Internal Revenue Bulletin 2007-6 (PDF rendition): IRS Revenue Rulings

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. 200
7-6
February 5, 2007
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 2007–9, page 422.
Federal rates; adjusted federal rates; adjusted federal
long-termrateandthelong-termexemptrate.For pur-
poses of sections 382, 642, 1274, 1288, and other sections
of the Code, tables set forth the rates for February 2007.
T.D. 9304,
page 423.
REG–16191
9–05, page 463.
Final, tem
porary, and proposed regulations under section 1561
of the Code
affect component members of controlled groups
and consol
idated groups filing life-nonlife returns. They pro-
vide guida
nce regarding the apportionment of tax benefit items
and the am
ount and type of information these members are re-
quired to
submit with their federal income tax returns.
T.D. 9306, page 420.
Final regulations under 31 USC 9701 increase the amount of
the user fees imposed under sections 300.1 and 300.2 for
entering into and restructuring or reinstating installment agree-
ments. The regulations bring the fees in line with the actual
costs to the IRS. Currently, the IRS charges $43 for entering
into an installment agreement and $24 for restructuring or re-
instating an installment agreement that is in default. The IRS
recently completed a review of the installment agreement pro-
gram and determined that the full cost of an installment agree-
ment is $105, and the full cost of restructuring or reinstating
an installment agreement is $45. The regulations reflect these
costs, with one exception; the fee for entering into an install-
ment agreement paid by way of a direct debit from the tax-
payer’s checking account will be $52, to encourage this type
of payment arrangement.
EMPLOYEE PLANS
T.D. 9298, page 434.
Final regulations under section 9802 of the Code provide guid-
ance which prohibits group health plans from discriminating in
eligibility or premiums among those covered by the plan. The
regulations also provide guidance on the limited exception to
the nondiscrimination requirements for programs of health pro-
motion or disease prevention.
T.D. 9299
,page460.
Final regu
lations under section 9802 of the Code provide guid-
ance on an
exception to the general nondiscrimination require-
ments, wh
ich prohibit group health plans from discriminating in
eligibil
ity or premiums among those covered by the plan. The
exceptio
n allows certain church plans to continue requiring ev-
idence of
good health of certain individuals.
EXCISE TAX
T.D. 9298, page 434.
Final regulations under section 9802 of the Code provide guid-
ance which prohibits group health plans from discriminating in
eligibility or premiums among those covered by the plan. The
regulations also provide guidance on the limited exception to
the nondiscrimination requirements for programs of health pro-
motion or disease prevention.
(Continued on the next page)
Actions Relating to Court Decisions is on the page following the Introduction.
Fi
nding Lists begin on page ii.

T.D. 9299, page 460.
Final regulations under section 9802 of the Code provide guid-
ance on an exception to the general nondiscrimination require-
ments, which prohibit group health plans from discriminating in
eligibility or premiums among those covered by the plan. The
exception allows certain church plans to continue requiring ev-
idence of good health of certain individuals.
ADMINISTRATIVE
T.D. 9304, page 423.
REG–161919–05, page 463.
Final, temporary, and proposed regulations under section 1561
of the Code affect component members of controlled groups
and consolidated groups filing life-nonlife returns. They pro-
vide guidance regarding the apportionment of tax benefit items
and the amount and type of information these members are re-
quired to submit with their federal income tax returns.
Announcement 2007–10, page 464.
This document contains corrections to final and temporary reg-
ulations (T.D. 9278, 2006–34 I.R.B. 256) regarding the treat-
ment of controlled services transactions under section 482 of
theCodeandtheallocationofincomefromintangibles,inpar-
ticular with respect to contributions by a controlled party to the
value of an intangible owned by another controlled party.
Announcement 2007–11, page 464.
This document contains corrections to a notice of proposed
rulemaking by cross-reference to temporary regulations,
notice of proposed rulemaking, and notice of public hearing
(REG–146893–02, 2006–34 I.R.B. 317) regarding the treat-
ment of controlled services transactions under section 482
of the Code and the allocation of income from intangibles, in
particular with respect to contributions by a controlled party to
the value of an intangible owned by another controlled party.
Announcement 2007–12, page 465.
This document contains corrections to final and temporary reg-
ulations (T.D. 9260, 2006–23 I.R.B. 1001) concerning the ap-
plication of separate foreign tax credit limitations to dividends
received from noncontrolled section 902 corporations under
section 904(d)(4) of the Code.
February 5, 20072007–6 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping
them understand and meet their tax responsibilities and by
applying the tax law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
Superintendent of Documents on a subscription basis. Bulletin
contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
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.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al 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, Leg-
islation 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 Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury’s Office of the Assistant Sec-
retary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d 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 c
ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.
2007–6 I.R.B.February 5, 2007

Actions Relating to Decisions of the Tax Court
It is the policy of the Internal Rev-
enue Service to announce at an early date
whether it will follow the holdings in cer-
tain cases. An Action on Decision is the
document making such an announcement.
An Action on Decision will be issued at
the discretion of the Service only on unap-
pealed issues decided adverse to the gov-
ernment. Generally, an Action on Decision
is issued where its guidance would be help-
ful to Service personnel working with the
same or similar issues. Unlike a Treasury
Regulation or a Revenue Ruling, an Action
on Decision is not an affirmative statement
of Service position. It is not intended to
serve as public guidance and may not be
cited as precedent.
Actions on Decisions shall be relied
upon within the Service only as conclu-
sions applying the law to the facts in the
particular case at the time the Action on
Decision was issued. Caution should be
exercised in extending the recommenda-
tion of the Action on Decision to similar
cases where the facts are different. More-
over, the recommendation in the Action on
Decision may be superseded by new legis-
lation, regulations, rulings, cases, or Ac-
tions on Decisions.
Prior to 1991, the Service published
acquiescence or nonacquiescence only in
certain regular Tax Court opinions. The
Service has expanded its acquiescence
program to include other civil tax cases
where guidance is determined to be help-
ful. Accordingly, the Service now may
acquiesce or nonacquiesce in the holdings
of memorandum Tax Court opinions, as
well as those of the United States District
Courts, Claims Court, and Circuit Courts
of Appeal. Regardless of the court decid-
ing the case, the recommendation of any
Action on Decision will be published in
the Internal Revenue Bulletin.
The recommendation in every Action
on Decision will be summarized as ac-
quiescence, acquiescence in result only,
or nonacquiescence. Both “acquiescence”
and “acquiescence in result only” mean
that the Service accepts the holding of
the court in a case and that the Service
will follow it in disposing of cases with
the same controlling facts. However, “ac-
quiescence” indicates neither approval
nor disapproval of the reasons assigned
by the court for its conclusions; whereas,
“acquiescence in result only” indicates
disagreement or concern with some or all
of those reasons. “Nonacquiescence” sig-
nifies that, although no further review was
sought, the Service does not agree with
the holding of the court and, generally,
will not follow the decision in disposing
of cases involving other taxpayers. In
reference to an opinion of a circuit court
of appeals, a “nonacquiescence” indicates
that the Service willnot follow the hold-
ing on a nationwide basis. However, the
Service will recognize the precedential
impact of the opinion on cases arising
within the venue of the deciding circuit.
The Actions on Decisions published in
the weekly Internal Revenue Bulletin are
consolidated semiannually and appear in
the first Bulletin for July and the Cumula-
tive Bulletin for the first half of the year. A
semiannual consolidation also appears in
the first Bulletin for the following January
and in the Cumulative Bulletin for the last
half of the year.
The Commissioner does NOT ACQUI-
ESCE in the following decision:
North Dakota State University v.
United States,
1
255 F.3d 599 (8th Cir. 2001),
nonacq., 2001–2 C.B. xv
1
Nonacquiescence relating to whether early retirement payments that the taxpayer made to tenured faculty members are wages subject to Federal Insurance Contributions Act (“FICA”) taxes.
The litigating position in the Action on Decision dated December 31, 2001, ismodified and replaced. The Service’s nonacquiescence in the Eighth Circuit’s decision remains unchanged.
February 5, 20072007–6 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 42.—Low-Income
Housing Credit
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 280G.—Golden
Parachute Payments
Federal short-term, mid-term, and long-term rates
are set forth for the month of February 2007. See Rev.
Rul. 2007-9, page 422.
Section 300 (31 USC
9701).—Installment
Agreement Fee
300.1: Installment agreement fee.
T.D. 9306
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 300
User Fees for Processing
Installment Agreements
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
amendments to the regulations relating to
user fees for installment agreements. The
amendments update the fees to reflect the
actual costs of the services provided and
create an exception to the increased fee for
entering into installment agreements for
low-income taxpayers. The amendments
affect taxpayers who wish to pay their
liabilities through installment agreements.
DATES:Effective Date:These regulations
are effective onDecember 28, 2006.
Applicability Date:These regulations
apply to installment agreements entered
into, restructured, or reinstated on or after
January 1, 2007.
FOR FURTHER INFORMATION
CONTACT: Concerning cost method-
ology, Eva Williams, 202–435–5514; con-
cerning the regulations, William Beard,
202–622–3620 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments
to 26 CFR part 300. On August 30,
2006, a notice of proposed rulemaking
(REG–148576–05, 2006–40 I.R.B. 627)
relating to the user fees charged for pro-
cessing installment agreements was pub-
lished in theFederal Register(71 FR
51538). The charging of user fees imple-
ments the Independent Offices Appropri-
ations Act (IOAA), which is codified at
31 U.S.C. 9701. The notice of proposed
rulemaking proposed an increase in the
amount of the user fees to reflect the full
cost of the service provided, as directed by
OMB Circular A–25, 58 FR 38142 (July
15, 1993) (the OMB Circular).
The notice of proposed rulemaking pro-
posed to increase the fee under §300.1
for entering into an installment agreement
from $43 to $105 and to increase the fee
under §300.2 for restructuring an install-
ment agreement from $24 to $45. The no-
tice of proposed rulemaking also proposed
an exception to the full-cost requirement in
cases where the taxpayer chooses to pay by
way of a direct debit from the taxpayer’s
bank account. The OMB Circular allows
the Office of Management and Budget to
grant a waiver of the full cost requirement
and, pursuant to such a waiver, the pro-
posed fee for entering into a direct-debit
agreement was $52 to encourage this type
of payment.
No public hearing on the notice of pro-
posed rulemaking was held because no
one requested to speak. Eight comments
were received. After consideration of
all the comments, this Treasury decision
adopts the proposed regulations with the
following change: the fee for entering into
an installment agreement will remain $43
for low-income taxpayers, that is, taxpay-
ers whose incomes fall at or below 250%
of the dollar criteria established by the
poverty guidelines updated annually in the
Federal Registerby the U.S. Department
of Health and Human Services or such
other measure as the Secretary may adopt.
The IRS sought and received an additional
waiver from OMB to charge less than full
cost to low-income taxpayers.
Summary of Comments and
Explanation of Revisions
Of the eight comments on the proposed
regulations, five stated that the increased
fees would have an adverse impact on low-
income taxpayers. Other commentators
stated that many low-income taxpayers do
not have bank accountsand cannot take ad-
vantage of the reduced fee for direct-debit
installment agreements. To accommodate
these concerns, the final regulations except
low-income taxpayers from the increase
of the fee for entering into an installment
agreement. Therefore the fee for entering
into an installment agreement remains $43
for low-income taxpayers, that is, taxpay-
ers whose income fall at or below 250%
of the dollar poverty criteria established by
the U.S. Department of Health and Human
Services. The exception does not apply to
the fee for restructuring or reinstating an
installment agreement.
Other commentators recommended that
the installment agreement user fee be re-
duced for any taxpayer who requests an
agreement on-line (over the internet). Un-
der the IOAA, user fees should be fair and
based on the costs to the government, the
value of the service to the recipient, and
the public policy or interest served. No ex-
ception was created for installment agree-
ments requested on-line because the ben-
efit of the installment agreement program
to the taxpayer does not change depend-
ing on how the installment agreement is
requested, the convenience of on-line re-
quests provides ample incentive for this
type of application for taxpayers who have
internet access, and taxpayers who do not
have internet access could not take advan-
tage of the lower fee. The IRS intends
to consider a cost methodology for install-
ment agreement user fees that reflects cost
differences attributable to various types of
installment agreements, as well as whether
additional exceptionsto full cost are war-
ranted.
2007–6 I.R.B.420February 5, 2007

Special Analyses
It has been determined that this notice
of rulemaking is not a significant regu-
latory action as defined in Executive Or-
der 12866. Therefore, a regulatory assess-
ment is not required. It is hereby certi-
fied that these regulations will not have a
significant economic impact on a substan-
tial number of small entities. Accordingly,
a regulatory flexibility analysis is not re-
quired. This certification is based on the
information that follows. The economic
impact of these regulations on any small
entity would result from the entity being
required to pay a fee prescribed by these
regulations in order to obtain a particular
service. The dollar amount of the fee is
not, however, substantial enough to have
a significant economic impact on any en-
tity subject to the fee. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
this regulation was submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.
Although the Administrative Proce-
dures Act prescribes a thirty-day waiting
period between the date of publication in
theFederal Registerand the applicability
date, this regulation is being made appli-
cable after a shorter period under the au-
thority provided by section 7805(b)(1)(B).
Drafting Information
The principal author of these regula-
tions is William Beard, Office of Associate
Chief Counsel (Procedure and Adminis-
tration), Collection, Bankruptcy and Sum-
monses Division.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 300 is
amended as follows:
PART 300—USER FEES
Paragraph 1. The authority citation for
part 300 continues to read as follows:
Authority: 31 U.S.C. 9701.
Par. 2. Section 300.0 is amended by
revising paragraph (c) to read as follows:
§300.0 User fees; in general.
*****
(c)Effective date. This part 300 is ap-
plicable March 16, 1995, except that the
user fee for processing offers in compro-
mise is applicable November 1, 2003; the
user fee for the special enrollment exam-
ination, enrollment, and renewal of en-
rollment for enrolled agents is applicable
November 6, 2006; the user fee for enter-
ing into installment agreements on or after
January 1, 2007, is applicable January 1,
2007; and the user fee for restructuring or
reinstatement of an installment agreement
on or after January 1, 2007, is applicable
January 1, 2007.
Par. 3. Section 300.1 is amended by
revising paragraph (b) to read as follows:
§300.1 Installment agreement fee.
*****
(b)Fee. The fee for entering into an
installment agreement before January 1,
2007, is $43. The fee for entering into an
installment agreement on or after January
1, 2007, is $105, except that:
(1) The fee is $52 when the taxpayer
pays by way of a direct debit from the tax-
payer’s bank account; and
(2) Notwithstanding the method of pay-
ment, the fee is $43 if the taxpayer is a
low-income taxpayer, that is, an individual
who falls at or below 250% of the dollar
criteria established by the poverty guide-
lines updated annually in theFederal Reg-
isterby the U.S. Department of Health and
Human Services under authority of section
673(2) of the Omnibus Budget Reconcili-
ation Act of 1981 (95 Stat. 357, 511), or
such other measure that is adopted by the
Secretary.
*****
Par. 4. Section 300.2 is amended by
revising paragraph (b) to read as follows:
§300.2 Restructuring or reinstatement of
installment agreement fee.
*****
(b)Fee. The fee for restructuring or
reinstating an installment agreement be-
fore January 1, 2007, is $24. The fee for
restructuring or reinstating an installment
agreement on or after January 1, 2007, is
$45.
*****
Kevin M. Brown,
Acting Deputy Commissioner for
Services and Enforcement.
Approved December 21, 2006.
Eric Solomon,
Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 27,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 28, 2006, 71 F.R. 78074)
Section 382.—Limitation
on Net Operating Loss
Carryforwards and Certain
Built-In Losses Following
Ownership Change
The adjusted applicable federal long-term rate is
set forth for the month of February 2007. See Rev.
Rul. 2007-9, page 422.
Section 412.—Minimum
Funding Standards
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 467.—Certain
Payments for the Use of
Property or Services
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 468.—Special
Rules for Mining and Solid
Waste Reclamation and
Closing Costs
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 482.—Allocation
of Income and Deductions
Among Taxpayers
Federal short-term, mid-term, and long-term rates
are set forth for the month of February 2007. See Rev.
Rul. 2007-9, page 422.
February 5, 20074212007–6 I.R.B.

