of GP’s sale of its interest, the API has a fair
market value of $15,000. GP has a divided holding
period in its interest in PRS; 50% of the partnership
interest has a holding period beginning on June 1,
2020, and 50% has a holding period that begins on
June 30, 2023.
(10) Example 10. Assume the same facts as in
paragraph (f)(9) of this section (Example 9), except
that on June 30, 2024, GP contributes an additional
$5,000 cash to GP prior to GP’s sale of its interest
in 2025. Immediately after the contribution of the
$5,000 on June 30, 2024, GP’s interest in PRS has
a value of $15,000, not taking into account the val-
ue of GP’s profits interest in PRS. GP calculates its
holding period in the portions not comprised by the
profits interest and two-thirds of its holding period
runs from June 30, 2020, and one-third runs from
June 30, 2024. On June 30, 2025, GP sells its inter-
est for $30,000 and the API has a fair market value
of $15,000. Accordingly, on the date of disposition,
one-third of GP’s interest has a five year holding pe-
riod from its interest received in 2020 for its $10,000
contribution, one-half of GP’s interest has a two year
holding period from the profits interest issued on
June 30, 2023, and one-sixth of GP’s interest has a
one year holding period from the contribution of the
$5,000.
(g) Applicability dates. * * * Para-
graphs (b)(5) and (f)(9) and (10) of this
section apply to taxable years beginning
on or after January 19, 2021.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: January 5, 2021.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on Jan-
uary 13, 2021, 4:15 p.m., and published in the issue
of the Federal Register for January 19, 2020, 85 F.R.
5452)

February 1, 2021 674 Bulletin No. 2021–5
Section 401. —Qualified
Pension, Profit-Sharing,
and Stock Bonus Plans
26 CFR 1.401(l)-1: Permitted disparity in employ-
er-provided contributions or benefits.
Rev. Rul. 2021-3
This revenue ruling provides tables of
covered compensation under § 401(l)(5)
(E) of the Internal Revenue Code and the
Income Tax Regulations thereunder, for
the 2021 plan year.
Section 401(l)(5)(E)(i) defines covered
compensation with respect to an employ-
ee as the average of the contribution and
benefit bases in effect under section 230
of the Social Security Act (“Act”) for each
year in the 35-year period ending with the
year in which the employee attains Social
Security retirement age.
Section 401(l)(5)(E)(ii) states that the
determination for any year preceding the
year in which the employee attains Social
Security retirement age shall be made by
assuming that there is no increase in cov-
ered compensation after the determination
year and before the employee attains So-
cial Security retirement age.
Section 1.401(l)-1(c)(34) of the In-
come Tax Regulations defines the taxable
wage base as the contribution and benefit
base under section 230 of the Act.
Section 1.401(l)-1(c)(7)(i) defines cov-
ered compensation for an employee as the
average (without indexing) of the taxable
wage bases in effect for each calendar year
during the 35-year period ending with the
last day of the calendar year in which the
employee attains (or will attain) Social
Security retirement age. A 35-year peri-
od is used for all individuals regardless
of the year of birth of the individual. In
determining an employee’s covered com-
pensation for a plan year, the taxable wage
base for all calendar years beginning after
the first day of the plan year is assumed to
be the same as the taxable wage base in
effect as of the beginning of the plan year.
An employee’s covered compensation for
a plan year beginning after the 35-year pe-
riod applicable under § 1.401(l)-1(c)(7)(i)
is the employee’s covered compensation
for a plan year during which the 35-year
period ends. An employee’s covered com-
pensation for a plan year beginning be-
fore the 35-year period applicable under
§ 1.401(l)-1(c)(7)(i) is the taxable wage
base in effect as of the beginning of the
plan year.
Section 1.401(l)-1(c)(7)(ii) provides
that, for purposes of determining the
amount of an employee’s covered com-
pensation under § 1.401(l)-1(c)(7)(i), a
plan may use tables, provided by the Com-
missioner, that are developed by rounding
the actual amounts of covered compensa-
tion for different years of birth.
For purposes of determining covered
compensation for the 2021 year, the tax-
able wage base is $142,800.
The following tables provide covered
compensation for 2021.
ATTACHMENT I
2021 COVERED COMPENSATION TABLE
CALENDAR YEAR OF BIRTH
CALENDAR YEAR OF SOCIAL
SECURITY RETIREMENT AGE
2021 COVERED COMPENSATION
TABLE II
19071972$ 4,488
19081973 4,704
19091974 5,004
19101975 5,316
19111976 5,664
19121977 6,060
19131978 6,480
19141979 7,044
19151980 7,692
19161981 8,460
19171982 9,300
19181983 10,236
19191984 11,232
19201985 12,276
19211986 13,368
19221987 14,520
19231988 15,708
19241989 16,968
19251990 18,312

Bulletin No. 2021–5 675 February 1, 2021
ATTACHMENT I
2021 COVERED COMPENSATION TABLE
CALENDAR YEAR OF BIRTH
CALENDAR YEAR OF SOCIAL
SECURITY RETIREMENT AGE
2021 COVERED COMPENSATION
TABLE II
19261991 19,728
19271992 21,192
19281993 22,716
19291994 24,312
19301995 25,920
19311996 27,576
19321997 29,304
19331998 31,128
19341999 33,060
19352000 35,100
19362001 37,212
19372002 39,444
19382004 43,992
19392005 46,344
19402006 48,816
19412007 51,348
19422008 53,952
19432009 56,628
19442010 59,268
19452011 61,884
19462012 64,560
19472013 67,308
19482014 69,996
19492015 72,636
19502016 75,180
19512017 77,880
19522018 80,532
19532019 83,244
19542020 86,052
19552022 91,764
19562023 94,560
19572024 97,260
19582025 99,876
19592026 102,432
19602027 104,928
19612028 107,364
19622029 109,704
19632030 112,044
19642031 114,324
19652032 116,544
19662033 118,668

February 1, 2021 676 Bulletin No. 2021–5
ATTACHMENT I
2021 COVERED COMPENSATION TABLE
CALENDAR YEAR OF BIRTH
CALENDAR YEAR OF SOCIAL
SECURITY RETIREMENT AGE
2021 COVERED COMPENSATION
TABLE II
19672034 120,672
19682035 122,580
19692036 124,356
19702037 126,012
19712038 127,608
19722039 129,180
19732040 130,680
19742041 132,072
19752042 133,368
19762043 134,532
19772044 135,564
19782045 136,584
1979 2046 137,616
19802047 138,552
19812048 139,380
19822049 140,124
19832050 140,820
19842051 141,504
19852052 141,960
19862053 142,368
19872054 142,644
1988 and Later2055 and Later 142,800

Bulletin No. 2021–5 677 February 1, 2021
ATTACHMENT II
2021 ROUNDED COVERED COMPENSATION TABLE
CALENDAR YEAR OF BIRTH2021 COVERED COMPENSATION ROUNDED
1937 $ 39,000
1938 – 1939 45,000
1940 48,000
1941 51,000
1942 54,000
1943 57,000
1944 60,000
1945 63,000
1946 – 1947 66,000
1948 69,000
1949 72,000
1950 75,000
1951 78,000
1952 81,000
1953 84,000
1954 87,000
1955 93,000
1956 – 1957 96,000
1958 99,000
1959 102,000
1960 105,000
1961 108,000
1962 – 1963 111,000
1964 114,000
1965 117,000
1966 – 1967 120,000
1968 – 1969 123,000
1970 126,000
1971 – 1972 129,000
1973 – 1975 132,000
1976 – 1977 135,000
1978 – 1981 138,000
1982 – 1984 141,000
1985 and Later 142,800
DRAFTING INFORMATION
The principal author of this notice is
Tom Morgan of the Office of the Asso-
ciate Chief Counsel (Employee Benefits,
Exempt Organizations, and Employment
Taxes). However, other personnel from
the IRS participated in the development
of this guidance. For further information
regarding this notice, contact Mr. Morgan
at 202-317-6700 or Christopher Denning
at 202-317-8698 (not toll-free numbers).

February 1, 2021 678 Bulletin No. 2021–5
Part III
Update for Weighted
Average Interest Rates,
Yield Curves, and Segment
Rates
Notice 2021-9
This notice provides guidance on the
corporate bond monthly yield curve, the
corresponding spot segment rates used
under § 417(e)(3), and the 24-month aver-
age segment rates under § 430(h)(2) of the
Internal Revenue Code. In addition, this
notice provides guidance as to the interest
rate on 30-year Treasury securities under
§ 417(e)(3)(A)(ii)(II) as in effect for plan
years beginning before 2008 and the 30-
year Treasury weighted average rate under
§ 431(c)(6)(E)(ii)(I).
YIELD CURVE AND SEGMENT
RATES
Section 430 specifies the minimum
funding requirements that apply to sin-
gle-employer plans (except for CSEC
plans under § 414(y)) pursuant to § 412.
Section 430(h)(2) specifies the inter-
est rates that must be used to determine
a plan’s target normal cost and funding
target. Under this provision, present val-
ue is generally determined using three
24-month average interest rates (“segment
rates”), each of which applies to cash
flows during specified periods. To the ex-
tent provided under § 430(h)(2)(C)(iv),
these segment rates are adjusted by the ap-
plicable percentage of the 25-year average
segment rates for the period ending Sep-
tember 30 of the year preceding the cal-
endar year in which the plan year begins.
1

However, an election may be made under
§ 430(h)(2)(D)(ii) to use the monthly yield
curve in place of the segment rates.
Notice 2007-81, 2007-44 I.R.B. 899,
provides guidelines for determining the
monthly corporate bond yield curve, and
the 24-month average corporate bond seg-
ment rates used to compute the target nor-
mal cost and the funding target. Consistent
with the methodology specified in Notice
2007-81, the monthly corporate bond yield
curve derived from December 2020 data is
in Table 2020-12 at the end of this notice.
The spot first, second, and third segment
rates for the month of December 2020 are,
respectively, 0.51, 2.26, and 3.01.
The 24-month average segment rates
determined under § 430(h)(2)(C)(i)
through (iii) must be adjusted pursuant to
§ 430(h)(2)(C)(iv) to be within the appli-
cable minimum and maximum percentag-
es of the corresponding 25-year average
segment rates. For plan years beginning
before 2021, the applicable minimum per-
centage is 90% and the applicable maxi-
mum percentage is 110%. For plan years
beginning in 2021, the applicable mini-
mum percentage is 85% and the applica-
ble maximum percentage is 115%. The
25-year average segment rates for plan
years beginning in 2019, 2020, and 2021
were published in Notice 2018-73, 2018-
40 I.R.B. 526, Notice 2019-51, 2019-41
I.R.B. 866, and Notice 2020-72, 2020-40
I.R.B. 789, respectively.
24-MONTH AVERAGE CORPORATE
BOND SEGMENT RATES
The three 24-month average corporate
bond segment rates applicable for January
2021 without adjustment for the 25-year
average segment rate limits are as follows:
24-Month Average Segment Rates Without 25-Year Average Adjustment
Applicable Month First Segment Second Segment Third Segment
January 2021 1.75 3.04 3.65
Based on § 430(h)(2)(C)(iv), the
24-month averages applicable for January
2021, adjusted to be within the applicable
minimum and maximum percentages of
the corresponding 25-year average seg-
ment rates, are as follows:
Adjusted 24-Month Average Segment Rates
For Plan Years
Beginning In
Applicable
Month
First
Segment
Second
Segment
Third
Segment
2019January 20213.745.356.11
2020January 20213.645.215.94
2021January 20213.324.795.47
30-YEAR TREASURY SECURITIES
INTEREST RATES
Section 431 specifies the minimum
funding requirements that apply to multi-
employer plans pursuant to § 412. Section
431(c)(6)(B) specifies a minimum amount
for the full-funding limitation described in
§ 431(c)(6)(A), based on the plan’s current
liability. Section 431(c)(6)(E)(ii)(I) pro-
vides that the interest rate used to calculate
current liability for this purpose must be
1
Pursuant to § 433(h)(3)(A), the 3
rd
segment rate determined under § 430(h)(2)(C) is used to determine the current liability of a CSEC plan (which is used to calculate the minimum amount
of the full funding limitation under § 433(c)(7)(C)).

Bulletin No. 2021–5 679 February 1, 2021
no more than 5 percent above and no more
than 10 percent below the weighted aver-
age of the rates of interest on 30-year Trea-
sury securities during the four-year period
ending on the last day before the beginning
of the plan year. Notice 88-73, 1988-2 C.B.
383, provides guidelines for determining
the weighted average interest rate. The rate
of interest on 30-year Treasury securities
for December 2020 is 1.67 percent. The
Service determined this rate as the average
of the daily determinations of yield on the
30-year Treasury bond maturing in No-
vember 2050. For plan years beginning in
January 2021, the weighted average of the
rates of interest on 30-year Treasury securi-
ties and the permissible range of rates used
to calculate current liability are as follows:
Treasury Weighted Average Rates
For Plan Years
Beginning In
30-Year Treasury
Weighted Average
Permissible Range
90% to 105%
January 20212.312.08 to 2.43
MINIMUM PRESENT VALUE
SEGMENT RATES
In general, the applicable interest rates
under § 417(e)(3)(D) are segment rates
computed without regard to a 24-month
average. Notice 2007-81 provides guide-
lines for determining the minimum pres-
ent value segment rates. Pursuant to that
notice, the minimum present value seg-
ment rates determined for December 2020
are as follows:
Minimum Present Value Segment Rates
Month First Segment Second Segment Third Segment
December 2020 0.51 2.26 3.01
DRAFTING INFORMATION
The principal author of this notice is
Tom Morgan of the Office of the Asso-
ciate Chief Counsel (Employee Benefits,
Exempt Organizations, and Employment
Taxes). However, other personnel from
the IRS participated in the development
of this guidance. For further information
regarding this notice, contact Mr. Morgan
at 202-317-6700 or Paul Stern at 202-317-
8702 (not toll-free numbers).

February 1, 2021 680 Bulletin No. 2021–5
Table 2020-12
Monthly Yield Curve for December 2020
Derived from December 2020 Data
MaturityYieldMaturityYieldMaturityYieldMaturityYieldMaturityYield
0.50.1620.52.8540.53.0360.53.0980.53.13
1.00.2621.02.8641.03.0361.03.0981.03.13
1.50.3521.52.8741.53.0361.53.0981.53.13
2.00.4222.02.8742.03.0362.03.1082.03.13
2.50.4822.52.8842.53.0362.53.1082.53.13
3.00.5323.02.8843.03.0463.03.1083.03.13
3.50.5923.52.8943.53.0463.53.1083.53.13
4.00.6624.02.8944.03.0464.03.1084.03.13
4.50.7524.52.9044.53.0464.53.1084.53.13
5.00.8525.02.9045.03.0565.03.1085.03.13
5.50.9625.52.9145.53.0565.53.1085.53.13
6.01.0826.02.9146.03.0566.03.1086.03.13
6.51.2126.52.9246.53.0566.53.1086.53.13
7.01.3427.02.9247.03.0567.03.1187.03.13
7.51.4727.52.9347.53.0667.53.1187.53.13
8.01.6028.02.9348.03.0668.03.1188.03.14
8.51.7328.52.9448.53.0668.53.1188.53.14
9.01.8529.02.9449.03.0669.03.1189.03.14
9.51.9629.52.9549.53.0669.53.1189.53.14
10.02.0630.02.9550.03.0670.03.1190.03.14
10.52.1630.52.9650.53.0770.53.1190.53.14
11.02.2531.02.9651.03.0771.03.1191.03.14
11.52.3331.52.9751.53.0771.53.1191.53.14
12.02.4032.02.9752.03.0772.03.1192.03.14
12.52.4632.52.9852.53.0772.53.1292.53.14
13.02.5233.02.9853.03.0773.03.1293.03.14
13.52.5733.52.9853.53.0773.53.1293.53.14
14.02.6134.02.9954.03.0874.03.1294.03.14
14.52.6534.52.9954.53.0874.53.1294.53.14
15.02.6835.02.9955.03.0875.03.1295.03.14
15.52.7135.53.0055.53.0875.53.1295.53.14
16.02.7336.03.0056.03.0876.03.1296.03.14
16.52.7536.53.0056.53.0876.53.1296.53.14
17.02.7737.03.0157.03.0877.03.1297.03.14
17.52.7937.53.0157.53.0977.53.1297.53.14
18.02.8038.03.0158.03.0978.03.1298.03.14
18.52.8138.53.0158.53.0978.53.1298.53.15
19.02.8339.03.0259.03.0979.03.1299.03.15
19.52.8339.53.0259.53.0979.53.1399.53.15
20.02.8440.03.0260.03.0980.03.13100.03.15

Bulletin No. 2021–5 681 February 1, 2021
26 CFR 601.105: Examination of returns and
claims for refund, credit or abatement; determina-
tion of correct tax liability.
(Also: Part I, §§ 860D, 860F, 860G, 1001; 1.856-6,
1.860G–2, 1.1001–3, 301.7701–2, 301.7701-3,
301.7701-4.)
Rev. Proc. 2021-12
SECTION 1. PURPOSE
In light of the continuing Coronavirus
Disease 2019 (COVID-19) pandemic, this
revenue procedure extends the expiration
dates relevant to the application of the
safe harbors in Rev. Proc. 2020-26, 2020-
18 I.R.B. 753. These safe harbors protect
the Federal income tax status of real estate
mortgage investment conduits (REMICs)
and investment trusts that provide certain
forbearances of mortgage loans they hold
or that acquire mortgage loans that have
received certain forbearances. Additional-
ly, this revenue procedure extends the ex-
piration dates relevant to the application
of the safe harbors in Rev. Proc. 2020-34,
2020-26 I.R.B. 990. These safe harbors
protect the Federal income tax status of
certain investment trusts whose trustees
request or agree to certain forbearances
of mortgage loans, make certain modifi-
cations of real property leases, or accept
certain cash contributions.
SECTION 2. BACKGROUND —
COVID-19 and the CARES ACT
On March 27, 2020, the President
signed into law the Coronavirus, Aid,
Relief, and Economic Security Act, Pub.
L. No. 116-136, 134 Stat. 281 (CARES
Act). The CARES Act provides, among
other things, that borrowers with Feder-
ally backed mortgage loans and multi-
family borrowers with Federally backed
multifamily mortgage loans experiencing
a financial hardship due, directly or indi-
rectly, to the COVID-19 emergency may
request and obtain forbearance on their
loans. See sections 4022 and 4023 of the
CARES Act.
SECTION 3. BACKGROUND —
REVENUE PROCEDURE 2020-26
.01 On April 13, 2020, the Department
of the Treasury (Treasury Department)
and the Internal Revenue Service (IRS)
issued Rev. Proc. 2020-26. Rev. Proc.
2020-26 provided safe harbors for deter-
mining the Federal income tax status of
REMICs and investment trusts that hold
mortgage loans. Under the safe harbors,
certain modifications of mortgage loans
in connection with forbearances described
in Rev. Proc. 2020-26 are not treated as
replacing the unmodified obligation with
a newly issued obligation, as giving rise
to prohibited transactions, as resulting in
a deemed reissuance of the REMIC regu-
lar interests, or as manifesting a power to
vary. In addition, under another safe har-
bor in the revenue procedure, REMICs are
not treated as having improper knowledge
of an anticipated default on the grounds
that they acquired a mortgage loan with
respect to which the borrower had request-
ed or agreed to a forbearance described in
Rev. Proc. 2020-26.
.02 The forbearances described in Rev.
Proc. 2020-26 are—
(1) Forbearances of any Federally
backed mortgage loans or Federally
backed multifamily mortgage loans
provided under sections 4022 or 4023
of the CARES Act, respectively, and
all related modifications [(CARES
Act Forbearances)], and
(2) Forbearances (and all related
modifications) that are not [CARES
Act Forbearances], that are provid-
ed by a holder or servicer, that are
agreed to by the borrower of any
Federally backed or non-Federally
backed mortgage loan, and that are
made under forbearance programs for
borrowers experiencing a financial
hardship due, directly or indirectly,
to the COVID-19 emergency. For
this purpose, forbearance programs
are programs that are identical or
similar to those described in section
2.07 of [Rev. Proc. 2020-26] pursuant
to which, between March 27, 2020,
and December 31, 2020, inclusive,
the borrower requests or agrees to the
forbearance (and all related modifica-
tions).
2020–18 I.R.B. 755.
.03 In light of the continuing COVID-19
pandemic, the Treasury Department and
the IRS have decided to extend the expira-
tion dates relevant to the application of the
safe harbors in Rev. Proc. 2020-26.
SECTION 4. BACKGROUND —
REVENUE PROCEDURE 2020-34
.01 On June 4, 2020, the Treasury De-
partment and the IRS issued Rev. Proc.
2020-34. Rev. Proc. 2020-34 provided
safe harbors for determining the Federal
income tax status of certain investment
trusts that hold real property. Under the
safe harbors, certain modifications of
mortgage loans in connection with for-
bearance programs described in Rev. Proc.
2020-26 are not treated as manifesting a
power to vary. Additionally, certain modi-
fications of real property leases and the ac-
ceptance of additional cash contributions
related to the COVID-19 emergency are
not treated as manifesting a power to vary.
.02 The SCOPE section of Rev. Proc.
2020-34 provides—
.01 [Rev. Proc. 2020–34] applies
to arrangements that are trusts under
§ 301.7701-4(c) and Rev. Rul. 2004-
86 and that hold real property and en-
gage in one or more of the actions de-
scribed in sections 6.02, 6.03, or 6.04
of [Rev. Proc. 2020–34]. Although
Rev. Rul. 2004–86 describes a trust
that had been formed under a specific
Delaware statute, [Rev. Proc. 2020–
34] applies to trusts formed under the
equivalent law (if any) of other States
or the District of Columbia.
.02 Modification of one or more
mortgage loans that secure the trust’s
real property in—
(1) A CARES Act Forbearance
(and all related modifications); or
(2) A forbearance (and all related
modifications)—
(a) That are described in section
2.07 of Rev. Proc. 2020-26;
(b) That the trust requested, or
agreed to, between March 27, 2020,
and December 31, 2020; and
(c) That were granted as a result
of the trust experiencing a financial
hardship due to the COVID-19 emer-
gency.
.03 Modifications of one or more
real property leases (including modi-
fications to the specific allocations of
fixed rent in the lease agreements as
described in § 467 of the Code and
the regulations under § 467; see sec-
tion 9.01 of [Rev. Proc. 2020–34]).
The lease must have been entered

February 1, 2021 682 Bulletin No. 2021–5
into by the trust on or before March
13, 2020, and the modifications must
have been requested and agreed to on
or after March 27, 2020, and on or be-
fore December 31, 2020. The reason
for the modifications must be—
(1) To coordinate the lease cash
flows with the cash flows that result
from [the forbearances described in
section 6.02 of Rev. Proc. 2020–34];
or
(2) To defer or waive one or more
tenants’ rental payments for any pe-
riod between March 27, 2020, and
December 31, 2020 (and all related
modifications), because the tenants
are experiencing a financial hardship
due to the COVID-19 emergency.
.04 Acceptance of cash contribu-
tions that are made between March
27, 2020, and December 31, 2020,
as a result of the trust experienc-
ing financial hardship due to the
COVID-19 emergency, provided the
contribution must be needed to in-
crease permitted trust reserves, to
maintain trust property, to fulfill ob-
ligations under mortgage loans, or to
fulfill obligations under real property
leases. See section 10 of [Rev. Proc.
2020–34] regarding the tax treatment
of non-pro rata contributions or con-
tributions from new investors for an
interest in the trust.
2020–26 I.R.B. 992.
.03 In light of the continuing COVID-19
pandemic, the Treasury Department and
the IRS have decided to extend the expira-
tion dates relevant to the application of the
safe harbors in Rev. Proc. 2020-34.
SECTION 5. EXTENSION OF TIME
PERIODS
.01 The time periods described in sec-
tions 5.01(2), 5.02(2), and 6.02(2) of Rev.
Proc. 2020-26 are extended until Septem-
ber 30, 2021. Accordingly, in sections
5.01(2), 5.02(2), and 6.02(2) of Rev. Proc.
2020-26, “September 30, 2021” is sub-
stituted for “December 31, 2020” in each
place it appears.
.02 The time periods described in sec-
tions 6.02(2)(b), 6.03, 6.03(2), and 6.04
of Rev. Proc. 2020-34 are extended until
September 30, 2021. Accordingly, in sec-
tions 6.02(2)(b), 6.03, 6.03(2) and 6.04
of Rev. Proc. 2020-34, “September 30,
2021” is substituted for “December 31,
2020” each place it appears.
SECTION 6. EFFECT ON OTHER
DOCUMENTS
This revenue procedure amplifies Rev.
Proc. 2020-26 and Rev. Proc. 2020-34.
SECTION 7. DRAFTING
INFORMATION
The principal authors of this revenue
procedure are Diana Imholtz and Michael
Chin of the Office of Associate Chief
Counsel (Financial Institutions & Prod-
ucts), with respect to the amplification of
Rev. Proc. 2020–26, and Christiaan Cleary
of the Office of Associate Chief Counsel
(Passthroughs and Special Industries),
with respect to the amplification of Rev.
Proc. 2020–34. For further information
regarding this revenue procedure, contact
Mr. Chin at (202) 317-6842 (not a toll-free
number) or Mr. Cleary at (202) 317-6850
(not a toll-free number).

Bulletin No. 2021–5 683 February 1, 2021
Part IV
Notice of Proposed
Rulemaking
Guidance on Passive
Foreign Investment
Companies and the
Treatment of Qualified
Improvement Property
under the Alternative
Depreciation System for
Purposes of Sections
250(b) and 951A(d)
REG-111950-20
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Withdrawal of notice of pro-
posed rulemaking; notice of proposed
rulemaking.
SUMMARY: This document contains
proposed regulations regarding the deter-
mination of whether a foreign corporation
is treated as a passive foreign investment
company (“PFIC”) for purposes of the
Internal Revenue Code (“Code”). The
proposed regulations also provide guid-
ance regarding the treatment of income
and assets of a qualifying insurance cor-
poration (“QIC”) that is engaged in the
active conduct of an insurance business
(“PFIC insurance exception”). This doc-
ument also contains proposed regulations
addressing the treatment of qualified im-
provement property (“QIP”) under the al-
ternative depreciation system (“ADS”) for
purposes of calculating qualified business
asset investment (“QBAI”) for purposes
of the global intangible low-taxed income
(“GILTI”) and the foreign-derived intan-
gible income (“FDII”) provisions, which
were added to the Code in the Tax Cuts
and Jobs Act. The proposed regulations
affect United States persons with direct
or indirect ownership interests in certain
foreign corporations, United States share-
holders of controlled foreign corporations,
and domestic corporations eligible for the
deduction for FDII.
DATES: Written or electronic comments
and requests for a public hearing must be
received by April 14, 2021. Requests for a
public hearing must be submitted as pre-
scribed in the “Comments and Requests
for a Public Hearing” section.
ADDRESSES: Commenters are strongly
encouraged to submit public comments
electronically. Submit electronic sub-
missions via the Federal eRulemaking
Portal at www.regulations.gov (indicate
IRS and REG-111950-20) by follow-
ing the online instructions for submit-
ting comments. Once submitted to the
Federal eRulemaking Portal, comments
cannot be edited or withdrawn. The IRS
expects to have limited personnel avail-
able to process public comments that are
submitted on paper through mail. Until
further notice, any comments submitted
on paper will be considered to the extent
practicable. The Department of the Trea-
sury (Treasury Department) and the IRS
will publish for public availability any
comment submitted electronically, and
to the extent practicable on paper, to its
public docket.
Send paper submissions to: CC:PA:LP-
D:PR (REG-111950-20), room 5203, In-
ternal Revenue Service, PO Box 7604,
Ben Franklin Station, Washington, D.C.
20044.
FOR FURTHER INFORMATION
CONTACT: Concerning proposed regu-
lations §§1.250(b)-1(b)(2) and 1.250(b)-
2(e)(2), Lorraine Rodriguez, (202) 317-
6726; concerning proposed regulations
§1.951A-3(e)(2), Jorge M. Oben and
Larry R. Pounders, (202) 317-6934; con-
cerning proposed regulations §§1.1297-0
through 1.1297-2, 1.1298-0 and 1.1298-4,
Christina G. Daniels at (202) 317-6934;
concerning proposed regulations §§
1.1297-4 through 1.1297-6 (the PFIC in-
surance exception), Josephine Firehock at
(202) 317-4932; concerning submissions
of comments and requests for a public
hearing, Regina L. Johnson at (202) 317-
6901 (not toll-free numbers) or by sending
an email to publichearings@irs.gov (pre-
ferred).
SUPPLEMENTARY INFORMATION:
Background
I. Passive Foreign Investment Companies
A. In general
This document contains proposed
amendments to 26 CFR part 1 under
sections 1297 and 1298. Under section
1297(a), a foreign corporation (“tested
foreign corporation”) qualifies as a PFIC
if it satisfies either of the following tests:
(i) 75 percent or more of the tested foreign
corporation’s gross income for a taxable
year is passive (“Income Test”); or (ii) the
average percentage of assets held by the
tested foreign corporation during a taxable
year that produce (or that are held for the
production of) passive income is at least
50 percent (“Asset Test”). Section 1297(b)
(1) generally defines passive income as
any income of a kind that would constitute
foreign personal holding company income
(“FPHCI”) under section 954(c), and sec-
tion 1297(b)(2) provides exceptions to
this general definition. In addition, section
1297(c) provides a look-through rule that
applies when determining the PFIC status
of a tested foreign corporation that direct-
ly or indirectly owns at least 25 percent
of the stock (determined by value) of an-
other corporation. Section 1298(b)(7) pro-
vides that certain stock (“qualified stock”)
in a domestic C corporation owned by
a tested foreign corporation through a
25-percent-owned domestic corporation is
treated as an asset generating non-passive
income for purposes of section 1297(a),
provided that the tested foreign corpora-
tion is subject to the accumulated earn-
ings tax or waives any treaty protections
against the imposition of the accumulated
earnings tax.
B. PFIC insurance exception
Before its amendment by section 14501
of the Tax Cuts and Jobs Act, Pub. L. 115-
97, 131 Stat. 2234 (2017) (the “Act”), for-
mer section 1297(b)(2)(B) provided that
passive income generally did not include
investment income derived in the active
conduct of an insurance business by a cor-

February 1, 2021 684 Bulletin No. 2021–5
poration that is predominantly engaged
in an insurance business and that would
be subject to tax under subchapter L if it
were a domestic corporation. Congress
was concerned about a lack of clarity and
precision in the PFIC insurance exception,
and in particular about the lack of preci-
sion regarding how much insurance or re-
insurance business a company must do to
qualify under the exception, which made
the exception difficult to enforce. H.R.
Report 115-409 at 409-10. To address
these concerns, the Act modified the PFIC
insurance exception to provide that pas-
sive income does not include investment
income derived in the active conduct of an
insurance business by a QIC.
Thus, for taxable years beginning after
December 31, 2017, the PFIC insurance
exception provides that a foreign corpora-
tion’s income attributable to an insurance
business will not be passive income if
three requirements are met. First, the for-
eign corporation must be a QIC as defined
in section 1297(f). Second, the foreign
corporation must be engaged in an “insur-
ance business.” Third, the income must be
derived from the “active conduct” of that
insurance business.
C. Prior proposed regulations
On April 24, 2015, the Federal Reg-
ister published a notice of proposed
rulemaking (REG-108214-15) at 80 FR
22954 (the “2015 proposed regulations”)
under former sections 1297(b)(2)(B) and
1298(g). The 2015 proposed regulations
addressed the PFIC insurance exception
and provided guidance regarding the ex-
tent to which a foreign corporation’s in-
vestment income and the assets producing
that income are excluded from passive
income and passive assets for purposes
of the passive income and passive asset
tests in section 1297(a). Comments were
received on the previously proposed reg-
ulations. A public hearing was requested
and was held on September 18, 2015.
On July 11, 2019, the Federal Register
published a notice of proposed rulemak-
ing (REG-105474-18) at 84 FR 33120
(the “2019 proposed regulations”) under
sections 1291, 1297, and 1298. The 2019
proposed regulations provided guidance
with respect to the application of the In-
come Test and the Asset Test under section
1297(a), the look-through rule under sec-
tion 1297(c), and indirect ownership rules
under section 1291. The 2019 proposed
regulations also addressed the PFIC insur-
ance exception under section 1297(b)(2)
(B), including the definition of a QIC un-
der section 1297(f) and the requirements
for a foreign corporation to be engaged in
the active conduct of an insurance busi-
ness.
A public hearing on the 2019 proposed
regulations was scheduled for December
9, 2019, but it was not held because there
were no requests to speak. The Treasury
Department and the IRS received written
comments with respect to the 2019 pro-
posed regulations. Concurrently with the
publication of these proposed regulations,
the Treasury Department and the IRS are
publishing in the Rules and Regulations
section of this edition of the Federal Reg-
ister (RIN 1545-BO59) final regulations
under sections 1291, 1297, and 1298 (the
“final regulations”). In response to certain
comments, the Treasury Department and
the IRS are publishing this notice of pro-
posed rulemaking to provide additional
proposed regulations under sections 1297
and 1298.
II. QBAI Rules for GILTI and FDII
A. GILTI and FDII — In general
Section 951A(a) requires a United
States shareholder (as defined in section
951(b)) (“U.S. shareholder”) of any con-
trolled foreign corporation (as defined
in section 957) (“CFC”) for any taxable
year to include in gross income the U.S.
shareholder’s GILTI for such taxable year
(“GILTI inclusion amount”). The U.S.
shareholder’s GILTI inclusion amount is
calculated based on its pro rata share of
certain items – such as tested income, test-
ed loss, and QBAI – of each CFC owned
by the U.S. shareholder. See §1.951A-1(c).
Section 951A(d)(3)
1
requires a taxpayer to
calculate QBAI by determining the adjust-
ed basis of property using the ADS under
section 168(g) “notwithstanding any pro-
vision of this title (or any other provision
of law) which is enacted after the date of
the enactment of [section 951A].” Section
1.951A-3(e)(2) states that “[t]he adjusted
basis in specified tangible property is de-
termined without regard to any provision
of law enacted after December 22, 2017,
unless such later enacted law specifical-
ly and directly amends the definition of
qualified business asset investment under
section 951A.” The GILTI provisions in
section 951A apply to taxable years of
foreign corporations beginning after De-
cember 31, 2017, and to taxable years of
U.S. shareholders in which or with which
such taxable years of foreign corporations
end. See section 14201(d) of the Act.
The definition of QBAI in section
951A(d) also applies for purposes of de-
termining deemed tangible income return
under section 250. See section 250(b)(2)
(B) and §1.250(b)-2(b). Section 250 gen-
erally allows a domestic corporation a
deduction equal to 37.5 percent (21.875
percent for taxable years after 2025) of its
FDII (as defined in section 250(b)(1) and
§1.250(b)-1(b)). For purposes of FDII,
QBAI is used to determine the deemed
tangible income return of a corporation,
which in turn reduces the amount of FDII
of a corporation. See section 250(b)(1) and
(2). Section 250(b)(2)(B) and §1.250(b)-
2 incorporate the definition of QBAI in
section 951A(d)(3), with some modifica-
tions. Similar to the GILTI rule provided
in §1.951A-3(e)(2), §1.250(b)-2(e)(2)
provides that “[t]he adjusted basis in spec-
ified tangible property is determined with-
out regard to any provision of law enact-
ed after December 22, 2017, unless such
later enacted law specifically and direct-
ly amends the definition of QBAI under
section 250 or section 951A.” The FDII
provisions in section 250 apply to taxable
years beginning after December 31, 2017.
See section 14202(a) of the Act.
B. ADS depreciation
ADS depreciation under section 168(g)
is determined by using the straight-line
method (without regard to salvage value),
the applicable convention determined un-
der section 168(d), and the applicable re-
1
As enacted, section 951A(d) contains two paragraphs designated as paragraph (3). The section 951A(d)(3) discussed in this preamble relates to the determination of the adjusted basis in
property for purposes of calculating QBAI.