Section 483.—Interest on
Certain Deferred Payments
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 642.—Special
Rules for Credits and
Deductions
Federal short-term, mid-term, and long-term rates
are set forth for the month of February 2007. See Rev.
Rul. 2007-9, page 422.
Section 807.—Rules for
Certain Reserves
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 846.—Discounted
Unpaid Losses Defined
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 1274.—Determi-
nation of Issue Price in the
Case of Certain Debt Instru-
ments Issued for Property
(Also Sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 807, 846, 1288, 7520, 7872.)
Federal rates; adjusted federal rates;
adjusted federal long-term rate and the
long-term exempt rate.For purposes of
sections 382, 642, 1274, 1288, and other
sections of the Code, tables set forth the
rates for February 2007.
Rev. Rul. 2007–9
This revenue ruling provides various
prescribed rates for federal income tax
purposes for February 2007 (the current
month). Table 1 contains the short-term,
mid-term, and long-term applicable fed-
eral rates (AFR) for the current month
for purposes of section 1274(d) of the
Internal Revenue Code. Table 2 contains
the short-term, mid-term, and long-term
adjusted applicable federal rates (adjusted
AFR) for the current month for purposes
of section 1288(b). Table 3 sets forth the
adjusted federal long-term rate and the
long-term tax-exempt rate described in
section 382(f). Table 4 contains the ap-
propriate percentages for determining the
low-income housing credit described in
section 42(b)(2) for buildings placed in
service during the current month. Finally,
Table 5 contains the federal rate for deter-
mining the present value of an annuity, an
interest for life or for a term of years, or
a remainder or a reversionary interest for
purposes of section 7520.
REV. RUL. 2007–9 TABLE 1
Applicable Federal Rates (AFR) for February 2007
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-term
AFR4.93%4.87%4.84%4.82%
110% AFR5.43%5.36%5.32%5.30%
120% AFR5.93%5.84%5.80%5.77%
130% AFR6.43%6.33%6.28%6.25%
Mid-term
AFR4.69%4.64%4.61%4.60%
110% AFR5.17%5.10%5.07%5.05%
120% AFR5.65%5.57%5.53%5.51%
130% AFR6.12%6.03%5.99%5.96%
150% AFR7.08%6.96%6.90%6.86%
175% AFR8.28%8.12%8.04%7.99%
Long-term
AFR4.86%4.80%4.77%4.75%
110% AFR5.35%5.28%5.25%5.22%
120% AFR5.84%5.76%5.72%5.69%
130% AFR6.34%6.24%6.19%6.16%
2007–6 I.R.B.422February 5, 2007

REV. RUL. 2007–
9TABLE2
Adjusted AFR for February 2007
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-term adjusted
AFR
3.46%3.43%3.42%3.41%
Mid-term adjusted AFR3.58%3.55%3.53%3.52%
Long-term ad
justed
AFR
4.07%4.03%4.01%4.00%
REV. RUL. 2007–9 TABLE 3
Rates Under Section 382 for February 2007
Adjusted federal long-term rate for the current month4.07%
Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted
federal long-term rates for the current month and the prior two months.)4.14%
REV. RUL. 2007–9 TABLE 4
Appropriate Percentages Under Section 42(b)(2) for February 2007
Appropriate percentage for the 70% present value low-income housing credit8.11%
Appropriate percentage for the 30% present value low-income housing credit3.48%
REV. RU
L. 2007–9 TABLE 5
Rate Under Section 7520 for February 2007
Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years,
or a remainder or reversionary interest5.6%
Section 1288.—Treatment
of Original Issue Discount
on Tax-Exempt Obligations
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 1561.—Limitations
on Certain Multiple Tax
Benefits in the Case
of Certain Controlled
Corporations
26 CFR 1.1561–1T: General rules regarding certain
tax benefits available to the component members of a
controlled group of corporations (temporary).
T.D. 9304
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 5
Guidance Necessary to
Facilitate Business Electronic
Filing Under Section 1561
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regula-
tions.
SUMMARY: This document contains tem-
porary regulations that affect component
members of controlled groups of corpora-
tions and consolidated groups filing life-
nonlife Federal income tax returns. They
provide guidance regarding the apportion-
ment of tax benefit items and the amount
and type of information these members
are required to submit with their returns.
The text of the temporary regulations also
serves as the text of the proposed regu-
lations (REG–161919–05) set forth in the
notice of proposed rulemaking on this sub-
ject in this issue of the Bulletin.
February 5, 20074232007–6 I.R.B.

DATES:Effective Date:These regulations
are effective on December 22, 2006.
Applicability Date:For dates of ap-
plicability, see §§1.1502–43T(e)(1),
1.1502–47T(t)(1),1.1561–1T(d)(1),
1.1561–2T(f)(1), 1.1561–3T(d)(1) and
1.1563–1T(e)(1). The applicability of
these regulations will expire on December
21, 2009.
FOR FURTHER INFORMATION
CONTACT: Grid Glyer, (202) 622–7930
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 1561(a) provides that thecom-
ponent membersof acontrolled group of
corporations(as those terms are defined
in section 1563) are limited to using the
amounts of certain tax benefit items de-
scribed therein in the same manner as if
they were one corporation. Although sec-
tion 1561(a) provides that these amounts
shall generally be divided equally among
those members, it also provides that if
those members consent to adopt an appor-
tionment plan, then, except as provided
below, they will be permitted to allocate
these amounts among themselves un-
equally. Section 1.1561–3(b) provides the
procedural format by which those mem-
bers may adopt an apportionment plan.
On May 26, 2006, the IRS and Trea-
sury Department released temporary regu-
lations (T.D. 9264, 2006–26 I.R.B. 1150),
which, among other things, eliminated
regulatory impediments to the electronic
filing (e-filing) of many statements that
corporate taxpayers were previously re-
quired to include on or with their Federal
income tax returns. As noted in section
2.C. of the preamble to those regulations,
§1.1561–3(b) presents an impediment to
the e-filing of that information which each
member of a controlled group is required
to provide with its Federal income tax
return when it makes the consent provided
therein. These temporary regulations re-
move that impediment and also clarify
the amount and type of information that
each member of such group is required
to submit with its return, whether or not
the group chooses to apportion unequally
the specified tax benefit items among its
members. Thus, these regulations require
each member of such group to provide the
requisite information, whether or not it
consents to adopt anapportionment plan,
on a form (i.e., Schedule O or any suc-
cessor to that form) to be filed with each
member’s Federal income tax return for
each taxable year for which it is a compo-
nent member of a controlled group.
Explanation of Provisions
1.Revision of the regulations under
section 1561.
The IRS and Treasury Department are
publishing temporary regulations under
section 1561 for several reasons. First,
the current regulations are outdated in that
they refer to tax benefit items that are no
longer listed in section 1561(a). Except
as provided below, to minimize this issue
in the future, the temporary regulations
refer generically to the tax benefit items
listed in section 1561(a) rather than refer
specifically to those items by listing and
describing each one.
Second, the current regulations do not
provide guidance to taxpayers regarding
how to allocate the amounts of the section
1561(a) tax benefit items among the com-
ponent members of a controlled group of
corporations which have an apportionment
plan in effect. As a result, the IRS often
can not determine whether taxpayers have
correctly allocated these items. Thus, the
temporary regulations refer to a new form
(i.e., Schedule O or any successor to that
form) on which such members will provide
information about these items.
Except as provided below, each com-
ponent member of a controlled group must
file this form every year with its Federal
income tax return whether or not: (1) an
apportionment plan is in effect, or (2) any
change is made to the group’s apportion-
ment of its section 1561(a) tax benefit
items from the previous year. However,
whenever one or more of the component
members of a controlled group of corpora-
tions are also members of a consolidated
group, the parent of such consolidated
group shall file one form on behalf of all
of its members. That form shall contain
all the information required for each such
member.
Finally, §1.1561–3(b) presents an im-
pediment to e-filing where such members
haveconsentedtotheadoptionofanap-
portionment plan. That section requires
each member of a controlled group to
attach to its return, for each year fol-
lowing the adoption of the plan, a copy
of its signed consent to such plan. As
explained in T.D. 9264, that signature
requirement presents an impediment to
e-filing. These temporary regulations
eliminate this impediment and provide
that the form will be the mechanism by
which such member adopts (and also
amend or terminate) such plan. Thus,
each member of the group (that is not
a member of a consolidated group) will
file this form to consent to adopt a plan,
even if it is a wholly-owned subsidiary of
the group.Compare§1.1561–3(b)(2)(i)
(a wholly-owned subsidiary of a con-
trolled group was not required to consent
to adopt a plan because it was deemed to
consent if all the component members of
that group that are not wholly owned sub-
sidiaries consent). Thus, these temporary
regulations eliminate the deemed consent
provision of §1.1561–3(b)(2)(i).
2.Regulation authorizing the component
members of a controlled group to
apportion the accumulated earnings
credit unequally if they have an
apportionment plan in effect.
Section 1561(a) provides that the com-
ponent members of a controlled group
of corporations must divide the amount
of the accumulated earnings credit (the
credit) equally unless the Secretary pre-
scribes regulations permitting an unequal
allocation of that amount. However,
§1.1561–2(c) requires that they divide that
amount equally. The IRS and Treasury
Department have concluded that they no
longer will require such members to divide
that amount equally. Therefore, these tem-
porary regulations now provide that the
component members of a controlled group
may choose to allocate the amount of that
credit unequally among themselves if they
have an apportionment plan in effect.
3.Revisions to §1.1563–1.
A.Reformatting the regulation.
For the sake of consistency, the IRS
and Treasury Department are reformatting
§1.1563–1 to conform it to current format-
ting conventions. It is not intended that
any such reformatting constitute a substan-
tive change. Moreover, the changes de-
2007–6 I.R.B.424February 5, 2007

scribed in this paragraph of the pream-
ble are only limited to formatting. Thus,
for example, except for the changes de-
scribed below, no examples in §1.1563–1
have been updated to reflect current law.
Such changes are beyond the scope of this
project and will be addressed in a separate
regulation project.
B.Updating the definition of a
brother-sister controlled group.
Section 900 of the American Jobs Cre-
ation Act of 2004, Pub. L. 108–357, 118
Stat. 1418 (the 2004 amendment), revised
the definition of a brother-sister controlled
groupinsection1563(a)(2). Priorto
this 2004 amendment, commonly owned
corporations qualified as a brother-sister
controlled group if five or fewer persons
who are individuals, estates, or trusts own
(within the meaning of section 1563(d)(2))
stock possessing: (A) at least 80 percent
of the total combined voting power of all
classes of stock entitled to vote or at least
80 percent of the total value of shares of
all classes of stock of each corporation
(the 80 percent requirement) and (B) more
than 50 percent of the total combined vot-
ing power of all classes of stock entitled to
vote or more than 50 percent of the total
value of shares of all classes of stock of
each corporation, taking into account the
stock ownership of each such person only
to the extent such stock ownership is iden-
tical with respect to each such corporation
(the more-than-50 percent requirement).
The 2004 amendment eliminated the
80 percent requirement from the section
1563(a)(2) definition of a brother-sister
controlled group. As a result, for pur-
poses of section 1561, corporations are
component members of a brother-sister
controlled group if just the more-than-50
percent requirement is satisfied. How-
ever, for all other provisions of law that
incorporate the section 1563(a) definition
of a brother-sister controlled group, both
the more-than-50 percent requirement and
the 80 percent requirement must be satis-
fied in order to qualify as a brother-sister
controlled group.Seesection 1563(f)(5).
Therefore, these temporary regulations
reflect this change.
These temporary regulations apply to
tax years beginning on or after the date
they are published in theFederal Regis-
ter. However, the above described 2004
amendment to section 1563(a)(2) is effec-
tive for tax years beginning after October
22, 2004.
C.Clarifying that an S corporation is
treated as an excluded member of a
controlled group under current law.
Section 1.1561–1(c)(1) provides that,
for purposes of sections 1561 and 1563,
the termcorporationincludes an electing
small business corporation and refers to
§1.1563–1(b)(2)(ii)(c) for the treatment of
such a corporation as an excluded mem-
ber of a controlled group of corporations.
Specifically, §1.1563–1(b)(2)(ii)(c)pro-
vides that only an electing small business
corporation which is not subject to the tax
imposed by section 1378 will be treated as
an excluded member.
Section 1378, as in effect when
§1.1563–1(b)(2)(ii)(c) was published (old
section 1378), taxed the income of an
electing small business corporation if its
income exceeded a certain threshold. That
income was taxed at the lower of the rate
determined under section 1201(a) or sec-
tion 11. Thus, when such corporation was
subject to tax under section 11, it was
appropriate to treatsuch corporation as a
component member of a controlled group
for purposes of allocating its section 11
tax benefit amount.
Old section 1378 was ultimately re-
pealed as part of the Tax Reform Act of
1986 (Pub. L. 99–514, 100 Stat. 2085).
Thus, §1.1563–1(b)(2)(ii)(c) became ob-
solete.
Under current law, an S corporation (the
successor to an electing small business cor-
poration) is generally subject to tax at the
entity level under only two provisions: (1)
section 1374, which imposes tax on certain
recognized built-in gain, and (2) section
1375, which imposes tax on passive invest-
ment income under certain circumstances.
However, in both cases, the amount of
tax imposed on an S corporation is com-
putedbyapplyingthehighestrateoftax
specified in section 11(b).Seesections
1374(b)(1) and 1375(a). Thus, under ei-
ther of these provisions, no portion of any
of the lower tax bracket amounts of section
11(b) could be allocated to such a corpora-
tion.
In other instances, an S corporation
is partially liable for taxes that were im-
posed on the income of its predecessor
C corporation that it must now recapture.
See,e.g., sections 167(g), 460(b), 1363(d)
and 1371(d)(2). However, these recapture
taxesarenotbeingimposedonanScor-
poration’s own income.
Since an S corporation is notcurrently
subject to any tax to which either the tax
bracket amounts of section 11(b) apply, or
any other tax benefit item to which section
1561(a) applies, it is appropriate to treat
that corporation as an excluded member of
a controlled group.
These temporary regulations clarify
that only to the extent that a particular
tax (and thus a particular tax benefit item
to which section 1561(a)) applies to an
S corporation is that type of corporation
treated as a component member of the
group. This general reference to a tax that
applies to an S corporation is intended to
avoid the issue in §1.1563–1(b)(2)(ii)(c)
of referring to a particular Code section
that later became obsolete (i.e., old section
1378).
D.Clarifying that the life insurance
company provisions do not apply to the
controlled group rules where that type of
company is a member (whether eligible or
ineligible) of a life-nonlife affiliated group
for the consolidated return year for which
a section 1504(c)(2) election is effective.
The current regulations under section
1563 describe the treatment of life in-
surance companies under the controlled
group rules. Section 1.1563–1(a)(5) pro-
vides that two or more life insurance
companies that are members of a con-
trolled group are treated as a distinct
controlled group of corporations com-
posed only of life insurance companies.
Section 1.1563–1(b)(2)(ii)(e) defines a
life insurance company as an excluded
member unless that type of company is
a member of a separate life insurance
company controlled group described in
§1.1563–1(a)(5).
Section 1504(c)(2) provides that if an
affiliated group includes any domestic life
insurance companies that would otherwise
not be treated as includible members of the
group, then, except as provided therein,
the common parent of such group may
elect (pursuant to regulations prescribed
by the Secretary) to treat all such compa-
nies as includible corporations. Paragraph
February 5, 20074252007–6 I.R.B.

(f)(6) of §1.1502–47 implements section
1504(c)(2) as it relates to section 1563.
These temporary regulations provide
that if one or more life insurance com-
panies are members (whether eligible or
ineligible) of an affiliated group for the
consolidated return year for which a sec-
tion 1504(c)(2) election is effective, then
those members are not treated as either
excluded members of the controlled group
or as members of a separate life insurance
controlled group.See§1.1502–47(f)(6).
Rather, any eligible members are treated
as members of the consolidated group, and
any ineligible members are treated, along
with the eligible and includible members
of the consolidated group, as members of
a life-nonlife controlled group.
These temporary regulations apply
to tax years beginning on or after the
date they are published in theFederal
Register. However, paragraph (f)(6) of
§1.1502–47 applies to tax years of con-
solidated groups beginning on or after
January 1, 1982.SeeT.D. 7877, 1983–1
C.B. 207.
4.Revisions to two consolidated return
regulations.
A.§1.1502–43.
Section 1.1502–43 provides rules for
calculating the consolidated accumulated
earnings tax. Section 1.1502–43(d) is cur-
rently reserved. These temporary regula-
tions clarify that if the consolidated group
is part of a controlled group then section
1561 applies in determining the amount of
that credit.
These temporary regulations apply to
consolidated return years for which a re-
turn is due (without extensions) after the
date it is published in theFederal Regis-
ter. However, pursuant to the Tax Reform
Act of 1969, Pub. L. 91–172, 78 Stat. 116,
the accumulated earnings credit became a
full tax benefit item under section 1561(a)
for tax years beginning after December 31,
1974.
B.§1.1502–47.
Section 1.1502–47 provides rules for a
life-nonlife consolidated group to calcu-
late its consolidated taxable income. Para-
graph (s) of §1.1502–47 requires a consol-
idated group to provide a notation on the
face of its return identifying it as a life-
nonlife return. This requirement presents
an impediment to e-filing. These tempo-
rary regulations remove the impediment
by deleting the requirement to provide that
notation.
5.Deleting obsolete regulations.
As part of this Treasury decision, the
IRS and Treasury Department are deleting
numerous obsolete regulations. This effort
is part of an ongoing process to remove
those types of regulations from the Code of
Federal Regulations (the CFR). Therefore,
the following regulations are deleted from
the CFR: §§1.342–1, 1.371–1 through
1.371–2, 1.372–1, 1.374–1 through
1.374–4, 1.1018–1, 1.1562–0 through
1.1562–7, 1.1564–1 and 5.1561–1.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It has also been deter-
mined that section 553(b) of the Admin-
istrative Procedure Act (5 U.S.C. chapter
5) does not apply to these regulations. For
the applicability of the Regulatory Flexi-
bility Act (5 U.S.C. chapter 6), refer to the
Special Analyses section of the preamble
to the cross-reference notice of proposed
rulemaking published in this issue of the
Bulletin. Pursuant to section 7805(f) of the
Code, these temporary regulations will be
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
for comment on their impact on small busi-
ness.
Drafting Information
The principal author of these regula-
tions is Grid Glyer, Office of Associate
Chief Counsel (Corporate). However,
other personnel from the IRS and Treasury
Department participated in their develop-
ment.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 5 are
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding entries in nu-
merical order to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1502–43T also issued under
26 U.S.C. 1502. * * *
Section 1.1561–2T also issued under
26 U.S.C. 1561. * * *
§1.108–1 [Removed]
Par. 2. Section 1.108–1 is removed and
reserved.
§1.342–1 [Removed]
Par. 3. Section 1.342–1 is removed.
§1.371–1 [Removed]
Par. 4. Section 1.371–1 is removed.
§1.371–2 [Removed]
Par. 5. Section 1.371–2 is removed.
§1.372–1 [Removed]
Par. 6. Section 1.372–1 is removed.
§1.374–1 [Removed]
Par. 7. Section 1.374–1 is removed.
§1.374–2 [Removed]
Par. 8. Section 1.374–2 is removed.
§1.374–3 [Removed]
Par. 9. Section 1.374–3 is removed.
§1.374–4 [Removed]
Par. 10. Section 1.374–4 is removed.
§1.924(a)–1T [Amended]
Par. 10A. For each entry in the “Lo-
cation” column of the following table, re-
move the language in the “Remove” col-
umn and add the language in the “Add”
column in its place:
2007–6 I.R.B.426February 5, 2007

LocationRemoveAdd
The fifth sentence of
§1.924(a)–1T(j)(2)(i)
a statementcompleting the form (i.e., Schedule O or
any successor to that form)
The fifth sentence of
§1.924(a)–1T(j)(2)(i)
§1.1561–3(b)§1.1561–3T
The sixth sentence of
§1.924(a)–1T(j)(2)(i)
§1.1561–3(c)§1.1561–3T(a)
§1.1018–1 [Removed]
Par. 11. Section 1.1018–1 is removed.
Par. 12. Section 1.1502–43 is amended
by revising paragraph (d) and adding para-
graph (e) to read as follows:
§1.1502–43 Consolidated accumulated
earnings tax.
*****
(d) [Reserved]. For further guidance,
see §1.1502–43T(d).
(e) [Reserved]. For further guidance,
see §1.1502–43T(e)(1).
Par. 13. Section 1.1502–43T is added
to read as follows:
§1.1502–43T Consolidated accumulated
earnings tax (temporary).
(a) through (c) [Reserved]. For further
guidance, see §1.1502–43(a) through (c).
(d)Consolidated accumulated earnings
credit—(1)In general.[Reserved]
(2)Special rule if consolidated group
part of controlled group. If a consolidated
group is treated as a component member of
a controlled group, or if each member of
a consolidated group is treated as a com-
ponent member of a controlled group, see
section 1561 for determining the portion of
the accumulated earnings credit to be allo-
cated to such group or to such members.
(e)Effective date—(1)Applicability
date. This section applies to any consoli-
dated Federal income tax return due (with-
out extensions) after December 22, 2006.
However, a consolidated group may apply
this section to any consolidated Federal in-
come tax return filed on or after December
22, 2006.
(2)Expiration date. The applicability
of this section will expire on December 21,
2009.
Par. 14. Section 1.1502–47 is amended
by revising paragraph (s) and adding para-
graph (t) to read as follows:
§1.1502–47 Consolidated returns by
life-nonlife groups.
*****
(s) [Reserved]. For further guidance,
see §1.1502–47T(s).
(t) [Reserved]. For further guidance,
see §1.1502–47T(t)(1).
Par. 15. Section 1.1502–47T is
amended by revising paragraph (s) and
adding paragraph (t) to read as follows:
§1.1502–47T Consolidated returns by
life-nonlife groups (temporary).
*****
(s)Filing requirements. Nonlife con-
solidated taxable income or loss under
paragraph (h) of §1.1502–47 shall be
determined on a separate Form 1120 or
1120–PC, and consolidated partial LICTI
under paragraph (j) of §1.1502–47 shall be
determined on a separate Form 1120–L.
The consolidated return shall be made on a
separate Form 1120, 1120–PC, or 1120–L
filedbythecommonparent(ifthegroup
includes a life company), which shows the
set-offs under paragraphs (g), (m), and (n)
of §1.1502–47 and clearly indicates on the
face of the return that it is a life-nonlife
consolidated return (if the group includes
a life company). See also §1.1502–75(j),
relating to statements and schedules for
subsidiaries.
(t)Effective date—(1)Applicability
date. Paragraph (s) of this section ap-
plies to any consolidated Federal income
tax return due (without extensions) after
December 22, 2006. However, a consol-
idated group may apply paragraph (s) of
this section to any consolidated Federal
income tax return filed on or after Decem-
ber 22, 2006.
(2)Expiration date. The applicability
of paragraph (s) of this section will expire
on December 21, 2009.
Par. 16. Section 1.1502–90 is amended
by:
1. Removing and reserving the entry for
§1.1502–95(e)(8).
2. Removing and reserving the entry for
§1.1502–95(f).
3. Reservinganentryfor
§1.1502–95(g).
4. Adding entries for §1.1502–95T.
The additions read as follows:
§1.1502–90 Table of contents.
*****
§1.1502–95 Rules on ceasing to be a
member of a consolidated group (or loss
subgroup).
*****
(g) [Reserved]
§1.1502–95T Rules on ceasing to be a
member of a consolidated group (or loss
subgroup) (temporary).
(a) through (e)(7) [Reserved]
(e)(8) Reporting requirements.
(i) Common Parent.
(ii) Former Member.
(iii) Exception.
(f) Filing the election to apportion the
section 382 limitation and net unrealized
built-in gain.
(1) Form of the election to apportion.
(i) Statement.
(ii) Agreement.
(2) Signing the agreement.
(3) Filing of the election.
(i) Filing by the common parent.
(ii) Filing by the former member.
(4) Revocation of election.
(g) Effective date.
(1) Applicability date.
(2) Expiration date.
§1.1561–0 [Removed]
Par. 17. Section 1.1561–0 is removed.
February 5, 20074272007–6 I.R.B.

§1.1561–1 [Removed]
Par. 18. Section 1.1561–1 is removed.
Par. 19. Section 1.1561–1T is added to
read as follows:
§1.1561–1T General rules regarding
certain tax benefits available to the
component members of a controlled group
of corporations (temporary).
(a)In general. (1) Part II (section 1561
and following) of subchapter B of chap-
ter 6 of the Internal Revenue Code (part
II) provides rules to limit the amounts of
certain specified tax benefit items of com-
ponent members of a controlled group of
corporations on a December 31, for their
taxable years which include such Decem-
ber 31. The component members of such a
group shall be limited for purposes of sub-
title A of the Code to the amounts of cer-
tain items, set forth in section 1561(a), as
if they were one corporation. Certain other
tax items also set forth in section 1561(a)
(e.g., the additional tax imposed by section
11(b)(1) and the section 55(d)(3) phase out
of the alternative minimum tax exemption
amount) will be determined by combin-
ing the taxable income of all such mem-
bers and then allocating the amount of such
items among such members.
(2) For certain definitions (including
the definition of acontrolled group of cor-
porationsand acomponent member)and
special rules for purposes of this part II, see
section 1563.
(b)Special rules. (1) For purposes of
this part II, the termcorporationincludes
a small business corporation (as defined in
section 1361). However, for the treatment
of such a corporation as anexcluded mem-
berof a controlled group of corporations
see §1.1563–1(b)(2)(ii)(C).
(2) In the case of corporations electing
a 52–53-week taxable year under section
441(f)(1), the provisions of this part II shall
be applied in accordance with the special
rule of section 441(f)(2)(A). See §1.441–2.
(c)Tax avoidance. The provisions of
this part II do not delimit or abrogate any
principle of law established by judicial de-
cision, or any existing provisions of the
Code, such as sections 269, 482, and 1551,
which have the effect of preventing the
avoidance or evasion of income taxes.
(d)Effective date—(1)Applicability
date. This section applies to any taxable
year beginning on or after December 22,
2006. However, taxpayers may apply this
section to any Federal income tax return
filed on or after December 22, 2006.
(2)Expiration date. The applicability
of this section will expire on December 21,
2009.
Par. 20. Section 1.1561–2 is amended
by removing and reserving paragraphs (a)
and (b), revising paragraph (c), removing
and reserving paragraph (d) and adding
paragraph (f) to read as follows:
§1.1561–2 Determination of amount of
tax benefits.
*****
(c) [Reserved]. For further guidance,
see §1.1561–2T(c).
*****
(f) [Reserved]. For further guidance,
see §1.1561–2T(f)(1).
Par. 21. Section 1.1561–2T is added to
read as follows:
§1.1561–2T Determination of amount of
tax benefits (temporary).
(a) through (b) [Reserved]
(c)Accumulated earnings credit.The
component members of a controlled group
of corporations may allocate the amount of
the accumulated earnings credit unequally
if they have an apportionment plan in ef-
fect.
(d) [Reserved]
(e) [Reserved]. For further guidance,
see §1.1561–2(e).
(f)Effective date—(1)Applicability
date. This section applies to any taxable
year beginning on or after December 22,
2006. However, taxpayers may apply this
section to any Federal income tax return
filed on or after December 22, 2006.
(2)Expiration date. The applicability
of this section will expire on December 21,
2009.
§1.1561–3 [Removed]
Par. 22. Section 1.1561–3 is removed.
Par. 23. Section 1.1561–3T is added to
read as follows:
§1.1561–3T Allocation of the section
1561(a) tax items (temporary).
(a)Filing of form—(1)In general.For
each taxable year that a corporation is a
component member of the same controlled
group of corporations on a December 31,
for its taxable year that includes such De-
cember 31, such corporation and all other
component members of such group must
each file the required form (i.e., Schedule
O or any successor to that form) with each
Federal income tax return. Each such cor-
poration must file that form with its return
whether or not—
(i) An apportionment plan is in effect;
or
(ii) Any change is made in the group’s
apportionment of its section 1561(a) tax
benefit items from the previous year.
(2)Exception for component members
that are members of a consolidated group.
If one or more of the component mem-
bers of a controlled group of corporations
are also members of a consolidated group,
the parent of such consolidated group shall
file only one form on behalf of all of such
members. Such form shall contain the in-
formation required for each such member.
(b)No apportionment plan in effect.If
the component members of a controlled
group of corporations do not have an ap-
portionment plan in effect, the amounts of
the section 1561(a) items must be divided
equally among all such members. For pur-
poses of the preceding sentence, if any
component members of a controlled group
of corporations are also members of a con-
solidated group, such members will each
be treated as a separate component mem-
ber of the controlled group.
(c)Apportionment plan in effect—(1)
Adoption of plan. The component mem-
bers of a controlled group of corporations
consent to the adoption (or amendment) of
an apportionment plan by checking the box
to that effect on such form. For purposes
of this paragraph (c)—
(i) An apportionment plan that is
adopted (including a plan that has been
amended) continues in effect until it is
terminated;
(ii) A consolidated group is treated as
one component member of such group;
and
(iii) The members must allocate the
amounts of the section 1561(a) items be-
tween or among themselves as described
in the plan.
(2)Limitation on adopting a plan—(i)
Sufficient statute of limitations period.The
members may only adopt or amend such
a plan if there is at least one year remain-
2007–6 I.R.B.428February 5, 2007