Bulletin No. 2021–5 685 February 1, 2021
covery period as determined under section
168(g)(2)(C).
2
On December 22, 2017, the
date the Act was enacted, section 168(g)
(2)(C)(iv) provided that the recovery pe-
riod for purposes of ADS depreciation for
nonresidential real property under section
168(e)(2)(B) was 40 years. Nonresiden-
tial real property is defined under section
168(e)(2)(B) as section 1250 property
(that is, real property not described in
section 1245) that is not residential rent-
al property or property with a class life of
less than 27.5 years.
Section 168(g)(2)(C)(i) provided that
the recovery period for property not de-
scribed in section 168(g)(2)(C)(ii) or (iii)
3

is the property’s class life. Class life is gen-
erally determined under section 168 or Rev.
Proc. 87-56; 1987-42 I.R.B. 4; however,
section 168(g)(3) specifies class lives for
certain types of property for ADS purposes.
C. Qualified improvement property
1. The Act
Effective for property placed in service
after December 31, 2017, section 13204 of
the Act amended section 168(e) by remov-
ing references to qualified leasehold im-
provement property, qualified restaurant
improvement property, and qualified retail
improvement property, and instead refer-
ring only to QIP. Under section 168(e)
(6), QIP includes certain improvements
made by a taxpayer
4
to the interior of a
nonresidential building that are placed in
service after the building was first placed
in service. The conference report under
the Act states that Congress intended QIP
to be classified as 15-year property under
the general depreciation system and be
assigned a 20-year ADS recovery period.
See Conference Report to Accompany
H.R. 1 at 366-367.
2. The CARES Act
The Coronavirus Aid, Relief, and Eco-
nomic Security Act, P.L. 116-136 (the
“CARES Act”) was enacted on March
27, 2020. According to the Description
of the Tax Provisions of Public Law
116-136, the Coronavirus Aid, Relief,
and Economic Security (“CARES”) Act,
prepared by the Staff of the Joint Com-
mittee on Taxation, when Congress add-
ed the definition of QIP in section 168(e)
(6) of the Code, it intended for QIP to
be classified as 15-year property under
section 168(e)(3)(E) of the Code, with a
15-year recovery period under the gener-
al depreciation system in section 168(a)
of the Code and a 20-year ADS recovery
period but inadvertently omitted from the
statute such language. See Joint Com-
mittee on Taxation, Description of the
Tax Provisions of Public Law 116-136,
The Coronavirus, Relief, and Economic
Security (“CARES”) Act (JCX-12R-20)
at 69-70 (Apr. 23, 2020) (“JCT CARES
Act Report”). Section 2307(a)(2) of the
CARES Act amended section 168(e) by
adding clause (vii) to paragraph (E)(3),
providing that QIP is classified as 15-year
property, and amending the table in sec-
tion 168(g)(3)(B) to provide a recovery
period of 20 years for QIP for purposes
of the ADS (the “technical amendment”).
The technical amendment is effective as
if it had been included in the Act.
5
D. Notice 2020-69
Notice 2020-69, 2020-30 I.R.B. 604,
announced that the Treasury Department
and the IRS intend to issue regulations
addressing the treatment of QIP under
the ADS depreciation provisions in sec-
tion 168(g) for purposes of calculating
QBAI under the FDII and GILTI provi-
sions. The notice provided that the Trea-
sury Department and the IRS expect the
regulations under sections 250 and 951A
to clarify that the technical amendment to
section 168 enacted in section 2307(a) of
the CARES Act applies to determine the
adjusted basis of property under section
951A(d)(3) as if it had originally been part
of section 13204 of the Act.
Explanation of Provisions
The proposed regulations provide
guidance on the valuation of assets and
on the treatment of working capital for
purposes of the Asset Test. They modi-
fy the treatment of dividends paid out of
earnings and profits not previously taken
into account, such as dividends paid out
of pre-acquisition earnings, and provide
safe harbors for application of the princi-
pal purpose anti-abuse test that may pro-
hibit the use of the qualified stock rules
of section 1298(b)(7). The proposed reg-
ulations also provide guidance regarding
whether the income of a foreign corpo-
ration is excluded from passive income
pursuant to section 1297(b)(2)(B) be-
cause the income is derived in the active
conduct of an insurance business by a
QIC.
Part I.A of this Explanation of Provi-
sions describes rules for income derived
in the active conduct of a banking busi-
ness, asset valuation, and working capital
in proposed §1.1297-1; the special div-
idend rules in proposed §1.1297-2; and
the proposed safe harbors for the quali-
fied stock principal purpose anti-abuse
test in proposed §1.1298-4(e). Part I.B of
this Explanation of Provisions describes
the rules in proposed §1.1297-4 for de-
termining whether a foreign corporation
is a QIC. Part I.C of this Explanation
of Provisions describes the rules in pro-
posed §1.1297-5 for determining wheth-
er a foreign corporation is engaged in the
active conduct of an insurance business.
Part I.D of this Explanation of Provisions
describes the rules in proposed §1.1297-
6 regarding the treatment of income and
assets of a qualifying domestic insurance
company.
The proposed regulations also provide
guidance on the treatment of QIP un-
der the ADS for purposes of calculating
QBAI under the GILTI and FDII provi-
sions. See Part II of this Explanation of
Provisions.
2
Although the applicable convention for nonresidential real property under section 168(d)(2)(A) is the mid-month convention, §1.951A-3(e)(1) provides that for the purpose of determining
QBAI, the period in the CFC inclusion year to which such depreciation relates is determined without regard to the applicable convention under section 168(d).
3
Section 168(g)(2)(C)(ii) and (iii) refer to personal property with no class life and residential rental property, respectively.
4
The phrase “made by a taxpayer” was added by section 2307(a)(2) of P.L. 116-136, discussed below.
5
Rev. Proc. 2020-25, 2020-19 I.R.B. 785, generally allows a taxpayer to change its depreciation method under section 168 for QIP placed in service by the taxpayer after December 31, 2017,
by amending the applicable tax returns or requesting an accounting method change. The determination of a taxpayer’s adjusted basis for purposes of determining QBAI is not addressed in
the revenue procedure and is not treated as a method of accounting. T.D. 9866, 84 FR 29288, 29304 (2019).

February 1, 2021 686 Bulletin No. 2021–5
I. Passive Foreign Investment Companies
A. General PFIC rules
1. Income Derived in the Active Conduct
of a Banking Business
a. Active banking business exception
Section 1297(b)(1) generally defines
the term passive income to mean any in-
come which is of a kind which would be
FPHCI as defined in section 954(c). Sec-
tion 1297(b)(2) provides exceptions to
this general definition. Section 1297(b)
(2)(A) provides that passive income does
not include any income derived in the
active conduct of a banking business by
an institution licensed to do business as a
bank in the United States (or, to the ex-
tent provided in regulations, by any other
corporation) (the “section 1297(b)(2)(A)
banking exception”), and section 1297(b)
(2)(B) provides a similar exception for in-
come derived in the active conduct of an
insurance business. The Treasury Depart-
ment and the IRS have determined that in
light of this statutory framework, qual-
ifying banking income should be treated
as non-passive under the section 1297(b)
(2)(A) banking exception (and qualify-
ing insurance income should be treated
as non-passive under the similar rule in
section 1297(b)(2)(B)) and not under the
general rule of section 1297(b)(1). Oth-
erwise, an exception for active banking
and insurance income of a tested foreign
corporation would apply indirectly under
section 1297(b)(1) and also directly under
sections 1297(b)(2)(A) and (B), which
would be duplicative and would effective-
ly narrow the scope of the statutory excep-
tions in section 1297(b)(2). Accordingly,
the Treasury Department and the IRS have
determined that section 954(h)(1), which
provides that for purposes of section
954(c)(1) FPHCI does not include quali-
fied banking or financing income of an el-
igible controlled foreign corporation, does
not apply for purposes of section 1297(b)
(1). See Part III.B.1 of the preamble to the
final regulations.
Notice 88-22, 1988-1 C.B. 489, states
that assets held by foreign corporations
described in section 1297(b)(2)(A) (then
section 1296(b)(2)(A)) that are utilized
to produce income in the active conduct
of a banking business will be treated as
non-passive assets. Notice 89-81, 1989-2
C.B. 399, provides guidance addressing
the characterization of income derived in
a banking business by a foreign corpora-
tion that is not licensed to do business as
a bank in the United States for purposes
of the definitional tests of the PFIC pro-
visions, and states that the rules contained
in Notice 89-81 will be incorporated into
future regulations. In 1995, regulations
were proposed to implement the section
1297(b)(2)(A) banking exception. See
proposed §1.1296-4, 60 FR 20922, April
28, 1995. In light of the fact that the 1995
proposed regulations have not been final-
ized, the Treasury Department and the IRS
are aware that taxpayers need guidance on
how to properly apply section 1297(b)(2)
(A).
Section 1297(b)(2)(A) requires that
income be derived in the active conduct
of a banking business, and grants author-
ity for regulations to expand the scope of
entities that are eligible for the section
1297(b)(2)(A) exception beyond U.S.-li-
censed banks. The preamble to the 1995
proposed regulations states that the Trea-
sury Department and the IRS believe that
Congress intended to grant the banking
exception only to corporations that con-
form to a traditional U.S. banking model.
1995-1 C.B. 978. The Treasury Depart-
ment and IRS continue to believe that the
section 1297(b)(2)(A) banking exception
should apply to foreign banks and not to
other types of financial institutions, based
on both the statutory framework and the
history of section 1297(b).
6
In the Tax Reform Act of 1986, Con-
gress repealed broad FPHCI exceptions
under section 954, including an exception
for active banks, while simultaneously en-
acting PFIC rules, including current sec-
tion 1297(b)(2)(A) (as subsequently re-
numbered in 1997). Thus, when the PFIC
rules were enacted, section 1297(b)(2)
(A) was the exclusive means by which an
active bank could avail itself of a passive
income exception to the PFIC rules.
Since 1986, Congress has repeatedly
amended section 1297(b) to add, repeal,
and modify the exceptions therein as they
apply to financial institutions. For ex-
ample, in 1993 a new paragraph (3) was
added to section 1297(b) (then section
1296(b)) providing that income earned in
the active conduct of a securities business
by a CFC was not treated as passive for
PFIC purposes for a United States share-
holder (“U.S. shareholder”) as defined in
section 951(b).

Pub. L. No. 103-66, Om-
nibus Budget Reconciliation Act of 1993,
section 13231(d)(3). In 1997, that para-
graph was repealed, in connection with the
enactment of section 1297(d) (then sec-
tion 1297(e)), which eliminated the need
for rules relating to CFCs in section 1297
with respect to US shareholders. Pub.
L. No. 105-34, Taxpayer Relief Act of
1997, section 1122(d)(4). In 2017, TCJA
amended section 1297(b)(2)(B), relating
to income earned in the active conduct of
an insurance business, and added section
1297(f). Congress has thus expressly ad-
dressed when income of a kind earned by
various active financial institutions should
be treated as non-passive. Because section
1297(b)(2)(A) applies to income derived
in the active conduct of a banking busi-
ness, the relevant class of foreign financial
institutions is foreign banks.
The Treasury Department and the IRS
have considered alternatives to the analy-
sis set forth above. In particular, because
the PFIC rules when enacted in 1986 pro-
vided broader exclusions for income of ac-
tive foreign financial institutions than the
subpart F rules did, and because broader
exclusions for active financial businesses
for PFIC purposes may be appropriate in
light of the fact that U.S. investors in a
PFIC do not control the PFIC, the Trea-
sury Department and the IRS have consid-
ered whether a wholesale incorporation of
section 954(h) into either section 1297(b)
(1) or section 1297(b)(2)(A) would be ap-
propriate as an exercise of regulatory dis-
cretion. A broader approach of that kind
6
See Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, at 1025 (JCS-10-87) (May 4, 1987) (“The Act provides regulatory authority to expand the exception
to passive income for income derived by a foreign bank licensed to do business in the United States to any other foreign corporation engaged in the active conduct of a banking business, as
well.”) (emphasis added); cf. H.R. Rep. No. 99-841, at II-644 (1986) (Conf. Rep.) (providing that “the Secretary has regulatory authority to apply the PFIC provisions to any ‘bank’ where
necessary to prevent U.S. individuals from earning what is essentially portfolio investment income in a tax deferred entity”) (emphasis added).

Bulletin No. 2021–5 687 February 1, 2021
could be of particular relevance to finance
companies whose income is eligible for
the section 954(h) exception.
The Treasury Department and the IRS
concluded that such a broader approach is
not warranted by the statutory language or
history, as described in Part I.A.1.a of this
Explanation of Provisions. Furthermore,
the 1993 legislative history to the expan-
sion of section 1297(b)’s passive income
exceptions makes clear that the PFIC rules
as in effect at that time did not apply to
finance companies, that is, entities that did
not engage in the deposit-taking activities
characteristic of banks.
7
Consequently, if
all of section 954(h) were permitted to
apply for purposes of section 1297(b)(2)
(A), finance companies, which can quali-
fy for the section 954(h) exception, would
obtain a privileged treatment for PFIC
purposes that Congress intended to deny
in 1993 and has not expressly approved in
the interim.
However, section 954(h) provides some
useful guideposts that can be applied to
interpret section 1297(b)(2)(A) in the ab-
sence of final regulations, because the two
provisions have similar and complementa-
ry purposes. Sections 954(h)(2)(B)(ii) and
1297(b)(2)(A) construe the same statuto-
ry phrase: income “derived in the active
conduct of a banking business.” And they
both are limited to banks licensed to do
business as a bank in the United States or
any other corporation as prescribed by the
Secretary. Moreover, the legislative histo-
ry to section 954(h) explicitly states that
the phrase “active conduct of a banking
business” under section 954(h) is intend-
ed to have the same meaning as under the
1995 proposed regulations issued under
section 1297(b)(2)(A).
8
Finally, section
954(h) is a more recent expression of
Congressional intent as to the conditions
under which banking income of a foreign
entity should be treated as non-passive
than section 1297(b)(2)(A).
Accordingly, in order to provide guid-
ance to foreign banks and in light of the
close connection between section 1297(b)
(2)(A) and section 954(h)(2)(B)(ii), the
Treasury Department and the IRS pro-
pose to apply certain principles of section
954(h) for purposes of section 1297(b)(2)
(A), under section 1297(b)(2)(A)’s specif-
ic grant of regulatory authority. See pro-
posed §1.1297-1(c)(2). Alternatively, tax-
payers also may rely upon Notice 89-81
or proposed §1.1296-4 (relating to bank-
ing income of active banks) to determine
whether income of a foreign entity may
be treated as non-passive under section
1297(b)(2)(A).
b. Proposed exception for active banking
income of foreign banks
Proposed §1.1297-1(c)(2) provides
that income of a tested foreign corpora-
tion will not be treated as passive if the
income would be eligible for section
954(h) if the tested foreign corporation
were a CFC, and the income is derived
in the active conduct of a banking busi-
ness by a foreign bank. The term active
conduct of a banking business has the
meaning given to it by section 954(h)
(2)(B)(ii). See proposed §1.1297-1(c)(2)
(i)(B). The term foreign bank is defined
in a manner similar to the definition of
active bank under proposed §1.1296-4,
and is intended to have the same mean-
ing, except where the proposed regula-
tions provide a different rule. For exam-
ple, a foreign bank must engage in one
or more of the list of relevant banking
activities provided by section 954(h)(4)
rather than being required to make loans.
See proposed §1.1297-1(c)(2)(ii). Some
clarifying changes have been made to the
definition to ensure that it applies only to
entities that are banks as that term is ordi-
narily understood, and not, for example,
to payment service providers or money
transmitters. As is the case under section
954(h), the exception is intended to apply
to the income of qualified business units
of a foreign bank.
As proposed, the exception does not
apply to affiliates of a foreign bank that
do not independently qualify for the ex-
ception, in light of the fact that section
954(h) takes affiliates into account only
for purposes of treating the activities of
same-country related persons that are
CFCs as activities that are conducted di-
rectly by an eligible CFC if certain con-
ditions are satisfied. See section 954(h)
(3)(E). Proposed §1.1297-1(c)(2)(i)(A)
permits such related persons to be treat-
ed as if they were CFCs so that section
954(h)(3)(E) may apply for purposes of
proposed §1.1297-1(c)(2).
A comment on the 2019 proposed
regulations suggested that the attribution
of activities of look-through subsidiar-
ies to other affiliates that is permitted by
§1.1297-2(e) for purposes of specified
provisions of section 954(c) be extended
to apply for purposes of section 954(h).
The comment indicated that such treat-
ment would be proper because financial
businesses generally segregate assets and
operations that are part of an integrated
business into different entities for non-
tax reasons. Because section 954(h)(3)(E)
operates to attribute activities among en-
tities for purposes of determining wheth-
er income constitutes qualified banking
income, the Treasury Department and the
IRS have determined that it would be in-
appropriate to adopt additional rules for
attribution of activities for purposes of the
incorporation of section 954(h) into sec-
tion 1297(b)(2)(A) and did not adopt this
comment in the final regulations. However,
as an alternative to proposed §1.1297-1(c)
(2), taxpayers may rely upon Notice 89-
81 or proposed §1.1296-4, which provide
rules treating banking income of qualified
bank affiliates as non-passive. If a foreign
bank is a look-through subsidiary of a test-
ed foreign corporation, then under section
1297(c) and §1.1297-2(b)(2) the income
and assets of the foreign bank are treated
as passive or non-passive at the level of
the tested foreign corporation to the extent
7
See H.R. CoNf. Rep. No. 103-213, Omnibus Budget Reconciliation Act of 1993, at 641 (Aug. 4, 1993) (“These rules [the banking exception and the securities dealer exception], however, do
not apply to income derived in the conduct of financing and credit services businesses”).
8
H.R. Rep. No. 817, 105th Cong. 2d Sess. 37 (Oct. 12, 1988) (“It generally is intended that these requirements for the active conduct of a banking or securities business be interpreted in the
same manner provided in the regulations proposed under prior law section 1296(b) ... See Prop. Treas. Reg. secs. 1.1296-4 and 1.1296-6. Specifically, it is intended that these requirements
include the requirements for foreign banks under Prop. Treas. Reg. sec. 1.1296-4 as currently drafted.”); see also H.R. Rep. No. 220, 105
th
Cong. 1
st
Sess. 642 (July 30, 1997) (similar lan-
guage); Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997, at 330 (JCS-23-97) (Dec. 17, 1997) (“The Congress generally intended that the income of a
corporation engaged in the active conduct of a banking or securities business that would have been eligible for this exception would have been the income that is treated as nonpassive under
the regulations proposed under prior law section 1296(b). See Prop. Treas. Reg. secs. 1.1296-4 and 1.1296-6.”).

February 1, 2021 688 Bulletin No. 2021–5
they are treated as passive or non-passive
at the level of the foreign bank. If that
foreign bank itself owns a look-through
subsidiary, then under section 1297(c) and
§1.1297-2(b)(2) the income and assets of
the look-through subsidiary are treated as
passive or non-passive at the level of the
foreign bank to the extent they are treated
as passive or non-passive at the level of
the look-through subsidiary.
Another comment noted that, in the
case of tested foreign corporations with
look-through subsidiaries that are do-
mestic corporations, section 954(h)(3)(A)
(ii)(I) would result in the section 954(h)
exception being inapplicable to active fi-
nancing income earned by these subsidiar-
ies from transactions with local custom-
ers, even though it would otherwise be of
a type that would not be passive. The com-
ment suggested that section 954(h) should
be applied in the PFIC context by treating
income as qualified banking or financing
income even if the income is derived from
transactions with customers in the United
States.
Section 1298(b)(7) provides an ex-
ception for income derived from certain
25-percent owned domestic subsidiaries
that treats such income as non-passive.
The Treasury Department and the IRS do
not agree that an additional rule should
be provided to treat income of a domestic
subsidiary that is not eligible for section
1298(b)(7) as non-passive, and according-
ly these proposed regulations do not adopt
this recommendation.
9
The preamble to the 2019 proposed
regulations requested comments address-
ing the question of whether the section
954(h) exception, if adopted as proposed
in the 2019 proposed regulations, should
continue to apply if final regulations im-
plementing section 1297(b)(2)(A), for
example final regulations similar to pro-
posed §1.1296-4, are adopted. Several
comments recommended that the section
954(h) exception continue to apply in
the PFIC context under section 1297(b)
(1) in such a case. In light of the different
approach taken by these proposed regu-
lations compared to the 2019 proposed
regulations, the Treasury Department and
the IRS request comments on whether
proposed §1.1297-1(c)(2) provides suffi-
cient guidance to foreign banks, such that
Notice 89-81 and proposed §1.1296-4 can
be withdrawn, whether alternatively pro-
posed §1.1296-4 should be finalized rath-
er than proposed §1.1297-1(c)(2), wheth-
er both proposed §1.1296-4 and proposed
§1.1297-1(c)(2) should be finalized, or
whether a single harmonized set of rules
should be provided. Until Notice 89-81
and proposed §1.1296-4 are withdrawn,
taxpayers may rely upon them as alterna-
tives to proposed §1.1297-1(c)(2).
The Treasury Department and the IRS
also request comments on the general ap-
proach taken by proposed §1.1297-1(c)
(2), on whether further guidance is needed
to address when income is derived in the
active conduct of a banking business, on
whether the definition of foreign bank is
drafted in a manner that does not exclude
bona fide foreign banks and does not in-
clude other types of financial institutions,
and on how income of affiliates of foreign
banks should be taken into account.
2. Valuation of Assets for Purposes of the
Asset Test
Under section 1297(e), the determina-
tion of whether a tested foreign corpora-
tion satisfies the Asset Test either must
or may be made on the basis of the value
of the assets of the tested foreign corpo-
ration, unless the tested foreign corpora-
tion is a controlled foreign corporation the
shares of which are not publicly traded.
Accordingly, it is typically necessary to
determine the relative value of a tested
foreign corporation’s passive and non-pas-
sive assets in order to determine whether
the tested foreign corporation satisfies the
Asset Test.
The value of individual assets of an op-
erating company may not be readily deter-
minable. However, financial accounting
standards generally provide rules that are
intended to provide stakeholders with an
economically realistic understanding of
a company’s financial position, includ-
ing the cost or value of its assets. Finan-
cial statement information also often is
accessible by tested foreign corporations
and their shareholders, and is prepared
for non-tax purposes. The Treasury De-
partment and the IRS understand that,
for these reasons, taxpayers often utilize
financial statements in order to determine
the value of a tested foreign corporation’s
assets. Section 1297(f)(4) specifically
requires the use of information from fi-
nancial statements prepared under U.S.
generally accepted accounting principles
(“GAAP”) or international financial re-
porting standards (“IFRS”) for purposes
of the QIC rules, indicating that Congress
believes that such information is appropri-
ate in some circumstances as a basis for
determining whether a tested foreign cor-
poration qualifies as a PFIC.
Accordingly, proposed §1.1297-1(d)
(1)(v)(D) generally permits a taxpayer to
rely upon the information in a tested for-
eign corporation’s financial statements
in order to determine the value of the
corporation’s assets. The Treasury De-
partment and the IRS request comments
on whether ordering rules similar to
those of section 1297(f)(4) and proposed
§1.1297-4(f)(1) should apply, and wheth-
er other safeguards such as requiring that
financial statements be audited should be
required.
The Treasury Department and the IRS
are aware that financial statements do not
include values for some types of assets
that are important to companies in certain
industries, for example self-created intan-
gibles. Accordingly, proposed §1.1297-
1(d)(1)(v)(D) provides that if a sharehold-
er has reliable information about the value
of an asset that differs from its financial
statement valuation, that information must
be used to determine the value of the asset.
Whether valuation information is more re-
liable than financial statement valuation
is based on the facts and circumstances,
including the experience and knowledge
of the source of the information, wheth-
er the information is recent and whether
there have been intervening developments
that would affect the accuracy of the infor-
mation, and whether the information spe-
cifically addresses the value of the asset
in question. Another fact pattern that may
raise questions as to whether divergence
from a financial statement valuation is
warranted is when a tested foreign corpo-
9
The legislative history of section 954(h) states that the active banking test is not intended to apply to affiliates that do not independently satisfy the test. H.R. Rep. No. 817, 105
th
Cong.
2d Sess. 37 (Oct. 12, 1988) (“[I]t is not intended that these requirements be considered to be satisfied by a CFC merely because it is a qualified bank affiliate ... within the meaning of the
proposed regulations under former section 1296(b).”)