ing in the statutory period (including any
extensions thereof) for the assessment of a
deficiency against every member the tax li-
ability of which would be increased by the
adoption of such a plan.
(ii)Insufficient statute of limitations
period. If any member cannot satisfy the
requirement of paragraph (c)(2)(i) of this
section, the members may not adopt or
amend such a plan unless the member not
satisfying such requirement has entered
into an agreement with the Internal Rev-
enue Service to extend the statute of limi-
tations for the limited purpose of assessing
any deficiency against such member at-
tributable to the adoption of such a plan.
(3)Termination of plan. An apportion-
ment plan that is in effect for the compo-
nent members of a controlled group with
respect to a particular December 31 is ter-
minated with respect to a succeeding De-
cember 31 if—
(i) Each member of such group consents
to the termination of such a plan for such
succeeding December 31 by checking the
box to that effect on its form;
(ii) The controlled group ceases to re-
main in existence (within the meaning of
section 1563(a)) during the calendar year
ending on such succeeding December 31;
(iii) Any corporation which was a com-
ponent member of such group on the par-
ticular December 31 is not a component
member of such group on such succeeding
December 31; or
(iv) Any corporation which was not a
component member of such group on the
particular December 31 is a component
member of such group on such succeeding
December 31.
(d)Effective date—(1)Applicability
date. This section applies to any taxable
year beginning on or after December 22,
2006. However, taxpayers may apply this
section to any Federal income tax return
filed on or after December 22, 2006.
(2)Expiration date. The applicability
of this section will expire on December 21,
2009.
§1.1562–0 [Removed]
Par. 24. Section 1.1562–0 is removed.
§1.1562–1 [Removed]
Par. 25. Section 1.1562–1 is removed.
§1.1562–2 [Removed]
Par. 26. Section 1.1562–2 is removed.
§1.1562–3 [Removed]
Par. 27. Section 1.1562–3 is removed.
§1.1562–4 [Removed]
Par. 28. Section 1.1562–4 is removed.
§1.1562–5 [Removed]
Par. 29. Section 1.1562–5 is removed.
§1.1562–6 [Removed]
Par. 30. Section 1.1562–6 is removed.
§1.1562–7 [Removed]
Par. 31. Section 1.1562–7 is removed.
§1.1563–1 [Removed]
Par. 32. Section 1.1563–1 is removed.
Par. 33. Section 1.1563–1T is amended
by revising paragraphs (a), (b), (c)(1),
(c)(2)(iv), (d) and (e) to read as follows:
§1.1563–1T Definition of controlled group
of corporations and component members
(temporary).
(a)Controlled group of corporations—
(1)In general. For purposes of sections
1561 through 1563, the termcontrolled
group of corporationsmeans any group
of corporations which is either aparent-
subsidiary controlled group(as defined in
paragraph (a)(2) of this section), abrother-
sister controlled group(as defined in para-
graph (a)(3)(i) of this section), acombined
group(as defined in paragraph (a)(4) of
this section), or alife insurance controlled
group(as defined in paragraph (a)(5) of
this section). For the exclusion of certain
stock for purposes of applying the defini-
tions contained in this paragraph, see sec-
tion 1563(c) and §1.1563–2.
(2)Parent-subsidiary controlled group.
(i) The termparent-subsidiary controlled
groupmeans one or more chains of corpo-
rations connected through stock ownership
with a common parent corporation if—
(A) Stock possessing at least 80 percent
of the total combined voting power of all
classes of stock entitled to vote or at least
80 percent of the total value of shares of all
classes of stock of each of the corporations,
except the common parent corporation, is
owned (directly and with the application
of §1.1563–3(b)(1), relating to options) by
one or more of the other corporations; and
(B) The common parent corporation
owns (directly and with the application of
§1.1563–3(b)(1), relating to options) stock
possessing at least 80 percent of the total
combined voting power of all classes of
stock entitled to vote or at least 80 percent
of the total value of shares of all classes of
stock of at least one of the other corpora-
tions, excluding, in computing such voting
power or value, stock owned directly by
such other corporations.
(ii) The definition of a parent-sub-
sidiary controlled group of corporations
maybeillustratedbythefollowingexam-
ples:
Example 1. P Corporation owns stock possessing
80 percent of the total combined voting power of all
classes of stock entitled to vote of S Corporation. P is
the common parent of a parent-subsidiary controlled
group consisting of member corporations P and S.
Example 2. Assume the same facts as inExam-
ple 1. Assume further that S owns stock possessing
80 percent of the total value of shares of all classes
of stock of T Corporation. P is the common parent
of a parent-subsidiary controlled group consisting of
member corporations P, S, and T. The result would be
the same if P, rather than S, owned the T stock.
Example 3. L Corporation owns 80 percent of the
only class of stock of M Corporation and M, in turn,
owns 40 percent of the only class of stock of O Cor-
poration. L also owns 80 percent of the only class of
stock of N Corporation and N, in turn, owns 40 per-
cent of the only class of stock of O. L is the common
parent of a parent-subsidiary controlled group con-
sisting of member corporations L, M, N, and O.
Example 4. X Corporation owns 75 percent of
the only class of stock of Y and Z Corporations;
Y owns all the remaining stock of Z; and Z owns
all the remaining stock of Y. Since intercompany
stockholdings are excluded (that is, are not treated
as outstanding) for purposes of determining whether
X owns stock possessing at least 80 percent of the
voting power or value of at least one of the other
corporations, X is treated as the owner of stock pos-
sessing 100 percent of the voting power and value of
Y and of Z for purposes of paragraph (a)(2)(i)(B) of
this section. Also, stock possessing 100 percent of
the voting power and value of Y and Z is owned by
the other corporations in the group within the mean-
ing of paragraph (a)(2)(i)(A) of this section. (X and
Y together own stock possessing 100 percent of the
voting power and value of Z, and X and Z together
own stock possessing 100 percent of the voting
power and value of Y.) Therefore, X is the common
parent of a parent-subsidiary controlled group of
corporations consisting of member corporations X,
Y, and Z.
(3)Brother-sister controlled group—
(i)In general.Thetermbrother-sister
controlled groupmeans two or more cor-
porations if the same five or fewer persons
February 5, 20074292007–6 I.R.B.

who are individuals, estates, or trusts own
(directly and with the application of the
rules contained in §1.1563–3(b)) stock
possessing more than 50 percent of the
total combined voting power of all classes
of stock entitled to vote or more than 50
percent of the total value of shares of all
classes of stock of each corporation, tak-
ing into account the stock ownership of
each such person only to the extent such
stock ownership is identical with respect
to each such corporation.
(ii)Additional stock ownership re-
quirement for purposes of certain other
provisions of law. For purposes of any
provision of law (other than sections 1561
through 1563) that incorporates the section
1563(a) definition of a controlled group,
the termbrother-sister controlled group
means two or more corporations if the
same five or fewer persons who are indi-
viduals, estates, or trusts own (directly and
with the application of the rules contained
in §1.1563–3(b)) stock possessing—
(A) At least 80 percent of the total com-
bined voting power of all classes of stock
entitled to vote or at least 80 percent of
the total value of shares of all classes of
stock of each corporation (the 80 percent
requirement);
(B) More than 50 percent of the to-
tal combined voting power of all classes
of stock entitled to vote or more than 50
percent of the total value of shares of all
classes of stock of each corporation, tak-
ing into account the stock ownership of
each such person only to the extent such
stock ownership is identical with respect to
each such corporation (the more-than-50
percent identical ownership requirement);
and
(C) The five or fewer persons whose
stock ownership is considered for pur-
poses of the 80 percent requirement must
bethesamepersonswhosestockown-
ership is considered for purposes of the
more-than-50 percent identical ownership
requirement.
(iii)Examples. The principles of para-
graph (a)(3)(ii) of this section may be il-
lustratedbythefollowingexamples:
Example 1. (i) The outstanding stock of corpo-
rations P, Q, R, S, and T, which have only one class
of stock outstanding is owned by the following unre-
lated individuals:
CORPORATIONS
IndividualsPQRSTIdentical ownership
A.............................
55%51%55%55%55%51%
B.............................
45%
49%
(45% in P & Q)
C.............................
45%
D.............................
45%
E.............................
45%
Total..........................100%100%100%100%100%
(ii) Corporations P and Q are members of a
brother-sister controlled group of corporations. Al-
though the more-than-50 percent identical ownership
requirement is met for all 5 corporations, corpora-
tions R, S, and T are not members because at least
80 percent of the stock of each of those corporations
is not owned by the same 5 or fewer persons whose
stock ownership is considered for purposes of the
more-than-50 percent identical ownership require-
ment.
Example 2. (i) The outstanding stock of corpo-
rations U and V, which have only one class of stock
outstanding, is owned by the following unrelated in-
dividuals:
Corporations
IndividualsUV
A...........................................12%12%
B...........................................12%12%
C...........................................12%12%
D...........................................12%12%
E...........................................13%13%
F...........................................13%13%
G...........................................13%13%
H...........................................13%13%
Total........................................100%100%
(ii) Any group of five of the shareholders will own
more than 50 percent of the stock in each corpora-
tion, in identical holdings. However, U and V are not
members of a brother-sister controlled group because
at least 80 percent of the stock of each corporation is
not owned by the same five or fewer persons.
Example 3. (i) Corporation X and Y each have
two classes of stock outstanding, voting common and
non-voting common. (None of this stock is excluded
from the definition of stock under section 1563(c).)
Unrelated individuals A and B own the following per-
centages of the class of stock entitled to vote (voting)
and of the total value of shares of all classes of stock
(value) in each of corporations X and Y:
Corporations
IndividualsXY
A.......................................... 100%voting,60%value.
75% voting, 60% value.
B..........................................0%voting,10%value.
25% voting, 10% value.
2007–6 I.R.B.430February 5, 2007

(ii) No other shareholder of X owns (or is consid-
ered to own) any stock in Y. X and Y are a brother-
sister controlled group of corporations. The group
meets the more-than-50 percent identical ownership
requirement because A and B own more than 50 per-
cent of the total value of shares of all classes of stock
of X and Y in identical holdings. (The group also
meets the more-than-50 percent identical ownership
requirement because of A’s voting stock ownership.)
The group meets the 80 percent requirement because
A and B own at least 80 percent of the total combined
voting power of all classes of stock entitled to vote.
Example 4. Assume the same facts as inExample
3except that the value of the stock owned by A and
B is not more than 50 percent of the total value of
shares of all classes of stock of each corporation in
identical holdings. X and Y are not a brother-sister
controlled group of corporations. The group meets
the more-than-50 percent identical ownership re-
quirement because A owns more than 50 percent
of the total combined voting power of the voting
stock of each corporation. For purposes of the 80
percent requirement, B’s voting stock in Y cannot
be combined with A’s voting stock in Y since B,
who does not own any voting stock in X, is not a
person whose ownership is considered for purposes
of the more-than-50 percent identical ownership re-
quirement. Because no other shareholder owns stock
in both X and Y, these other shareholders’ stock
ownership is not counted towards meeting either the
more-than-50 percent identical ownership require-
ment or the 80 percent ownership requirement.
(iv)Special rule if prior law applies.
Paragraph (a)(3)(ii) of this section, as
amended by T.D. 8179, 1988–1 C.B. 122,
applies to taxable years ending on or after
December 31, 1970. See, however, the
transitional rule in paragraph (d) of this
section.
(4)Combined group.(i)Thetermcom-
bined groupmeans any group of three or
more corporations if—
(A) Each such corporation is a mem-
ber of either a parent-subsidiary controlled
group of corporations or a brother-sister
controlled group of corporations; and
(B) At least one of such corporations is
the common parent of a parent-subsidiary
controlled group and also is a member of a
brother-sister controlled group.
(ii) The definition of a combined group
of corporations may be illustrated by the
following examples:
Example 1. Smith, an individual, owns stock pos-
sessing 80 percent of the total combined voting power
of all classes of the stock of corporations X and Y. Y,
in turn, owns stock possessing 80 percent of the total
combined voting power of all classes of the stock of
corporationZ.X,Y,andZaremembersofthesame
combined group since—
(i) X, Y, and Z are each members of either a par-
ent-subsidiary or brother-sister controlled group of
corporations; and
(ii) Y is the common parent of a parent-subsidiary
controlled group of corporations consisting of Y and
Z, and also is a member of a brother-sister controlled
group of corporations consisting of X and Y.
Example 2. Assume the same facts as inExample
1, and further assume that corporation X owns 80 per-
cent of the total value of shares of all classes of stock
ofcorporationT.X,Y,Z,andTaremembersofthe
same combined group.
(5)Life insurance controlled group.(i)
The termlife insurance controlled group
means two or more life insurance com-
panies each of which is a member of a
controlled group of corporations described
in paragraph (a)(2), (a)(3)(i), or (a)(4) of
this section and to which §1.1502–47(f)(6)
does not apply. Such insurance companies
shall be treated as a controlled group of
corporations separate from any other cor-
porations which are members of a con-
trolledgroupdescribedinsuchparagraph
(a)(2), (a)(3)(i), or (a)(4). For purposes of
this section, the common parent of the con-
trolled group described in paragraph (a)(2)
of this section shall be referred to as the
common parent of the life insurance con-
trolled group.
(ii) The following examples illustrate
the definition of a life insurance controlled
group. In these examples, L indicates a life
company, another letter indicates a non-
life company and each corporation uses the
calendar year as its taxable year.
Example 1. Since January 1, 1999, corporation
P has owned all the stock of corporations L
1
and Y,
and L
1
has owned all the stock of corporation X. On
January 1, 2005, Y acquired all of the stock of cor-
poration L
2
.SinceL
1
and L
2
aremembersofapar-
ent-subsidiary controlled group of corporations, such
companies are treated as members of a life insurance
controlled group separate from the parent-subsidiary
controlled group consisting of P, X and Y. For pur-
poses of this section, P is referred to as the common
parent of the life insurance controlled group even
though P is not a member of such group.
Example 2. The facts are the same as inExample
1, except that, beginning with the 2005 tax year, the
P affiliated group elected to file a consolidated return
and P made a section 1504(c)(2) election. Pursuant
to paragraph (a)(5)(i) of this section, L
1
and L
2
are
not members of a separate life insurance controlled
group. Instead, P, X, Y, L
1
and L
2
constitute one
controlled group.See§1.1502–47(f)(6).
(6)Voting power of stock. For pur-
poses of this section, and §§1.1563–2
and 1.1563–3, in determining whether
the stock owned by a person (or persons)
possesses a certain percentage of the total
combined voting power of all classes of
stock entitled to vote of a corporation,
consideration will be given to all the facts
and circumstances of each case. A share of
stock will generally be considered as pos-
sessing the voting power accorded to such
share by the corporate charter, by-laws,
or share certificate. On the other hand, if
there is any agreement, whether express or
implied, that a shareholder will not vote his
stock in a corporation, the formal voting
rights possessed by his stock may be dis-
regarded in determining the percentage of
the total combined voting power possessed
by the stock owned by other shareholders
in the corporation, if the result is that the
corporation becomes a component mem-
ber of a controlled group of corporations.
Moreover, if a shareholder agrees to vote
his stock in a corporation in the manner
specified by another shareholder in the
corporation, the voting rights possessed
by the stock owned by the first shareholder
may be considered to be possessed by the
stock owned by such other shareholder if
the result is that thecorporation becomes a
component member of a controlled group
of corporations.
(b)Component members—(1)In gen-
eral. For purposes of sections 1561
through 1563, a corporation is a com-
ponent member of a controlled group of
corporations on a December 31 (and with
respect to the taxable year which includes
such December 31) if such corporation—
(i) Is a member of such controlled group
on such December 31 and is not treated
as an excluded member under paragraph
(b)(2) of this section; or
(ii) Is not a member of such controlled
group on such December 31 but is treated
as an additional member under paragraph
(b)(3) of this section.
(2)Excluded members. (i) A corpora-
tion, which is a member of a controlled
group of corporations on the December
31 included within its taxable year, but
was a member of such group for less than
one-half of the number of days in such tax-
able year which precede such December
31, shall be treated as an excluded mem-
ber of such group on such December 31.
(ii) A corporation which is a member
of a controlled group of corporations on
any December 31 shall be treated as an
excluded member of such group on such
date if, for its taxable year including such
date, such corporation is—
(A) Exempt from taxation under section
501(a) (except a corporation which is sub-
ject to tax on its unrelated business taxable
income under section 511) or 521 for such
taxable year;
February 5, 20074312007–6 I.R.B.