Bulletin No. 2021–5 689 February 1, 2021
ration or look-through entity owns proper-
ty that is subject to a lease or license that is
disregarded under the rules for intercom-
pany obligations between a tested foreign
corporation and a look-through entity, and
similar fact patterns. See §1.1297-2(c)(1)
(ii). The Treasury Department and the IRS
request comments on whether the Asset
Test should take into account the value
of the property subject to the lease or li-
cense and the value of the lease or license,
or whether instead the Asset Test should
take into account the value of the proper-
ty disregarding the lease or license. The
Treasury Department and the IRS request
comments on additional considerations
that may be relevant to determining when
shareholders may use information other
than financial statement valuations for
purposes of the Asset Test.
3. Treatment of Working Capital and
Goodwill for Purposes of the Asset Test,
and Other Asset Test Rules Provided by
Notice 88-22
Notice 88-22, 1988-1 C.B. 489 (“No-
tice 88-22”), provides guidance on the
application of the Asset Test pending the
issuance of regulations. The Treasury De-
partment and the IRS propose to adopt
final regulations that will address the por-
tions of Notice 88-22 that have not already
been addressed by regulations, for exam-
ple the guidance relating to depreciable
property used in a trade or business, trade
or service receivables, intangible proper-
ty, working capital, and tax-exempt assets.
After the issuance of those regulations
Notice 88-22 would be obsoleted. Except
as described in the remainder of this Part
I.A.3 of this Explanation of Provisions
section, the rules provided in Notice 88-22
are proposed to be adopted in final form
as set forth in Notice 88-22. The Treasury
Department and the IRS request com-
ments on whether any changes should be
made to those rules when they are adopted
in final regulations.
Notice 88-22 provides that cash and
other current assets readily convertible
into cash, including assets that may be
characterized as the working capital of an
active business, are treated as passive as-
sets for purposes of the Asset Test. Notice
88-22 indicated that passive treatment is
warranted because working capital pro-
duces passive income (that is, interest in-
come).
Comments have noted that the ap-
proach taken in Notice 88-22 with respect
to working capital may be inconsistent
with the intent of the PFIC regime to dis-
tinguish between investments in passive
assets and investments in active business-
es. It has been asserted that the working
capital rule in Notice 88-22 causes many
foreign corporations otherwise engaged in
active operating businesses to be classi-
fied as PFICs because Notice 88-22 treats
working capital as a passive asset even
though it is an asset used in the active con-
duct of business operations. Critics of No-
tice 88-22’s working capital rule have also
noted that, for some purposes of the Code,
cash is treated as a business (non-passive)
asset to the extent it is held as working
capital for use in a trade or business. See
generally section 1202(e)(6) and §§1.864-
4(c)(2) and 1.897-1(f)(1)(iii).
The Treasury Department and the IRS
recognize that, because any active oper-
ating company must have some cash or
cash equivalents on hand to pay operating
expenses, Notice 88-22’s working capital
rule, which treats all working capital as a
passive asset, does not reflect the manner
in which bona fide businesses operate.
The Treasury Department and the IRS
also are aware that some foreign compa-
nies engaged in active businesses hold
cash or liquid securities in amounts that
substantially exceed the present needs of
the business for extended periods. There-
fore, the proposed regulations provide
a limited exception to the treatment of
working capital as passive. Under pro-
posed §1.1297-1(d)(2), an amount of cash
held in a non-interest bearing account that
is held for the present needs of an active
trade or business and is no greater than the
amount reasonably expected to cover 90
days of operating expenses incurred in the
ordinary course of the trade or business of
the tested foreign corporation (for exam-
ple, accounts payable for ordinary operat-
ing expenses or employee compensation)
is not treated as a passive asset.
The Treasury Department and the IRS
understand that this definition is narrow-
er than the ordinary business meaning of
working capital and the definitions used in
some other Treasury regulations. Because
the PFIC rules are based on numeric for-
mulas, it is important that taxpayers and
the IRS can determine what the amount
treated as working capital is for purposes
of the PFIC asset test with some level of
precision. Moreover, because the statuto-
ry PFIC rules (and FPHCI rules) generally
treat an asset held to produce interest as
passive, it may not be appropriate to treat
an interest-bearing instrument held by an
operating company as working capital
other than as an asset that produces pas-
sive income. Those rules permit inter-
est-bearing assets to be treated as active
assets for limited classes of taxpayers like
banks, insurance companies and securi-
ties dealers, and also permit interest from
related persons to be treated in whole or
part as active, but in those cases there are
specific statutory exceptions from passive
treatment. See sections 1297(b)(2)(A)
(banks), 1297(b)(2)(B) and (f) (insurance
companies), 1297(b)(2)(C) (interest from
related persons) and 954(c)(2)(C) (secu-
rities dealers). The Treasury Department
and the IRS request comments on this ex-
ception to the general rule of Notice 88-22
that cash is a passive asset, including the
scope of statutory authority to treat inter-
est-bearing accounts or instruments held
as working capital as an active asset and
the ways in which the exception might be
broadened while maintaining appropriate
safeguards to avoid uncertainty as to how
to determine the amounts and types of in-
struments properly treated as held for the
present needs of a business and to ensure
that a business’s investments and capital
held for future needs continue to be char-
acterized as passive assets.
Like working capital, goodwill was not
addressed by the 2019 proposed regula-
tions. Notice 88-22 provides that, for pur-
poses of the Asset Test, goodwill or going
concern value must be identified with a
specific income-producing activity of the
corporation and characterized as a passive
or non-passive asset based on the income
derived from the activity. The Treasury
Department and the IRS understand that
some taxpayers believe that Notice 88-22
takes an improper approach with respect
to the treatment and characterization of
goodwill for purposes of the Asset Test
and argue that goodwill related to an ac-
tive trade or business should be treated in
its entirety as a non-passive asset or, in the
alternative, that the dual-character asset

February 1, 2021 690 Bulletin No. 2021–5
rule in the proposed regulations should be
read to apply to goodwill.
The Treasury Department and the IRS
agree that goodwill should be allocated to
business activities but do not agree that
goodwill should always be treated entirely
as a non-passive asset because the PFIC
rules may treat certain business assets as
passive and it is therefore possible that
goodwill would be associated with those
assets. Because companies in different
lines of business may be valued as an eco-
nomic matter under different valuation
models, some of which may give more
weight to income and others to assets or to
other aspects of a business like customer
relationships, there is no single basis for
allocating goodwill that is likely to be best
suited to every company as an economic
matter. The Treasury Department and the
IRS believe that the approach provided by
Notice 88-22 for determining the charac-
ter of goodwill for purposes of the Asset
Test is a reasonable approach although
other approaches may be more economi-
cally accurate for a particular tested for-
eign corporation. In light of the complex
nature of goodwill as an economic and ac-
counting matter, and developments in tax
law since 1988 with respect to the treat-
ment of goodwill and similar assets, the
Treasury Department and the IRS request
comments on alternative approaches to
addressing the treatment of goodwill for
purposes of the Asset Test.
4. Elimination of Intercompany
Dividends for Purposes of the Income
Test and Related Adjustments
Proposed §1.1297-2(c)(2) provided
that, for purposes of applying the Income
Test, intercompany payments of dividends
between a look-through subsidiary and a
tested foreign corporation are eliminated
to the extent the payment is attributable
to income of a look-through subsidiary
that was included in gross income by the
tested foreign corporation for purposes of
determining its PFIC status. The preamble
to the proposed regulations indicated that
the Treasury Department and the IRS in-
tended for the elimination of such items to
prevent double counting of intercompany
income and assets.
A comment expressed concern that the
proposed regulation did not eliminate a
payment of a dividend by a look-through
subsidiary to a tested foreign corporation
that is made out of earnings and profits
not attributable to income of the subsid-
iary previously included in the gross in-
come of the tested foreign corporation for
purposes of determining its PFIC status
(“dividends from non-accounted-for earn-
ings”), for example a dividend paid out of
earnings and profits accumulated before
the tested foreign corporation’s acquisi-
tion of the look-through subsidiary. The
comment recommended that final regu-
lations provide for the elimination of all
dividends from look-through subsidiaries
and made a number of alternative sugges-
tions intended to reduce or eliminate the
likelihood that a dividend from a look-
through subsidiary would be treated as a
dividend from non-accounted-for earn-
ings. The final regulations did not adopt
these recommendations, because treating
a distribution from a look-through subsid-
iary as not giving rise to gross income to
the tested foreign corporation for purposes
of the Income Test could reduce gain on a
future sale of the stock of the look-through
subsidiary unless a basis or other adjust-
ment were made to the stock or gain.
The final regulations indicate that for
purposes of applying the Income Test, a
tested foreign corporation must take into
account its gain on the disposition of
stock in a look-through subsidiary. See
§1.1297-2(f)(2). In the final regulations,
the amount of gain derived from a tested
foreign corporation’s direct disposition of
stock of a look-through subsidiary, or an
indirect disposition resulting from the dis-
position of stock of a look-through subsid-
iary by other look-through subsidiaries or
by look-through partnerships, that is taken
into account by the tested foreign corpo-
ration for purposes of section 1297(a)(1),
section 1298(b)(3), and §1.1298-2 is the
residual gain. See §1.1297-2(f)(2). The
residual gain equals the total gain recog-
nized by the tested foreign corporation
from the disposition of the stock of the
look-through subsidiary reduced (but not
below zero) by unremitted earnings. Id.
Unremitted earnings are the excess of the
aggregate income taken into account by
the tested foreign corporation pursuant to
section 1297(c) with respect to the stock
of the disposed-of look-through subsidi-
ary over the aggregate dividends received
by the tested foreign corporation from the
disposed-of look-through subsidiary with
respect to the stock. Id.
Reducing unremitted earnings to take
dividends into account as provided by the
final regulations does not fully account for
the effect of dividends from non-account-
ed-for earnings, for example where there
are no unremitted earnings after taking
into account distributions of earnings and
profits previously included in the gross in-
come of the tested foreign corporation for
purposes of determining its PFIC status
but the stock of the look-through subsid-
iary is sold at a gain. Consequently, either
such dividends should be treated as giving
rise to income to the recipient, as provided
by the final regulations, or some other ad-
justment such as to basis should be made
in order to prevent the disappearance
of potential gain. See Part IV.D.1 of the
Summary of Comments and Explanation
of Revisions for the final regulations.
The PFIC regulations do not provide
rules for determining or adjusting the basis
of the stock of a look-through subsidiary.
In addition to the fact pattern described
above, many other fact patterns could
raise questions about how the basis of
stock of a look-through subsidiary should
be adjusted. Examples of such transac-
tions include unremitted earnings, certain
reorganizations the parties to which are
look-through subsidiaries, in-kind divi-
dend distributions that could give rise to
gain at the level of the distributing sub-
sidiary but the elimination of dividends
from the income of the dividend recipi-
ent, and other transactions governed by
subchapter C. Additional questions arise
if a subsidiary becomes, or ceases to be,
a look-through subsidiary while its shares
continue to be held by the same share-
holder, and with respect to transactions
that shift property between a look-through
entity and a tested foreign corporation that
owns the look-through entity (or between
two look-through entities) in light of the
fact that the transaction may give rise to
gain or loss if it is regarded but the tested
foreign corporation is treated as owning
the asset for Asset Test purposes both be-
fore and after the transaction.
Rules addressing similar issues ex-
ist for members of a consolidated group,
which might provide a possible model
for rules addressing “corporate” transac-

Bulletin No. 2021–5 691 February 1, 2021
tions between a look-through subsidiary
and its owner(s). However, the consoli-
dated return regulations are highly com-
plex and may not be suitable for foreign
corporations that do not follow U.S. tax
principles. The consolidated return reg-
ulations are also based on a single-enti-
ty paradigm that may not be relevant for
section 1297(c) given that the stock own-
ership threshold for treating a subsidiary
as a look-through subsidiary is 25 percent
rather than 80 percent. Accordingly, those
rules may not be an appropriate model for
basis and related rules for look-through
subsidiaries.
Proposed §1.1297-2(c)(2) and (f) pro-
vide rules that would—for purposes of
determining a tested foreign corporation’s
PFIC status—eliminate from the gross
income of the corporation a dividend it
receives from a look-through subsidiary
that is made out of earnings and profits
not attributable to income of the subsid-
iary previously included in the gross in-
come of the tested foreign corporation.
The rules also would make corresponding
adjustments to the basis of a look-through
subsidiary’s stock for purposes of deter-
mining gain upon the disposition of such
stock in applying the Income Test. For
the reasons already described, these rules
may or may not be a desirable approach
to addressing the issues with respect to
earnings and distributions of look-through
subsidiaries. For example, the basis re-
duction rule could apply if a subsidiary
paid a dividend when it was not a look-
through subsidiary but later became one.
The Treasury Department and the IRS in-
vite comments addressing these issues—
in particular, comments are requested on
the treatment of pre-acquisition earnings
and profits.
5. Safe Harbors for the Domestic
Subsidiary Anti-Abuse Rule
Section 1298(b)(7) provides a special
characterization rule that applies when (i)
a tested foreign corporation owns at least
25 percent of the value of the stock of a
domestic corporation (“25-percent-owned
domestic corporation”), (ii) the 25-per-
cent-owned domestic corporation owns
stock in another domestic corporation
(“the second-tier domestic corporation”),
and (iii) the tested foreign corporation is
subject to the accumulated earnings tax
under section 531 (or waives any benefit
under a treaty that would otherwise pre-
vent imposition of such tax). In that case,
section 1298(b)(7) treats the stock of the
second-tier domestic corporation held by
the 25-percent-owned domestic corpora-
tion (“qualified stock”) as a non-passive
asset, and the related income as non-pas-
sive income.
The 2019 proposed regulations provid-
ed that section 1298(b)(7) did not apply
if, among other matters, a principal pur-
pose for the tested foreign corporation’s
formation or acquisition of the 25-per-
cent-owned domestic corporation was to
avoid classification of the tested foreign
corporation as a PFIC (“principal purpose
anti-abuse rule”). See proposed §1.1298-
4(f)(2). A modified version of the princi-
pal purpose anti-abuse rule is adopted in
the final regulations. See §1.1298-4(e)(1).
The proposed regulations provide two
safe harbors from the principal purpose
anti-abuse rule in §1.1298-4(e)(1). The
Treasury Department and the IRS request
comments on the application of the safe
harbors discussed in this Part I.A.5 of the
Explanation of Provisions.
Under the first safe harbor, the an-
ti-abuse rule will not apply if more than
80 percent of the assets of the second-tier
domestic corporation are used in an active
U.S. trade or business, as determined un-
der modified section 367 rules. See pro-
posed §1.1298-4(e)(2)(i). For purposes of
the safe harbor, the assets of the domestic
subsidiary qualified affiliates (as defined
in proposed §1.1298-4(e)(2)(i)(B)) are
also taken into account in determining
whether the assets of the second-tier do-
mestic corporation are used in a U.S. trade
or business. See proposed §1.1298-4(e)(2)
(i)(A).
The proposed regulations provide a
second safe harbor for active companies
undergoing transition and start-up com-
panies. See proposed §1.1298-4(e)(2)(ii).
Under this safe harbor, the anti-abuse rule
will not apply if the second-tier domes-
tic corporation engages in an active U.S.
trade or business that satisfies the first safe
harbor by the end of the transition period
following the testing date. See proposed
§1.1298-4(e)(2)(ii). Proposed §1.1298-
4(e)(2)(ii)(B) defines testing date as the
last day of the month in which either (i)
the second-tier domestic corporation is
created, organized, or acquired (“start-up
testing date”) or (ii) a second-tier domes-
tic corporation that previously satisfied
the first safe harbor disposes of substan-
tially all its active U.S. trade or business
(“change-of-business testing date”). Pro-
posed §1.1298-4(e)(2)(ii)(C) provides that
the transition period is thirty-six months
after a testing date. If the requirements of
the business transition and start-up safe
harbor are not satisfied within the transi-
tion period, the benefit of the safe harbor
is lost retroactively for the entire period
in which the safe harbor was claimed. See
proposed §1.1298-4(e)(2)(ii)(D). In these
instances, the general anti-abuse rule in
§1.1298-4(e)(1) will be applied to the
tested foreign corporation to determine
whether a principal purpose to avoid PFIC
classification existed for the preceding
years, which would be within the normal
statute of limitations on assessments un-
der section 6501.
B. Proposed revisions to §1.1297-4 –
qualifying insurance corporation
Section 1297(f) provides that a QIC
is a foreign corporation that (1) would be
subject to tax under subchapter L if it were
a domestic corporation, and (2) either
(A) has applicable insurance liabilities
(“AIL”) constituting more than 25 percent
of its total assets on its applicable finan-
cial statement (“AFS”) (“the 25 percent
test”), or (B) meets an elective alternative
facts and circumstances test which lowers
the required AIL-to-total assets ratio to
10 percent (“alternative facts and circum-
stances test”).
Most of the rules for determining
whether a foreign corporation is a QIC
under section 1297(f) are provided in the
final regulations under §1.1297-4. Pro-
posed §1.1297-4 contains additional rules
relating to the definition of an applicable
financial statement, the definition of appli-
cable insurance liabilities, and an optional
adjustment to total assets.
1. Definition of Applicable Financial
Statement
Proposed §1.1297-4(f)(1) defines
the term applicable financial statement
(“AFS”) in a manner that provides order-

February 1, 2021 692 Bulletin No. 2021–5
ing rules for how to prioritize between
multiple financial statements prepared at
the same level of priority, for example
multiple financial statements prepared
on the basis of GAAP or multiple finan-
cial statements prepared on the basis of
IFRS, and between multiple financial
statements prepared taking into account
the assets and liabilities of different legal
entities. The definition is modeled on sim-
ilar definitions elsewhere in the Code and
Treasury regulations, such as regulations
under section 451, but has been adapted to
the QIC context.
The term financial statement is defined
to mean a complete balance sheet, income
statement, and cash flow statement, or the
equivalent statements under the relevant
accounting standard, and ancillary doc-
uments typically provided together with
such statements. As regards an AFS, in
addition to the general levels of priority
set forth in section 1297(f)(4)(A) (GAAP,
IFRS, and insurance regulatory (statuto-
ry) statements), ordering rules provide
sub-priority levels (based on the purpose
for which the statement is prepared), with
higher priority being accorded to account-
ing statements viewed as more reliable.
Since the AFS is the financial statement
of a non-U.S. entity, financial statements
provided to foreign regulatory bodies gen-
erally are treated as having the same pri-
ority as if provided to an equivalent U.S.
regulatory body. The requirement that a
non-U.S. regulatory agency have stan-
dards not less stringent than those of the
U.S. Securities & Exchange Commission
is intended to provide a standard similar
to the definition of a qualified exchange
or other market for purposes of section
1296, with respect to reporting standards.
Because audited financial statements have
been reviewed by independent auditors,
and it is anticipated that insurance regu-
lators will require audited financial state-
ments, only audited statements can quali-
fy as AFS.
If a tested foreign corporation has mul-
tiple financial statements, the order of
priority described above is determinative.
However, if there are multiple financial
statements within a single level of prior-
ity and sub-priority (for example, multi-
ple GAAP financial statements provided
to creditors), additional ordering rules are
provided to assign priority first to a finan-
cial statement that is not prepared on a
consolidated basis (and that accounts for
investments in the tested foreign corpo-
ration’s subsidiaries (if any) on a cost or
equity basis), and then to a consolidated
financial statement that has the tested for-
eign corporation as the parent of the con-
solidated group. These rules are intended
to make it more likely that the AFS reflects
the same or similar assets and liabilities as
the financial statement used to determine
whether the section 1297(f)(3)(B) limita-
tion on the amount of applicable insurance
liabilities applies.
A financial statement prepared on a
consolidated basis that takes into account
affiliates that are not owned by the tested
foreign corporation (for example, sister
companies) is not treated as the AFS un-
less it is the only financial statement of the
tested foreign corporation and is provided
to an insurance regulator. It is anticipat-
ed that the only financial statement likely
to fall within that category is a financial
statement that includes the tested foreign
corporation and subsidiaries if any, and a
parent corporation.
Accordingly, if there are multiple fi-
nancial statements with the same level
of priority, non-consolidated financial
statements take priority over consolidated
financial statements. However, a consoli-
dated financial statement prepared on the
basis of GAAP that has the tested foreign
corporation as the parent of the consoli-
dated group has priority over a non-con-
solidated statement prepared on the basis
of statutory accounting standards, because
financial statements prepared on the basis
of GAAP are higher priority than financial
statements prepared on the basis of stat-
utory accounting standards. Similarly, a
consolidated statement prepared on the
basis of IFRS would have priority over
a non-consolidated statement prepared
on the basis of statutory accounting stan-
dards.
The Treasury Department and IRS re-
quest comments on the expanded defini-
tion of an AFS and the priority rules pro-
vided, including whether special rules are
needed to properly apply the limitation
under §1.1297-4(e)(2) if the statutory ac-
counting statement covers a different peri-
od than the AFS, and whether other more
detailed rules are necessary in order to
identify the AFS when a foreign corpora-
tion operates in multiple jurisdictions and
is subject to the authority of more than one
insurance regulatory body.
2. Definition of Applicable Insurance
Liabilities
As described in Part V.A.2 of the Sum-
mary of Comments and Explanation of
Revisions to the final regulations, section
1297(f)(4) contemplates that a foreign
corporation can use GAAP, IFRS, or the
accounting standard used for the annual
statement required to be filed with the lo-
cal regulator (if a statement prepared for
financial reporting purposes using GAAP
or IFRS is not available) as the starting
point to determine AIL. The preamble to
the final regulations notes, however, that
AIL is defined more specifically so that
only those liabilities that meet the require-
ments of section 1297(f)(3) and the relat-
ed regulatory definitions in §1.1297-4(f)
(2) are included in AIL, irrespective of
differences in nomenclature and methods
that may be used by different financial re-
porting standards.
Proposed §1.1297-4(f)(2)(i)(D)(3)
clarifies that, in determining AIL, liabil-
ities are reduced by an amount equal to
the assets reported on the corporation’s
financial statement that represent amounts
relating to those liabilities that may be re-
coverable from other parties through re-
insurance. The rule is necessary because
GAAP and the newest IFRS accounting
standard for insurance contracts, IFRS
17, (and possibly local statutory account-
ing depending on the laws of the foreign
jurisdiction) record amounts recoverable
from other parties as reinsurance with re-
spect to unpaid insurance losses and other
reserves on the asset side of the balance
sheet, rather than reducing balance sheet
liabilities. In contrast, insurance regula-
tory accounting rules (including those in
the United States) often reduce a ceding
company’s insurance liabilities by those
amounts instead of including them as as-
sets on the balance sheet. Both methods
result in the same amount of shareholder
equity for a foreign corporation but create
different ratios of AIL to total assets and,
thus, can potentially produce a difference
in a foreign corporation’s QIC status.
The Treasury Department and IRS
have determined that AIL should ex-

Bulletin No. 2021–5 693 February 1, 2021
clude amounts that have been reinsured
because the ratio test would otherwise
be subject to manipulation, and because
the Treasury Department and IRS be-
lieve that a uniform approach is appro-
priate for the treatment of reinsured risk
regardless of the particular accounting
standard that may apply. In addition, pro-
posed §1.1297-4(f)(2)(i)(D)(3) clarifies
that, if a tested foreign corporation’s fi-
nancial statement is prepared on a con-
solidated basis, liabilities of the tested
corporation must be reduced (to the ex-
tent not reduced under other provisions)
by an amount equal to the assets relating
to those liabilities that may be recover-
able through reinsurance from another
entity included in the consolidated fi-
nancial statement, regardless of whether
the reinsurance transaction is eliminated
in the preparation of the consolidated
financial statement. This proposed rule
is consistent with the rules of §1.1297-
4(f)(2)(i)(D)(1) and (2), which provide
that no item may be taken into account
more than once and that AIL include only
the liabilities of the foreign corporation
whose QIC status is being tested, and not
liabilities of other entities within a con-
solidated group.
The Treasury Department and IRS are
aware that certain arrangements permit
a ceding company to continue to hold
the reserves and assets required to sup-
port the insurance liabilities for the re-
insured contracts during the policy term
(so-called modified coinsurance or mod-
co). It has been held that life insurance
reserves on policies reinsured under a
modco arrangement are attributed to the
ceding company, and not the assuming
company. See Rev. Rul. 70-508, 1970-2
C.B. 136 (1970). See generally Colonial
Am. Life Ins. v. United States, 491 U.S.
244, 248, n.2 (1989); Anchor National
Life Ins. v. Commissioner, 93 T.C. 382,
423 (1989). Proposed §1.1297-4(f)(2)(i)
(D)(3) is not intended to apply to mod-
co arrangements where the ceding com-
pany retains the assets supporting the
insured risks (because they do not cre-
ate an amount recoverable from another
party), but the Treasury Department and
IRS request comments as to whether the
rule appropriately addresses modco ar-
rangements and whether additional rules
may be necessary in the final regulations.
The Treasury Department and IRS also
request comments as to whether to more
specifically define amounts recoverable
from another party through reinsurance
and whether there are other special cir-
cumstances in which modification of the
definition of AIL is appropriate.
3. Optional Asset Adjustment
Due to the manner in which AIL are
defined under §1.1297-4(f)(2), it may be
necessary to adjust the amount of a for-
eign corporation’s total assets to avoid
distortions in applying the 25 percent test
and the 10 percent test. First, if a foreign
corporation’s AFS is prepared on a con-
solidated basis, total assets may be re-
duced by the amount equal to the amount
of insurance liabilities of affiliated en-
tities that are reported on the AFS and
would be included in AIL if its definition
did not limit AIL to the AIL of the sub-
ject foreign corporation. See proposed
§1.1297-4(e)(4)(i). This adjustment is
appropriate because insurance liabilities
of an affiliate, though excluded from the
definition of AIL, can have the effect of
reducing the assets available to satisfy
the foreign corporation’s insurance lia-
bilities.
Second, if a foreign corporation reports
amounts recoverable from other parties
through reinsurance as assets on its AFS,
proposed §1.1297-4(e)(4)(ii) provides that
total assets may be reduced by the amount
by which AIL are reduced under proposed
§1.1297-4(f)(2)(i)(D)(3). As explained in
Part I.B.2 of this Explanation of Provi-
sions, proposed §1.1297-4(f)(2)(i)(D)(3)
requires a foreign corporation’s AIL to be
reduced to reflect those amounts. Without
a corresponding adjustment to total assets,
the same reinsurance contract could have
the effect of reducing a foreign corpora-
tion’s AIL while also increasing its total
assets. The Treasury Department and IRS
request comments as to whether there are
other situations that warrant an adjustment
to total assets.
C. Proposed §1.1297-5: active conduct of
an insurance business
Section 1297(b)(2)(B) provides an
exclusion from the definition of passive
income for income derived in the ac-
tive conduct of an insurance business by
a QIC. As described in Part VI.A of the
Summary of Comments and Explana-
tion of Revisions to the final regulations,
proposed §1.1297-5 revises previously
proposed rules for determining whether a
QIC is engaged in the active conduct of an
insurance business.
1. Overview
As explained in Part VI.A of the Sum-
mary of Comments and Explanation of
Revisions to the final regulations, the
Treasury Department and the IRS have
determined that the active conduct of an
insurance business is a requirement man-
dated by the statute in addition to (and
separate from) the requirements of sub-
chapter L and section 1297(f), but that in
response to comments, the active conduct
test should be amended to provide more
flexibility in determining whether a QIC
is engaged in the active conduct of an
insurance business. Proposed §1.1297-
5(b)(1) provides that a QIC is treated as
engaged in the active conduct of an in-
surance business if it satisfies either the
factual requirements test under proposed
§1.1297-5(c) or the active conduct per-
centage test under proposed §1.1297-5(d).
The Treasury Department and IRS request
comments on the active conduct test, in-
cluding the addition of the new factual re-
quirements test and revisions to the active
conduct percentage test.
2. Exclusions from Active Conduct
Under §1.1297-5(b)(2), two catego-
ries of insurance companies are preclud-
ed from meeting the active conduct test.
First, a QIC is not engaged in the active
conduct of an insurance business if it has
no employees (or a nominal number of
employees) and relies exclusively (or al-
most exclusively) on independent contrac-
tors to perform its core functions. Second,
the active conduct test excludes securiti-
zation vehicles (such as vehicles used to
issue catastrophe bonds, sidecars, or col-
lateralized reinsurance vehicles) and in-
surance linked securities funds that invest
in securitization vehicles. These vehicles
are excluded because they are designed to
provide a passive investment return tied to
insurance risk rather than participation in

February 1, 2021 694 Bulletin No. 2021–5
the earnings of an active insurance busi-
ness.
3. Factual Requirements Test
As noted in Part VI.A of the Summary
of Comments and Explanation of Revi-
sions to the final regulations, several com-
ments requested the addition of a facts
and circumstances test; other comments
recommended that the active conduct test
focus on the assumption of insurance risk;
and a comment specifically identified un-
derwriting as a core insurance function
that must be performed by an insurance
company’s officers and employees. The
factual requirements test has been added
in response to these comments. The active
conduct percentage test has been retained
(in modified form) as an alternative means
of satisfying the active conduct require-
ment.
Proposed §1.1297-5(c) provides that
the factual requirements test is satisfied
if the QIC’s officers and employees carry
out substantial managerial and operation-
al activities on a regular and continuous
basis with respect to all of its core func-
tions and perform virtually all of the ac-
tive decision-making functions relevant to
underwriting. A QIC’s core functions are
generally defined to include underwriting,
investment, contract and claim manage-
ment, and sales activities. See proposed §
1.1297-5(f) for definitions of these terms.
See Part I.C.5 of this Explanation of Pro-
visions for rules concerning officers and
employees of related entities.
A QIC’s officers and employees are
considered to carry out substantial mana-
gerial and operational activities relevant to
its core functions only if they are involved
in all levels of planning and implementa-
tion related to the QIC’s core functions
as described in proposed §1.1297-5(c)
(2). The required activities must be con-
ducted by officers or senior employees
with appropriate experience who devote
all (or virtually all) of their work to those
activities and similar activities for related
entities.
The active decision-making functions
relevant to a QIC’s underwriting activities
are those underwriting activities most im-
portant to decisions of the QIC relating to
the assumption of specific insurance risks.
See proposed §1.1297-5(c)(3). To meet
this requirement, officers and employees
of the QIC must carry out virtually all of
the activities related to a QIC’s decision to
assume an insurance risk and must conduct
virtually all of the decision-making with
respect to the execution of an insurance
contract on a contract-by-contract basis.
Development of underwriting policies and
parameters that are changed infrequently
is not an active decision-making function
in the absence of further ongoing involve-
ment by the QIC’s officers and employees.
See proposed §1.1297-5(c)(3)(iii)(A).
4. Active Conduct Percentage Test
The active conduct percentage test is
provided in proposed §1.1297-5(d). To
meet this test, two requirements must be
satisfied. First, the total costs incurred
by a QIC with respect to its officers and
employees for services rendered with re-
spect to its core functions (other than in-
vestment activities) must equal at least
50 percent of the total costs incurred for
all services rendered with respect to the
QIC’s core functions (other than invest-
ment activities). In response to comments
to the 2019 proposed regulations, invest-
ment activities have been excluded from
both the numerator and denominator of
the percentage calculation. Second, if any
part of a QIC’s core functions (including
investment management) is outsourced to
an unrelated entity, the QIC’s officers and
employees must conduct robust oversight
with respect to the outsourced activities.
See proposed §1.1297-5(d)(2).
The proposed regulations provide a
definition of total costs that is used to ap-
ply the active conduct percentage test. See
§1.1297-5(f)(8). With respect to a QIC’s
own officers and employees, total costs are
defined as compensation costs plus other
expenses reasonably allocable to the ser-
vices provided (determined in accordance
with section 482 and taking into account
all expenses that would be included in the
total services costs under §1.482-9(j) and
§1.482-9(k)(2)). With respect to services
performed by employees of another entity
(whether related or unrelated), total costs
are equal to the amount paid or accrued by
the QIC to the other entity for the relevant
services. Ceding commissions paid with
respect to reinsurance contracts and com-
missions paid to brokers or sales agents to
procure reinsurance contracts are exclud-
ed from the definition of total costs.
5. Officers and Employees of Related
Entities
For purposes of applying the factual
requirements test and the active conduct
percentage test, a QIC’s officers and em-
ployees are considered to include the of-
ficers and employees of related entities,
where such entities are qualified affiliates
of the QIC within the meaning of §1.1297-
2(e)(2), except that the 50 percent owner-
ship standard is based on both value and
voting power. See proposed §1.1297-5(e).
A qualified affiliate is a corporation or a
partnership that is included in an affiliat-
ed group that includes the QIC. Affiliated
group has the meaning provided in section
1504(a), determined without regard to
section 1504(b)(2) and (3) (which would
otherwise exclude foreign corporations
and life insurance companies from mem-
bership) and substituting “more than 50
percent” ownership for “at least 80 per-
cent”. In addition, consistent with the rules
of §1.1297-2(e)(2), the common parent of
the group must be a foreign corporation or
foreign partnership, and a corporation or
a partnership is included in the affiliated
group only if it is a look-through subsidi-
ary or look-through partnership, as appli-
cable, of the common parent. Also, a part-
nership is included in the affiliated group
only if more than 50 percent of the value
of its capital interests, profits interests and
any other partnership interests is owned
by one or more corporations that are in-
cluded in the affiliated group. The related
entity rule applies only if the QIC bears
the compensation costs on an arm’s length
basis and exercises oversight and supervi-
sion with respect to the services provided
by affiliated officers and employees. See
proposed §1.1297-5(e)(3).
As noted in Part VI.A of the Summary
of Comments and Explanation of Revi-
sions to the final regulations, comments
requested broader attribution rules that
would cover employees of entities that are
related to the QIC within the meaning of
section 954(d)(3) or are under common
practical control with the QIC. These com-
ments have not been adopted. Because the
active conduct test is designed to assess
the activities of a QIC on a separate entity

Bulletin No. 2021–5 695 February 1, 2021
basis (rather than the activities conducted
by an insurance group as a whole), ser-
vices performed by officers and employ-
ees of other entities cannot be attributed
to a QIC except in the circumstances de-
scribed in proposed §1.1297-5(e). Howev-
er, the Treasury Department and the IRS
determined that it was appropriate to align
the common ownership requirements for
purposes of the insurance active conduct
rule with the ownership requirements
used in §1.1297-2(e)(2) for look-through
subsidiary activity attribution purposes,
except including a vote as well as value
requirement to ensure a heightened level
of common control of the related entity
officers and employees.
D. Proposed §1.1297-6(e)(2): qualifying
domestic insurance corporation non-
passive income and asset limitations
1. Qualifying Domestic Insurance
Corporation Rule
Sections 1.1297-6(b)(2) and (c)(2)
of the final regulations provide that in-
come and assets, respectively, of a qual-
ifying domestic insurance corporation
(“QDIC”) are non-passive for purposes
of determining whether a non-U.S. cor-
poration is treated as a PFIC (the “QDIC
Rule”). Section 1.1297-6(e)(1) of the fi-
nal regulations defines a QDIC as a do-
mestic corporation that is subject to tax as
an insurance company under subchapter
L, is subject to Federal income tax on its
net income, and is a look-through subsid-
iary of a tested foreign corporation. The
QDIC Rule is intended to address situa-
tions where a tested foreign corporation
owns a 25 percent or greater interest in
a domestic insurance corporation through
a structure to which section 1298(b)(7)
does not apply, such that the income and
assets of the QDIC are taken into account
in determining whether the tested foreign
corporation is a PFIC.
The previous 2019 proposed regula-
tions also provided that the QDIC Rule
did not apply for purposes of section
1298(a)(2) and determining if a U.S. per-
son indirectly owns stock in a lower tier
PFIC (“Proposed QDIC Attribution Ex-
ception”). Consequently, for attribution
purposes, the 2019 proposed regulations
required a tested foreign corporation to
apply the Income Test and Asset Test
without applying the QDIC Rule.
Several comments on the 2019 pro-
posed regulations requested that the Pro-
posed QDIC Attribution Exception be
removed because U.S. shareholders of
a tested foreign corporation that would
not otherwise be a PFIC but owns a PFIC
and a U.S. insurance subsidiary that is a
QDIC could become indirect owners of a
PFIC as a result of the section 1298(a)(2)
attribution rule. Comments asserted that
turning off the QDIC Rule when testing
for lower-tier PFIC ownership attribution
would undermine the purpose of the rule
and create significant burden for U.S. mi-
nority shareholders of the tested foreign
corporation, who would have to sepa-
rately evaluate the PFIC status of all of
the tested foreign corporation’s foreign
subsidiaries.
2. Proposed §1.1297-6(e)(2) QDIC
Limitation Rule
The Treasury Department and IRS
agree that the Proposed QDIC Attribution
Exception was overbroad and removed it
from the final regulations. However, the
Treasury Department and IRS believe that
limits on the amount of a QDIC’s assets
and income that are treated as non-pas-
sive may be appropriate in cases where
a QDIC holds substantially more passive
assets than necessary to support its insur-
ance and annuity obligations. Thus, pro-
posed §1.1297-6(e)(2) provides that the
amount of a QDIC’s otherwise passive
income and assets that may be treated
as non-passive is subject to a maximum
based on an applicable percentage of the
QDIC’s total insurance liabilities (“QDIC
Limitation Rule”).
Proposed §1.1297-6(e)(2)(i) provides
that the amount of a QDIC’s passive as-
sets that are treated as non-passive under
the QDIC Rule may not exceed an appli-
cable percentage of the corporation’s total
insurance liabilities. This amount is the
QDIC’s non-passive asset limitation. Pro-
posed §1.1297-6(e)(2)(ii) provides that
the amount of a QDIC’s passive income
that is treated as non-passive under the
QDIC Rule may not exceed the corpora-
tion’s passive income multiplied by the
proportion that the QDIC’s non-passive
asset limitation bears to its total passive
assets (determined without the application
of the rules under §1.1297-6(c)(2)).
Under proposed §1.1297-6(e)(2)
(iii), the applicable percentage is 200
percent for a life insurance company
and 400 percent for a nonlife insurance
company. Proposed §1.1297-6(e)(2)(iv)
(A) provides that, for a QDIC taxable
under Part I of Subchapter L (that is, a
life insurance company), total insurance
liabilities means the sum of the compa-
ny’s total reserves (as defined in section
816(c)) plus (to the extent not included in
total reserves) the reserve items referred
to in paragraphs (3), (4), (5), and (6) of
section 807(c). For a company taxable
under Part II of Subchapter L (that is,
a nonlife insurance company), the term
total insurance liabilities means the sum
of unearned premiums and unpaid loss-
es. See proposed §1.1297-6(e)(2)(iv)
(B). Because a QDIC will be subject to
tax under Subchapter L, it is appropriate
to determine the amount of its insurance
liabilities for purposes of the QDIC Lim-
itation Rule in accordance with Subchap-
ter L rules governing insurance liabilities
because the QDIC will already be deter-
mining these amounts for U.S. income
tax purposes. See proposed §1.1297-6(e)
(3) for an example illustrating the appli-
cation of these rules.
The Treasury Department and the IRS
request comments on the QDIC Limita-
tion Rule and in particular on whether
the specified applicable percentages are
reasonable based on industry data. The
Treasury Department and IRS expect most
QDICs to not exceed the passive asset and
income limitations based on the applicable
percentages. In addition, a tested foreign
corporation may hold less than 50 per-
cent passive assets and receive less than
75 percent passive income without being
classified as a PFIC. Thus, the QDIC Lim-
itation Rule provides a disincentive for a
foreign corporation to shift excessive pas-
sive assets into its U.S. insurance subsid-
iary in order not to qualify as a PFIC and
is likely to affect the PFIC classification of
only a very small number of companies.
Comments are also requested on whether
final regulations should specifically allow
for the applicable percentages to be ad-
justed or supplemented in subregulatory
guidance (for example, to reflect possible
future changes in industry practice).

February 1, 2021 696 Bulletin No. 2021–5
E. Life insurance and annuity contract
status
Section 1297(f)(1)(A) provides that a
QIC must be a foreign corporation that
would be subject to tax under subchapter
L if it were a domestic corporation. An
insurance company is defined in sections
816(a) and 831(c), which limit insurance
company status to a company more than
half the business of which during the tax-
able year is the issuing of insurance or
annuity contracts or the reinsurance of
risks underwritten by insurance compa-
nies. Thus, the status of a company as an
insurance company under subchapter L
depends upon the characterization of the
contracts that a company issues or rein-
sures. In addition, section 816(a) provides
that if more than half of the company’s to-
tal reserves (as defined in section 816(c))
are life insurance reserves (as defined in
section 816(b)) or unearned premiums and
unpaid losses on non-cancellable life, ac-
cident, or health contracts, then the com-
pany is a life insurance company taxable
under part 1 of subchapter L; otherwise,
an insurance company is taxable under
part II of subchapter L.
Life insurance contracts and annuity
contracts must meet certain statutory re-
quirements to be treated as contracts giving
rise to life insurance reserves for subchap-
ter L purposes. Section 7702(a) defines a
life insurance contract for purposes of the
Code as a life insurance contract under ap-
plicable law (which includes foreign law)
that satisfies one of two actuarial tests set
forth in section 7702. Similarly, section
72(s) sets forth distribution on death re-
quirements that an annuity contract must
satisfy in order to be considered an annu-
ity contract for purposes of the Code. In
addition, if a contract is a variable contract
within the definition of section 817(d), it
must satisfy the diversification require-
ments for variable contracts under section
817(h) to be treated as a life insurance or
annuity contract for purposes of subchap-
ter L. These statutory requirements reflect
Congress’s concern that the tax-favored
treatment generally accorded to life insur-
ance and annuity contracts under the Code
should not be available to contracts that
are too investment oriented or provide for
undue tax deferral.
A taxpayer request (and follow-up
submission) was received by the Trea-
sury Department and the IRS regarding
promulgating regulations that would pro-
vide that these statutory requirements do
not apply for purposes of determining
whether a foreign corporation satisfies the
section 1297(f)(1)(A) requirement that
the corporation would be subject to tax
under subchapter L if it were a domestic
corporation (as well as for other PFIC
purposes), if certain requirements are met.
The request suggested an approach to the
statutory requirements analogous to the
approach Congress took in section 953(e)
(5). Section 953(e)(5) waives the statutory
requirements for purposes of the subpart
F insurance and foreign base company
income rules if a contract is regulated as
a life insurance or annuity contract in the
issuer’s home country and no policyhold-
er, insured, annuitant, or beneficiary with
respect to the contract is a U.S. person.
The request asserts that such a waiver is
warranted for PFIC purposes because con-
tracts issued by non-U.S. insurance com-
panies are unlikely to satisfy the statutory
requirements, since non-U.S. insurance
companies that do not target sales to the
U.S. market typically do not take the stat-
utory requirements into account when set-
ting the terms of their life insurance and
annuity contracts. The request also states
that local law requirements may in some
cases conflict with the statutory require-
ments. The follow-up submission sug-
gested that additional qualification rules
could be imposed that restrict the rule to
cases in which the issuing company meets
substantial home country requirements
(such as deriving more than 50 percent of
its aggregate net written premiums from
insuring or reinsuring home country risks
of unrelated persons).
The proposed regulations do not ad-
dress the request as it is beyond the scope
of the current rulemaking. The Treasury
Department and the IRS are evaluating
whether further guidance is necessary or
appropriate regarding the application of
these provisions in the context of PFICs
and request comments on this issue.
II. QIP’s 20-Year ADS Recovery Period
Applies to Determine QBAI for FDII and
GILTI
The proposed regulations contain cer-
tain rules announced in Notice 2020-69.
Proposed §1.250(b)-2(e)(2) and proposed
§1.951A-3(e)(2) clarify that the technical
amendment to section 168 enacted in sec-
tion 2307(a) of the CARES Act applies
to determine the adjusted basis of prop-
erty under section 951A(d)(3) as if it had
originally been part of section 13204 of
the Act. The Treasury Department and the
IRS have determined that this clarification
is consistent with congressional intent.
See JCT CARES Act Report at 69-70.
The Treasury Department and the IRS
request comments on whether a transition
rule should be provided that would allow
a corrective adjustment in the first taxable
year ending after the date of publication
in the Federal Register of the Treasury
Decision adopting proposed §1.250(b)-
2(e)(2) and proposed §1.951A-3(e)(2) as
final regulations for taxpayers that took
a position that is inconsistent with pro-
posed §1.250(b)-2(e)(2) and proposed
§1.951A-3(e)(2) on a return filed before
September 1, 2020 and that do not file
an amended return with respect to such
year.
10
Applicability Dates
I. Applicability Dates Relating to the
General PFIC Rules
These regulations are proposed to apply
to taxable years of United States persons
that are shareholders in certain foreign cor-
porations beginning on or after the date of
filing of the Treasury Decision adopting
these rules as final regulations in the Fed-
eral Register. However, until these regu-
lations are finalized, taxpayers may rely on
one or more of the following proposed rules
with respect to a tested foreign corporation
for any open taxable year beginning before
the date of publication of the Treasury de-
10
The Treasury Department and the IRS requested comments on the need for a transition rule in Notice 2020-69. The Treasury Department and the IRS will consider comments that are
timely submitted in response to the request for comments in Notice 2020-69, along with any comments received in response to this notice of proposed rulemaking, when finalizing proposed
§1.250(b)-2(e)(2) and proposed §1.951A-3(e)(2).

Bulletin No. 2021–5 697 February 1, 2021
cision adopting these rules as final regu-
lations in the Federal Register, provided
they consistently follow each such rule for
each subsequent taxable year beginning
before the date of filing of the Treasury
decision adopting these rules as final reg-
ulations in the Federal Register: proposed
§1.1297-1(c)(1)(i)(B) (exceptions to sec-
tion 954 not taken into account); proposed
§1.1297-1(c)(2) (exception for active bank-
ing income of certain foreign banks); pro-
posed §1.1297-1(d)(1)(v)(D) (valuation of
assets); proposed §1.1297-1(d)(2) (regard-
ing working capital); proposed §1.1297-
2(b)(2)(ii)(A), (b)(3)(ii)(A), and (e)(4) (re-
garding application of exception for active
banking income of certain foreign banks);
proposed §1.1297-2(c)(2)(i) and (4)(ii)
(A) (regarding not taking into account
certain dividends); proposed §1.1297-2(f)
(1) and (2) (regarding gain on disposition
of stock in a look-through subsidiary), and
proposed §1.1298-4(e) (regarding safe har-
bors to the domestic subsidiary anti-abuse
rule). For a taxable year ending on or be-
fore December 31, 2020, a taxpayer may
rely on proposed §1.1297-1(c)(1)(A) of the
2019 proposed regulations concerning the
application of section 954(h) rather than
proposed §1.1297-1(c)(2) with respect to
a tested foreign corporation, without re-
gard to whether the taxpayer consistently
applies all of the provisions of these pro-
posed regulations or the 2019 proposed
regulations with respect to the tested for-
eign corporation. As discussed in greater
detail in the preamble to the final regula-
tions published in the Rules and Regula-
tions section of this edition of the Federal
Register (RIN 1545-BO59), when a tested
foreign corporation no longer qualifies as
a PFIC (due to a change in facts or law),
the foreign corporation nonetheless retains
its PFIC status with respect to a sharehold-
er unless and until the shareholder makes
an election under section 1298(b)(1) and
§1.1298–3 (“purging election”) on Form
8621 attached to the shareholder’s tax re-
turn (including an amended return), or re-
quests the consent of the Commissioner to
make a late election under section 1298(b)
(1) and §1.1298–3(e) (“late purging elec-
tion”) on Form 8621-A.
II. Applicability Dates Relating to the
Insurance Exception
For a taxable year beginning after
December 31, 2017 and before the date
of filing of the Treasury Decision adopt-
ing these rules as final regulations in the
Federal Register, taxpayers may rely on
§§1.1297-4, 1.1297-5, and 1.1297-6 of
the proposed regulations with respect to a
tested foreign corporation, provided they
consistently follow the rules of §§1.1297-
4, 1.1297-5, and 1.1297-6 of the proposed
regulations with respect to such tested
foreign corporation for such taxable year
and for each subsequent taxable year be-
ginning before the date of filing of the
Treasury decision adopting these rules
as final regulations in the Federal Reg-
ister. In addition, taxpayers may rely on
proposed §1.1297-4(e)(4), provided they
consistently apply §1.1297-4 of the final
regulations for the same taxable year.
Alternatively, for a taxable year begin-
ning after December 31, 2017 and before
January 14, 2021, taxpayers may rely on
proposed §§1.1297-4 and 1.1297-5 of the
2019 proposed regulations with respect
to a tested foreign corporation, provided
they consistently apply the rules of pro-
posed §§1.1297-4 and 1.1297-5 of the
2019 proposed regulations with respect to
such tested foreign corporation for such
taxable year.
III. Applicability Dates Relating to
Regulations under Sections 250 and 951A
Consistent with section 2307(b) of the
CARES Act, the proposed regulations
addressing QIP are proposed to apply ret-
roactively. The modification to proposed
§1.951A-3(e)(2) is proposed to apply to
taxable years of foreign corporations be-
ginning after December 31, 2017, and
to taxable years of U.S. shareholders in
which or with which such taxable years
of foreign corporations end. The mod-
ification to proposed §1.250(b)-2(e)(2)
is proposed to apply to taxable years be-
ginning after December 31, 2017.
11
See
section 7805(b)(2). U.S. shareholders and
domestic corporations (including any in-
dividuals that elect to apply section 962)
may, before the date of publication of the
Treasury Decision adopting these rules
as final regulations in the Federal Reg-
ister, rely on proposed §§1.951A-3(e)(2)
and 1.250(b)-2(e)(2) for any taxable year
beginning after December 31, 2017, pro-
vided they consistently apply those rules
for purposes of FDII and GILTI under sec-
tions 250 and 951A to such taxable year
and all subsequent taxable years.
Special Analyses
I. Regulatory Planning and Review –
Economic Analysis
Executive Orders 13771, 13563, and
12866 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to se-
lect regulatory approaches that maximize
net benefits, including potential economic,
environmental, public health and safety
effects, distributive impacts, and equi-
ty. Executive Order 13563 emphasizes
the importance of quantifying both costs
and benefits, reducing costs, harmonizing
rules, and promoting flexibility. The Ex-
ecutive Order 13771 designation for any
final rule resulting from the final regula-
tions will be informed by comments re-
ceived.
This proposed regulation has been des-
ignated by the Office of Information and
Regulatory Affairs (OIRA) as subject to
review under Executive Order 12866 pur-
suant to the Memorandum of Agreement
(MOA, April 11, 2018) between the Trea-
sury Department and the Office of Man-
agement and Budget regarding review
of tax regulations. OIRA has determined
that the final rulemaking is significant and
subject to review under Executive Order
12866 and section 1(b) of the Memoran-
dum of Agreement. Accordingly, the final
regulations have been reviewed by OMB.
A. Background
The passive foreign investment com-
pany (PFIC) rules of the Internal Rev-
enue Code address situations in which
11
The rule in proposed §1.250(b)-2(e)(2) in this notice of proposed rulemaking applies to taxable years beginning after December 31, 2017 and before January 1, 2021 regardless of whether
the taxpayer has relied on proposed §§1.250(a)-1 through 1.250(b)-6 (as proposed in REG-104464-18, 84 FR 8188), the final regulations under §§1.250(a)-1 through 1.250(b)-6 under §1.250-
1(b) (T.D. 9901, 85 FR 43042), or neither.

February 1, 2021 698 Bulletin No. 2021–5
taxable U.S. persons indirectly hold
assets that earn “passive income” (gen-
erally, interest, dividends, capital gains,
and similar types of income) through a
foreign corporation. If not subject to the
PFIC rules, the income earned on these
assets would be subject to U.S. tax only
when that income is distributed as divi-
dends by the foreign corporation or when
shares of the foreign corporate stock are
sold for a gain by the U.S. shareholder.
If the income were subject to a low or
zero rate of foreign tax, the U.S. inves-
tor would have a tax incentive to hold
passive assets in this manner rather than
hold the securities directly. By creating
tax-deferral opportunities, these types
of investment arrangements could sig-
nificantly lower the effective tax rate
on passive income ultimately received
by participating U.S. investors. This po-
tential result would decrease U.S. tax
revenues and possibly lower the cost of
capital faced by foreign and domestic
corporations whose securities were held
in this manner.
A foreign corporation is considered a
PFIC if at least 75 percent of the corpo-
ration’s gross income for a given taxable
year is passive income or if assets that
produce passive income, or that are held
for the production of passive income,
comprise at least 50 percent of the corpo-
ration’s total assets. A PFIC is not subject
to U.S. tax under the PFIC regime; rather,
U.S. shareholders of a PFIC are subject to
tax on a current, or current-equivalent, ba-
sis in proportion to their ownership share
in the PFIC’s income.
Passive income generally consists
of dividends, interest, rents, royalties,
annuities, gains on the sale of property
that is not inventory or property used in
an active business, and similar forms of
income. Passive income is distinguished
generally from non-passive income in
that it is not earned in the active con-
duct of a trade or business by the foreign
corporation, by a party closely affiliated
with the foreign corporation, or by other
corporations or partnerships that can be
assumed to be controlled by the foreign
corporation.
The “subpart F” rules in the Code also
address the taxation of passive income
earned by foreign corporations but only in
the context of U.S. controlled foreign cor-
porations (CFCs), defined as being more
than 50 percent owned by U.S. share-
holders (where a U.S. shareholder of a
CFC is a U.S. person owning at least ten
percent of the vote or value of the foreign
corporation’s shares). There is no such
minimum ownership requirement for a
U.S. shareholder of a PFIC. A PFIC that
is also a CFC during a portion of a U.S.
PFIC shareholder’s holding period is not
treated as a PFIC with respect to a U.S.
shareholder of a CFC during that portion
of the holding period.
A U.S. shareholder of a PFIC is re-
sponsible for determining its proportion-
ate share of ownership in the PFIC and
the appropriate amount of PFIC income
to include on the shareholder’s tax re-
turn. The Code and regulations provide
ownership attribution rules for deter-
mining indirect ownership of PFICs by
U.S. persons and rules for determining
amounts of a corporation’s annual total
and passive income and the amounts of
total and passive assets on each of sev-
eral measuring periods (generally quar-
terly) throughout the year. Compliance
with the PFIC regime requires an ability
to negotiate its often-complicated rules
and generally means that those willing
to invest in potential PFICs are relatively
sophisticated taxpayers that have access
to professional tax advice in order to nav-
igate the tax complexities presented by
the PFIC regime. It is also possible that
a less sophisticated taxpayer could invest
in a PFIC without a full understanding of
the tax treatment of that investment.
The PFIC definition of passive income
refers to the passive income definition
of “foreign personal holding company
income” (FPHCI) used for purposes of
the CFC rules. That definition contains
exceptions from passive income that in-
volve certain income derived by a CFC in
the active conduct of a banking or financ-
ing business and certain income derived
by a CFC in the active conduct of an
insurance business. However, the PFIC
statutory rules have separate exceptions
from the definition of passive income
that include any income “derived in the
active conduct of a banking business by
an institution licensed to do business as a
bank in the United States (or, to the ex-
tent provided in regulations, by any other
corporation)” and any income “derived in
the active conduct of an insurance busi-
ness by a qualifying insurance corpora-
tion.” Regulations under the PFIC bank-
ing exception were proposed in 1995 (the
“1995 proposed regulations”) to provide
greater clarity and additional specifica-
tion of this exception to passive income.
These 1995 proposed regulations have
not been finalized. Regulations under the
PFIC insurance exception were proposed
in 2015 to clarify further the meaning
of “active conduct” in this context, but
these regulations have not been finalized.
More recently, the Tax Cuts and Jobs Act
(TCJA) of 2017 amended the statuto-
ry provision by requiring that the PFIC
insurance exception applies only to an
insurance business conducted by a qual-
ifying insurance corporation (QIC) and
provided a statutory definition of a QIC.
The Treasury Department and the IRS
previously published proposed regula-
tions pertaining to sections 1291, 1297,
and 1298 of the Code (the “2019 proposed
regulations”). See 84 FR 33120. These
regulations dealt with several general
PFIC implementation issues and with the
new requirement (beginning in 2018) that
a foreign corporation must be a QIC for
its insurance-related income to qualify as
non-passive under the insurance business
exception. Regulations to finalize these
proposed regulations (the “2020 final reg-
ulations”) are being published contempo-
raneously with these newly proposed reg-
ulations (“these regulations” or the “2020
proposed regulations”). See TD 9936.
Upon further reflection on certain issues,
and in response to public comments re-
ceived with respect to the 2019 proposed
regulations, certain revised rules and ad-
ditional specifications are being re-pro-
posed.
B. Need for the proposed regulations
These regulations are needed because a
number of the details behind the relevant
terms and necessary calculations required
for the determination of PFIC status
would benefit from greater specificity be-
yond that provided by the 2020 final regu-
lations. In particular, these 2020 proposed
regulations further clarify the determina-
tion of the banking and insurance “active
conduct” statutory exceptions to the defi-
nition of passive income.

Bulletin No. 2021–5 699 February 1, 2021
C. Economic analysis
This economic analysis provides a
summary of the economic effects of the
regulations relative to the no-action base-
line. It further analyzes, first, proposed
regulations under the general rules that
implement the exception from passive
income for income derived in the active
conduct of a banking business and, sec-
ond, proposed regulations under the pas-
sive income exception for income earned
in the active conduct of an insurance
business by a qualifying insurance corpo-
ration (QIC). This latter analysis covers,
in particular, elements of these proposed
regulations as they relate to the primary
test ratio that must be satisfied by a QIC.
This test requires measurement of certain
applicable insurance liabilities (AIL) and
total assets of a tested corporation.
1. Baseline
In this analysis, the Treasury Depart-
ment and the IRS assess the benefits and
costs of these regulations relative to a
no-action baseline reflecting anticipated
Federal income tax-related behavior in the
absence of these proposed regulations.
2. Summary of Economic Effects
These 2020 proposed regulations will
provide improved certainty and consis-
tency in the application of sections 1297
and 1298 of the Internal Revenue Code
with respect to passive foreign investment
companies (PFICs) and qualified insur-
ance corporations (QICs) by providing
definitions and clarifications regarding ap-
plication of the statute’s terms and rules.
Efficient investment requires planning,
and good planning requires knowledge
of the proper and consistent application
of tax rules. Furthermore, uncertainty re-
garding the applicability of tax rules in-
vites aggressive taxpayer interpretations
and increased enforcement costs, includ-
ing increased litigation.
Divergence in taxpayers’ interpreta-
tions of the statute can cause similarly sit-
uated U.S. persons to allocate investment
funds differently. If economic investment
is not guided by uniform tax incentives,
the resulting pattern of investment may be
inefficient, leading to relatively lower in-
comes. By providing clarity to the law and
greater uniformity in its application, the
2020 proposed regulations, when final-
ized, will help to ensure that similar eco-
nomic activities are taxed similarly. Thus,
the Treasury Department and the IRS ex-
pect that the definitions and guidance pro-
vided in the proposed regulations will lead
to an improved allocation of investment
among U.S. taxpayers as well as more eq-
uitable treatment of those taxpayers.
To the extent that certain regulatory
provisions provide greater opportunities
for foreign corporations to avoid PFIC
status relative to the no-action baseline,
they provide U.S. investors with addi-
tional tax deferral opportunities relative
to a no-action baseline. An increased use
of these tax deferral opportunities would
decrease effective shareholder taxes and
generally lower the cost of real invest-
ment by both domestic businesses and
foreign corporations for which U.S. inves-
tors are investment funding sources. This
would likely increase such investment and
thereby increase U.S. GNP relative to the
no-action baseline. However, such actions
would reduce U.S. tax revenues, although
this effect could be offset to a degree by
increased taxable capital gains due to a
resultant increase in the valuation of cor-
porate equities.
To the extent that other provisions of
the regulations reduce the opportunities
for foreign corporations to avoid PFIC sta-
tus, they would eliminate deferral by U.S.
persons and thereby increase U.S. share-
holder tax burdens. This may dissuade
U.S. persons from pursuing profitable in-
vestment opportunities in active foreign
corporations that would be sought under
a no-action baseline. Such provisions also
could cause some active foreign corpora-
tions to incur additional economic costs
in order to avoid designations as PFICs,
resulting in lower investment returns and
less investment in such corporations. The
avoidance of otherwise profitable foreign
investment opportunities by U.S. persons
can result in a loss of U.S. GNP.
It is unclear whether these proposed
regulations have a net effect of increasing
or decreasing the ability of foreign corpo-
rations to avoid PFIC status relative to the
no-action baseline.
The Treasury Department and the IRS
have not estimated the differences in
economic activity that might result from
implementation of these proposed regula-
tions relative to alternative regulatory ap-
proaches, including the no-action baseline.
They do not have readily available data or
models that capture in sufficient detail the
economic activities that taxpayers might
undertake under each of these regulatory
approaches. The Treasury Department and
the IRS have similarly not estimated the
differences in compliance costs of U.S.
persons or IRS administrative burden that
would arise under each of the alternative
regulatory approaches because they do not
have readily available data or models that
capture these aspects in sufficient detail.
The Treasury Department and the IRS
solicit comments on this economic anal-
ysis and particularly solicit data, models,
or other evidence that could be used to
enhance the rigor with which the final reg-
ulations are developed.
3. Economic Analysis of Specific
Provisions
a. Income derived in the active conduct
of a banking business
The PFIC provisions define passive in-
come as income which is of a kind that
would be foreign personal holding compa-
ny income (FPHCI) as defined in section
954(c), which is part of the subpart F rules
of the Internal Revenue Code. A related
provision, section 954(h), excludes from
FPHCI for subpart F purposes the “qual-
ified banking or financing income” of an
“eligible controlled foreign corporation,”
that is, a CFC that is predominantly en-
gaged in the active conduct of a banking,
financing, or similar business and that
conducts substantial activity with respect
to such business. A banking, financing
or similar business includes (i) a lending
or finance business, (ii) a banking busi-
ness conducted by an institution that is
licensed to do business as a bank in the
United States or is a corporation specified
in regulations, and (iii) a securities busi-
ness conducted by a corporation that is ei-
ther registered with the SEC as a securities
broker or dealer or is otherwise specified
in regulations.
The 2019 PFIC proposed regulations
would have incorporated this section
954(h) exception to FPHCI into the defi-

February 1, 2021 700 Bulletin No. 2021–5
nition of passive income for the purpose
of the PFIC rules. However, the Treasury
Department and the IRS subsequently
determined that this exception does not
apply for purposes of the PFIC definition
of passive income absent regulations and
that any such regulations should be issued
under the separate PFIC statutory rule de-
scribed in the next paragraph. According-
ly, these 2020 proposed regulations spec-
ify that the FPHCI exception for active
banking income of CFCs is not to be tak-
en into account in the general definition
of passive income for the purpose of the
PFIC regime.
The Treasury Department and the IRS
considered two options for the implemen-
tation of an active banking exception un-
der the PFIC tax regime. The first alterna-
tive would re-propose the 1995 proposed
regulations. The second alternative would
adopt the statutory rules of the FPHCI
exception for CFCs, with modifications
(such as not limiting the rule to CFCs).
Each alternative is discussed in turn.
i. 1995 proposed regulations
The 1995 proposed regulations treat
“banking income” of “active banks” and
“qualified bank affiliates” as non-pas-
sive. An active bank is either a domestic
or foreign corporation that is licensed by
federal or state regulators to do business
as a bank in the United States or a foreign
corporation that satisfies the following re-
quirements:
1. It must be licensed or authorized to
accept deposits from its home country
residents and must actively conduct a
banking business;
2. It must regularly accept such depos-
its in the ordinary course of business;
in addition, the amount of deposits
shown on the corporation’s balance
sheet must be substantial; and
3. It must regularly make loans to cus-
tomers in the ordinary course of busi-
ness.
Banking income is defined as gross in-
come that is derived from the active con-
duct of a specified banking activity. The
regulations list 14 banking activities (plus
a provision that allows the IRS Commis-
sioner to specify additional banking activ-
ities). The major activities listed include
lending activities, the purchasing or sell-
ing of notes or other debt instruments for
customers, issuing of letters of credit, per-
forming trust services, arranging foreign
exchange transactions, interest rate or
currency futures, etc., underwriting issues
of securities for customers, engaging in
finance leases, and providing credit card
services.
The 1995 proposed regulations also
extend the banking income definition to
certain affiliates of active banks that are
not themselves active banks. To be a qual-
ified bank affiliate, at least 60 percent of
a foreign corporation’s gross income must
be income that qualifies as non-passive
income under the PFIC active conduct
exceptions. In addition, a qualified bank
affiliate must be a member of an affiliated
group (based on an affiliation ownership
standard of more than 50 percent voting
power), and at least 30 percent of the
group’s “aggregate gross financial services
income” (defined in foreign tax credit reg-
ulations) must be banking income earned
by active banks that are group affiliates.
Also, at least 70 percent of such group in-
come must be income excepted under the
PFIC active conduct rules.
ii. FPHCI exception for banking, finance,
or similar income of CFCs
The FPHCI exception, while limited to
eligible CFCs, applies to a broader group
of eligible corporations and qualified fi-
nancial activities than the 1995 proposed
regulations for banking income. The
FPHCI rules for CFCs define an eligible
business as including a banking business,
a securities business, and a “lending or
finance” business. While the FPHCI stat-
utory rules include identical language re-
garding banks as does the PFIC statutory
exception; neither set of statutory rules
specifically define eligible banks, leaving
the definition to regulations.
The FPHCI exception for CFCs applies
to qualified banking or financing income.
A CFC that is not engaged in a banking
or securities business must derive more
than 70 percent of its gross income from a
lending or finance business with unrelated
customers. A “lending or finance” busi-
ness includes a business that is making
loans, purchasing or discounting accounts
receivable or certain other assets, engag-
ing in leasing, issuing letters of credit or
providing guarantees, providing credit
card services, and rendering services re-
lated to the other listed activities. This list
is similar to, but not the same as, the list
of banking activities provided in the 1995
proposed regulations.
Qualified banking or other financing
income can be derived in the active con-
duct of a branch or other “qualified busi-
ness unit” (QBU) of an eligible CFC. A
QBU is a separate and clearly identified
unit that maintains its own separate books
and records. Qualified banking or financ-
ing income must be derived from transac-
tions with customers located in a country
other than the United States. Substantially
all of the activities of the business must
be conducted directly by the corporation
in its home country, or by its QBU in the
home country of the QBU. There are no
similar requirements in the 1995 proposed
regulations. Under the FPHCI exception
for CFCs, business activity may include
the activity of the employees of a related
CFC located in the same home country as
that of the corporation or QBU, provid-
ed the activity is conducted in the home
country of the related person. Unlike the
1995 proposed regulations, the FPHCI ex-
ception for CFCs does not treat income of
affiliates of an eligible CFC that are not
themselves eligible CFCs as non-passive
income.
iii. 2020 proposed regulations – definition
of a foreign bank
The 2020 proposed regulations gener-
ally adopt the approach taken under the
FPHCI statutory language but substitute
a tested foreign corporation (TFC) (or a
related person of the TFC) for a CFC. As
in the case of the PFIC banking exception
adopted in the 1995 proposed regulations,
the 2020 proposed regulations apply only
to foreign banks.
Similar to the “active bank” definition
of the 1995 regulations, the 2020 proposed
regulations require a “foreign bank” to be
either licensed as a bank in the United
States or as a bank in the country in which
it is chartered or incorporated (its “home
country”). The 2020 proposed regulations
also require that a foreign bank accept bank
deposits from home country residents, and
indirectly incorporate the “substantial de-
posits” requirement of the 1995 proposed