(B) A foreign corporation not subject to
taxation under section 882(a) for the tax-
able year;
(C) An S corporation (as defined in sec-
tion 1361) for purposes of any tax benefit
itemdescribedinsection1561(a)towhich
it is not subject;
(D) A franchised corporation (as
defined in section 1563(f)(4) and
§1.1563–4); or
(E) An insurance company subject to
taxation under section 801, unless such
insurance company (without regard to this
paragraph (b)(2)(ii)(E)) is a component
member of a life insurance controlled
group described in paragraph (a)(5)(i) of
this section or unless §1.1502–47(f)(6)
applies (which treats a life insurance
company, for which a section 1504(c)(2)
election is effective, as a member (whether
eligible or ineligible) of a life-nonlife af-
filiated group).
(3)Additional members. A corporation
shall be treated as an additional member of
a controlled group of corporations on the
December 31 included within its taxable
year if it—
(i) Is not a member of such group on
such December 31;
(ii) Is not described, with respect
to such taxable year, in paragraph
(b)(2)(ii)(A), (B), (C), (D), or (E) of this
section; and
(iii) Was a member of such group for
one-half (or more) of the number of days
in such taxable year which precede such
December 31.
(4)Examples. The provisions of this
paragraph may be illustrated by the follow-
ing examples:
Example 1. Brown, an individual, owns all of the
stock of corporations W and X on each day of 1964.
W and X each uses the calendar year as its taxable
year. On January 1, 1964, Brown also owns all the
stock of corporation Y (a fiscal year corporation with
a taxable year beginning on July 1, 1964, and ending
on June 30, 1965), which stock he sells on October
15, 1964. On December 1,1964, Brown purchases
all the stock of corporation Z (a fiscal year corpora-
tion with a taxable year beginning on September 1,
1964, and ending on August 31, 1965). On Decem-
ber 31, 1964, W, X, and Z are members of the same
controlled group. However, the component members
of the group on such December 31 are W, X, and Y.
Under paragraph (b)(2)(i) of this section, Z is treated
as an excluded member of the group on December
31, 1964, since Z was a member of the group for less
than one-half of the number of days (29 out of 121
days) during the period beginning on September 1,
1964 (the first day of its taxable year) and ending on
December 30, 1964. Under paragraph (b)(3) of this
section, Y is treated as an additional member of the
group on December 31, 1964, since Y was a mem-
ber of the group for at least one-half of the number of
days (107 out of 183 days) during the period begin-
ning on July 1, 1964 (the first day of its taxable year)
and ending on December 30, 1964.
Example 2. On January 1, 1964, corporation P
owns all the stock of corporation S, which in turn
owns all the stock of corporation S–1. On Novem-
ber 1, 1964, P purchases all of the stock of corpora-
tion X from the public and sells all of the stock of
S to the public. Corporation X owns all the stock
of corporation Y during 1964. P, S, S–1, X, and Y
file their returns on the basis of the calendar year.
On December 31, 1964, P, X, and Y are members
of a parent-subsidiary controlled group of corpora-
tions; also, corporations S and S–1 are members of a
different parent-subsidiary controlled group on such
date. However, since X and Y have been members
of the parent-subsidiary controlled group of which
P is the common parent for less than one-half the
number of days during the period January 1 through
December 30, 1964, they are not component mem-
bers of such group on such date. On the other hand,
X and Y have been members of a parent-subsidiary
controlled group of which X is the common parent
for at least one-half the number of days during the
period January 1 through December 30, 1964, and
therefore they are component members of such group
on December 31, 1964. Also since S and S–1 were
members of the parent-subsidiary controlled group of
which P is the common parent for at least one-half the
number of days in the taxable years of each such cor-
poration during the period January 1 through Decem-
ber 30, 1964, P, S, and S–1 are component members
of such group on December 31, 1964.
Example 3. Throughout 1964, corporation M
owns all the stock of corporation F which, in turn,
owns all the stock of corporations L–1, L–2, X,
and Y. M is a domestic mutual insurance company
subject to taxation under section 821, F is a for-
eign corporation not engaged in a trade or business
within the United States, L–1 and L–2 are domestic
life insurance companies subject to taxation under
section 802, and X and Y are domestic corporations
subject to tax under section 11 of the Code. Each
corporation uses the calendar year as its taxable year.
On December 31, 1964, M, F, L–1, L–2, X, and Y
are members of a parent-subsidiary controlled group
of corporations. However, under paragraph (b)(2)(ii)
of this section, M, F, L–1, and L–2 are treated as
excluded members of the group on December 31,
1964. Thus, on December 31, 1964, the component
members of the parent-subsidiary controlled group
of which M is the common parent include only X and
Y. Furthermore, since paragraph (b)(2)(ii)(E) of this
section does not result in L–1 and L–2 being treated
as excluded members of a life insurance controlled
group, L–1 and L–2 are component members of a life
insurance controlled group on December 31, 1964.
(5)Application of constructive own-
ership rules. For purposes of paragraphs
(b)(2)(i) and (3) of this section, it is nec-
essary to determine whether a corporation
was a member of a controlled group of
corporations for one-half (or more) of
the number of days in its taxable year
which precede the December 31 falling
within such taxable year. Therefore, the
constructive ownership rules contained in
§1.1563–3(b) (to the extent applicable in
making such determination) must be ap-
plied on a day-by-day basis. For example,
if P Corporation owns all the stock of X
Corporation on each day of 1964, and on
December 30, 1964, acquires an option to
purchase all the stock of Y Corporation (a
calendar-year taxpayer which has been in
existence on each day of 1964), the appli-
cation of §1.1563–3(b)(1) on a day-by-day
basis results in Y being a member of the
brother-sister controlled group on only
one day of Y’s 1964 year which precedes
December 31, 1964. Accordingly, since Y
is not a member of such group for one-half
or more of the number of days in its 1964
year preceding December 31, 1964, Y is
treated as an excluded member of such
group on December 31, 1964.
(c)Overlapping groups—(1)In gen-
eral. If on a December 31 a corporation is
a component member of a controlled group
of corporations by reason of ownership of
stock possessing at least 80 percent of the
total value of shares of all classes of stock
of the corporation, and if on such Decem-
ber 31 such corporation is also a compo-
nent member of another controlled group
of corporations by reason of ownership of
other stock (that is, stock not used to sat-
isfy the at-least-80 percent total value test)
possessing at least 80 percent of the total
combined voting power of all classes of
stock of the corporation entitled to vote,
then such corporation shall be treated as a
component member only of the controlled
group of which it is a component member
by reason of the ownership of at least 80
percent of the total value of its shares.
(2)Brother-sister controlled groups.
*****
(iv) The provisions of this paragraph
(c)(2) may be illustrated by the following
examples (in which it is assumed that all
the individuals are unrelated):
Example 1. (i) On each day of 1970 all the out-
standing stock of corporations M, N, and P is held in
the following manner:
2007–6 I.R.B.432February 5, 2007

Corporations
IndividualsMNP
A..........................................
55%
40%
5%
B..........................................40%20%40%
C..........................................
5%
40%
55%
(ii) Since the more-than-50 percent identical own-
ership requirement of section 1563(a)(2) is met with
respect to c
orporations M and N and with respect to
corporations N and P, but not with respect to corpo-
rations M, N, and P, corporation N would, without
the application of this paragraph (c)(2), be a compo-
nent member on December 31, 1970, of overlapping
groups cons
istingofMandNandofNandP.IfN
does not file an election in accordance with paragraph
(c)(2)(i) of this section, the Internal Revenue Service
will determine the group in which N is to be included.
Example 2.(
i) On each day of 1970, all the out-
standing stock of corporations S, T, W, X, and Z is
held in the following manner:
Corporations
IndividualsSTWXZ
D..............................................................
5252525252
E..............................................................402222
F..............................................................240222
G..............................................................224022
H..............................................................222402
I...............................................................222240
(ii) On December 31, 1970, the more-than-50
percent identical ownership requirement of section
1563
(a)(2) may be met with regard to any combi-
nation of the corporations but all five corporations
cannot be included as component members of a sin-
gle c
ontrolled group because the inclusion of all the
corporations in a single group would be dependent
upon taking into account the stock ownership of more
tha
n five persons. Therefore, if the corporations do
not file a statement in accordance with paragraph
(c)(2)(ii) of this section, the Internal Revenue Service
wil
l determine the group in which each corporation
is to be included. The corporations or the Internal
Revenue Service, as the case may be, may designate
th
at three corporations be included in one group
and two corporations in another, or that any four
corporations be included in one group and that the
re
maining corporation not be included in any group.
(d
)Transitional rules—(1)In general.
Tr
easury decision 8179 amended para-
g
raph (a)(3)(ii) of this section to revise
t
he definition of a brother-sister controlled
g
roup of corporations. In general, those
a
mendments are effective for taxable years
e
nding on or after December 31, 1970.
(
2)Limited nonretroactivity.(i)Under
t
he authority of section 7805(b), the Inter-
n
al Revenue Service will treat an old group
as a brother-sister controlled group corpo-
rations for purposes of applying sections
401, 404(a), 408(k), 409A, 410, 411, 412,
414, 415, and 4971 of the Code and sec-
tions 202, 203, 204, and 302 of the Em-
ployment Retirement Income Security Act
of 1974 (ERISA) in a plan year or taxable
year beginning before March 2, 1988, to
the extent necessary to prevent an adverse
effect on any old member (or any other cor-
poration), or on any plan or other entity de-
scribed in such sections (including plans,
etc., of corporations not part of such old
group), that would result solely from the
retroactive effect of the amendment to this
section by T.D. 8179. An adverse effect in-
cludes the disqualification of a plan or the
disallowance of a deduction or credit for
a contribution to a plan. The Internal Rev-
enue Service, however, will not treat an old
member as a member of an old group to the
extent that such treatment will have an ad-
verse effect on that old member.
(ii) Section 7805(b) will not be applied
pursuant to paragraph (d)(2)(i) of this sec-
tion to treat an old member of an old group
as a member of a brother-sister controlled
group to prevent an adverse effect for a
taxable year if, for that taxable year, that
old member treats or has treated itself as
not being a member of that old group for
purposes of sections 401, 404(a), 408(k),
409A, 410, 411, 412, 414, 415, and 4971
of the Code and sections 202, 203, 204,
and 302 and Title IV of ERISA for such
taxable year (such as by filing, with respect
to such taxable year, a return, amended re-
turn, or claim for credit or refund in which
the amount of any deduction, credit, lim-
itation, or tax due is determined by treat-
ing itself as not being a member of the
old group for purposes of those sections).
However, the fact that one or more (but
not all) of the old members do not qual-
ify for section 7805(b) treatment because
of the preceding sentence will not preclude
that old member (or members) from being
treated as a member of the old group under
paragraph (d)(2)(i) of this section in order
to prevent the disallowance of a deduction
or credit of another old member (or other
corporation) or to prevent the disqualifi-
cation of, or other adverse effect on, an-
other old member’s plan (or other entity)
described in the sections of the Code and
ERISA enumerated in such paragraph.
(3)Election of general nonretroactiv-
ity. In the case of a taxable year ending
on or after December 31, 1970, and before
March2,1988,anoldgroupwillbetreated
as a brother-sister controlled group of cor-
porations for all purposes of the Code for
such taxable year if—
(i) Each old member files a statement
consenting to such treatment for such tax-
able year with the District Director having
audit jurisdiction over its return within six
months after March 2, 1988; and
(ii) No old member—
(A) Files or has filed, with respect to
such taxable year, a return, amended re-
turn, or claim for credit or refund in which
the amount of any deduction, credit, limi-
tation, or tax due is determined by treating
any old member as not a member of the old
group; or
(B) Treats the employees of all mem-
bers of the old group as not being em-
ployed by a single employer for purposes
of sections 401, 404(a), 408(k), 409A, 410,
411, 412, 414, 415, and 4971 of the Code
February 5, 20074332007–6 I.R.B.