Bulletin No. 2021–5 701 February 1, 2021
regulations. Unlike the 1995 proposed
regulations, the 2020 proposed regulations
do not require a foreign bank to regularly
make loans to customers in the ordinary
course of its business. Instead, the bank
must carry out with unrelated customers
one or more of the activities listed in the
FPHCI statute that constitute a lending or
finance business. One of those activities
is the making of loans, but a foreign bank
can have as its business activity any of the
other listed finance business activities in
order to qualify for the PFIC banking ex-
ception. This change in the definition of a
qualifying foreign bank may be a signif-
icant difference from the 1995 proposed
regulations, depending on what activities
are required of and permitted to be carried
out by a bank under bank regulatory rules.
If bank regulatory rules do not require a
bank to make loans to customers as part
of a banking business, the definition of
foreign bank may represent a broadening
of the type of institutions that may quali-
fy for an exception under the PFIC active
conduct exception for banking compared
to the 1995 proposed regulations.
In contrast to the 1995 proposed reg-
ulations, the 2020 proposed regulations
provide that the banking exception applies
separately to the income and activities of
a qualified branch (i.e., a QBU) of a for-
eign bank. Depending on the activities of
a branch, this may either increase or de-
crease the likelihood that income of a for-
eign bank is treated as non-passive.
iv. 2020 proposed regulations – banking
income
While it may be easier to qualify as a
foreign bank under the 2020 proposed reg-
ulations than as an active bank under the
1995 proposed regulations, the conditions
that must be satisfied in order to treat in-
come as qualified banking or financing in-
come eligible for the FPHCI exception are
more stringent than the requirements for
treating income as banking income under
the 1995 proposed regulations. The 2020
proposed regulations require that sub-
stantially all activities that produce active
banking income must be performed by the
TFC or its QBU in the home country of
the bank or that of the QBU, respective-
ly. However, an affiliated entity can pro-
vide employees to perform the requisite
activity, but only if the affiliate is created
or organized in the relevant home country
and the activity is performed in the home
country of the related person. No such re-
quirement exists under the 1995 proposed
regulations. This home country activity
requirement limits the variety of organi-
zational structures that foreign banks may
use in order to qualify for the new PFIC
banking exception. If a bank must restruc-
ture its operations in order to satisfy the
home-country requirement, this might be
considered a significant PFIC compliance
cost by foreign banks and therefore it may
impact the investment choices of U.S. per-
sons.
In addition, under the FPHCI excep-
tion, eligible income must be derived in
transactions with customers located in
a country other than the United States.
Relative to the 1995 regulations, this rule
imposes an additional compliance burden
on foreign corporations that desire to ac-
cess the U.S. investment community. It re-
quires them to distinguish income derived
from U.S.-based customers from income
derived from other customers.
v. 2020 proposed regulations – affiliates
Under the 2020 final regulations, a test-
ed foreign corporation (TFC) that owns at
least 25 percent (by value) of a corpora-
tion or partnership may be treated as if it
held its proportionate share of the assets of
the look-through subsidiary (LTS) or look-
through partnership (LTP) and received its
proportionate share of the income of the
LTS or LTP. The income and assets of the
subsidiary entity are treated as passive or
non-passive in the hands of the TFC in the
same manner as such items are treated in
the hands of the LTS or LTP. In general,
an exception to the passive income rules
applies to income of an LTS or LTP only
if the exception would have applied to
exclude the income from passive income
in the hands of the LTS or LTP. For this
purpose, the activities of a specified af-
filiated group of entities that includes the
TFC may be taken into account to judge
the active conduct nature of the LTS’s or
LTP’s income.
Under certain conditions, the 1995
proposed regulations permit the banking
income of a qualified bank affiliate to be
treated as non-passive income for the pur-
pose of determining the PFIC status of its
affiliated companies. No similar rule ap-
plies under the 2020 proposed regulations
for bank affiliates. Thus, for banking in-
come of an LTS to be treated as excepted
income, the LTS must itself be an eligible
foreign bank.
The income of an LTS that is a U.S.
bank conducting business with U.S. resi-
dents does not qualify as having excepted
income under the 2020 proposed regula-
tions. Such a bank would likely qualify as
an active bank under the 1995 proposed
regulations and, under the look-through
rules, that income would be considered
non-passive in the hands of the TFC. In
this respect the 2020 proposed regulations
make it more difficult for certain foreign
corporations to avoid PFIC status relative
to the 1995 proposed regulations.
vi. Summary of economic effects
The Treasury Department and the IRS
expect that the 2020 proposed regulations
may produce different outcomes relative to
the no-action baseline. However, whether
“on net” these different outcomes make it
more difficult for income of certain for-
eign corporations to qualify as non-pas-
sive under the banking active conduct ex-
ception or make it more likely that income
of foreign banking institutions will be
treated as non-passive depends heavily on
the individual facts and circumstances of
the TFC and its affiliates, so that no gener-
al conclusion can be drawn in that regard.
b. Applicable financial statement and
applicable insurance liabilities
For PFIC purposes, passive income
does not include income derived in the ac-
tive conduct of an insurance business by
a qualifying insurance corporation (QIC).
Under the statute, a QIC must have “ap-
plicable insurance liabilities” (AIL) that
constitute more than 25 percent of its total
assets (the “QIC test”). AIL generally in-
clude amounts shown on a financial state-
ment for unpaid loss reserves (including
unpaid loss adjustment expenses) of insur-
ance and reinsurance contracts and certain
life and health insurance reserves and un-
paid claims with respect to contracts pro-
viding coverage for mortality or morbidity
risks.

February 1, 2021 702 Bulletin No. 2021–5
i. Definition of an AFS
For the purpose of the QIC test, AIL are
based on insurance liabilities as they are
accounted for on the taxpayer’s applica-
ble financial statement (AFS). Under the
statute and the 2020 final regulations, an
AFS is a financial statement prepared for
financial reporting purposes that is based
on U.S. generally accepted accounting
principles (GAAP), or international finan-
cial reporting standards (IFRS) if there is
no statement based on GAAP. If neither
of these statements exist, then an AFS can
be an annual statement that is required to
be filed with an applicable insurance reg-
ulatory body. Such a statement would be
one that is prepared on the basis of a lo-
cal regulatory accounting standard. Thus,
the statute has a preference for financial
statements prepared on the basis of GAAP
or IFRS, which are rigorous and wide-
ly-respected accounting standards, but
will permit a foreign corporation to have
an AFS that is prepared on the basis of a
local regulatory accounting standard if the
foreign corporation does not do financial
reporting based on GAAP or IFRS.
This definition of an AFS does not
necessarily produce a single financial
statement that can be deemed “the” AFS
of a foreign insurance company. GAAP
and IFRS statements may be prepared
for several financial reporting purposes,
and there may be differences in the value
of assets or in the presentation of results,
depending on the purpose and jurisdic-
tion for which it is prepared. This may be
particularly true in the case of a financial
statement filed with local regulatory bod-
ies. For example, a company that operates
branches in more than one jurisdiction
may be filing multiple regulatory financial
statements, each based on a separate local
accounting standard. This variability may
be tempered, however, if the local regu-
latory authorities require their regulatory
statements to be filed on a GAAP or IFRS
basis.
The Treasury Department and the IRS
determined that it was appropriate to mod-
ify the definition of AFS in order to im-
pose greater structure on the identification
of the AFS used for purposes of the QIC
test. These 2020 proposed regulations re-
fine the definition of a financial statement
to ensure that an AFS includes a complete
balance sheet, statement of income, a
statement of cash flows and related exhib-
its, schedules, forms, and footnotes that
are normal components of such a filing.
A complete financial statement is more
likely to present an accurate picture of a
company’s financial position. These 2020
proposed regulations also require that an
AFS be an audited financial statement.
While an audit requirement may impose
additional accounting costs on the foreign
corporation (and, therefore, on its share-
holders), a financial statement reviewed
by independent auditors insures adherence
to the relevant accounting standard. The
Treasury Department and the IRS have de-
termined that local jurisdictions generally
will require audited financial statements to
be filed with insurance regulatory bodies,
so that this requirement should not impose
a significant additional compliance burden
on foreign corporations.
The 2020 proposed regulations impose
a new set of sub-priorities on financial
statements prepared under GAAP and a
similar set of sub-priorities on statements
prepared under IFRS. These sub-prior-
ities have been used in other regulatory
contexts. They are based on the purpose
for which a financial statement is being
released or filed. In the opinion of the
Treasury Department and the IRS, these
different priorities represent the reliability
of the statement. Thus, a GAAP statement
filed by publicly regulated corporations
with the Securities and Exchange Com-
mission or with an equivalent foreign
agency is deemed highly reliable and is
preferred to a statement that is used, say,
for credit purposes or for reporting in
shareholder reports.
The new rule narrows the potential
number of financial statements that might
be considered as AFSs relative to the
no-action baseline and should thereby re-
duce compliance and tax administrative
costs, while bringing taxpayer behavior
closer in line with the intent and purpose
of the statute.
If an AFS is a consolidated financial
statement in which the tested corporation
is not the parent, such statement could in-
clude AIL and assets of the parent, as well
as AIL and assets of other sibling corpora-
tions. Nevertheless, under the 2020 final
regulations, the amount of AIL on an AFS
that can be AIL for the purpose of the QIC
test includes only the AIL of the corpora-
tion being tested. Consequently, the 2020
proposed regulations stipulate that a fi-
nancial statement that includes parent and
sibling assets and liabilities cannot be an
AFS unless it is a financial statement filed
with a local regulator and is the only such
financial statement available, in which
case the AIL as reported on the statement
would have to be adjusted to remove the
double counted parental and sibling AIL.
This rule is expected to reduce the likeli-
hood that the AIL shown on an AFS would
have to be adjusted prior to the application
of the QIC test and thereby reduce compli-
ance costs relative to alternative regulato-
ry approaches. The Treasury Department
and the IRS have not estimated this reduc-
tion in compliance costs because they do
not have data or models with this level of
specificity.
If more than one financial statement
exists for an AFS subcategory and that
subcategory is the highest priority sub-
category of AFS for which an AFS is
available, then the 2020 proposed regula-
tions dictate that any financial statement
prepared on a non-consolidated basis
has priority over a statement prepared
on a consolidated basis. In most cases, a
non-consolidated AFS will be preferred
by the tested corporation because assets
of the tested corporation will generally
include the corporation’s net equity share
of its subsidiaries and not the full value
of its assets. A consolidated statement
will include all assets and liabilities of
lower-tiered subsidiaries (whether fully
or partially owned) other than eliminated
items that represent intra-corporate trans-
actions when viewed from a consolidated
perspective. Nevertheless, AIL eligible to
be taken into account for purposes of the
QIC test includes only AIL of the tested
corporation. Therefore, use of a consol-
idated AFS requires that any AIL of en-
tities other than the tested corporation
(such as subsidiaries) that are recorded
on the consolidated statement must be
eliminated for the purpose of the QIC
test. Because this would bias downward
the QIC test statistic (because the subsid-
iary assets supporting these eliminated
AIL remain on the AFS), the 2020 pro-
posed regulations allow a tested corpora-
tion to reduce its assets by the amount of
AIL that are eliminated for this reason.

Bulletin No. 2021–5 703 February 1, 2021
Any AIL of the tested corporation that
have been eliminated because of the prepa-
ration of a consolidated statement (for ex-
ample, if the tested corporation had insured
or reinsured a subsidiary) are not added
back to the AIL reported on the AFS. The
corresponding subsidiary assets have also
been eliminated in the preparation of the
consolidated AFS, so that the reverse pro-
cess of that described in the previous para-
graph is accomplished automatically.
ii. Limitations on applicable insurance
liabilities
Pursuant to statutory mandate and ex-
plicitly granted regulatory authority, the
2020 final regulations specify that any
amount of AIL used in the QIC test can-
not exceed the smallest of following three
amounts:
1) The amount of AIL of the tested
corporation shown on any financial
statement that is filed or required to
be filed with the corporation’s appli-
cable insurance regulatory body;
2) The amount of AIL determined on an
AFS that is prepared on the basis of
GAAP or IFRS, whether or not such
statement is filed by the tested corpo-
ration with its applicable insurance
regulatory body;
3) The amount of AIL required by law
or regulation to be held by the tested
corporation (or a lesser amount, if the
corporation is holding a lesser amount
as a permitted practice of the applica-
ble insurance regulatory body).
These limitation amounts may induce
local regulators to require the filing of
financial statements based on GAAP or
IFRS instead of filing statements based
on a local regulatory accounting standard.
Such actions would eliminate limitation
amount 1) above, and assuming that lim-
itation amount 3) does not apply, would
leave the amount of AIL reported on a
GAAP- or IFRS-prepared statement as the
relevant AIL. This approach will improve
the application of the QIC test, relative to
the no-action baseline, by increasing the
likelihood that AIL and total assets are
both derived from consistent accounting
principles by the tested corporations af-
fected by the PFIC insurance rules.
A tested corporation that has an AFS
based on GAAP or IFRS may be required
to file a financial statement with its home
country regulator using local statutory ac-
counting rules, where the AIL on the latter
statement are less than those shown on the
AFS. The difference in AIL could perhaps
be due to the use of dissimilar accounting
rules, the use of different discounting as-
sumptions or other assumptions regarding
the measurement of liabilities, or dispa-
rate methods of valuing assets. Under the
2020 proposed regulations, such account-
ing differences are not accounted for by
prescribed asset adjustments or by other
means.
As a regulatory alternative, the Trea-
sury Department and the IRS considered
whether to require asset or liability ad-
justments based on certain identified dif-
ferences between an AFS based on GAAP
or IFRS and a financial statement based
on local accounting standards, where the
differences were due solely to different
accounting standard requirements. For
example, in preparing the 2020 final reg-
ulations, the Treasury Department and the
IRS considered imposing the discounting
rules specified by the Code for measur-
ing property and casualty unpaid losses
for domestic tax purposes on losses mea-
sured on a non-GAAP or non-IFRS basis.
Such an option was rejected due partly
to its anticipated heavy compliance costs
(and thus the possibility that the foreign
corporation may not take the steps neces-
sary to attract U.S. investors) without any
accompanying, identifiable general eco-
nomic benefit. The Treasury Department
and the IRS determined that prescribing
other requirements or adjustments could
have similar compliance costs and that the
impacts of such accounting discrepancies
on the QIC test ratio are generally either
unknown or without a consistent bias. In
this regard, the Treasury Department and
the IRS further determined that they did
not have and could not practically ob-
tain sufficient information regarding the
differences among GAAP, IFRS, and the
various local accounting standard require-
ments that might apply to tested corpora-
tions in different foreign jurisdictions to
formulate additional appropriate rules.
iii. Reinsurance recoverable
In the context of reinsurance, howev-
er, the differences in the measurement of
AIL and assets under different accounting
standards are in some cases due merely to
a different presentation of the accounting
results with respect to reinsurance, rath-
er than more fundamental differences in
measurement or accounting methods.
Companies that have ceded business to
another insurer under a contract of rein-
surance will have amounts recoverable
from those reinsurers that could represent
a reimbursement of AIL. These amounts
may be related to claims that have been
paid or unpaid. Generally, if the insurer
has paid a claim, the reinsurance recover-
able is shown as a receivable (that is, an
asset) on its balance sheet. However, the
treatment of amounts recoverable with
respect to unpaid losses and unpaid loss
adjustment expenses can differ amongst
different accounting standards. For ex-
ample, under current GAAP, reinsurance
recoverable with respect to unpaid claims
is reported as an asset. The same is true
under IFRS 17 (an insurance accounting
standard that will be effective generally
beginning in 2023), where a single rein-
surance asset may be reported with re-
spect to both paid and unpaid claims. The
situation is different under U.S. statutory
accounting rules as specified by the Na-
tional Association of Insurance Commis-
sioners and implemented by the various
states. Under U.S. statutory accounting,
reinsurance recoverable for unpaid losses
and loss adjustment expenses is treated as
an offset to the unpaid loss reserves and
would thus reduce AIL. It is likely that
some non-U.S. local statutory accounting
standards similarly reduce unpaid loss re-
serves (and thus AIL) by amounts recov-
erable through reinsurance.
Measuring AIL on a “gross” basis, as
under GAAP and IFRS 17, necessarily
increases the QIC test ratio relative to a
“net” AIL measure. However, if the local
accounting standard governing the finan-
cial statement filed with an applicable
regulatory body requires a “net” measure
of AIL, then the AIL of the GAAP- or IF-
RS-based AFS will generally be limited
for the purpose of the QIC test.
Reporting AIL on a “gross” basis
could enable a foreign insurer to raise
its QIC test ratio to almost any desired
level simply by being a reinsurance con-
duit (that is by reinsuring business and
then retroceding all, or virtually all, of

February 1, 2021 704 Bulletin No. 2021–5
that business to other reinsurers). Such a
possibility could allow corporations that
might otherwise be designated as PFICs
instead to qualify as QICs and thereby
avoid PFIC status.
For these reasons the 2020 proposed
regulations specify that amounts recov-
erable from reinsurance and related to
AIL, if reported as assets on a financial
statement of the tested corporation, must
be subtracted from the reported AIL. That
is, all AIL are to be determined on a “net”
basis with respect to reinsurance recov-
erable. Furthermore, if such reinsurance
amounts are recoverable from an insur-
ance subsidiary of the tested corporation,
and such amounts of reinsurance recov-
erable are eliminated in the preparation
of a consolidated financial statement, the
AIL of the tested corporation neverthe-
less must be reduced by the recoverable
amount. Under the 2020 proposed regula-
tions, total assets reported on the AFS of
the tested corporation may be reduced by
amounts equal to the reductions in AIL for
the purpose of the QIC test.
4. Number of Potentially Affected
Taxpayers
An entity must file a separate Form
8621 for each PFIC for which it has an
ownership interest. The accompanying ta-
ble indicates how many entities have filed
at least one form 8621 between 2016 and
2018. These data are based on IRS mas-
ter files of tax return filings and do not
encompass late filings that have not yet
been received. For 2018, nearly 62,000
Forms 8621 were filed. Over 70 percent
of the entities filing a Form 8621 are in-
dividuals, although certain individuals are
exempt from filing a Form 8621 if their
aggregate holdings are less than $25,000
($50,000 if filing a joint return) and they
do not have PFIC income to report. An-
other 27 percent are pass-through entities,
the overwhelming number of which are
partnerships, but which also include S cor-
porations, estates, and non-grantor trusts.
These pass-through entities primarily
have individuals as partners, sharehold-
ers, or beneficiaries. It is possible there
is some double counting whereby both
partnerships and partners are filing a Form
8621 for the same PFIC. C corporations
comprise just over one percent of total en-
tities, while another nearly two percent of
Forms 8621 do not identify on the form
the filing status of the filer.
In general, only the taxpayer that
is the lowest tier U.S. entity owning a
PFIC needs to file a Form 8621. Thus,
an individual that is a PFIC shareholder
because he or she owns an interest in a
U.S. partnership that holds shares of a
PFIC does not need to file a Form 8621
if the individual is not required to report
PFIC-related income on the Form 8621.
This may happen if, for example, the in-
dividual and the partnership have made a
Qualifying Electing Fund (QEF) election
with respect to the PFIC. In that case,
only the partnership files the Form 8621.
The partnership records the QEF income
for the year, and that taxable income is
reported to the taxpayer as part of his or
her distributive share of partnership in-
come.
Table
Number of Entities Filing Form 8621
201620172018
Individuals36,97840,89143,406
Passthrough Entities
15,32616,13316,607
C Corporations
713733739
Unreported Filer Type1,1141,0531,084
All Entities54,13158,81061,836
In 2018, each reporting taxpaying enti-
ty filed an average of 12 Forms 8621. This
average was 11 forms per entity for indi-
viduals, 16 forms per entity for partner-
ships and other pass-through entities, and
28 forms per entity for C corporations.
The Treasury Department and the IRS
do not have information in current tax
filings regarding how many shareholders
own shares in qualifying insurance com-
panies or qualifying banks.
5. Regulatory Flexibility Act
It is hereby certified that these proposed
regulations will not have a significant eco-
nomic impact on a substantial number of
small entities within the meaning of sec-
tion 601(6) of the Regulatory Flexibility
Act (5 U.S.C. chapter 6). The proposed
regulations provide guidance with respect
to the statutory provisions in sections
1291 through 1298 (the “PFIC regime”),
which generally affect U.S. taxpayers that
have ownership interests in foreign corpo-
rations that are not CFCs. The proposed
regulations do not impose any new costs
on taxpayers. Consequently, the Treasury
Department and the IRS have determined
that the proposed regulations will not have
a significant economic impact on a sub-
stantial number of small entities. Notwith-
standing this certification, the Treasury
Department and the IRS invite comments
on the impact of these rules on small en-
tities.
Pursuant to section 7805(f), this notice
of proposed rulemaking has been submit-
ted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business.
The Treasury Department and the IRS
request comments on the impact of these
proposed regulations on small business
entities.
II. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 (UMRA) requires
that agencies assess anticipated costs and
benefits and take certain other actions be-
fore issuing a final rule that includes any
Federal mandate that may result in expen-

Bulletin No. 2021–5 705 February 1, 2021
ditures in any one year by a state, local,
or tribal government, in the aggregate, or
by the private sector, of $100 million in
1995 dollars, updated annually for infla-
tion. This rule does not include any Fed-
eral mandate that may result in expendi-
tures by state, local, or tribal governments,
or by the private sector in excess of that
threshold.
III. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive Order. This proposed rule
does not have federalism implications and
does not impose substantial direct compli-
ance costs on state and local governments
or preempt state law within the meaning
of the Executive Order.
Comments and Requests for a Public
Hearing
Before these proposed amendments
to the regulations are adopted as final
regulations, consideration will be given
to comments that are submitted timely
to the IRS as prescribed in the preamble
under the “ADDRESSES” section. The
Treasury Department and the IRS request
comments on all aspects of the proposed
regulations. See also the specific requests
for comments in the following Parts of
the Explanation of Provisions: I.A.1 (con-
cerning rules for foreign banks and the
ongoing application of Notice 89-81 and
proposed §1.1296-4), I.A.2 (regarding
financial statement valuation), I.A.3 (on
the treatment of working capital in apply-
ing the Asset Test), I.A.4 (concerning the
elimination of intercompany dividends
and the treatment of pre-acquisition earn-
ings and profits), I.A.5 (on the safe harbor
for the anti-abuse rule for section 1298(b)
(7)), I.B.1 (on the expanded definition
of an AFS and the priority rules provid-
ed), I.B.2 (concerning modco arrange-
ments and other special circumstances in
which modification of the definition of
AIL is appropriate), I.B.3 (on situations
that may warrant an adjustment to total
assets), I.C.1 (concerning the active con-
duct test), I.D.2 (on the QDIC Limitation
Rule), I.E (concerning the application of
statutory requirements relating to life in-
surance contracts and annuity contracts),
and II (concerning a transition rule). Any
electronic comments submitted, and to the
extent practicable any paper comments
submitted, will be made available at www.
regulations.gov or upon request.
A public hearing will be scheduled if
requested in writing by any person who
timely submits electronic or written com-
ments. Requests for a public hearing are
also encouraged to be made electronically
by sending an email to publichearings@
irs.gov. If a public hearing is scheduled,
notice of the date and time for the public
hearing will be published in the Federal
Register. Announcement 2020-4, 2020-
17 I.R.B. 667 (April 20, 2020), provides
that until further notice, public hearings
conducted by the IRS will be held tele-
phonically. Any telephonic hearing will
be made accessible to people with disabil-
ities.
Statement of Availability of IRS
Documents
IRS Revenue Procedures, Revenue
Rulings, notices, and other guidance cit-
ed in this document are published in the
Internal Revenue Bulletin (or Cumulative
Bulletin) and are available from the Su-
perintendent of Documents, U.S. Govern-
ment Publishing Office, Washington, DC
20402, or by visiting the IRS website at
www.irs.gov.
Drafting Information
The principal drafters of these regula-
tions are Christina G. Daniels, Josephine
Firehock, Jorge M. Oben, and Larry R.
Pounders of the Office of Associate Chief
Counsel (International). Other personnel
from the Treasury Department and the
IRS also participated in the development
of these regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
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 * * *
Par. 2. In § 1.250-1 amend paragraph
(b) by revising the first sentence and add-
ing a sentence at the end of the paragraph
to read as follows:
§1.250-1 Introduction.
* * * * *
(b) * * * Except as otherwise provid-
ed in this paragraph (b)(2), §§1.250(a)-1
and 1.250(b)-1 through 1.250(b)-6 apply
to taxable years beginning on or after Jan-
uary 1, 2021. * * * The last sentence in
§1.250(b)-2(e)(2) applies to taxable years
beginning after December 31, 2017.
* * * * *
Par. 3. Section 1.250(b)-2 is amended
by adding a sentence at the end of para-
graph (e)(2) to read as follows:
§1.250(b)-2 Qualified business asset
investment (QBAI).
* * * * *
(e) * * *
(2) * * * For purposes of applying sec-
tion 250(b)(2)(B) and this paragraph (e),
the technical amendment to section 168(g)
enacted in section 2307(a) of the Corona-
virus Aid, Relief, and Economic Security
Act, Pub. L. 116-136 (2020) is treated as
enacted on December 22, 2017.
Par. 4. Section 1.951A-3 is amended by
adding a sentence at the end of paragraph
(e)(2) to read as follows:
§1.951A-3 Qualified business asset
investment.
* * * * *
(e) * * *
(2) * * * For purposes of applying sec-
tion 951A(d)(3) and this paragraph (e), the
technical amendment to section 168(g)
enacted in section 2307(a) of the Corona-
virus Aid, Relief, and Economic Security

February 1, 2021 706 Bulletin No. 2021–5
Act, Pub. L. 116-136 (2020) is treated as
enacted on December 22, 2017.
* * * * *
Par. 5. Section 1.1297-0 is amended by:
1. Revising the entries for §1.1297-2(f)
(1) and (2).
2. Revising the entries for §1.1297-4(e)
(4) and (5), (f)(1)(iv), (f)(6)(i), (ii), and
(iii), and (g)(1) and (2).
3. Adding an entry for §1.1297-5.
4. Revising the entries for §1.1297-6(e)
(2) and (3) and (f)(1) and (2).
The revisions and additions read as fol-
lows:
§1.1297-0 Table of contents.
* * * * *
§1.1297-1 Definition of passive foreign
investment company.
* * * * *
(c) * * *
(2) Exception for certain income derived
in the active conduct of a banking busi-
nesses by a foreign bank.
(i) In general.
(ii) Foreign bank determination.
* * * * *
(d) * * *
(1) * * *
(v) * * *
(D) Valuation.
* * * * *
(2) Working capital.
* * * * *
(g) * * *
(3) Paragraphs (c)(1)(i)(B), (c)(2), (d)(1)
(v)(D), and (d)(2) of this section.
§1.1297-2 Special rules regarding look-
through subsidiaries and look-through
partnerships.
* * * * *
(e) * * *
(4) Active banking business.
(f) * * *
(1) Stock basis adjustment.
(2) Amount of gain taken into account.
* * * * *
§1.1297-4 Qualifying insurance
corporation.
* * * * *
(e) * * *
(4) Corresponding adjustment to total as-
sets.
(i) Consolidated applicable financial state-
ment
(ii) Insurance risk transferred through re-
insurance.
(5) Example.
(i) Facts.
(ii) Results.
(A) AIL reduction.
(B) Asset reduction.
* * * * *
(f) * * *
(1) * * *
(iv) Priority of financial statements.
* * * * *
(6) * * *
(i) In general.
(ii) Consolidated and non-consolidated fi-
nancial statement.
(iii) Audited financial statement.
* * * * *
(g) * * *
(1) General applicability date.
(2) Exception.
(3) Early application.
§1.1297-5 Active conduct of an
insurance business.
(a) Scope.
(b) Active conduct of an insurance busi-
ness.
(1) In general.
(2) Exceptions.
(c) Factual requirements test.
(1) In general.
(2) Substantial managerial and operational
activities with respect to core functions.
(i) Substantial managerial and operational
activities.
(ii) Regular and continuous basis.
(3) Performance of virtually all of the ac-
tive decision-making functions relevant to
a QIC’s underwriting activities.
(i) Active decision-making functions.
(ii) Performance requirements.
(iii) Exclusions.
(4) Number of officers and employees.
(d) Active conduct percentage test.
(1) Percentage test.
(2) Outsourcing.
(e) Related officers and employees.
(1) Modified qualified affiliate requirement.
(2) Oversight and supervision require-
ment.
(3) Compensation requirement.
(f) Definitions.
(1) Applicable reporting period.
(2) Compensation costs.
(3) Contract and claims management ac-
tivities.
(4) Core functions.
(5) Investment activities.
(6) Qualifying insurance corporation or
QIC.
(7) Sales activities.
(8) Total costs.
(9) Underwriting activities.
(10) Virtually all.
(g) Applicability date.
§1.1297-6 Exception from the
definition of passive income for active
insurance income.
* * * * *
(e) * * *
(2) Qualifying domestic insurance corpo-
ration non-passive asset and income lim-
itations.
(i) Qualifying domestic insurance corpo-
ration’s non-passive assets.
(ii) Qualifying domestic insurance corpo-
ration’s non-passive income.
(iii) Non-passive asset limitation.
(iv) Total insurance liabilities.
(A) Companies taxable under Part I of
Subchapter L.
(B) Companies taxable under Part II of
Subchapter L.
(3) Example.
(i) Facts.
(ii) Result.
(A) Non-passive asset limitation.
(B) Non-passive income limitation.
(f) * * *
(1) General applicability date.
(2) Exception.
(3) Early application.
Par. 6. Section 1.1297-1 is amended by:
1. Revising paragraphs (c)(1)(i)(B), (c)
(2), (d)(1)(v)(D), and (d)(2).
2. Revising the first sentence of paragraph
(g)(1).
3. Adding paragraph (g)(3).
The revisions and addition read as fol-
lows:
§1.1297-1 Definition of passive foreign
investment company.
* * * * *

Bulletin No. 2021–5 707 February 1, 2021
(c) * * *
(1) * * *
(i) * * *
(B) The exceptions in sections 954(c)
(3) (relating to certain income received
from related persons), 954(c)(6) (relating
to certain amounts received from related
controlled foreign corporations), 954(h)
(relating to entities engaged in the ac-
tive conduct of a banking, financing, or
similar business), and 954(i) (relating to
entities engaged in the active conduct of
an insurance business) are not taken into
account;* * *
* * * * *
(2) Exception for certain income de-
rived in the active conduct of a banking
business by a foreign bank—(i) In gener-
al. For purposes of section 1297(b)(2)(A),
income of a tested foreign corporation is
treated as non-passive if—
(A) The income would not be treated as
foreign personal holding company income
under section 954(h) (relating to entities
engaged in the active conduct of a bank-
ing, financing, or similar business) if the
tested foreign corporation (and, to the ex-
tent relevant, any related person as defined
by section 954(d)(3)) were a controlled
foreign corporation within the meaning of
section 957(a); and
(B) The tested foreign corporation is a
foreign bank that is engaged in the active
conduct of a banking business (within the
meaning of section 954(h)(2)(B)(ii)) and
the income is derived in the conduct of
that banking business.
(ii) Foreign bank determination. A test-
ed foreign corporation will be treated as a
foreign bank only if it—
(A) is licensed by federal or state bank
regulatory authorities to do business as a
bank in the United States, or is licensed or
authorized by a bank regulatory authority
in the country in which it is chartered or
incorporated (or, in the case of a qualified
business unit, in the country in which the
unit maintains its principal office) to do
business as a bank in that country, includ-
ing to—
(1) Accept bank deposits from resi-
dents of that country; and
(2) Carry out one or more of the activi-
ties listed in section 954(h)(4), and
(B) regularly receives bank deposits
from and carries out one or more of the
activities listed in section 954(h)(4) with
unrelated customers in the ordinary course
of a banking business.
* * * * *
(d) * * *
(1) * * *
(v) * * *
(D) Valuation. For purposes of deter-
mining the value of assets during a mea-
suring period when the shares of a test-
ed foreign corporation are not publicly
traded, valuation may be determined on
the basis of periodic financial account-
ing statements provided at least annually.
If the tested foreign corporation or one or
more shareholders has actual knowledge or
reason to know based on readily accessible
information that the financial accounting
statements do not reflect a reasonable esti-
mate of an asset’s value and the information
provides a more reasonable estimate of the
asset’s value, then the information must be
used to determine the value of the assets to
which it relates.
* * * * *
(2) Working capital. For purposes of
section 1297(a)(2), an amount of curren-
cy denominated in functional currency
(as defined in section 985(b)) held in a
non-interest bearing financial account that
is held for the present needs of an active
trade or business and is no greater than the
amount necessary to cover operating ex-
penses incurred in the ordinary course of
the trade or business of the tested foreign
corporation (for example, accounts pay-
able for ordinary operating expenses) and
reasonably expected to be paid within 90
days is not treated as a passive asset. For
purposes of the preceding sentence, cash
equivalents are not treated as currency,
and amounts held for purposes other than
to meet the ordinary course operating ex-
penses of the trade or business, including
for the purpose of providing for (i) future
diversification into a new trade or busi-
ness, (ii) expansion of trade or business
activities, (iii) future plant replacement,
or (iv) future business contingencies, are
treated as passive assets.
* * * * *
(g) * * *
(1) In general. Except as otherwise
provided, the rules of this section apply
to taxable years of shareholders beginning
on or after January 14, 2021. * * *
* * * * *
(3) Paragraphs (c)(1)(i)(B), (c)(2), (d)
(1)(v)(D), and (d)(2) of this section. Para-
graphs (c)(1)(i)(B), (c)(2), (d)(1)(v)(D),
and (d)(2) of this section apply to taxable
years of shareholders beginning on or af-
ter [the date these regulations are filed as
final regulations in the Federal Register].
A shareholder may choose to apply the
paragraphs in the preceding sentence for
any open taxable year beginning before
[the date these regulations are filed as fi-
nal regulations in the Federal Register]
without regard to whether the rules of this
section are applied consistently, provided
that once applied, each rule must be ap-
plied for each subsequent taxable year be-
ginning before [the date these regulations
are filed as final regulations in the Federal
Register].
Par. 7. Section 1.1297-2 is amended by:
1. Revising the third sentence in para-
graph (b)(2)(ii)(A), the second sentence in
paragraph (b)(3)(ii)(A), the first sentence
in paragraph (c)(2)(i), and the second sen-
tence in (c)(4)(ii)(A).
2. Adding subparagraph (e)(4).
3. Revising the first sentence and
adding two sentences to the end of para-
graph (h).
The revisions and additions read as fol-
lows:
§1.1297-2 Special rules regarding look-
through subsidiaries and look-through
partnerships.
* * * * *
(b) * * *
(2) * * *
(ii) * * *
(A) * * * The exceptions to passive
income in section 1297(b)(2) and the rel-
evant exceptions to foreign personal hold-
ing company income in sections 954(c)
and (h) that are based on whether income
is derived in the active conduct of a busi-
ness or whether a corporation is engaged
in the active conduct of a business ap-
ply to such income only if the exception
would have applied to exclude the income
from passive income or foreign personal
holding company income in the hands of
the subsidiary, determined by taking into
account only the activities of the subsidi-
ary except as provided in paragraph (e) of
this section. * * *
* * * * *

February 1, 2021 708 Bulletin No. 2021–5
(3) * * *
(ii) * * *
(A) * * * The exceptions to passive
income in section 1297(b)(2) and the rel-
evant exceptions to foreign personal hold-
ing company income in sections 954(c)
and (h) that are based on whether income
is derived in the active conduct of a busi-
ness or whether a corporation is engaged
in the active conduct of a business ap-
ply to such income only if the exception
would have applied to exclude the income
from passive income or foreign personal
holding company income in the hands of
the partnership, determined by taking into
account only the activities of the partner-
ship except as provided in paragraph (e) of
this section. * * *
* * * * *
(c) * * *
(2) * * *
(i) LTS stock. For purposes of section
1297, a tested foreign corporation does
not take into account dividends derived
with respect to LTS stock, including div-
idends that the tested foreign corporation
is treated as receiving on a measurement
date pursuant to section 1297(c) and para-
graphs (b)(2) or (b)(3) of this section. *
* *
* * * * *
(4) * * *
(ii) * * *
(A) * * * During the first quarter of the
taxable year, TFC received $20x of divi-
dends from LTS1 and $30x of interest on
the loan, both of which were paid in cash.
* * * * *
(e) * * *
(4) Active banking business. For pur-
poses of §1.1297-1(c)(2), the activities of
the employees of a person that is a relat-
ed person with respect to a look-through
subsidiary or partnership are taken into
account to the extent provided in section
954(h)(3)(E).
* * * * *
(f) Gain on disposition of a look-
through subsidiary or look-through part-
nership—(1) Stock basis adjustment. For
purposes of determining gain in paragraph
(2) of this paragraph (f), a tested foreign
corporation’s basis in the stock of a look-
through subsidiary is decreased, but not
below zero, by the aggregate amount of
distributions made by the look-through
subsidiary with respect to the look-through
subsidiary’s stock that are attributable to
income of the look-through subsidiary not
treated as received directly by the tested
foreign corporation pursuant to paragraph
(b)(2) of this section.
(2) Amount of gain taken into account.
The amount of gain derived from a tested
foreign corporation’s direct disposition of
stock of a look-through subsidiary, or an
indirect disposition resulting from the dis-
position of stock of a look-through subsid-
iary by other look-through subsidiaries or
by look-through partnerships, that is taken
into account by the tested foreign corpo-
ration for purposes of section 1297(a)(1),
section 1298(b)(3), and §1.1298-2 is the
residual gain. The residual gain equals the
total gain recognized by the tested foreign
corporation (including gain treated as rec-
ognized by the tested foreign corporation
pursuant to section 1297(c) and paragraph
(b)(2) of this section or §1.1297-1(c)(2))
from the disposition of the stock of the
look-through subsidiary reduced (but not
below zero) by unremitted earnings. Un-
remitted earnings are the excess (if any)
of the aggregate income (if any) taken into
account by the tested foreign corporation
pursuant to section 1297(c) and paragraph
(b)(2) of this section or §1.1297-1(c)(2)
with respect to the stock of the disposed-of
look-through subsidiary (including with
respect to any other look-through subsidi-
ary, to the extent it is owned by the tested
foreign corporation indirectly through the
disposed-of look-through subsidiary) over
the aggregate dividends (if any) received
by the tested foreign corporation from the
disposed-of look-through subsidiary with
respect to the stock other than dividends
described in paragraph (f)(1) of this sec-
tion. For purposes of this paragraph (f)
(2), the amount of gain derived from the
disposition of stock of a look-through
subsidiary and income of and dividends
received from the look-through subsidiary
is determined on a share-by-share basis,
determined under a reasonable method.
* * * * *
(h) Applicability date. Except as oth-
erwise provided, the rules of this section
apply to taxable years of shareholders
beginning on or after January 14, 2021.
* * * Paragraphs (b)(2)(ii)(A), (b)(3)(ii)
(A), (c)(2)(i), (c)(4)(ii)(A), (e)(4), (f)(1),
and (f)(2) of this section apply to taxable
years of shareholders beginning on or af-
ter [the date these regulations are filed as
final regulations in the Federal Register].
A shareholder may choose to apply the
paragraphs in the preceding sentence for
any open taxable year beginning before
[the date these regulations are filed as fi-
nal regulations in the Federal Register]
without regard to whether the rules of this
section are applied consistently, provided
that once applied, each rule must be ap-
plied for each subsequent taxable year be-
ginning before [the date these regulations
are filed as final regulations in the Federal
Register].
Par. 8. Section 1.1297-4 is amended by
revising paragraphs (e)(4), (e)(5), (f)(1),
(f)(2)(i)(D)(3), (f)(6)(i), (ii), and (iii), and
(g) to read as follows:
§1.1297-4 Qualifying insurance
corporation.
* * * * *
(e) * * *
(4) Corresponding adjustment to to-
tal assets. For purposes of determining
whether a foreign corporation satisfies
the 25 percent test or the 10 percent test,
the amount of total assets reported on the
foreign corporation’s applicable financial
statement may be reduced as described in
paragraphs (e)(4)(i) through (iii) of this
section.
(i) Consolidated applicable financial
statement. If a foreign corporation’s ap-
plicable financial statement is prepared on
a consolidated basis, the amount of total
assets may be reduced by the amount of
liabilities of another entity that are report-
ed on the applicable financial statement
and would be treated as applicable insur-
ance liabilities but for the application of
paragraphs (e)(2) or (f)(2)(i)(D)(2) of this
section.
(ii) Insurance risk transferred through
reinsurance. If the applicable financial
statement is prepared on the basis of an
accounting method that measures insur-
ance liabilities without a reduction for
amounts that may be recovered from
other parties through reinsurance and the
amount that may be recovered through
reinsurance is reported as an asset on the
applicable financial statement (rather than
as a reduction in the amount of an insur-
ance liability), the foreign corporation’s
total assets may be reduced by the amount

Bulletin No. 2021–5 709 February 1, 2021
of the corporation’s insurance liabilities
that are reinsured to another party and are
excluded from the definition of applicable
insurance liabilities under paragraph (f)(2)
(i)(D)(3) of this section.
(iii) No amount may be used more than
once to reduce total assets under para-
graphs (e)(4)(i) and (ii) of this section.
(5) Example. The following example illustrates
the application of paragraph (e)(4) of this section.
(i) Facts. P, a foreign corporation, issues property
and casualty insurance contracts and has a consol-
idated applicable financial statement (AFS) con-
structed using IFRS accounting principles, including
those of IFRS 17, for the applicable reporting pe-
riod. The AFS reports insurance contract liabilities
for incurred claims that meet the requirements of
paragraphs (f)(2)(i)(A) and (f)(2)(i)(B) of this sec-
tion in an amount equal to 1,100x, 200x of which
are liabilities under contracts issued by S, a whol-
ly owned insurance subsidiary, and 900x of which
are liabilities under contracts issued by P. The AFS
also reports 2,500x of total assets, including 250x of
assets related to P’s insurance contract liabilities for
incurred claims that are recoverable from unrelated
parties through reinsurance.
(ii) Results—(A) Reduction to applicable insur-
ance liabilities (AIL). Under paragraph (f)(2)(i)(D)
(2) of this section, only AIL of the foreign corpora-
tion whose QIC status is being determined may be
included in AIL. Thus, P’s AIL do not include the
200x of insurance contract liabilities on P’s consol-
idated AFS that are liabilities under contracts issued
by S. Under paragraph (f)(2)(i)(D)(3) of this sec-
tion, the amount of insurance liabilities determined
under paragraphs (f)(2)(i)(A) through (C) and (D)
(1) and (2) of this section are reduced by an amount
equal to the assets reported on P’s AFS that repre-
sent amounts relating to those liabilities that may be
recoverable from other parties through reinsurance.
Thus, P’s AIL are reduced by an amount equal to
the 250x of assets for incurred claims related to the
insurance liabilities of P that are recoverable from
another party through reinsurance. Assuming no
other limitation applies (such as those contained in
paragraph (e) of this section), P’s AIL equals 650x
(1,100x – 200x – 250x).
(B) Reduction to total assets. Pursuant to para-
graph (e)(4)(i) of this section, P may reduce its total
assets by amounts of liabilities of another entity that
are excluded from P’s AIL because of paragraphs (e)
(2) or (f)(2)(i)(D)(2) of this section. Under paragraph
(f)(2)(i)(D)(2) of this section, P’s AIL may include
only the liabilities of P, the entity whose QIC status is
being determined. Therefore, P may reduce its total
assets by 200x, the amount of liabilities under con-
tracts issued by S that are included on P’s AFS but
excluded from P’s AIL. Pursuant to paragraph (e)(4)
(ii) of this section, P may also reduce its total assets
by 250x, the amount of P’s liabilities that are rein-
sured by another party and excluded from the defi-
nition of AIL under paragraph (f)(2)(i)(D)(3) of this
section. After these adjustments, P has total assets of
2,050x (2,500x – 200x – 250x).
(C) AIL to total assets tests. Accordingly, for pur-
poses of the 25 percent and 10 percent tests, P has
AIL of 650x and total assets of 2,050x, for a test ratio
of 650x/2,050x, or 31.7%.
(f) Definitions. * * *
(1) Applicable financial statement. The
term applicable financial statement means
the foreign corporation’s financial state-
ment prepared for the financial reporting
purposes listed in paragraphs (f)(1)(i)
through (iii) of this section that has the
highest priority, including priority within
paragraphs (f)(1)(i)(B) and (f)(1)(ii) of this
section. Subject to paragraph (f)(1)(iv) of
this section, the financial statements are,
in order of descending priority—
(i) GAAP statements. A financial state-
ment that is prepared in accordance with
GAAP and is:
(A) A Form 10–K (or successor form),
or annual statement to shareholders, filed
with the United States Securities and Ex-
change Commission (SEC), or filed by the
taxpayer with an agency of a foreign gov-
ernment that is equivalent to the SEC, and
has reporting standards not less stringent
than the standards required by the SEC;
(B) An audited financial statement of
the taxpayer that is used for:
(1) Credit purposes;
(2) Reporting to shareholders, partners,
or other proprietors, or to beneficiaries;
(3) Filing with the Federal government
or any Federal agency, other than the SEC
or the Internal Revenue Service or an
applicable insurance regulatory body, or
filing with a state or foreign government
or an agency of a state or foreign govern-
ment, other than an agency that is equiv-
alent to the SEC or the Internal Revenue
Service or is an applicable insurance reg-
ulatory body; or
(4) Any other substantial non-tax pur-
pose, including filing with the applicable
insurance regulatory body; or
(ii) IFRS statements. A financial state-
ment that is prepared in accordance with
IFRS and is described in paragraphs (f)(1)
(i)(A) or (B) of this section, in the order of
priority set forth in those paragraphs; or
(iii) Regulatory annual statement. An
audited financial statement required to be
filed with the applicable insurance regu-
latory body that is not prepared in accor-
dance with GAAP or IFRS.
(iv) Priority of financial statements.
(A) A financial statement that takes
into account assets and liabilities of af-
filiates of the foreign corporation that are
not owned in whole or part by the foreign
corporation is not treated as an applicable
financial statement for purposes of para-
graphs (f)(1)(i) and (ii) of this section, and
is not treated as an applicable financial
statement for purposes of paragraph (f)
(1)(iii) of this section unless it is the only
financial statement described in paragraph
(f)(1)(iii) of this section.
(B) A financial statement that is de-
scribed in more than one clause listed in
paragraphs (f)(1)(i) through (iii) of this
section is treated for purposes of this
paragraph (f)(1) as described solely in the
highest priority clause. If a foreign corpo-
ration has more than one financial state-
ment with equal priority under paragraphs
(f)(1)(i) through (iii) of this section, a
non-consolidated financial statement has
priority over other financial statements.
(2) Applicable insurance liabilities. *
* *
(i) * * *
(D) * * *
(3) Amounts of liabilities determined
under paragraphs (f)(2)(i)(A) through
(C) and (D)(1) and (2) are reduced by an
amount equal to the assets reported on the
corporation’s financial statement as of the
financial statement end date that represent
amounts relating to those liabilities that
may be recoverable from other parties
through reinsurance. If a foreign corpo-
ration’s financial statement is prepared
on a consolidated basis, to the extent not
reduced already under paragraphs (f)(2)(i)
(A) through (C) and (D)(1) and (2), liabil-
ities are reduced by an amount equal to the
assets relating to those liabilities that may
be recoverable through reinsurance from
another entity included in the consolidated
financial statement, regardless of whether
the reinsurance transaction is eliminated
in the preparation of the consolidated fi-
nancial statement.
* * * * *
(6) Financial statements—(i) In gen-
eral. The term financial statement means
a statement prepared for a legal entity for
a reporting period in accordance with the
rules of a financial accounting or statutory
accounting standard that includes a com-
plete balance sheet, statement of income,
a statement of cash flows (or equivalent
statements under the applicable reporting
standard), and related exhibits, schedules,
forms, and footnotes that usually accom-

February 1, 2021 710 Bulletin No. 2021–5
pany the balance sheet, income statement
and cash flow statement.
(ii) Consolidated and non-consolidated
financial statement. The term consolidat-
ed financial statement means a financial
statement of a consolidated group of en-
tities that includes a parent and its sub-
sidiaries presented as those of a single
economic entity, prepared in accordance
with GAAP, IFRS or another financial or
statutory accounting standard. A non-con-
solidated financial statement means a fi-
nancial statement that is not prepared on
a consolidated basis and that accounts for
investments in subsidiaries on a cost or
equity basis.
(iii) Audited financial statement. The
term audited financial statement means
a financial statement that has been ex-
amined by an independent auditor that
has provided an opinion that the financial
statement presents fairly in all material
respects the financial position of the au-
dited company (and its subsidiaries and
controlled entities, if relevant) and the
results of their operations and cash flows
in accordance with GAAP or IFRS, or an
equivalent opinion under GAAP, IFRS or
another financial accounting or statutory
accounting standard.
* * * * *
(g) Applicability date—(1) General
applicability date. Except as provided in
paragraph (g)(2) of this section, this sec-
tion applies to taxable years of sharehold-
ers beginning on or after January 14, 2021.
(2) Exception. Paragraphs (e)(4), (e)
(5), (f)(1), (f)(2)(i)(D)(3), and (f)(6) of
this section apply to taxable years of Unit-
ed States persons that are shareholders in
foreign corporations beginning on or after
[the date these regulations are filed as final
regulations in the Federal Register].
(3) Early application—(i) A share-
holder may choose to apply the rules of
this section (other than paragraphs (f)(1),
(f)(2)(i)(D)(3), and (f)(6) of this section)
for any open taxable year beginning after
December 31, 2017 and before the appli-
cability dates described in paragraphs (g)
(1) and (2) of this section, provided that,
with respect to a tested foreign corpora-
tion, it consistently applies those rules and
the rules described in §1.1297-6(f)(3) for
such year and all subsequent years.
(ii) A shareholder may choose to apply
paragraphs (f)(1), (f)(2)(i)(D)(3), and (f)
(6) of this section for any open taxable
year beginning after December 31, 2017
and before [the date these regulations are
filed as final regulations in the Federal
Register], provided that, with respect to a
tested foreign corporation, it consistently
applies the rules of this section, §1.1297-
5, and §1.1297-6 for such year and all sub-
sequent years.
Par. 9. Section 1.1297-5 is revised to
read as follows:
§1.1297-5 Active conduct of an
insurance business.
(a) Scope. This section provides rules
pertaining to the exception from passive
income under section 1297(b)(2)(B) for
income derived in the active conduct of
an insurance business. Paragraph (b) of
this section sets forth the options for a
qualifying insurance company (QIC) to
qualify as engaged in the active conduct
of an insurance business and describes
circumstances under which a QIC will
not be engaged in the active conduct of an
insurance business. Paragraph (c) of this
section describes the factual requirements
that are sufficient to show that a QIC is
engaged in the active conduct of an in-
surance business for purposes of section
1297(b)(2)(B). Paragraph (d) of this sec-
tion describes an alternative active con-
duct percentage test, pursuant to which a
QIC may be deemed to be engaged in the
active conduct of an insurance business
for purposes of section 1297(b)(2)(B).
Paragraph (e) of this section describes the
circumstances under which officers and
employees of certain entities related to a
QIC may be treated as if they were em-
ployees of the QIC. Paragraph (f) of this
section provides definitions applicable to
this section. Paragraph (g) of this section
provides the applicability date of this sec-
tion.
(b) Active conduct of an insurance
business—(1) In general. A QIC is en-
gaged in the active conduct of an insur-
ance business only if it satisfies—
(i) the factual requirements test in para-
graph (c) of this section; or
(ii) the active conduct percentage test
in paragraph (d) of this section.
(2) Exceptions. Notwithstanding para-
graph (b)(1) of this section, a QIC is not
engaged in the active conduct of an insur-
ance business if either of the following
circumstances apply—
(i) It has no employees or only a nom-
inal number of employees and relies ex-
clusively or almost exclusively upon inde-
pendent contractors (disregarding for this
purpose any related entity that has entered
into a contract designating its status as an
independent contractor with respect to the
QIC) to perform its core functions;
(ii) It is a vehicle that has the effect of
securitizing or collateralizing insurance
risks underwritten by other insurance or
reinsurance companies or is an insurance
linked securities fund that invests in secu-
ritization vehicles, and its stock (or a fi-
nancial instrument, note, or security that is
treated as equity for U.S. tax purposes) is
designed to provide an investment return
that is tied to the occurrence of a fixed or
pre-determined portfolio of insured risks,
events, or indices related to insured risks.
(c) Factual Requirements Test—(1) In
general. A QIC satisfies the factual re-
quirements test of paragraph (b)(1)(i) of
this section if all the following are met—
(i) The officers and employees of the
QIC carry out substantial managerial and
operational activities on a regular and
continuous basis with respect to its core
functions as described in paragraph (c)(2)
of this section; and
(ii) The officers and employees of the
QIC perform virtually all of the active
decision-making functions relevant to un-
derwriting functions as described in para-
graph (c)(3) of this section.
(2) Substantial managerial and op-
erational activities with respect to core
functions—(i) Substantial managerial
and operational activities. Substantial
managerial and operational activities with
respect to a QIC’s core functions requires
all of the following—
(A) Establishing the strategic, overall
parameters with respect to each core func-
tion;
(B) Establishing, or reviewing and ap-
proving, detailed plans to implement the
strategic, overall parameters for each of
the QIC’s core functions;
(C) Managing, controlling and super-
vising the execution of the detailed plans
to carry out each of the QIC’s core func-
tions;
(D) Establishing criteria for the hiring
of employees or independent contractors

Bulletin No. 2021–5 711 February 1, 2021
to execute the detailed plans to carry out
each of the QIC’s core functions, and if
independent contractors are hired, pre-
scribing the goals and objectives of the en-
gagement, the scope of work, evaluation
criteria for contractor eligibility and for
submissions by prospective contractors,
and criteria and budget for the work to be
performed;
(E) Reviewing the conduct of the work
performed by employees or independent
contractors to ensure that it meets the
goals, standards, criteria, timeline and
budget specified by the QIC, and taking
appropriate action if it does not; and
(F) Conducting each of the require-
ments above by officers or senior employ-
ees of the QIC, which officers or employ-
ees are experienced in the conduct of those
activities and devote all or virtually all of
their work to those activities and similar
activities for related entities.
(ii) Regular and continuous basis. Car-
rying out managerial and operational ac-
tivities on a regular and continuous basis
requires that the parameters and plans de-
scribed in paragraphs (c)(2)(i)(A) and (B)
of this section are regularly reviewed and
updated and that the activities described in
paragraphs (c)(2)(i)(C) and (E) of this sec-
tion are carried out on a daily or other fre-
quent basis as part of the ordinary course
of the QIC’s operations.
(3) Performance of virtually all of the
active decision-making functions relevant
to a QIC’s underwriting activities—(i)
Active decision-making functions. Active
decision-making functions are the under-
writing activities that are most important
to decisions of the QIC relating to the as-
sumption of specific insurance risks.
(ii) Performance requirements. Per-
formance of virtually all of the active
decision-making functions relating to
underwriting activities requires all of the
following—
(A) Carrying out virtually all of the ac-
tivities related to a QIC’s decision to as-
sume an insurance risk, as set forth in the
definition of underwriting activities, by
employees and not by independent con-
tractors; and
(B) Evaluating, analyzing, and con-
ducting virtually all of the decision-mak-
ing with respect to executing an insurance
contract on a contract-by-contract basis,
including determining whether the con-
tract meets the QIC’s criteria with respect
to the risks to be undertaken and pricing
and is otherwise sound and appropriate.
(iii) Exclusions. The following activi-
ties are not active decision-making func-
tions relevant to a QIC’s core functions—
(A) Development of underwriting
policies or parameters that are changed
infrequently without further ongoing, ac-
tive involvement in the day-to-day deci-
sion-making related to these functions;
and
(B) Clerical or ministerial functions
with respect to underwriting that do not
involve the exercise of discretion or busi-
ness judgment.
(4) Number of officers and employees.
The number of officers and employees ac-
tively engaged in each core function is a
relevant factor in determining whether the
factual requirements in paragraph (c)(1)
of this section have been satisfied.
(d) Active conduct percentage test. A
QIC satisfies the active conduct percent-
age test of paragraph (b)(1)(ii) and will be
deemed to be engaged in an active insur-
ance business for the applicable reporting
period only if it satisfies the percentage
requirement in paragraph (d)(1) of this
section and, to the extent core functions
are outsourced, the oversight requirement
in paragraph (d)(2) of this section.
(1) Percentage test. For the applicable
reporting period covered by the applicable
financial statement, total costs incurred by
the QIC with respect to the QIC’s officers
and employees for services rendered with
respect to its core functions (other than in-
vestment activities) equals or exceeds 50
percent of total costs incurred by the QIC
with respect to the QIC’s officers and em-
ployees and any other person or entities for
services rendered with respect to its core
functions (other than investment activities).
(2) Outsourcing. To the extent the QIC
outsources any part of its core functions to
unrelated entities, officers and employees
of the QIC with experience and relevant
expertise must select and supervise the
person that performs the outsourced func-
tions, establish objectives for performance
of the outsourced functions, and prescribe
rigorous guidelines relating to the out-
sourced functions which are routinely
evaluated and updated.
(e) Related officers and employees.
For purposes of this section, a QIC’s of-
ficers and employees are considered to
include the officers and employees of a
related entity if the requirements of this
paragraph (e) are satisfied. In determin-
ing whether an activity is carried out by
employees, the activities of persons that
are independent contractors and that are
not related entities are disregarded. An
entity may be a related entity regardless
of whether it has entered into a contract
designating its status as an independent
contractor with respect to the QIC. An
entity is treated as a related entity only
if the requirements of this paragraph (e)
are satisfied.
(1) Modified qualified affiliate require-
ment. The entity is a qualified affiliate of
the QIC within the meaning of §1.1297-
2(e)(2) (determined by treating the QIC
as the tested foreign corporation) except
that, for purposes of this section, section
1504(a)(2)(A) (with “more than 50 per-
cent” substituted for “at least 80 percent”)
also applies for purposes of determining
qualified affiliate status.
(2) Oversight and supervision require-
ment. The QIC exercises regular oversight
and supervision over the services per-
formed by the related entity’s officers and
employees for the QIC.
(3) Compensation requirement. The
QIC either—
(i) Pays directly all the compensation
costs of the related entity’s officers and
employees attributable to core functions
performed by those officers and employ-
ees on behalf of the QIC;
(ii) Reimburses the related entity for
the portion of its expenses, including
compensation costs and related expenses
(determined in accordance with section
482 and taking into account all expenses
that would be included in the total services
costs under §1.482-9(j) and §1.482-9(k)
(2)) for the performance by its officers and
employees of core functions on behalf of
the QIC; or
(iii) Otherwise pays arm’s length com-
pensation in accordance with section 482
on a fee-related basis to the related entity
for services related to core functions.
(f) Definitions. The following defini-
tions apply solely for purposes of this sec-
tion.
(1) Applicable reporting period. The
term applicable reporting period has the
meaning set forth in §1.1297-4(f)(4).