and sections 202, 203, 204, and 302 of
ERISA for such taxable year.
(4)Definitions. For purposes of this
paragraph (d)—
(i) Anold groupis a brother-sister con-
trolled group of corporations, determined
by applying paragraph (a)(3)(ii) of this
section as in effect before the amendments
made by Treasury decision 8179, that
is not a brother-sister controlled group
of corporations, determined by apply-
ing paragraph (a)(3)(ii) of this section as
amended by such Treasury decision; and
(ii) Anold memberis any corporation
that is a member of an old group.
(5)Election to choose between mem-
bership in more than one controlled group.
If—
(i) An old member has filed an election
under paragraph (c)(2) of this section to be
treated as a component member of an old
group for a December 31 before March 2,
1988; and
(ii) That corporation would (without
regard to such paragraph) be a component
member of more than one brother-sister
controlled group (not including an old
group) on the December 31, that corpo-
ration may make an election under that
paragraph by filing an amended return
on or before September 2, 1988. This
paragraph (d)(5) does not apply to a cor-
poration that is treated as a member of an
old group under paragraph (d)(3) of this
section.
(6)Refunds. See section 6511(a) for
period of limitation on filing claims for
credit or refund.
(e)Effective date—(1)Applicability
date. Paragraphs (a), (b), (c)(1), (c)(2)(iv)
and (d) of this section apply to taxable
years beginning on or after December
22, 2006. However, taxpayers may apply
these paragraphs to any Federal income
tax return filed on or after December 22,
2006. Paragraphs (c)(2)(i) through (iii) of
this section apply to any original Federal
income tax return (including any amended
return filed on or before the due date
(including extensions) of such original
return) timely filed on or after May 30,
2006.
(2)Expiration date. The applicability
of paragraphs (a), (b), (c)(1), (c)(2)(iv) and
(d) of this section will expire on December
21, 2009. The applicability of paragraphs
(c)(2)(i) through (iii) of this section will
expire on May 26, 2009.
§1.1563–3 [Amended]
Par. 34. In §1.1563–3, at the end
of paragraph (d)(3) Example 3, add
the phrase “for purposes of paragraph
(a)(3)(ii) of §1.1563–1T”.
§1.1564–1 [Removed]
Par. 35. Section 1.1564–1 is removed.
PART 5—TEMPORARY INCOME
TAX REGULATIONS UNDER THE
REVENUE ACT OF 1978
Par. 36. The authority citation for part
5 continues to read as follows:
Authority: 26 U.S.C. 7805.
§5.1561–1 [Removed]
Par. 37. Section 5.1561–1 is removed.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 12, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 21,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 22, 2006, 71 F.R. 76904)
Section 7520.—Valuation
Tables
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 7872.—Treatment
of Loans With Below-Market
Interest Rates
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2007. See Rev. Rul. 2007-9, page 422.
Section 9802.—Prohibiting
Discrimination Against
Individual Participants
and Benefic
iaries Based
on Health St
atus
26 CFR 54.9802–1: Prohibiting discrimination
against participants and beneficiaries based on a
health factor.
T.D. 9298
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 54
DEPARTMENT OF LABOR
Employee Benefits
Security Administration
29 CFR Part 2590
DEPARTMENT OF HEALTH
AND HUMAN SERVICES
Centers for Medicare
& Medicaid Services
45 CFR Part 146
Final Rules for
Nondiscrimination and
Wellness Programs in Health
Coverage in the Group Market
AGENCIES:Internal Revenue Service,
Department of the Treasury; Employee
Benefits Security Administration, Depart-
ment of Labor; Centers for Medicare &
Medicaid Services, Department of Health
and Human Services.
ACTION:Final rules.
SUMMARY:This document contains
final rules governing the provisions pro-
hibiting discrimination based on a health
factor for group health plans and issuers
of health insurance coverage offered in
connection with a group health plan. The
rules contained in this document im-
plement changes made to the Internal
Revenue Code of 1986 (Code), the Em-
ployee Retirement Income Security Act
of 1974 (ERISA), and the Public Health
Service Act (PHS Act) enacted as part
of the Health Insurance Portability and
Accountability Act of 1996 (HIPAA).
2007–6 I.R.B.434February 5, 2007

DATES:Effective date:These final regu-
lations are effective February 12, 2006.
Applicability dates:These final regula-
tions apply for plan years beginning on or
after July 1, 2007.
FOR FURTHER INFORMATION
CONTACT:Russ Weinheimer, Inter-
nal Revenue Service, Department of the
Treasury, at (202) 622–6080; Amy Turner
or Elena Lynett, Employee Benefits Secu-
rity Administration, Department of Labor,
at (202) 693–8335; or Karen Levin or
Adam Shaw, Centers for Medicare &
Medicaid Services, Department of Health
and Human Services, at (877) 267–2323
extension 65445 and 61091, respectively.
CUSTOMER SERVICE INFORMA-
TION:Individuals interested in obtaining
copies of Department of Labor publica-
tions concerning health care laws may
request copies by calling the Department
of Labor (DOL), Employee Benefits Se-
curity Administration (EBSA) Toll-Free
Hotline at 1–866–444–EBSA (3272) or
may request a copy of the Department of
Health and Human Services (HHS), Cen-
ters for Medicare & Medicaid Services
(CMS) publication entitled “Protecting
Your Health Insurance Coverage” by
calling 1–800–633–4227. These regu-
lations as well as other information on
HIPAA’s nondiscrimination rules and
other health care laws are also available
on the Department of Labor’s website
(http://www.dol.gov/ebsa), including the
interactive web pages Health Elaws.
SUPPLEMENTARY INFORMATION:
I. Background
The Health Insurance Portability and
Accountability Act of 1996 (HIPAA),
Public Law 104–191 (110 Stat. 1936),
was enacted on August 21, 1996. HIPAA
amended the Internal Revenue Code of
1986 (Code), the Employee Retirement
Income Security Act of 1974 (ERISA),
and the Public Health Service Act (PHS
Act) to provide for, among other things,
improved portability and continuity of
health coverage. HIPAA added section
9802 of the Code, section 702 of ERISA,
and section 2702 of the PHS Act, which
prohibit discrimination in health coverage
based on a health factor. Interim final
rules implementing the HIPAA provisions
were published in theFederal Register
on April 8, 1997 (T.D. 8716, 1997–1 C.B.
225 [62 FR 16894]) (1997 interim rules).
On December 29, 1997, the Department
of Labor, the Department of Health and
Human Services, and the Department of
the Treasury (the Departments) published
a clarification of the April 1997 interim
rules as they relate to individuals who
were denied coverage before the effective
date of HIPAA on the basis of any health
factor (62 FR 67689).
On January 8, 2001, the Departments
published interim final regulations (2001
interim rules) on many issues under the
HIPAA nondiscrimination provisions
(T.D. 8931, 2001–1 C.B. 542 [66 FR
1378]) and proposed regulations on well-
ness programs under those nondiscrimina-
tion provisions (REG–114084–00, 2001–1
C.B. 633 [66 FR 1421]). These regula-
tions being published today in theFederal
Registerfinalize both the 2001 interim
rules and the proposed rules.
II. Overview of the Regulations
Section 9802 of the Code, section 702
ofERISA,andsection2702ofthePHS
Act (the HIPAA nondiscrimination provi-
sions) establish rules generally prohibiting
group health plans and group health insur-
ance issuers from discriminating against
individual participants or beneficiaries
based on any health factor of such partic-
ipants or beneficiaries. The 2001 interim
rules —
•Explained the application of these pro-
visions to benefits;
•Clarified the relationship between the
HIPAA nondiscrimination provisions
and the HIPAA preexisting condition
exclusion limitations;
•Explained the application of these pro-
visions to premiums;
•Described similarly situated individu-
als;
•Explained the application of these pro-
visions to actively-at-work and non-
confinement clauses; and
•Clarified that more favorable treatment
of individuals with medical needs gen-
erally is permitted.
In general, these final regulations do not
change the 2001 interim rules or the pro-
posed rules on wellness programs. How-
ever, these regulations do not republish the
expired transitional rules regarding indi-
viduals who were denied coverage based
on a health factor prior to the applicabil-
ity date of the 2001 interim rules. (These
regulations do republish, and slightly mod-
ify, the special transitional rule for self-
funded nonfederal governmental plans that
had denied any individual coverage due to
the plan’s election to opt out of the nondis-
crimination requirements under 45 CFR
146.180, in cases where the plan spon-
sor subsequently chooses to bring the plan
into compliance with those requirements).
These regulations clarify how the source-
of-injury rules apply to the timing of a di-
agnosis of a medical condition and add an
example to illustrate how the benefits rules
apply to the carryover feature of health re-
imbursement arrangements (HRAs). For
wellness programs, the final regulations
clarify some ambiguities in the proposed
rules, make some changes in terminology
and organization, and add a description of
wellness programs not required to satisfy
additional standards.
Application to Benefits
Under the 2001 interim rules and these
regulations, a plan or issuer is not required
to provide coverage for any particular ben-
efit to any group of similarly situated indi-
viduals. However, benefits provided must
be uniformly available to all similarly sit-
uated individuals. Likewise, any restric-
tion on a benefit or benefits must apply
uniformly to all similarly situated individ-
uals and must not be directed at individual
participants or beneficiaries based on any
health factor of the participants or benefi-
ciaries (determined based on all the rele-
vant facts and circumstances).
With respect to these benefit rules,
the Departments received many inquiries
about HRAs and one comment about
nondiscrimination requirements under
other laws. Under HRAs, employees are
reimbursed for medical expenses up to a
maximum amount for a period, based on
the employer’s contribution to the plan.
These plans may or may not be funded.
Another common feature is that the plans
typically allow amounts remaining avail-
able at the end of the period to be used
February 5, 20074352007–6 I.R.B.

to reimburse medical expenses in later
periods. Because the maximum reim-
bursement available under a plan to an
employee in any single period may vary
based on the claims experience of the em-
ployee, concerns have arisen about the
application of the HIPAA nondiscrimina-
tion rules to these plans.
To address these concerns, these fi-
nal regulations include an example un-
der which the carryforward of unused
employer-provided medical care reim-
bursement amounts to later years does
not violate the HIPAA nondiscrimination
requirements, even though the maximum
reimbursement amount for a year varies
among employees within the same group
of similarly situated individuals based on
prior claims experience. In the example,
an employer sponsors a group health plan
under which medical care expenses are
reimbursed up to an annual maximum
amount. The maximum reimbursement
amount with respect to an employee for
a year is a uniform amount multiplied by
the number of years the employee has
participated in the plan, reduced by the
total reimbursements for prior years. Be-
cause employees who have participated
in the plan for the same length of time
are eligible for the same total benefit over
that length of time, the example concludes
that the arrangement does not violate the
HIPAA nondiscrimination requirements.
The Equal Employment Opportunity
Commission (EEOC) asked the Depart-
ments to clarify that certain plan practices
or provisions permitted under the bene-
fits paragraphs of the 2001 interim rules
may violate the Americans with Disabil-
ities Act of 1990 (ADA) or Title VII of
the Civil Rights Act of 1964 (Title VII).
Specifically, the 2001 interim rules allow
plans to exclude or limit benefits for cer-
tain types of conditions or treatments. The
EEOC commented that, if such a benefit
limitwereappliedtoAIDS,itwouldbe
a disability-based distinction that violates
the ADA (unless it is permitted under sec-
tion 501(c) of the ADA). In addition, the
EEOC commented that an exclusion from
coverage of prescription contraceptives,
but not of other preventive treatments,
would violate Title VII because prescrip-
tion contraceptives are used exclusively
by women.
Paragraph (h) of the 2001 interim rules
and these final regulations is entitled “No
effect on other laws.” This section clari-
fies that compliance with the nondiscrimi-
nation rules is not determinative of compli-
ance with any other provision of ERISA,
or any other State or Federal law, includ-
ing the ADA. Moreover, in paragraph (b)
of the 2001 interim rules and these final
regulations, the general rule governing the
application of the nondiscrimination rules
to benefits clarifies that whether any plan
provision or practice with respect to bene-
fits complies with these rules does not af-
fect whether the provision or practice is
permitted under any other provision of the
Code, ERISA, or the PHS Act, the Amer-
icans with Disabilities Act, or any other
law, whether State or Federal.
Many other laws may regulate plans
and issuers in their provision of benefits
to participants and beneficiaries. These
laws include the ADA, Title VII, the
Family and Medical Leave Act, ERISA’s
fiduciary provisions, and State law. The
Departments have not attempted to sum-
marize the requirements of those laws in
the HIPAA nondiscrimination rules. In-
stead, these rules clarify the application
of the HIPAA nondiscrimination rules to
group health plans, which may permit
certain practices thatother laws prohibit.
Nonetheless, to avoid misleading plans
and issuers as to the permissibility of any
plan provision under other laws, the De-
partments included, in both paragraph (h)
and paragraph (b) of the regulations, ref-
erences to the potential applicability of
other laws. Employers,plans, issuers, and
other service providers should consider
the applicability of these laws to their cov-
erage and contact legal counsel or other
government agencies such as the EEOC
and State insurance departments if they
have questions under those laws.
Source-of-Injury Exclusions
Some plans and issuers, while generally
providing coverage for the treatment of an
injury, deny benefits if the injury arose
from a specified cause or activity. These
kinds of exclusions are known as source-
of-injury exclusions. Under the 2001 in-
terim rules, if a plan or issuer provides ben-
efits for a particular injury, it may not deny
benefits otherwise provided for treatment
of the injury due to the fact that the injury
results from a medical condition or an act
of domestic violence. Two examples in the
2001 interim rules illustrate the application
of this rule, to injuries resulting from an at-
tempted suicide due to depression and to
injuries resulting from bungee jumping.
These final regulations retain the pro-
visions in the 2001 interim rules and add a
clarification. Some people have inquired if
a suicide exclusion can apply if an individ-
ual had not been diagnosed with a medi-
cal condition such as depression before the
suicide attempt. These final regulations
clarify that benefits may not be denied for
injuries resulting from a medical condition
even if the medical condition was not di-
agnosed before the injury.
Some comments expressed concern
that the discussion of the source-of-in-
jury rule in the 2001 interim rules might
be used to support the use of vague lan-
guage to identify plan benefit exclusions,
especially to identify source-of-injury ex-
clusions. Requirements for plan benefit
descriptions are generally outside of the
scope of these regulations. Nonetheless,
Department of Labor regulations at 29
CFR 2520.102–2(b) provide, “The format
of the summary plan description must not
have the effect of misleading, misinform-
ing or failing to inform participants and
beneficiaries. Any description of excep-
tion, limitations, reductions, and other
restrictions of planbenefits shall not be
minimized, rendered obscure or otherwise
made to appear unimportant...The ad-
vantages and disadvantages of the plan
shall be presented without either exag-
gerating the benefits or minimizing the
limitations.” State laws governing group
insurance or nonfederal governmental
plans may provide additional protections.
The Departments received thousands of
comments protesting that the source-of-in-
jury provisions in the 2001 interim rules
would generally permit plans or issuers to
exclude benefits for the treatment of in-
juries sustained in the activities listed in
the conference report to HIPAA (motor-
cycling, snowmobiling, all-terrain vehicle
riding, horseback riding, skiing, and other
similar activities). Many comments re-
quested that the source-of-injury rule be
amended to provide that a source-of-in-
jury exclusion could not apply if the in-
jury resulted from (in addition to an act of
domestic violence or a medical condition)
participation in legal recreational activities
such as those listed in the conference re-
port. Some comments expressed the con-
2007–6 I.R.B.436February 5, 2007