February 1, 2021 712 Bulletin No. 2021–5
(2) Compensation costs. The term
compensation costs means all amounts in-
curred by the QIC during the applicable
reporting period with respect to an officer
and employee (including, for example,
wages, salaries, deferred compensation,
employee benefits, and employer payroll
taxes).
(3) Contract and claims management
activities. The term contract and claims
management activities means performing
the following activities with respect to an
insurance or annuity contract: monitoring
a contract (or group of contracts) over
its life cycle (that is, maintaining the in-
formation on contractual developments,
insured risk and occurrences, and main-
taining accounts on premiums, claims
reserves and commissions); performing
loss and claim reporting (establishing and
maintaining loss reporting systems, devel-
oping reliable claims statistics, defining
and adjusting claims provisions and in-
troducing measures to protect and reduce
claims in future); and all the activities re-
lated to a policyholder’s claim, including
processing the claims report, examining
coverage, handling the claim (working out
the level of the claim, clarifying causes,
claims reduction measures, legal analysis)
and seeking recovery of funds due to the
QIC.
(4) Core functions. The term core
functions means the QIC ‘s underwriting,
investment, contract and claims man-
agement and sales activities; however,
contract and claims management activ-
ities will not be considered to be a core
function of a reinsurance company with
respect to indemnity reinsurance contracts
to the extent that the ceding company has
agreed to retain this core function under a
reinsurance contract.
(5) Investment activities. The term in-
vestment activities means investment in
equity and debt instruments and related
hedging transactions and other assets of a
kind typically held for investment, for the
purpose of producing income to meet ob-
ligations under the insurance, annuity or
reinsurance contracts.
(6) Qualifying insurance corporation
or QIC. The term qualifying insurance
corporation or QIC has the meaning de-
scribed in §1.1297-4(b).
(7) Sales activities. The term sales ac-
tivities means sales, marketing and cus-
tomer relations with respect to insurance
or reinsurance policies.
(8) Total costs. With respect to the
QIC’s own officers and employees (and
without regard to related officers and
employees described in paragraph (e) of
this section), the term total costs means
the compensation costs of those officers
and employees and related expenses (de-
termined in accordance with section 482
and taking into account all expenses that
would be included in the total services
costs under §1.482-9(j) and §1.482-9(k)
(2)) for services performed related to core
functions. With respect to services per-
formed by related officers and employees
and unrelated persons or entities, the term
total costs means the amount paid or ac-
crued to the related or unrelated persons
or entities for the services related to core
functions. For purposes of this section,
total costs, however, do not include any
ceding commissions paid or accrued with
respect to reinsurance contracts or com-
missions or fees paid or accrued to bro-
kers or sales agents to procure reinsurance
contracts.
(9) Underwriting activities. The term
underwriting activities means the per-
formance of activities related to a QIC’s
decision to assume an insurance risk (for
example, the decision to enter into an in-
surance or reinsurance contract, setting
underwriting policy, risk classification
and selection, designing or tailoring in-
surance or reinsurance products to meet
market or customer requirements, per-
forming actuarial analysis with respect
to insurance products, and performing
analysis for purposes of setting premium
rates or calculating reserves, and risk re-
tention).
(10) Virtually all. The term virtually all
means all, other than a de minimis portion,
measured on any reasonable basis.
(g) Applicability date. This section
applies to taxable years of shareholders
beginning on or after [the date these regu-
lations are filed as final regulations in the
Federal Register]. A shareholder may
choose to apply the rules of this section
for any open taxable year beginning after
December 31, 2017 and before [the date
these regulations are filed as final regula-
tions in the Federal Register], provided
that, with respect to a tested foreign cor-
poration, it consistently applies the rules
of this section, §1.1297-4, and §1.1297-6
for such year and all subsequent years.
Par. 10. Section 1.1297-6 is amended
by adding a sentence to the end of para-
graph (b)(2), adding a sentence to the end
of paragraph (c)(2), and revising para-
graphs (e)(2), (e)(3), and (f), to read as
follows:
§1.1297-6 Exception from the definition
of passive income for active insurance
income.
* * * * *
(b) Exclusion from passive income of
active insurance income. * * *
(2) * * * See paragraph (e)(2)(i) of this
section for additional rules regarding the
amount of income of a qualifying domes-
tic insurance corporation that is treated as
non-passive.
* * * * *
(c) Exclusion of assets for purpos-
es of the passive asset test under section
1297(a)(2). * * *
(2) * * * See paragraph (e)(2)(ii) of this
section for additional rules regarding the
amount of assets of a qualifying domestic
insurance corporation that are treated as
non-passive.
* * * * *
(e) Qualifying domestic insurance cor-
poration. * * *
(2) Qualifying domestic insurance cor-
poration non-passive asset and income
limitations. For purposes of section 1297
and §1.1297-1—
(i) Qualifying domestic insurance cor-
poration’s non-passive assets. The amount
of passive assets of a qualifying domestic
insurance corporation that may be treated
as non-passive is equal to the lesser of the
passive assets of the corporation (deter-
mined without application of paragraph
(c)(2) of this section) or the corporation’s
non-passive asset limitation (as defined in
paragraph (e)(2)(iii) of this section).
(ii) Qualifying domestic insurance
corporation’s non-passive income. The
amount of passive income of a qualifying
domestic insurance corporation that may
be treated as non-passive is equal to the
lesser of the passive income of the cor-
poration (determined without application
of paragraph (b)(2) of this section) or the
corporation’s passive income multiplied
by the proportion that its non-passive as-

Bulletin No. 2021–5 713 February 1, 2021
set limitation (as defined in paragraph (e)
(2)(iii) of this section) bears to its total
passive assets (determined without appli-
cation of paragraph (c)(2) of this section).
(iii) Non-passive asset limitation. For
purposes of paragraph (e) of this section,
the non-passive asset limitation equals the
corporation’s total insurance liabilities
multiplied by the applicable percentage.
The applicable percentage is—
(A) 400 percent of total insurance lia-
bilities, for a company taxable under Part
II of Subchapter L; and
(B) 200 percent of total insurance lia-
bilities, for a company taxable under Part
I of Subchapter L.
(iv) Total insurance liabilities. For pur-
poses of paragraph (e) of this section—
(A) Companies taxable under Part I of
Subchapter L. In the case of a company
taxable under part I of Subchapter L, the
term total insurance liabilities means the
sum of the total reserves (as defined in
section 816(c)) plus (to the extent not in-
cluded in total reserves) the items referred
to in paragraphs (3), (4), (5), and (6) of
section 807(c).
(B) Companies taxable under Part II of
Subchapter L. In the case of a company
taxable under part II of Subchapter L, the
term total insurance liabilities means the
sum of unearned premiums (determined
under §1.832-4(a)(8)) and unpaid losses.
(3) Example. The following example
illustrates the application of this section.
(i) Facts. X, a qualifying domestic insurance cor-
poration within the meaning of paragraph (e)(1) of
this section, is a nonlife insurance company taxable
under part II of Subchapter L. X has passive assets
of $1000x, total insurance liabilities of $200x, and
passive income of $100x.
(ii) Result— (A) Non-passive asset limitation.
The applicable percentage for nonlife insurance
companies is 400%. Pursuant to paragraph (e)(2)(iii)
of this section, X has a non-passive asset limitation
of $800x, which is equal to its total insurance liabil-
ities of $200x multiplied by 400%. Under paragraph
(e)(2)(i) of this section, $800x of X’s passive assets
(equal to the lesser of the non-passive asset limita-
tion ($800x) or passive assets ($1000x)) are treated
as non-passive, and $200x remains passive.
(B) Non-passive income limitation. X has a
non-passive asset limitation of $800x. The propor-
tion of its non-passive asset limitation ($800x) to
its total passive assets ($1000x) is 80%. Pursuant
to paragraph (e)(2)(ii) of this section, X has $80x
of passive income treated as non-passive (equal to
the lesser of passive income ($100x) or 80% times
$100x) and $20x remains passive.
(f) Applicability date—(1) General
applicability date. Except as provided in
paragraph (f)(2) of this section, this sec-
tion applies to taxable years of sharehold-
ers beginning on or after January 14, 2021.
(2) Exception. Paragraphs (e)(2) and
(e)(3) of this section apply to taxable years
of shareholders beginning on or after [the
date these regulations are filed as final reg-
ulations in the Federal Register].
(3) Early application. A shareholder
may choose to apply the rules of this sec-
tion (other than paragraphs (e)(2) and (e)
(3) of this section) for any open taxable
year beginning after December 31, 2017
and before January 14, 2021, provided
that, with respect to a tested foreign cor-
poration, it consistently applies those rules
and the rules described in §1.1297-4(g)(3)
(i) for such year and all subsequent years.
Par. 11. Section 1.1298-0 is amended
by adding entries for §1.1298-4(e)(2)(i)
and (ii); §1.1298-4(e)(2)(ii)(A), (B), (C),
and (D); §1.1298-4(e)(3); §1.1298-4(e)(3)
(i), (ii), (iii), and (iv); §1.1298-4(e)(3)(i)
(A) and (B); §1.1298-4(e)(3)(ii)(A) and
(B); §1.1298-4(e)(3)(iii)(A) and (B); and
§1.1298-4(e)(3)(iv)(A) and (B) to read as
follows:
§1.1298-0 Table of contents.
* * * * *
§1.1298-4 Rules for certain foreign
corporations owning stock in 25-percent-
owned domestic corporations.
* * * * *
(e) * * *
(2) Safe harbor.
(i) Active business within Unites States.
(ii) Businesses undergoing change and
new businesses.
(A) In general.
(B) Testing date.
(C) Transition period.
(D) Inapplicability.
(3) Examples.
(i) Example 1.
(A) Facts.
(B) Results.
(ii) Example 2.
(A) Facts.
(B) Results.
(iii) Example 3.
(A) Facts.
(B) Results.
(iv) Example 4.
(A) Facts.
(B) Results.
* * * * *
Par. 12. Section 1.1298-4 is amended
by:
1. Revising paragraphs (e)(2) and (3).
2. Revising the first sentence and
adding two sentences to the end of para-
graph (f).
The additions and revisions read as fol-
lows:
§1.1298-4 Rules for certain
foreign corporations owning stock
in 25-percent-owned domestic
corporations.
* * * * *
(e) * * *
(2) Safe harbor. Paragraph (e)(1) of
this section will not apply if paragraph (e)
(2)(i) or (e)(2)(ii) of this section applies.
(i) Active business within United States.
The value of the assets of the second-tier
domestic corporation used or held for use
in an active trade or business within the
U.S. is more than 80 percent of the fair
market value of the gross assets of such
corporation. For purposes of this para-
graph (e)(2)—
(A) The value of the assets of the sec-
ond-tier domestic corporation takes into
account its pro-rata share of the value of
the assets of its domestic subsidiary qual-
ified affiliates and does not take into ac-
count the stock of such affiliates;
(B) The term domestic subsidiary
qualified affiliate means each member of
the affiliated group (as defined in section
1504(a) applied by substituting “more
than 50 percent” for “at least 80 percent”
each place it appears), treating the sec-
ond-tier domestic corporation as the com-
mon parent of such affiliated group; and
(C) For purposes of this paragraph (e)
(2), the determination of the existence of
an active trade or business and whether as-
sets are used in an active trade or business
is made under §1.367(a)-2(d)(2), (3), and
(5) except that officers and employees of
related entities as provided in §1.367(a)-
2(d)(3) include only the officers and em-
ployees of related domestic entities within
the meaning of section 267(b) or 707(b)
(1).
(ii) Businesses undergoing change and
new businesses—(A) In general. The sec-

February 1, 2021 714 Bulletin No. 2021–5
ond-tier domestic corporation engages in
an active U.S. trade or business that satis-
fies paragraph (e)(2)(i) of this section by
the end of the transition period following
the testing date.
(B) Testing date. For purposes of this
paragraph (e)(2)(ii), the term “testing
date” means the last day of the month in
which either—
(1) The second-tier domestic corpora-
tion is created or organized or is acquired,
directly or indirectly, by the tested foreign
corporation; or
(2) A second-tier domestic corporation
that previously satisfied (e)(2)(i) of this
paragraph (e) disposes of, to a person that
is not related within the meaning of sec-
tion 267(b) or 707(b)(1), substantially all
of the assets used or held for use in its ac-
tive U.S. trade or business.
(C) Transition period. For purposes of
this paragraph (e)(2)(ii), the term “transi-
tion period” means thirty-six months after
the testing date as defined in paragraph (e)
(2)(ii)(B)(1) or (2) of this section.
(D) Inapplicability. This paragraph (e)
(2)(ii) does not apply for any taxable year
(including previous taxable years) of the
tested foreign corporation if the second-ti-
er domestic corporation does not engage
in an active U.S. trade or business that sat-
isfies paragraph (e)(2)(i) of this section by
the end of the transition period following
a testing date.
(3) Examples. The following exam-
ples illustrate the rules of this paragraph
(e). For purposes of these examples,
TFC is a foreign corporation that is not
a controlled foreign corporation (within
the meaning of section 957(a)) and that
is subject to the section 531 tax, USS1
and USS2 are domestic corporations for
TFC’s entire taxable year, TFC owns
100% of the single class of stock of
USS1, and USS1 owns 100% of the sin-
gle class of stock of USS2.
(i) Example 1—(A) Facts. USS2 operates an
active trade or business within the United States
within the meaning of §1.367(a)-2(d)(2), (3), and
(5). Throughout TFC’s Year 1, the value of USS2’s
assets is $100x, and the value of USS2’s assets that
are used or held for use in its active trade or busi-
ness within the United States is $20x. USS2 was not
created, organized, or acquired within the preceding
thirty-six months and has not disposed of an active
trade or business within the United States within the
preceding thirty-six months.
(B) Results. Paragraph (e)(2)(i) of this section
does not apply in Year 1 even though USS2 is en-
gaged in an active trade or business within the Unit-
ed States because only 20% ($20x/$100x) of its as-
sets are used or held for use in an active U.S. trade
or business within the meaning of §1.367(a)-2(d)(2),
(3), and (5), an amount that is not more than 80%
of the fair market value of the total gross assets of
USS2. Accordingly, the general rule in paragraph (e)
(1) of this section will apply if there is a principal
purpose to hold passive assets through USS2, the
second-tier domestic corporation, to avoid classifi-
cation of TFC, the tested foreign corporation, as a
PFIC.
(ii) Example 2—(A) Facts. The facts are the
same as in as in paragraph (e)(4)(i)(A) of this section
(the facts in Example 1), except that USS2 also has
an investment in USS3, a wholly owned domestic
subsidiary of USS2. Throughout TFC’s taxable Year
1, the value of USS3’s assets is $400x and USS3 uses
100% of its assets in an active trade or business with-
in the United States within the meaning of §1.367(a)-
2(d)(2), (3), and (5).
(B) Results. Because USS3 is a domestic sub-
sidiary qualified affiliate of USS2, USS2’s pro-rata
share of the assets of USS3 is taken into account to
determine whether USS2 satisfies paragraph (e)(2)(i)
of this section. Accordingly, USS2 takes into account
$400x (its pro-rata share) of USS3’s assets in addi-
tion to the $100x of its own assets and, thus, is treat-
ed for purposes of paragraph (e)(2)(i) of this section
as owning $500x of assets, with 84% ($420x/$500x)
of such assets being used or held for use in an active
trade or business within the United States within the
meaning of §1.367(a)-2(d)(2), (3), and (5). There-
fore, paragraph (e)(2)(i) of this section applies in
Year 1 and the general rule in paragraph (e)(1) of this
section does not apply.
(iii) Example 3—(A) Facts. Throughout Year 1,
USS2 uses 100% of its assets in an active trade or
business within the United States within the mean-
ing of §1.367(a)-2(d)(2), (3), and (5), and thus sat-
isfied paragraph (e)(2)(i) of this section in Year 1.
On the first day of Year 2, USS2 disposes of all of
those assets for cash. On the seventh day of Year 5
(before the end of the first month in Year 5), USS2
invests the cash in assets that it immediately begins
to use in an active trade or business in the United
States.
(B) Results. Because USS2, the second-tier do-
mestic corporation, engages in an active U.S. trade
or business that satisfies paragraph (e)(2)(i) of this
section by the end of thirty-six months after the last
day of the month in which it disposed of its entire
active U.S. trade or business that previously satisfied
paragraph (e)(2)(i) of this section, paragraph (e)(2)
(ii) of this section applies in Year 2, Year 3, and Year
4, and the general rule in paragraph (e)(1) of this sec-
tion does not apply.
(iv) Example 4—(A) Facts. The facts are the
same as in paragraph (e)(4)(iii)(A) of this section
(the facts in Example 3), except that at the end of the
first month of Year 5, USS2 is still in negotiations
to purchase assets to be used in an active trade or
business in the United States within the meaning of
§1.367(a)-2(d)(2), (3), and (5), and USS2 does not
complete the purchase of such assets until the third
month of Year 5.
(B) Results. The safe harbor in paragraph (e)(2)
(ii) of this section does not apply for Year 2, Year 3,
or Year 4, because USS2, the second-tier domestic
corporation, did not engage in an active U.S. trade
or business that satisfied paragraph (e)(2)(i) of this
section by the end of the thirty-six month transition
period after the end of the month in which it sold its
prior active trade or business. Accordingly, the gen-
eral rule in paragraph (e)(1) of this section will apply
if there is a principal purpose to hold passive assets
through USS2, the second-tier domestic corporation,
to avoid classification of TFC, the tested foreign cor-
poration, as a PFIC.
(f) Applicability date. Except as oth-
erwise provided, the rules of this section
apply to taxable years of shareholders be-
ginning on or after January 14, 2021. * *
* Paragraphs (e)(2) and (3) of this section
apply to taxable years of shareholders be-
ginning on or after [DATE OF FILING
OF FINAL RULE IN THE Federal Reg-
ister]. A shareholder may choose to apply
the paragraphs in the preceding sentence
for any open taxable year beginning before
[DATE OF FILING OF FINAL RULE IN
THE Federal Register] without regard to
whether the rules of this section are ap-
plied consistently, provided that once ap-
plied, each rule must be applied for each
subsequent taxable year beginning before
[DATE OF FILING OF FINAL RULE IN
THE Federal Register].
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
(Filed by the Office of the Federal Register on January
14, 2021, 8:45 a.m., and published in the issue of the
Federal Register for January 15, 2020, 85 F.R. 4582)
Notice of Proposed
Rulemaking
REG-115057-20
Mandatory 60-Day
Postponement of Certain
Tax-Related Deadlines
by Reason of a Federally
Declared Disaster
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTIONS: Notice of proposed rulemak-
ing.

Bulletin No. 2021–5 715 February 1, 2021
SUMMARY: This document contains
proposed regulations relating to the new
mandatory 60-day postponement of cer-
tain time-sensitive tax-related deadlines
by reason of a Federally declared disas-
ter. This document also contains proposed
regulations clarifying the definition of
“Federally declared disaster.” These pro-
posed regulations affect individuals who
reside in or were killed or injured in a
disaster area, businesses that have a prin-
cipal place of business in a disaster area,
relief workers who provide assistance in
a disaster area, or any taxpayer whose tax
records necessary to meet a tax deadline
are located in a disaster area. This docu-
ment invites comments from the public
regarding these proposed regulations.
DATES: Written or electronic comments
and requests for a public hearing must be
received by March 15, 2021. Requests for
a public hearing must be submitted as pre-
scribed in the “Comments and Requests
for a Public Hearing” section.
ADDRESSES: Commenters are strongly
encouraged to submit public comments
electronically. Submit electronic submis-
sions via the Federal eRulemaking Portal
at www.regulations.gov (indicate IRS and
REG-115057-20) by following the online
instructions for submitting comments.
Once submitted to the Federal eRulemak-
ing Portal, comments cannot be edited
or withdrawn. The IRS expects to have
limited personnel available to process
public comments that are submitted on
paper through mail. Until further notice,
any comments submitted on paper will
be considered to the extent practicable.
The Department of the Treasury (Trea-
sury Department) and the IRS will pub-
lish for public availability any comment
submitted electronically, and to the extent
practicable on paper, to its public docket.
Send paper submissions to: CC:PA:LP-
D:PR (REG-115057-20), room 5203, In-
ternal Revenue Service, PO Box 7604,
Ben Franklin Station, Washington, D.C.
20044.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, William V. Spatz at (202) 317-5461;
concerning submission of comments, Re-
gina Johnson, (202) 317-5177; (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Background
These proposed regulations amend the
Procedure and Administration Regulations
(26 CFR part 301) under section 7508A of
the Internal Revenue Code (Code) relat-
ing to the discretionary authority of the
Secretary of the Treasury or his delegate
(Secretary) to postpone certain time-sensi-
tive tax deadlines by reason of a Federally
declared disaster. These proposed regula-
tions also amend the Income Tax Regula-
tions (26 CFR part 1) under section 165 to
clarify the definition of Federally declared
disaster.
I. FEMA Procedures for Declaring a
Disaster and Providing Relief
When it is apparent that a Federal di-
saster declaration, pursuant to the Robert
T. Stafford Disaster Relief and Emergen-
cy Assistance Act (Stafford Act), P.L. 93-
288, as amended, 42 U.S.C. §5121 et seq,
may be necessary to assist in the recovery
of an affected area, a state, territory, or
tribal government may contact the appro-
priate regional office of the Federal Emer-
gency Management Agency (FEMA) and
request a joint Federal-state, territory, or
tribal government Preliminary Damage
Assessment (PDA). Local government
representatives are also included, if pos-
sible. Together, the team conducts an as-
sessment of the affected area to determine
the extent of the disaster, its impact on
individuals and public facilities, and the
types of Federal assistance that may be
needed. This information is gathered to
show whether the disaster is of such se-
verity and magnitude that an effective
response is beyond the capabilities of the
state, territory, or tribal governments and
the affected local governments and that
supplemental Federal assistance is neces-
sary. See 44 C.F.R. §206.33.
After the PDA is complete and the
chief executive of the state, territory, or
tribal government determines that the
damage from the major disaster exceeds
the state’s, territory’s, or tribal govern-
ment’s resources, the executive may sub-
mit a declaration request to the President
through the applicable FEMA Regional
Office.
1
As part of the request, the chief
executive must furnish information on the
nature and amount of state, territory, or
tribal government and local resources that
have been or will be committed to allevi-
ating the results of the disaster, provide
an estimate of the amount and severity of
damage and the impact on the private and
public sectors, and provide an estimate of
the type and amount of assistance need-
ed under the Stafford Act. The President
determines whether a disaster has caused
damage of such severity that it is beyond
the combined capabilities of state, territo-
ry, or tribal governments and local gov-
ernments to respond. A major disaster dec-
laration provides a wide range of Federal
assistance programs for individuals and
public infrastructure. See Stafford Act sec-
tion 401 (42 U.S.C. §5170). A similar dec-
laration request may be submitted to the
President in the event of an emergency of
such severity and magnitude that effective
response is beyond the capabilities of the
state, territory, or tribal governments. If
the United States has the primary respon-
sibility for response to an emergency, the
President may issue an emergency decla-
ration without a request from the chief ex-
ecutive of a state, territory, or tribal gov-
ernment. See Stafford Act section 501 (42
U.S.C. 5191).
2
Once a declaration is made, affected ar-
eas and eligible assistance are determined.
See 44 CFR 206.40. FEMA announces
on its website and in the Federal Regis-
ter whether specific counties, parishes,
boroughs, tribal lands, or municipalities
1
In rare catastrophic events, the PDA may not be completed before the disaster is declared. Tribal governments may seek assistance either under a state declaration request or tribal leaders
may independently choose to request a major disaster declaration from the President.
2
More information about the process for declaring major disasters or emergencies under the Stafford Act can be found at 44 CFR 206.31 et seq. and on the FEMA website: https://www.fema.
gov/disasters/how-declared. It is rare for the President to declare an emergency without a request from a state, territory, or tribal government. Examples include the bombing of the Alfred P.
Murrah Federal Building in Oklahoma City in 1995, the loss of the Space Shuttle Columbia in 2003, and the COVID-19 pandemic in 2020.

February 1, 2021 716 Bulletin No. 2021–5
(counties) within a state that were affected
by a major disaster are eligible for Fed-
eral “public assistance” and/or “individual
assistance.”
3
“Public assistance” relief is
described in Stafford Act sections 406 and
407 as including Federal assistance to re-
pair, restore, and replace disaster-damaged
public facilities, which may include debris
removal, roads and bridges, water control
facilities, buildings and equipment, utili-
ties, parks, and recreational facilities. 42
U.S.C. 5172 and 5173. Emergency protec-
tive measures, described in Stafford Act
section 403 (42 U.S.C. 5170b), are actions
taken by state, tribal, territorial and local
governments to meet immediate threats
to life and property resulting from a ma-
jor disaster. “Individual assistance” relief
is described in Stafford Act section 408
as Federal assistance to individuals and
households, including disaster programs
for crisis counseling, unemployment as-
sistance, legal services, and supplemen-
tal nutrition assistance. 42 U.S.C. 5174.
FEMA defines an “incident” as any condi-
tion which meets the definition of a major
disaster or emergency under the Stafford
Act and which causes damage or hardship
that may result in a Presidential declara-
tion of a major disaster or an emergency.
44 CFR 206.32(e). FEMA also defines an
“incident period” as “[t]he time interval
during which the disaster-causing incident
occurs.” 44 C.F.R. §206.32(f).
II. Disaster Relief under Section
7508A(a)
A. Overview
Under section 7508A(a), the Secretary
has discretionary authority to determine
which taxpayers can have acts postponed
by reason of being affected by a Federally
declared disaster and to specify both the
time-sensitive acts that are postponed and
a period of time that may be disregarded,
up to one year, in determining wheth-
er such acts were timely performed. The
time-sensitive acts that may be postponed
under section 7508A(a) include acts due
to be performed by taxpayers or the gov-
ernment. See §301.7508A-1(c).
The term “Federally declared disas-
ter” is defined in section 165(i)(5) as “any
disaster subsequently determined by the
President of the United States to warrant
assistance by the Federal Government
under the Robert T. Stafford Disaster Re-
lief and Emergency Assistance Act.” The
Stafford Act does not use the term “Feder-
ally declared disaster.” It uses the defined
terms “emergency” and “major disaster”
and also uses the generic term “disaster”
to refer to both emergencies and major di-
sasters. See Stafford Act §101, 42 U.S.C.
5121 (using the term “disaster”); Stafford
Act §102, 42 U.S.C. 5122 (defining the
terms “emergency” and “major disaster”);
H.R. Rep. 93-1037, p. 26 (May 13, 1974)
120 Cong. Rec. 14156 (clarifying that the
term “disaster” as used in the Stafford Act
“includes an emergency or a major disas-
ter”). As described above, the declaration
of either an emergency or a major disaster
requires a determination by the President
that Federal assistance is warranted under
the Stafford Act. Accordingly, the IRS has
previously acknowledged that a Federally
declared disaster under section 165(i)(5)
includes either an emergency or a major
disaster declared under the Stafford Act.
See Rev. Rul. 2003-29, 2003-11 I.R.B.
587 (Mar. 17, 2003); Rev. Rul. 2002-11,
2002-10 I.R.B. 608 (Mar. 11, 2002); Rev.
Rul. 2001-15, 2001-13 I.R.B. 922 (Mar.
26, 2001); and Rev. Rul. 2000-15, 2000-
12 I.R.B. 774 (Mar. 20, 2000).
Section 7508A(a) of the Code nei-
ther mentions FEMA, nor the concept of
the “incident period” as determined by
FEMA. As noted above, section 7508A(a)
leaves it to the Secretary’s discretion to
identify the period of postponement, that
is, the start and end dates of the “incident,”
and the type of relief to provide, from a
tax administration perspective. The Sec-
retary has historically looked to FEMA
declarations to identify which counties are
sufficiently affected by a major disaster
for the Secretary to exercise the discretion
under section 7508A(a) to postpone peri-
ods of time for the taxpayers in these di-
saster-affected counties to perform certain
specified time-sensitive tax actions.
Section 7508A(a) is not self-executing;
it does not operate, on its own, to post-
pone any time-sensitive act in the event
of a Federally declared disaster. Instead,
the statute authorizes the Secretary to de-
termine who is affected by a Federally
declared disaster for purposes of section
7508A, what time-sensitive acts per-
formed by these taxpayers (or performed
by the government with respect to these
taxpayers)should be postponed, and for
what period of time the postponement pe-
riod should run.
Section 7508(a)(1) enumerates
time-sensitive acts that are postponed with
respect to a taxpayer serving in a combat
zone (and which the Secretary may post-
pone with respect to taxpayers affected by
a Federally declared disaster, via section
7508A(a)(1)). These acts include filing
any income, estate, gift, employment, or
excise tax return; making any income,
estate, gift, employment, or excise tax
payment or any installment thereof; filing
a petition with the Tax Court for redeter-
mination of a deficiency, or for review of
a Tax Court decision; allowing a credit or
refund of any tax; filing a claim for credit
or refund of any tax; bringing suit upon a
claim for credit or refund; making an as-
sessment of any tax; giving or making any
notice or demand for the payment of any
tax, or with respect to any liability to the
United States in respect of any tax; col-
lecting, by levy or otherwise, the amount
of any liability in respect of any tax; bring-
ing suit by the United States, or any officer
on its behalf, in respect of any liability in
respect of any tax; and any other act re-
quired or permitted under the internal rev-
enue laws specified by the Secretary.
Additional acts that may be postponed in
the event of a Federally declared disaster
are listed in Rev. Proc. 2018-58, 2018-50
I.R.B. 990, which is the current version of
a revenue procedure that is updated peri-
odically to reflect additional acts or other
changes. The revenue procedure provides
that in order for taxpayers to be entitled to
a postponement of the time-sensitive acts
listed in the revenue procedure, the IRS
needs to issue guidance providing such
relief with respect to a Federally declared
disaster, typically by cross-referencing the
revenue procedure in an IRS news release.
This is the case not just for acts listed in
the revenue procedure, but for all acts list-
ed in section 7508(a)(1). As a result, in
the event of a Federally declared disaster,
the IRS generally issues a news release
3
https://www.fema.gov/disasters/disaster-declarations.

Bulletin No. 2021–5 717 February 1, 2021
or other guidance identifying the affected
taxpayers for purposes of section 7508A
(typically by reference to counties or
states), the time-sensitive acts postponed,
and the period of time for the postpone-
ment.
B. Historical Application
The historical practice before the en-
actment of section 7508A(d) was gener-
ally to postpone time-sensitive tax acts
under section 7508A(a) without regard
to the latest incident date for a disaster as
described by FEMA. The postponement
period set by the Secretary generally be-
gan on the earliest incident date specified
in a FEMA disaster declaration and ended
120 days later, although a longer period
for relief could be selected if the disaster
coincided with any major filing deadlines.
See IRM 25.16.1.5.2(2) (rev. 06-26-2018)
(“The severity of the disaster and proxim-
ity of tax deadlines are primary factors in
determining the level of tax relief that is
provided.”). These postponement periods
typically extended more than 60 days af-
ter the latest incident date specified in a
FEMA disaster declaration. For example,
an end date for the major disaster incident
was indicated in FEMA’s initial disaster
declarations for 48 of FEMA’s 53 major
disaster declarations issued for disasters
occurring in 2019 and declared before
December 19, 2019. For these 48 FEMA
major disaster declarations in 2019 with
initial ending incident dates assigned
to them by FEMA, the incident period
ranged from one day to 130 days, with a
median incident period of nine days. For
the five 2019-year major disasters where
FEMA’s initial declarations did not speci-
fy an end date for the disaster, FEMA later
amended the declarations to provide an
end date to the incident period for the di-
saster. FEMA major disaster declarations
and any amendments thereto are posted on
the FEMA website
4
and published in the
Federal Register.
III. Section 7508A(d)
On December 20, 2019, section
7508A(d) was added to the Code by sec-
tion 205 of the Taxpayer Certainty and
Disaster Tax Relief Act of 2019, enacted
as Division Q of the Further Consolidat-
ed Appropriations Act, 2020, P.L. 116-94,
133 Stat. 2534, 3226 (FCAA). Section
7508A(d) provides qualified taxpayers
a mandatory 60-day period that is to be
disregarded “in the same manner as a pe-
riod specified under [section 7508A(a)]”
(mandatory 60-day postponement period).
Section 7508A(d)(1). Section 7508A(d)
does not identify the acts for which a peri-
od is disregarded under section 7508A(a).
Section 7508A(d)(4) provides that a rule
similar to section 7508A(d)(1) applies
with respect to any person described in
section 7508A(b) for certain pension-re-
lated acts. In contrast to the rest of section
7508A(d), section 7508A(d)(4) identifies
specific pension-related acts to which the
mandatory 60-day postponement period
provided in section 7508A(d)(1) applies.
In addition, section 7508A(d)(5) coordi-
nates the mandatory 60-day postponement
period with a period specified by the Sec-
retary by providing that the mandatory
60-day postponement period with respect
to a person (including by reason of the
application of section 7508A(d)(4)) is in
addition to (or concurrent with, as the case
may be) any period specified by the Sec-
retary under section 7508A(a) or (b) with
respect to such person.
Because section 7508A(a) does not,
on its own, operate to postpone any acts,
the Secretary must determine which acts
to postpone. As a result, the requirement
in section 7508A(d)(1) that the mandatory
60-day postponement period be disregard-
ed “in the same manner as a period spec-
ified under [section 7508A(a)]” indicates
that the acts covered by the mandatory 60-
day postponement period under section
7508A(d)(1) must also be determined by
the Secretary in the manner required un-
der section 7508A(a).
Under section 7508A(d)(5), the manda-
tory 60-day postponement period in sec-
tion 7508A(d) runs concurrently with the
postponement period determined by the
Secretary under section 7508A(a) if the
period determined by the Secretary under
section 7508A(a) is equal to or longer than
60 days. If the Secretary’s postponement
period under section 7508A(a) is less than
60 days, the mandatory 60-day postpone-
ment period would run concurrently for
the length of the Secretary’s postpone-
ment period under section 7508A(a) and
then continue running in addition to the
Secretary’s postponement period. The
mandatory 60-day postponement period
generally begins on the earliest incident
date specified in a FEMA disaster declara-
tion and ends on the date which is 60 days
after the latest incident date.
IV. Legislative History of Section
7508A(d)
The legislative history of section
7508A(d) of the Code is sparse. There are
no House, Senate, or Conference Reports
concerning the FCAA. The identical text
of section 7508A(d) was included in the
same session of Congress in H.R. 3301,
which was not enacted. Before H.R. 3301
was set to be marked up by the House
Ways and Means Committee on June 30,
2019, the staff of the Joint Committee on
Taxation prepared a partial description of
proposed section 7508A(d) in JCX 30-19
(June 18, 2019) (Joint Committee Report).
The Joint Committee Report (at 86-87)
described twelve categories of time-sen-
sitive acts that could be postponed which
are performed by taxpayers (for exam-
ple, filing any return or paying any tax)
or by the IRS (for example, assessment
or collection of any tax), which are the
same eleven items described in section
7508(a)(1)(A)-(K) (for taxpayers serv-
ing in a combat zone), plus the set of acts
regarding pensions that are described in
§301.7508A-1(c)(1)(iii). The Joint Com-
mittee Report did not discuss why section
7508A(d) only refers to the acts regard-
ing pensions in section 7508A(d)(4) to be
postponed, but not the eleven categories
of acts described in section 7508(a)(1)(A)-
(K). The Joint Committee Report also did
not discuss the intended meaning of sec-
tion 7508A(d)(1)’s provision that periods
of time “shall be disregarded in the same
manner as under [section 7508A(a)].”
As regards the proposed length of the
mandatory 60-day postponement peri-
od, the Joint Committee (at 87) stated
4
https://www.fema.gov/disasters/disaster-declarations