cern that the rule in the 2001 interim rules
would cause plans andissuers to begin ex-
cluding benefits for treatment of injuries
sustained in these kinds of activities.
One comment generally supported the
position in the 2001 interim rules. That
comment expressed the belief that Con-
gress intended with this issue, as with
many other issues, to continue its long-
standing deference to the States on the
regulation of benefit design under health
insurance. The comment also noted that
the source-of-injury rule in the 2001 in-
terim rules would not change the practice
of plans or issuers with regard to the ac-
tivities listed in the conference report and
that the practice of plans and issuers in this
regard would continue to be governed, as
they had been before HIPAA, by market
conditions and the States.
The Departments have not added the
list of activities from the conference re-
port to the source-of-injury rule in the fi-
nal regulations. The statute itself is unclear
about how benefits in general are affected
by the nondiscrimination requirements and
is silent with respect to source-of-injury
exclusions in particular. The legislative
history provides that the inclusion of ev-
idence of insurability in the list of health
factors is intended to ensure, among other
things, that individuals are not excluded
from health care coverage due to their par-
ticipation in the activities listed in the con-
ference report. This language is unclear
because the term “health care coverage”
could mean only eligibility to enroll for
coverage under the plan, so that people
who participate in the activities listed in
the conference report could not be kept out
of the plan but could be denied benefits for
injuries sustained in those activities. Al-
ternatively, it could mean eligibility both
to enroll for coverage and for benefits, so
that people who participate in those activi-
ties could not be kept out of the plan or de-
nied benefits for injuries sustained in those
activities. Without any indication in the
statute and without a clear indication in the
legislative history about this issue, and in
light of the overall scheme of the statute,
the Departments have made no changes to
the regulations.
Moreover, to the extent not prohibited
by State law, plans and issuers have been
free to impose source-of-injury exclusions
since before HIPAA. There is no reason
to believe that plans and issuers will be-
gin to impose source-of-injury exclusions
with respect to the conference report ac-
tivities merely because such exclusions are
not prohibited under the 2001 interim rules
and these final regulations.
Relationship of Prohibition on
Nonconfinement Clauses to State
Extension-of-Benefits Laws
Questions have arisen about the rela-
tionship of the prohibition on nonconfine-
ment clauses in the 2001 interim rules to
State extension-of-benefits laws. Plan pro-
visions that deny an individual benefits
based on the individual’s confinement to
a hospital or other health care institution
at the time coverage would otherwise be-
come effective are often called noncon-
finement clauses. The 2001 interim rules
prohibit such nonconfinement clauses. At
the same time, many States require issuers
to provide benefits beyond the date on
which coverage under the policy would
otherwise have ended to individuals who
continue to be hospitalized beyond that
date. Example 2 in the 2001 interim rules
illustrated that a current issuer cannot im-
pose a nonconfinement clause that restricts
benefits for an individual based on whether
that individual is entitled to continued ben-
efits from a prior issuer pursuant to a State
law requirement. The final sentence in
Example 2 provided that HIPAA does not
affect the prior issuer’s obligation under
State law and does not affect any State law
governing coordination of benefits.
Under the laws of some States, a prior
issuer has the obligation to provide health
benefits to an individual confined to a hos-
pital beyond the nominal end of the policy
only if the hospitalization is not covered by
a succeeding issuer. Because HIPAA re-
quires a succeeding issuer to provide ben-
efits that it would otherwise provide if not
for the nonconfinement clause, in such a
case State law would not require the prior
issuer to provide benefits for a confine-
ment beyond the nominal end of the pol-
icy. In this context, the statement in the fi-
nal sentence of Example 2 — that HIPAA
does not affect the prior issuer’s obligation
under State law — could be read to con-
flict with the text of the rule and the main
point of Example 2 that the succeeding is-
suer must cover the confinement.
There has been some dispute about
how this potential ambiguity should be
resolved. One interpretation is that the
succeeding issuer can never impose a non-
confinement clause, and if this has the
effect under State law of not requiring the
prior issuer to provide benefits beyond
the nominal end of the policy, then the
prior issuer is not obligated to provide the
extended benefits. This interpretation is
consistent with the text of the nonconfine-
ment rule and the main point of Example
2, though it could be read to conflict with
the last sentence in Example 2.
Another interpretation proposed by
some is that, consistent with the last sen-
tence of Example 2, the obligation of
a prior issuer is never affected by the
HIPAA prohibition against nonconfine-
ment clauses. Under this interpretation, if
a State law conditions a prior issuer’s obli-
gation on there being no succeeding issuer
with the obligation, then in order to leave
the prior issuer’s obligation unaffected un-
der State law, the succeeding issuer could
apply a nonconfinement clause and the
HIPAA prohibition would not apply. This
interpretation elevates a minor clarifica-
tion at the end of an example to supersede
not only the main point of the example
but also the express text of the rule the
example illustrates. This proposed inter-
pretation is clearly contrary to the intent
of the 2001 interim rules.
To avoid other interpretations, these fi-
nal rules have replaced the final sentence
of Example 2 in the 2001 interim rules with
three sentences. The new language clari-
fies that: State law cannot change the suc-
ceeding issuer’s obligation under HIPAA;
a prior issuer may also have an obligation;
and in a case in which a succeeding issuer
has an obligation under HIPAA and a prior
issuer has an obligation under State law
to provide benefits for a confinement, any
State laws designed to prevent more than
100 percent reimbursement, such as State
coordination-of-benefits laws, continue to
apply. Thus, under HIPAA a succeed-
ing issuer cannot deny benefits to an in-
dividual on the basis of a nonconfinement
clause. If this requirement under HIPAA
has the effect under State law of remov-
ing a prior issuer’s obligation to provide
benefits, then the prior issuer is not obli-
gated to provide benefits for the confine-
ment. If under State law this requirement
under HIPAA has the effect of obligating
both the prior issuer and the succeeding is-
suer to provide benefits, then any State co-
February 5, 20074372007–6 I.R.B.

ordination-of-benefits law that is used to
determine the order of payment and to pre-
vent more than 100 percent reimbursement
continues to apply.
Actively-at-Work Rules and Employer
Leave Policies
The final regulations make no changes
to the 2001 interim rules relating
to actively-at-work provisions. Ac-
tively-at-work clauses are generally pro-
hibited, unless individuals who are absent
from work due to anyhealth factor are
treated, for purposes of health coverage, as
if they are actively at work. Nonetheless,
a plan or issuer may distinguish between
groups of similarly situated individuals
(provided the distinction is not directed
at individual participants or beneficiaries
based on a health factor). Examples in the
regulations illustrate that a plan or issuer
may condition coverage on an individual’s
meeting the plan’s requirement of working
full-time (such as a minimum of 250 hours
in a three-month period or 30 hours per
week).
Several members of the regulated com-
munity have asked the Departments
to clarify the applicability of the ac-
tively-at-work rules to various plan provi-
sions that require an individual to perform
a minimum amount of service per week
in order to be eligible for coverage. It is
the Departments’ experience that much
of the complexity in applying these rules
derives from the myriad variations in the
operation of employers’ leave policies.
The Departments believe that the 2001 in-
terim rules provide adequate principles for
applying the actively-at-work provisions
to different types of eligibility provisions.
In order to comply with these rules, a plan
or issuer should apply the plan’s service
requirements consistently to all similarly
situated employees eligible for coverage
under the plan without regard to whether
an employee is seeking eligibility to en-
roll in the plan or continued eligibility
to remain in the plan. Accordingly, if a
plan imposes a 30-hour-per-week require-
ment and treats employees on paid leave
(including sick leave and vacation leave)
who are already in the plan as if they are
actively-at-work, the plan generally is re-
quired to credit time on paid leave towards
satisfying the 30-hour-per-week require-
ment for employees seeking enrollment
in the plan. Similarly, if a plan allowed
employees to continue eligibility under
the plan while on paid leave and for an
additional period of 30 days while on un-
paid leave, the plan is generally required
to credit these same periods for employees
seeking enrollment in the plan.
1
To help
ensure consistency in application, plans
andissuersmaywishtoclarify,inwriting,
how employees on various types of leave
are treated for purposes of interpreting a
service requirement. Without clear plan
rules, plans and issuers might slip into
inconsistent applications of their rules,
which could lead to violations of the ac-
tively-at-work provisions.
Wellness Programs
The HIPAA nondiscrimination provi-
sions do not prevent aplan or issuer from
establishing discounts or rebates or mod-
ifying otherwise applicable copayments
or deductibles in return for adherence to
programs of health promotion and disease
prevention. The 1997 interim rules refer
to these programs as “bona fidewellness
programs.” In the preamble to the 1997
interim rules, the Departments invited
comments on whether additional guid-
ance was needed concerning, among other
things, the permissible standards for de-
terminingbona fidewellness programs.
The Departments also stated their intent
to issue further regulations on the nondis-
crimination requirements and that in no
event would the Departments take any
enforcement action against a plan or issuer
that had sought to comply in good faith
with section 9802 of the Code, section 702
ofERISA,andsection2702ofthePHS
Act before the publication of additional
guidance. The preambles to the 2001 in-
terim final and proposed rules noted that
the period for nonenforcement in cases of
good faith compliance with the HIPAA
nondiscrimination provisions generally
ended on the applicability date of those
regulations but continued with respect to
wellness programs until the issuance of
further guidance. Accordingly, the nonen-
forcement policy of the Departments ends
upon the applicability date of these final
regulations for cases in which a plan or
issuer fails to comply with the regula-
tions but complies in good faith with an
otherwise reasonable interpretation of the
statute.
The HIPAA nondiscrimination provi-
sions generally prohibit a plan or issuer
from charging similarly situated individ-
uals different premiums or contributions
based on a health factor. These final reg-
ulations also generally prohibit a plan or
issuer from requiring similarly situated
individuals to satisfy differing deductible,
copayment, or other cost-sharing require-
ments. However, the HIPAA nondiscrim-
ination provisions do not prevent a plan
or issuer from establishing premium dis-
counts or rebates or modifying otherwise
applicable copayments or deductibles in
return for adherence to programs of health
promotion and disease prevention. Thus,
there is an exception to the general rule
prohibiting discrimination based on a
health factor if the reward, such as a pre-
mium discount or waiver of a cost-sharing
requirement, is based on participation in
a program of health promotion or disease
prevention.
Both the 1997 interim rules and the
2001 proposed regulations refer to pro-
grams of health promotion and disease pre-
vention allowed under this exception as
“bona fidewellness programs.” These reg-
ulations generally adopt the provisions in
the 2001 proposed rules. However, as
more fully explained below, the final regu-
lations no longer use the term “bona fide”
in connection with wellness programs, add
a description of wellness programs that do
not have to satisfy additional requirements
in order to comply with the nondiscrim-
ination requirements, reorganize the four
requirements from the proposed rules into
five requirements, provide that the reward
for a wellness program — coupled with the
reward for other wellness programs with
respect to the plan that require satisfaction
of a standard related to a health factor —
must not exceed 20% of the total cost of
coverage under the plan, and add examples
and make other changes to more accurately
describe how the requirements apply.
The term “wellness program”.Com-
ments suggested that the use of the term
“bona fide” with respect to wellness pro-
grams was confusing because, under the
proposed rules, some wellness programs
1
These nondiscrimination rules do not address the applicability of the Family and Medical Leave Act to employers or group health coverage.
2007–6 I.R.B.438February 5, 2007

that are not “bona fide” within the narrow
meaning of that term in the proposed rules
nonetheless satisfy the HIPAA nondis-
crimination requirements. To address this
concern, these final regulations do not use
the term “bona fidewellness program.”
Instead the final regulations treat all pro-
grams of health promotion or disease pre-
vention as wellness programs and specify
which of those wellness programs must
satisfy additional standards to comply with
the nondiscrimination requirements.
Programs not subject to additional
standards. The preamble to the 2001
proposed rules described a number of
wellness programs that comply with the
HIPAA nondiscrimination requirements
without having to satisfy any additional
standards. However, the text of the reg-
ulation did not make such a distinction.
The Departments have received many
comments and inquiries about whether
programs like those described in the 2001
preamble would have to satisfy the ad-
ditional standards in the proposed rules.
As a result, a paragraph has been added
to the final regulations defining and il-
lustrating programs that comply with the
nondiscrimination requirements without
having to satisfy any additional standards
(assuming participation in the program
is made available to all similarly situated
individuals). Such programs are those
under which none of the conditions for
obtainingarewardisbasedonanindi-
vidual satisfying a standard related to a
health factor or under which no reward is
offered. The final regulations include the
following list to illustrate the wide range
of programs that would not have to satisfy
any additional standards to comply with
the nondiscrimination requirements:
•A program that reimburses all or part
of the cost for memberships in a fitness
center.
•A diagnostic testing program that pro-
vides a reward for participation and
does not base any part of the reward on
outcomes.
•A program that encourages preventive
care through the waiver of the copay-
ment or deductible requirement under
a group health plan for the costs of,
for example, prenatal care or well-baby
visits.
•A program that reimburses employees
for the costs of smoking cessation pro-
grams without regard to whether the
employee quits smoking.
•A program that provides a reward to
employees for attending a monthly
health education seminar.
Only programs under which any of the
conditions for obtaining a reward is based
on an individual satisfying a standard re-
lated to a health factor must meet the five
additional requirements described in para-
graph (f)(2) of these regulations in order
to comply with the nondiscrimination re-
quirements.
Limit on the reward. As under the pro-
posed rules, the total reward that may be
given to an individual under the plan for
all wellness programs is limited. A re-
ward can be in the form of a discount or re-
bate of a premium or contribution, a waiver
of all or part of a cost-sharing mechanism
(such as deductibles, copayments, or coin-
surance), the absence of a surcharge, or the
value of a benefit that would otherwise not
be provided under the plan. Under the pro-
posed rule, the reward for the wellness pro-
gram, coupled with the reward for other
wellness programs with respect to the plan
that require satisfaction of a standard re-
lated to a health factor, must not exceed
a specified percentage of the cost of em-
ployee-only coverage under the plan. The
cost of employee-only coverage is deter-
mined based on the total amount of em-
ployer and employee contributions for the
benefit package under which the employee
is receiving coverage.
Comments indicated that in some cir-
cumstances dependents are permitted to
participate in the wellness program in ad-
dition to the employee and that in those cir-
cumstances the reward should be higher to
reflect dependent participation in the pro-
gram. These final regulations provide that
if, in addition to employees, any class of
dependents (such as spouses or spouses
and dependent children) may participate in
the wellness program, the limit on the re-
ward is based on the cost of the coverage
category in which the employee and any
dependents are enrolled.
The proposed regulations specified
three alternative percentages: 10, 15, and
20. The final regulations provide that the
amount of the reward may not exceed 20
percent of the cost of coverage. The pro-
posed regulations solicited comments on
the appropriate percentage. The percent-
age limit is designed to avoid a reward or
penalty being so large as to have the effect
of denying coverage or creating too heavy
a financial penalty on individuals who
do not satisfy an initial wellness program
standard that is related to a health factor.
Comments from one employer and two
national insurance industry associations
requested that the level of the percentage
for rewards should provide plans and is-
suers maximum flexibility for designing
wellness programs. Comments suggested
that plans and issuers have a greater op-
portunity to encourage healthy behaviors
through programs of health promotion
and disease prevention if they are allowed
flexibility in designing such programs.
The20percentlimitonthesizeofthere-
ward in the final regulations allows plans
and issuers to maintain flexibility in their
ability to design wellness programs, while
avoiding rewards or penalties so large as
to deny coverage or create too heavy a
financial penalty on individuals who do
not satisfy an initial wellness program
standard that is related to a health factor.
Reasonably-designed and at-least-
once-per-year requirements. In the 2001
proposed rules, the second of four re-
quirements was that the program must
be reasonably designed to promote good
health or prevent disease. The regulations
also provided that a program did not meet
this standard unless it gave individuals
eligible for the program the opportunity
to qualify for the reward at least once per
year.
One comment suggested a safe harbor
under which a wellness program that al-
lows individuals to qualify at least once
a year for the reward under the program
would satisfy the “reasonably designed”
standard without regard to other attributes
of the program. The Departments have not
adopted this suggestion. The “reasonably
designed” standard is a broad standard. A
wide range of factors could affect the rea-
sonableness of the design of a wellness
program, not just the frequency with which
a participant could qualify for the reward.
For example, a program might not be rea-
sonably designed to promote good health
or prevent disease if it imposed, as a condi-
tion to obtaining the reward, an overly bur-
densome time commitment or a require-
February 5, 20074392007–6 I.R.B.