February 1, 2021 718 Bulletin No. 2021–5
only that “[t]he 60-day period begins on
the earliest incident date specified in the
declaration of the relevant disaster and
ends on the date which is 60 days after
the latest incident date so specified.” The
Joint Committee Report did not refer to
or explain how the new proposed section
7508A(d) might be applied in the event
that a declaration did not specify an inci-
dent date, or in the event of a prolonged
and uncertain disaster period, such as in
the case of a drought or pandemic.
On January 21, 2020, a month after
the enactment of section 7508A(d), the
House Ways and Means Committee re-
leased a report on H.R. 3301, H. Rept.
No. 116-379 (2020) (House Committee
Report), which largely repeated (at 97-
100) the explanations previously provid-
ed by the Joint Committee Report regard-
ing the features of section 7508A(d). In
this report, the Ways and Means Com-
mittee titled the section discussing the
text of what had been enacted as section
7508A(d), “Automatic Extension of Fil-
ing Deadlines in Case of Certain Tax-
payers Affected by Federally Declared
Disasters.” H.R. Rep. No. 116-379, at 97
(2020). Next, the House Committee Re-
port described the current law (prior to
enactment of section 7508A(d)), begin-
ning with a discussion of the filing dead-
lines for Federal income tax returns and
quarterly estimated tax payments, and
ending with a listing of all of the items in
section 7508(a)(1) and section 7508A(a)
that the Secretary may postpone in the
event of a Federally declared disaster. Id.
at 97-98. Then, the report identified the
reason for change as follows:
The Committee believes that the cer-
tainty and additional time provided by
an automatic extension of filing dead-
lines for taxpayers affected by Fed-
erally declared disasters will ease the
burden of tax compliance for taxpayers
dealing with the hardship of disaster
recovery.
Id. at 99. Again, the House Committee Re-
port only identified an automatic extension
of filing deadlines as the purpose for the
new statutory text. However, in the Expla-
nation of Provision section that followed,
the House Committee Report seems to in-
dicate that the statute was meant to post-
pone all of the deadlines that it had listed
in its description of current law:
The provision provides to qualified
taxpayers in the case of a Federally
declared disaster a mandatory 60-day
period that is disregarded in determin-
ing whether the acts listed above were
performed in the time prescribed; the
amount of interest, penalty, addition-
al amount, or addition to tax; and the
amount of credit or refund. The 60-day
period begins on the earliest incident
date specified in the declaration of the
relevant disaster and ends on the date
which is 60 days after the latest inci-
dent date so specified.
Id. at 99. The “Explanation of Provision”
section of the House Committee Report
is inconsistent with the report’s “Reason
for Change” section, and neither section
comports with the statutory text of section
7508A(d) as enacted, because the statuto-
ry text does not reference which specified
acts (let alone all) are postponed under
section 7508A(a).
Explanation of Provisions
The Treasury Department and the IRS
have determined it necessary to propose
regulations addressing the enactment of
section 7508A(d) because the statutory
text is ambiguous in at least two respects.
First, it is unclear what time-sensitive acts
are to be postponed. Second, it is unclear
how the mandatory 60-day postponement
period is to be calculated when the decla-
ration specified in section 7508A(d) does
not contain an incident date. Further, the
legislative history described in the Back-
ground section is insufficient to explain
these areas of ambiguity. The Treasury
Department and the IRS have also deter-
mined it necessary to propose regulations
addressing the ambiguity between the dif-
ferent terms used in the Code and in the
Stafford Act to refer to disasters deter-
mined by the President to warrant Federal
assistance. This Explanation of Provisions
section discusses the proposed regulations
addressing each of these areas of ambigu-
ity.
I. Time-Sensitive Tax Acts
Section 7508A(d) provides a manda-
tory 60-day period during which quali-
fied taxpayers will receive disaster relief.
Except for the rules regarding pensions
described in section 7508A(d)(4), section
7508A(d) does not specify the time-sen-
sitive tax acts to be postponed during the
mandatory 60-day postponement period.
Section 7508A(d)(1), however, provides
that this mandatory 60-day postponement
period “shall be disregarded in the same
manner as a period specified under [sec-
tion 7508A(a)].” Section 7508A(a) is not
self-executing. Rather, it requires the Sec-
retary to determine whether a taxpayer is
affected by a Federally declared disaster
for purposes of section 7508A(a), whether
any time-sensitive tax acts are to be post-
poned for such taxpayers, and the duration
of such postponement. Section 7508A(d)
(1)’s reference to section 7508A(a) thus
requires a determination by the Secretary
of the time-sensitive tax acts, if any, to be
postponed under section 7508A(a). There-
fore, these proposed regulations provide
that the Secretary’s determination under
section 7508A(a) of the acts subject to
postponement due to a Federally declared
disaster is an essential prerequisite to de-
termining the acts to which the mandatory
60-day postponement period applies with
respect to that Federally declared disaster
for qualified taxpayers.
There are circumstances when the
Secretary has chosen to limit the extent to
which the discretion to postpone time-sen-
sitive acts under section 7508A(a) might
otherwise be exercised. For example, sec-
tion 7508A(a)(1) (through its reference
to acts described in section 7508(a)(1))
lists several time sensitive acts performed
by the IRS – not by taxpayers – that are
available for postponement in the event
of a Federally declared disaster, including
the assessment of any tax, making of no-
tice and demand for payment of any tax,
collection of any tax, and initiating litiga-
tion with respect to any tax liability. Al-
though all of these acts can be postponed
under section 7508A(a) in the same man-
ner as time-sensitive acts performed by
taxpayers, the Secretary rarely chooses
to postpone them. Over the past 20 years,
time-sensitive government acts were only
postponed under section 7508A(a) in con-
nection with four Federally declared di-
sasters: the September 11, 2001 terrorist
attacks (Notice 2001-68, 2001-47 I.R.B.
504), Hurricane Katrina (Notice 2005-
66, 2005-40 I.R.B. 620 and Notice 2005-
81, 2005-47 I.R.B. 977), Hurricane Rita

Bulletin No. 2021–5 719 February 1, 2021
(Notice 2005-82, 2005-47 I.R.B. 978),
and the COVID-19 pandemic (Notice
2020-23, 2020-18 I.R.B. 742). The stat-
utory text of section 7508A(d) provides
no indication that Congress intended to
postpone all time-sensitive acts for which
relief potentially could be provided under
section 7508A(a), including those acts
due to be performed by the government
with respect to a qualified taxpayer. It has
generally not been the practice of the Sec-
retary to exercise all of the authority giv-
en under section 7508A(a) to postpone all
time-sensitive government acts with re-
spect to taxpayers affected by a Federally
declared disaster.
The Secretary generally also chooses
not to exercise the discretion under section
7508A(a) with respect to many time-sen-
sitive acts carried out by taxpayers. For
example, section 7508(a)(1)(A)-(B) and
section 7508A(a)(1) combine to provide,
among other things, that the Secretary has
the discretion to specify a period of up to
one year that may be disregarded in de-
termining whether an affected taxpayer
with respect to a qualifying disaster has
timely filed any return of income tax or
paid the United States any employment or
excise taxes. The Secretary may exercise
the discretion under section 7508A(a) to
not provide postponement periods for the
filing of certain information returns with
respect to income, such as Forms W-2
(Wage and Tax Statement) and forms in
the 1099 series. These information returns
with respect to income are required by
most income tax filers in order to time-
ly prepare their own income tax returns,
such as Forms 1040 (U.S. Individual In-
come Tax Returns) or Forms 1120 (U.S.
Corporation Income Tax Returns). These
information returns may also be used by
the IRS to verify withheld amounts that
were claimed on an income tax return be-
fore tax refunds are issued. As a result, for
tax administration reasons, the Secretary
generally does not postpone the time-sen-
sitive acts of filing and furnishing these
information returns, except for certain
information returns relating to individual
retirement accounts (IRAs) and certain
other tax-exempt accounts.
Finally, the Secretary may choose not
to provide any relief under section 7508A
in response to a Federally declared disas-
ter. For example, when a disaster is eligi-
ble for assistance that is limited to only
the clean-up of public property or other
short-term public services, the Secretary
may determine that relief is not warranted
under section 7508A.
For the foregoing reasons, these pro-
posed regulations provide that the phrase,
“shall be disregarded in the same man-
ner as a period specified under [section
7508A(a)]” in section 7508A(d)(1) first
requires the Secretary’s exercise of discre-
tion under section 7508A(a) to specify the
postponed set of time-sensitive acts for
taxpayers (and potentially for the govern-
ment) during the entirety of the postpone-
ment period under both section 7508A(a)
and (d). Accordingly, if the Secretary de-
termines not to postpone a time-sensitive
act pursuant to the discretionary authority
under section 7508A(a), that act will also
not be postponed under section 7508A(d).
Similarly, if no time-sensitive acts are
postponed under section 7508A(a), then
none will be postponed under section
7508A(d).
II. Calculation of the Mandatory 60-day
Postponement Period
The earliest and latest incident dates
referred to in subsections 7508A(d)(1)
(A)-(B) for a Federally declared disaster
are the dates for these events set forth in
the declaration establishing the Federally
declared disaster for purposes of section
7508A. In the circumstances where there
is a certain event with an incident date or
incident dates stated in the declaration, as
described in Examples (1)-(3) of the pro-
posed regulation, the period described in
section 7508A(d)(1) will generally run
concurrently with the discretionary peri-
ods specified by the Secretary under sec-
tion 7508A(a) or (b), when the postpone-
ment period provided by the Secretary
is equal to or greater than 60 days. (As
explained previously, the postponement
period provided by the Secretary is gener-
ally 120 days.) If the postponement period
provided by the Secretary is less than 60
days, then section 7508A(d) would apply
to provide a mandatory 60-day postpone-
ment period, running concurrently with
the Secretary’s postponement period at the
start, and then after the period prescribed
under section 7508A(a) ran out, the man-
datory period under section 7508A(d)
would continue to run for the remainder
of the 60-day period.
In flooding, wildfire, or earthquake
disasters, it is not unusual for FEMA ini-
tially to issue a major disaster declaration
with no known end date for the disaster
incident period. However, insofar as Con-
gress could have been aware when section
7508A(d) was enacted, these open-ended
disaster incident periods were generally
resolved with the addition by FEMA of a
closing date within a short time (usually
less than 60 days) after the first reported
incident date. Also, it is clear from the
legislative history that Congress did not
anticipate a situation such as a pandem-
ic or drought, where the beginning date
and end dates are not clear, or a situation
where the declaration does not specify an
incident date.
Ambiguities in applying section
7508A(d) arise when the incident date is
specified in the declaration as beginning
on a certain date but remaining open-end-
ed for an extended period of time. In those
cases, the calculation of the mandatory
60-day postponement period could result
in a prolonged postponement of specified
time-sensitive acts that could span well
beyond the one-year discretionary peri-
od authorized under section 7508A(a).
It defies logic for the Secretary’s discre-
tionary postponement period under sec-
tion 7508A(a) to be limited to “a period
of up to 1 year,” and there be no limit on
the mandatory 60-day postponement pe-
riod under section 7508A(d). If section
7508A(d) were interpreted as requiring
such prolonged postponement periods,
that interpretation would be contrary to
the directive of section 7508A(d)(1) that
the mandatory 60-day postponement pe-
riod must “be disregarded in the same
manner as a period specified under [sec-
tion 7508A(a)].” For the foregoing rea-
sons, these proposed regulations provide
that the phrase “shall be disregarded in the
same manner as a period specified under
subsection (a)” in section 7508A(d)(1)
means that the mandatory postponement
period cannot exceed the one-year period
authorized under section 7508A(a).
Further ambiguities arise when the
declaration establishing a Federally de-
clared disaster for purposes of section
7508A does not specify any incident
date. Under such circumstances, it is not

February 1, 2021 720 Bulletin No. 2021–5
possible to apply the statutory language
in section 7508A(d)(1) to provide relief
“beginning on the earliest incident date
specified in the declaration” and “ending
on the date which is 60 days after the lat-
est incident date so specified.” For that
reason, these proposed regulations pro-
vide that where a declaration establish-
ing a Federally declared disaster for pur-
poses of section 7508A does not specify
an incident date, there is no mandatory
period for relief under section 7508A(d).
If the Secretary determines to postpone
time-sensitive tax acts in response to
such a declaration, under the discretion-
ary authority in section 7508A(a), the
only postponement period will be the
period determined by the Secretary under
7508A(a).
These proposed regulations apply only
to the relief that is made available under
section 7508A in the event of a Federal-
ly declared disaster. It does not apply to
other relief provisions under other provi-
sions of the Code that automatically arise
as a result of a Federally declared disaster,
such as the loss provisions under section
165 of the Code.
III. Federally Declared Disasters
As noted above, the term “Federally
declared disaster” is defined in section
165(i)(5) as “any disaster subsequently
determined by the President of the Unit-
ed States to warrant assistance by the
Federal Government under the Robert T.
Stafford Disaster Relief and Emergency
Assistance Act.” The term “Federally
declared disaster” does not appear in the
Stafford Act, but the term “disaster” is
used in the Stafford Act to refer to ei-
ther an “emergency” or a “major disas-
ter” declared by the President in accor-
dance with the procedures contained
therein. The use of different terminology
between the Code and the Stafford Act
could cause confusion as to whether a
declaration of an emergency under the
Stafford Act establishes a “Federally
declared disaster” under the Code. Sec-
tion 165(i)(5) provides that a Federally
declared disaster is “any disaster” that
is determined to warrant assistance un-
der the Stafford Act. Under the Stafford
Act, the President can declare either an
emergency or a major disaster. There is
no provision to declare a “disaster,” but
the term “disaster” is used in the Stafford
Act as an umbrella term that encompass-
es both an emergency and a major disas-
ter. As a result, the term “any disaster”
in section 165(i)(5) encompasses both an
emergency and a major disaster. The IRS
has previously acknowledged in multiple
Revenue Rulings that Federally declared
disasters include either an emergency or
a major disaster declared under the Staf-
ford Act. See Rev. Rul. 2003-29, 2003-
11 I.R.B. 587 (Mar. 17, 2003); Rev.
Rul. 2002-11, 2002-10 I.R.B. 608 (Mar.
11, 2002); Rev. Rul. 2001-15, 2001-13
I.R.B. 922 (Mar. 26, 2001); and Rev.
Rul. 2000-15, 2000-12 I.R.B. 774 (Mar.
20, 2000). These proposed regulations
formalize that clarification by amending
the definition of “Federally declared di-
saster” in §1.165-11(b)(1) of the Income
Tax Regulations to specifically provide
that the term “Federally declared disas-
ter” includes both a major disaster de-
clared under section 401 of the Stafford
Act and an emergency declared under
section 501 of the Stafford Act.
IV. The COVID-19 Pandemic
The disaster relief provided under sec-
tion 7508A in response to the COVID-19
pandemic illustrates some of the provi-
sions in these proposed regulations. The
COVID-19 pandemic became a Federal-
ly declared disaster for purposes of sec-
tion 7508A on March 13, 2020, when the
President issued his nationwide emer-
gency declaration under section 501(b)
of the Stafford Act.
5
In response to that
declaration, pursuant to the discretionary
authority under section 7508A(a) and
(b), the Secretary determined the taxpay-
ers affected by the disaster, the time-sen-
sitive tax acts that should be postponed,
and the time period for postponement.
Those determinations were reflected in
several notices released to the public be-
ginning in late March. Notice 2020-17
was issued on March 18, 2020,
6
Notice
2020-18, superseding Notice 2020-17,
was issued on March 20, 2020,
7
Notice
2020-20, amplifying Notice 2020-18,
was issued on March 27, 2020,
8
and No-
tice 2020-23, amplifying Notices 2020-
18 and 2020-20, was issued on April 9,
2020.
9
Additional notices continued to be
released thereafter, as the Secretary con-
tinued to exercise his discretionary au-
thority under section 7508A(a) and (b) in
response to the President’s March 13 dec-
laration, including a joint notice with the
Department of Labor published on May
4, 2020,
10
and Notice 2020-35, issued on
May 28, 2020.
11
Because the President’s
March 13 emergency declaration did
not specify an incident date, there is no
mandatory 60-day postponement period
under section 7508A(d). The only post-
ponement period provided under section
7508A for the time-sensitive acts post-
poned in response to that declaration are
the periods determined by the Secretary
under section 7508A(a) and (b).
Subsequent to the President’s March
13 nationwide emergency declaration,
beginning on March 20, 2020, and con-
tinuing on almost a daily basis until April
13, 2020, the President approved major
disaster declarations under section 401
of the Stafford Act for all 50 states, the
District of Columbia, and 5 U.S. territo-
ries, in connection with the COVID-19
pandemic. Those declarations speci-
fied an incident period of “January 20,
2020 and continuing.” The Secretary
did not use his discretion under section
7508A(a) to postpone any time-sensitive
tax acts in response to those state-by-
state declarations. As discussed earlier, a
5
https://www.whitehouse.gov/briefings-statements/letter-president-donald-j-trump-emergency-determination-stafford-act/
6
2020-15 I.R.B. 590 (April 6, 2020).
7
2020-15 I.R.B. 590 (April 6, 2020).
8
2020-16 I.R.B. 660 (April 13, 2020).
9
2020-18 I.R.B. 742 (April 27, 2020).
10
85 Fed. Reg. 26351 (May 4, 2020).
11
2020-25 I.R.B. 948 (June 15, 2020).

Bulletin No. 2021–5 721 February 1, 2021
period for performing acts cannot be dis-
regarded under section 7508A(d) “in the
same manner as a period specified under
[section 7508A(a)]” if no period for per-
forming such acts is in fact disregarded
under section 7508A(a) in connection
with a declaration. As a result, section
7508A(d) does not operate to postpone
any acts for a mandatory 60-day period
in connection with those state-by-state
declarations.
Applicability Date
Section 7805(b)(1)(A) and (B) of the
Code generally provide that no temporary,
proposed, or final regulation relating to the
internal revenue laws may apply to any
taxable period ending before the earliest
of (A) the date on which such regulation
is filed with the Federal Register, or (B)
in the case of a final regulation, the date on
which a proposed or temporary regulation
to which the final regulation relates was
filed with the Federal Register. However,
section 7805(b)(2) provides that regula-
tions filed or issued within 18 months of
the date of the enactment of the statutory
provision to which they relate are not pro-
hibited from applying to taxable periods
prior to those described in section 7805(b)
(1). As noted above, section 7508A(d)
was enacted on December 20, 2019, as
part of the FCAA.
Accordingly, as provided in section
7805(b)(2) of the Code, these proposed reg-
ulations are proposed to apply to disasters
declared on or after December 21, 2019.
Special Analyses
Certain IRS regulations, including
these, are exempt from the requirements
of Executive Order 12866, as supple-
mented and affirmed by Executive Order
13563. Therefore, a regulatory assessment
is not required.
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is hereby
certified that these proposed regulations
will not have a significant economic im-
pact on a substantial number of small en-
tities. The proposed regulations clarify
how the Secretary may postpone certain
time-sensitive tax deadlines by reason
of a Federally declared disaster. Such
postponements provide more time for
affected taxpayers to complete time-sen-
sitive acts than they otherwise would
have under the internal revenue laws.
In addition, the proposed regulations
would not impose a collection of infor-
mation on any person, including small
entities, for purposes of the Regulatory
Flexibility Act (5 U.S.C. chapter 6). Ac-
cordingly, the Secretary certifies that the
regulations will not have a significant
economic impact on a substantial num-
ber of small entities.
Pursuant to section 7805(f) of the In-
ternal Revenue Code, the IRS will sub-
mit the proposed regulations to the Chief
Counsel for the Office of Advocacy of
the Small Business Administration for
comments on the regulations’ impact on
small businesses.
Comments and Request for a Public
Hearing
Before these proposed regulations are
adopted as final, consideration will be giv-
en to comments that are submitted timely
to the IRS as prescribed in the preamble
under the “ADDRESSES” section. The
Treasury Department and the IRS request
comments on all aspects of the proposed
regulations. Any electronic comments
submitted, and to the extent practicable
any paper comments submitted, will be
made available at www.regulations.gov or
upon request.
A public hearing will be scheduled if
requested in writing by any person who
timely submits electronic or written com-
ments. Requests for a public hearing are
also encouraged to be made electronically.
If a public hearing is scheduled, notice of
the date and time for the public hearing
will be published in the Federal Register.
Announcement 2020-4, I.R.B. 2020-17,
provides that until further notice, public
hearings conducted by the IRS will be
held telephonically. Any telephonic hear-
ing will be made accessible to people with
disabilities.
Drafting Information
The principal author of these regula-
tions is William V. Spatz of the Office of
Associate Chief Counsel (Procedure and
Administration). However, other person-
nel from the Treasury Department and the
IRS participated in the development of the
regulations.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Ex-
cise taxes, Gift taxes, Income taxes, Pen-
alties, Reporting and recordkeeping re-
quirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 301
are proposed 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 * * *
Par. 2. Section 1.165-11 is amended by
revising paragraph (b)(1) to read as fol-
lows:
§1.165-11 Election to take disaster loss
deduction for preceding year.
* * * * *
(b) * * *
(1) A federally declared disaster means
any disaster subsequently determined by
the President of the United States to war-
rant assistance by the Federal Government
under the Robert T. Stafford Disaster Re-
lief and Emergency Assistance Act (Staf-
ford Act). A federally declared disaster
includes both a major disaster declared
under section 401 of the Stafford Act and
an emergency declared under section 501
of the Stafford Act.
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 3. The authority citation for part
301 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *

February 1, 2021 722 Bulletin No. 2021–5
Par. 4. Section 301.7508A-1 is amend-
ed by revising paragraph (g) and adding
paragraph (h) to read as follows::
§301.7508A-1 Postponement of certain
tax-related deadlines by reasons
of a Federally declared disaster or
terroristic or military action.
* * * * *
(g) Mandatory 60-day postponement—
(1) In general. In addition to (or concur-
rent with) the postponement period speci-
fied by the Secretary in an exercise of the
authority under section 7508A(a) to post-
pone time-sensitive acts by reason of a
Federally declared disaster, qualified tax-
payers (as defined in section 7508A(d)(2))
are entitled to a mandatory 60-day post-
ponement period during which the time to
perform those time-sensitive acts is disre-
garded in the same manner as under sec-
tion 7508A(a). A similar rule applies with
respect to a postponement period specified
by the Secretary under section 7508A(b),
to postpone acts as provided in section
7508A(d)(4). Except for the acts set forth
in paragraph (g)(2) of this section, section
7508A(d) does not apply to postpone any
acts.
(2) Acts postponed. The time-sensitive
acts that are postponed for the mandatory
60-day postponement period are the acts
determined to be postponed by the Secre-
tary’s exercise of authority under section
7508A(a) or (b). In addition, in the case
of any person described in 7508A(b), the
time-sensitive acts postponed for the man-
datory 60-day postponement period in-
clude those described in section 7508A(d)
(4):
(i) Making contributions to a qualified
retirement plan (within the meaning of
section 4974(c)) under section 219(f)(3),
404(a)(6), 404(h)(1)(B), or 404(m)(2);
(ii) Making distributions under section
408(d)(4);
(iii) Recharacterizing contributions un-
der section 408A(d)(6); and
(iv) Making a rollover under section
402(c), 403(a)(4), 403(b)(8), or 408(d)(3).
(3) Calculation of mandatory 60-day
postponement period—(i) In general.
The mandatory 60-day postponement
period begins on the earliest incident
date specified in a disaster declaration
for a Federally declared disaster and
ends on the date that is 60 days after
the latest incident date specified in the
disaster declaration. In accordance with
section 7508A(d)(5), if the period de-
termined by the Secretary in exercising
discretion under 7508A(a) is equal to or
longer than 60 days, the mandatory 60-
day postponement period under section
7508A(d) runs concurrently with the
postponement period determined by the
Secretary under section 7508A(a). If the
period determined by the Secretary in ex-
ercising discretion under 7508A(a) is less
than 60 days, in accordance with section
7508A(d)(5), the mandatory 60-day post-
ponement period will run concurrently
for the length of the period determined
by the Secretary under section 7508A(a)
and then continue running in addition to
the period determined by the Secretary
under section 7508A(a).
(ii) Limitations on the mandatory 60-
day postponement period. (A) In no event
will the mandatory 60-day postponement
period be calculated to exceed one year.
(B) In the event the Secretary deter-
mines to postpone time-sensitive acts
pursuant to a declaration establishing a
Federally declared disaster for purposes
of section 7508A that does not specify an
incident date, there is no mandatory post-
ponement period under section 7508A(d).
In such cases, the only postponement pe-
riod will be the period determined by the
Secretary under 7508A(a).
(5) Examples. The rules of this para-
graph (g) are illustrated by the following
examples:
(i) Example (1). Individual A lives in a state that
experienced severe but isolated tornado damage on
March 15. On March 20, FEMA issued a Federal
Register Notice announcing a major disaster decla-
ration approved by the President for the state where
Individual A lives, describing the incident date for
the tornado as March 15. Based upon that major di-
saster declaration, the IRS published a news release
identifying the taxpayers (by county) affected by the
disaster for purposes of section 7508A and specify-
ing the time-sensitive acts that are postponed and
a period of postponement from March 15 through
July 31, pursuant to section 7508A(a). Under section
7508A(d), the mandatory 60-day postponement pe-
riod that Individual A is entitled to begins on March
15 and ends 60 days after March 15, on May 14. The
mandatory postponement period applies to the same
time-sensitive acts and runs concurrently with the re-
lief the IRS provided to Individual A under section
7508A(a).
(ii) Example (2). Individual B lives in a coastal
state which experienced harmful effects from a hur-
ricane that began to affect the weather in his state on
August 15 and ceased to be a weather factor in his state
on August 19. On August 22, FEMA issued a Federal
Register Notice announcing a major disaster declara-
tion approved by the President, determining that the
coastline counties in the state where Individual B lives
were severely affected and that these counties were
entitled to both individual assistance and public assis-
tance. The major disaster declaration specified the ear-
liest incident date for the hurricane in the state where
Individual B lives as August 15 and the latest incident
date as August 19. Based upon that major disaster dec-
laration, the IRS published a news release identifying
the taxpayers affected by the disaster for purposes of
section 7508A and specifying the time-sensitive acts
that are postponed and a period of postponement from
August 15 through December 31, pursuant to section
7508A(a). Under section 7508A(d), the mandatory
60-day postponement period that Individual B is enti-
tled to begins on August 15 and ends 60 days after Au-
gust 19, on October 18. The mandatory postponement
period applies to the same time-sensitive acts and runs
concurrently with the relief the IRS provided to Indi-
vidual B under section 7508A(a).
(iii) Example (3). Individual C lives in a state
that is experiencing multiple ongoing wildfires. On
August 14, FEMA issued a Federal Register Notice
announcing a major disaster declaration approved
by the President for the state where Individual C
lives, specifying the earliest incident date for the
wildfires as August 14 and the incident was ongoing.
Based upon that major disaster declaration, the IRS
published a news release identifying the taxpayers
(by county) affected by the disaster for purposes of
section 7508A and specifying the time-sensitive acts
that are postponed and a period of postponement
from August 14 through December 15, pursuant to
section 7508A(a). The wildfire disaster remains on-
going, with no ending incident date specified, for
several months. The IRS publishes a second news
release postponing the time-sensitive acts through
January 15. FEMA amends the major disaster decla-
ration to specify the latest incident date of November
19. Under section 7508A(d), the mandatory 60-day
postponement period that Individual D is entitled to
begins on August 14 and ends 60 days after the latest
incident date of November 19. The mandatory post-
ponement period applies to the same time-sensitive
acts and runs concurrently with the relief the IRS
provided to Individual D under section 7508A(a),
and ends on January 18, which is 60 days after the
latest incident date and three days beyond the post-
ponement period specified by the IRS under section
7508A(a) in its news release.
(iv) Example (4). Individual D lives in the
United States, which is experiencing a nationwide
emergency as a result of its residents being exposed
to a highly infectious and dangerous pandemic dis-
ease. On March 13, the President declared a na-
tionwide emergency under section 501(b) of the
Stafford Act. The pandemic became a Federally
declared disaster for purposes of section 7508A on
March 13, however, no incident date was specified
in the President’s emergency declaration. Pursuant
to the President’s March 13 emergency declaration,
the IRS published several notices identifying the
taxpayers affected by the disaster for purposes of
section 7508A and specifying the time-sensitive
acts that are postponed and a period of postpone-

Bulletin No. 2021–5 723 February 1, 2021
ment that generally ran from April 1 through July
15, pursuant to section 7508A(a). Because, in this
circumstance, the emergency declaration pursuant
to which the notices were published did not spec-
ify an incident date, there is no mandatory post-
ponement period under section 7508A(d). The only
postponement period is the period determined by
the Secretary pursuant to the discretionary authori-
ty under section 7508A(a).
(h) Applicability dates—(1) In general.
Except as provided in paragraph (h)(2) of
this section, this section applies to disas-
ters declared after January 15, 2009.
(2) Paragraph (g). Paragraph (g) of
this section applies to disasters declared
on or after December 21, 2019.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
(Filed by the Office of the Federal Register on Jan-
uary 11, 2021, 4:15 p.m., and published in the issue
of the Federal Register for January 13, 2020, 86 F.R.
2607)

Bulletin No. 2021–5 i February 1, 2021
Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) 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 pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that
the same principle 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 be-
ing made clear because the language has
caused, or may cause, some confusion. It
is not used where a position in a prior rul-
ing is being changed.
Distinguished describes a situation
where a ruling mentions a previously pub-
lished 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 amplified and clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transactions.
This term is most commonly used in a ruling
that lists previously published rulings that
are obsoleted because of changes in laws or
regulations. A ruling may also be obsoleted
because the substance has been included in
regulations subsequently adopted.
Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a 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 published under the 1939 Code
and regulations. 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 the
new ruling does more than restate the sub-
stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes 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 previous-
ly 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 rul-
ings 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 cas-
es in litigation, or the outcome of a Ser-
vice 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 Contributions 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.—Statement 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.

February 1, 2021 ii Bulletin No. 2021–5
Numerical Finding List
1
Bulletin 2021–5
Announcements:
2021-01, 2021-04 I.R.B. 506
Notices:
2021-01, 2021-02 I.R.B. 315
2021-03, 2021-02 I.R.B. 316
2021-04, 2021-02 I.R.B. 319
2021-02, 2021-03 I.R.B. 478
2021-05, 2021-03 I.R.B. 479
2021-07, 2021-03 I.R.B. 482
2021-09, 2021-05 I.R.B. 678
Proposed Regulations:
REG-130081-19, 2021-02 I.R.B. 321
REG-114615-16, 2021-03 I.R.B. 489
REG-111950-20, 2021-05 I.R.B. 683
REG-115057-20, 2021-05 I.R.B. 714
Revenue Procedures:
2021-01, 2020-01 I.R.B. 1
2021-02, 2020-01 I.R.B. 116
2021-03, 2020-01 I.R.B. 140
2021-04, 2020-01 I.R.B. 157
2021-05, 2020-01 I.R.B. 250
2021-07, 2020-01 I.R.B. 290
2021-09, 2020-03 I.R.B. 485
2021-08, 2020-04 I.R.B. 502
2021-10, 2020-04 I.R.B. 503
2021-12, 2020-05 I.R.B. 681
Revenue Rulings:
2021-01, 2021-02 I.R.B. 294
2021-02, 2021-04 I.R.B. 495
2021-03, 2021-05 I.R.B. 674
Treasury Decisions:
9925, 2021-02 I.R.B. 296
9940, 2021-02 I.R.B. 311
9932, 2021-03 I.R.B. 345
9939, 2021-03 I.R.B. 376
9941, 2021-03 I.R.B. 396
9942, 2021-03 I.R.B. 450
9937, 2021-04 I.R.B. 495
9936, 2021-05 I.R.B. 508
9943, 2021-05 I.R.B. 577
9945, 2021-05 I.R.B. 627
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2020–27 through 2020–52 is in Internal Revenue Bulletin
2020–52, dated December 27, 2020.

Bulletin No. 2021–5 iii February 1, 2021
Finding List of Current Actions on
Previously Published Items
1
Bulletin 2021–5
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2020–27 through 2020–52 is in Internal Revenue Bulletin
2020–52, dated December 27, 2020.

Internal Revenue Service
Washington, DC 20224
Official Business
Penalty for Private Use, $300
INTERNAL REVENUE BULLETIN
The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue
Bulletins are available at www.irs.gov/irb/.
We Welcome Comments About the Internal Revenue Bulletin
If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it,
we would be pleased to hear from you. You can email us your suggestions or comments through the IRS Internet Home Page
www.irs.gov) or write to the Internal Revenue Service, Publishing Division, IRB Publishing Program Desk, 1111 Constitution Ave.
NW, IR-6230 Washington, DC 20224.