ment to engage in illegal behavior. The
once-per-year requirement was included in
the proposed rules merely as a bright-line
standard for determining the minimum fre-
quency that is consistent with a reason-
able design for promoting good health or
preventing disease. Thus, this second re-
quirement of the proposed rules has been
divided into two requirements in the fi-
nal rules (the second and the third require-
ments). This division was made to empha-
size that a program that must satisfy the ad-
ditional standards in order to comply with
the nondiscrimination requirements must
allow eligible individuals to qualify for the
reward at least once per year and must also
be otherwise reasonably designed to pro-
mote health or prevent disease.
Comments also expressed other con-
cerns about the “reasonably designed”
requirement. While acknowledging that
this standard provides significant flexibil-
ity, these comments were concerned that
this flexible approach might also require
substantial resources in evaluating all the
facts and circumstances of a proposed
program to determine whether it was rea-
sonable in its design.
The “reasonably designed” requirement
is intended to be an easy standard to sat-
isfy. To make this clear, the final regula-
tions have added language providing that if
a program has a reasonable chance of im-
proving the health of participants and it is
not overly burdensome, is not a subterfuge
for discriminating based on a health fac-
tor, and is not highly suspect in the method
chosen to promote health or prevent dis-
ease, it satisfies this standard. There does
not need to be a scientific record that the
method promotes wellness to satisfy this
standard. The standard is intended to allow
experimentation in diverse ways of pro-
moting wellness. For example, a plan or
issuer could satisfy this standard by pro-
viding rewards to individuals who partic-
ipated in a course of aromatherapy. The
requirement of reasonableness in this stan-
dard prohibits bizarre, extreme, or illegal
requirements in a wellness program.
One comment requested that the final
regulations set forth one or more safe har-
bors that would demonstrate compliance
with the “reasonably designed” standard.
The examples in the proposed and final
regulations present a range of wellness
programs that are well within the borders
of what is considered reasonably designed
to promote health or prevent disease. The
examples serve as safe harbors, so that
a plan or issuer could adopt a program
identical to one described as satisfying
the wellness program requirements in the
examples and be assured of satisfying the
requirements in the regulations. Wellness
programs similar to the examples also
would satisfy the “reasonably designed”
requirement. The Departments, though,
do not want plans or issuers to feel con-
strained by the relatively narrow range of
programs described by the examples but
want plans and issuers to feel free to con-
sider innovative programs for motivating
individuals to make efforts to improve
their health.
Reasonable alternative standard.Un-
der the 2001 proposed rules and these fi-
nal regulations, a wellness program that
provides a reward requiring satisfaction of
a standard related to a health factor must
provide a reasonable alternative standard
for obtaining the reward for certain indi-
viduals. This alternative standard must be
available for individuals for whom, for that
period, it is unreasonably difficult due to
a medical condition to satisfy the other-
wise applicable standard, or for whom, for
that period, it is medically inadvisable to
attempt to satisfy the otherwise applicable
standard. A program does not need to es-
tablish the specific reasonable alternative
standard before the program commences.
It is sufficient to determine a reasonable
alternative standard once a participant in-
forms the plan that it is unreasonably dif-
ficult for the participant due to a medical
condition to satisfy the general standard
(or that it is medically inadvisable for the
participant to attempt to achieve the gen-
eral standard) under the program.
Some comments suggested that the
requirement to devise and offer such a
reasonable alternative standard potentially
creates a significant burden on plans and
issuers. Comments also suggested that the
Departments should define a “safe harbor”
for what constitutes a reasonable alterna-
tive standard, and that plans and issuers
should be permitted to establish a single
alternative standard, rather than having to
tailor a standard foreach individual for
whom a reasonable alternative standard
must be offered.
The Departments understand that, in
devising wellness programs, plans and
issuers strive to improve the health of
participating individuals in a way that is
not administratively burdensome or ex-
pensive. Under the proposed and final
rules, it is permissible for a plan or issuer
to devise a reasonable alternative standard
by lowering the threshold of the existing
health-factor-related standard, substitut-
ing a different standard, or waiving the
standard. (For the alternative standard
to be reasonable, the individual must be
able to satisfy it without regard to any
health factor.) To address the concern
regarding the potential burden of this re-
quirement, the final regulations explicitly
provide that a plan or issuer can waive the
health-factor-related standard for all indi-
viduals for whom a reasonable alternative
standard must be offered. Additionally,
the final regulations include an example
demonstrating that a reasonable alterna-
tive standard could include following the
recommendations of an individual’s physi-
cian regarding the health factor at issue.
Thus, a plan or issuer need not assume the
burden of designing a discrete alternative
standard for each individual for whom an
alternative standard must be offered. An
example also illustrates that if analterna-
tivestandard is health-factor-related (i.e.,
walking three days a week for 20 minutes
a day), the wellness program must provide
an additional alternative standard (i.e.,
following the individual’s physician’s rec-
ommendations regarding the health factor
at issue) to the appropriate individuals.
The 2001 proposed rules included an
example illustrating a smoking cessation
program. Comments expressed concern
that, under the proposed regulations, indi-
viduals addicted to nicotine who comply
with a reasonable alternative standard year
after year would always be entitled to the
reward even if they did not quit using to-
bacco. Comments questioned whether this
result is consistent with the goal of pro-
moting wellness. The final regulations re-
tain the example from the proposed rules.
Comments noted that overcoming an ad-
diction sometimes requires a cycle of fail-
ure and renewed effort. For those individ-
uals for whom it remains unreasonably dif-
ficult due to an addiction, a reasonable al-
ternative standard must continue to be of-
fered. Plans and issuers can accommo-
date this health factor by continuing to of-
fer the same or a new reasonable alterna-
tive standard. For example, a plan or is-
suer using a smoking cessation class might
2007–6 I.R.B.440February 5, 2007

use different classes from year to year or
might change from using a class to provid-
ing nicotine replacement therapy. These
final regulations provide an additional ex-
ample of a reasonable alternative standard
of viewing, over a period of 12 months,
a 12-hour video series on health problems
associated with tobacco use.
Concern has been expressed that indi-
viduals might claim that it would be un-
reasonably difficult or medically inadvis-
able to meet the wellness program stan-
dard, when in fact the individual could
meet the standard. The final rules clarify
that plans may seek verification, such as a
statement from a physician, that a health
factor makes it unreasonably difficult or
medically inadvisable for an individual to
meet a standard.
Disclosure requirements.Thefifthre-
quirement for a wellness program that pro-
vides a reward requiring satisfaction of a
standard related to a health factor is that all
plan materials describing the terms of the
program must disclose the availability of
a reasonable alternative standard. This re-
quirement is unchanged from the proposed
rules. The2001proposedrulesandthese
final regulations include the same model
language that can be used to satisfy this
requirement; examples also illustrate sub-
stantially similar language that would sat-
isfy the requirement.
The final regulations retain the two
clarifications of thisrequirement. First,
plan materials are not required to describe
specific reasonable alternative standards.
It is sufficient to disclose that some rea-
sonable alternative standard will be made
available. Second, any plan materials that
describe the general standard would also
have to disclose the availability of a rea-
sonable alternative standard. However,
if the program is merely mentioned (and
does not describe the general standard),
disclosure of the availability of a reason-
able alternative standard is not required.
Special Rule for Self-Funded Nonfederal
Governmental Plans Exempted Under 45
CFR 146.180
The sponsor of a self-funded nonfederal
governmental plan may elect under section
2721(b)(2) of the PHS Act and 45 CFR
146.180 to exempt its group health plan
from the nondiscrimination requirements
ofsection2702ofthePHSActand45CFR
146.121. Under the interim final nondis-
crimination rules, if the plan sponsor sub-
sequently chooses to bring the plan into
compliance with the nondiscrimination re-
quirements, the plan must provide notice to
that effect to individuals who were denied
enrollment based on one or more health
factors, and afford those individuals an op-
portunity, that continues for at least 30
days, to enroll in the plan. (An individual
is considered to have been denied cover-
age if he or she failed to apply for cover-
age because, given an exemption election
under 45 CFR 146.180, it was reasonable
to believe that an application for coverage
would have been denied based on a health
factor). The notice must specify the effec-
tive date of compliance, and inform the in-
dividual regarding any enrollment restric-
tions that may apply under the terms of
the plan once the plan comes into compli-
ance. The plan may not treat the individ-
ual as a late enrollee or a special enrollee.
These final regulations retain this transi-
tional rule, and state that the plan must
permit coverage to be effective as of the
first day of plan coverage for which an ex-
emption election under 45 CFR 146.180
(with regard to the nondiscrimination re-
quirements) is no longer in effect. (These
final regulations delete the reference giv-
ing the plan the option of having the cover-
age start July 1, 2001, because that option
implicated the expired transitional rules re-
garding individuals who were denied cov-
erage based on a health factor prior to the
applicability of the 2001 interim rules. As
previously stated, those transitional rules
have not been republished in these final
regulations.) Additionally, the examples
illustrating how the special rule for non-
federal governmental plans operates have
been revised slightly.
Applicability Date
These regulations apply for plan years
beginning on or after July 1, 2007. Un-
til the applicability date for this regulation,
plans and issuers are required to comply
with the corresponding sections of the reg-
ulations previously published in theFed-
eral Register(66 FR 1378) and other ap-
plicable regulations.
III. Economic Impact and Paperwork
Burden
Summary — Department of Labor and
Department of Health and Human
Services
HIPAA’s nondiscrimination provisions
generally prohibit group health plans and
group health insurance issuers from dis-
criminating against individuals in eligibil-
ity or premiums on the basis of health fac-
tors. The Departments have crafted these
regulations to secure the protections from
discrimination as intended by Congress in
as economically efficient a manner as pos-
sible, and believe that the economic bene-
fits of the regulations justify their costs.
The primary economic benefits associ-
ated with securing HIPAA’s nondiscrim-
ination provisions derive from increased
access to affordable group health plan cov-
erage for individuals with health problems.
Increased access benefits both newly-cov-
ered individuals and society at large. It
fosters expanded health coverage, timelier
and more complete medical care, better
health outcomes, and improved productiv-
ity and quality of life. This is especially
true for the individuals most affected by
HIPAA’s nondiscrimination provisions —
those with adverse health conditions. De-
nied health coverage, individuals in poorer
health are more likely to suffer economic
hardship, to forego badly needed care for
financial reasons, and to suffer adverse
health outcomes as a result. For them,
gaining health coverage is more likely to
mean gaining economic security, receiv-
ing timely, quality care, and living health-
ier, more productive lives. Similarly, par-
ticipation by these individuals in wellness
programs fosters better health outcomes,
increases productivity and quality of life,
and has the same outcome in terms of over-
all gains in economic security. The well-
ness provisions of these regulations will
result in fewer instances in which wellness
programs shift costs to high-risk individu-
als, and more instances in which these indi-
viduals succeed at improving health habits
and health.
Additional economic benefits derive
directly from the improved clarity pro-
vided by the regulations. The regulations
will reduce uncertainty and costly disputes
and promote confidence in health benefits’
value, thereby improving labor market ef-
February 5, 20074412007–6 I.R.B.

ficiency and fostering the establishment
and continuation of group health plans and
their wellness program provisions.
The Departments estimate that the dol-
lar value of the expanded coverage attrib-
utable to HIPAA’s nondiscrimination pro-
visions is approximately $850 million an-
nually. The Departments believe that the
cost of HIPAA’s nondiscrimination provi-
sions is borne by covered workers. Costs
can be shifted to workers through increases
in employee premium shares or reductions
(or smaller increases) in pay or other com-
ponents of compensation, by increases in
deductibles or other cost sharing, or by
reducing the richness of health benefits.
Whereas the benefits of the nondiscrim-
ination provisions are concentrated in a
relatively small population, the costs are
distributed broadly across plans and en-
rollees.
The proposed rules on wellness pro-
grams impose certain requirements on
wellness programs providing rewards that
would otherwise discriminate based on a
health factor in order to ensure that the
exception for wellness programs does not
eviscerate the general rule contained in
HIPAA’s nondiscrimination provisions.
Costs associated with the wellness pro-
gram provisions are justified by the ben-
efits received by those individuals now
able, through alternative standards, to par-
ticipate in such programs. Because the
new provisions limit rewards for well-
ness programs that require an individual
to satisfy a standard related to a health
factor to 20 percent of the cost of single
coverage (with additional provisions re-
lated to rewards that apply also to classes
of dependents), some rewards will be re-
duced and this reduction might compel
some individuals to decline coverage. The
number of individuals affected, however,
is thought to be small. Moreover, the
Departments estimate that the cost of the
reduction in rewards that would exceed
the limit will amount to only $6 million.
Establishing reasonable alternative stan-
dards, which should increase coverage for
those now eligible for discounts as well as
their participation in programs designed
to promote health or prevent disease, is
expected to cost between $2 million to $9
million. The total costs should therefore
fall within a range between $8 million and
$15 million annually.
New economic costs may be also in-
curred in connection with the wellness pro-
visions if reductions in rewards result in
the reduction of wellness programs’ effec-
tiveness, but this effect is expected to be
very small. Other new economic costs
maybeincurredbyplansponsorstomake
available reasonable alternative standards
where required. The Departments are un-
able to estimate these costs due to the va-
riety of options available to plan sponsors
for bringing wellness programs into com-
pliance with these rules.
Executive Order 12866 — Department
of Labor and Department of Health and
Human Services
Under Executive Order 12866, the De-
partments must determine whether a regu-
latory action is “significant” and therefore
subject to the requirements of the Execu-
tive Order and subject to review by the Of-
fice of Management and Budget (OMB).
Under section 3(f), the order defines a “sig-
nificant regulatory action” as an action that
is likely to result in a rule (1) having an
annual effect on the economy of $100 mil-
lion or more, or adversely and materially
affecting a sector of the economy, produc-
tivity, competition, jobs, the environment,
public health or safety, or State, local or
tribal governments or communities (also
referred to as “economically significant”);
(2) creating serious inconsistency or oth-
erwise interfering with an action taken or
planned by another agency; (3) materially
altering the budgetary impacts of entitle-
ment grants, user fees, or loan programs
or the rights and obligations of recipients
thereof; or (4) raising novel legal or pol-
icy issues arising out of legal mandates, the
President’s priorities, or the principles set
forth in the Executive Order.
Pursuant to the terms of the Executive
Order, this action is “economically signif-
icant” and subject to OMB review under
Section3(f)oftheExecutive Order. Con-
sistent with the Executive Order, the De-
partments have assessed the costs and ben-
efits of this regulatory action. The Depart-
ments performed a comprehensive, unified
analysis to estimate the costs and bene-
fits attributable to the final regulations for
purposes of compliance with the Execu-
tive Order 12866, the Regulatory Flexibil-
ity Act, and the Paperwork Reduction Act.
The Departments’ analyses and underlying
assumptions are detailed below. The De-
partments believe that the benefits of the
final regulations justify their costs.
Regulatory Flexibility Act — Department
of Labor and Department of Health and
Human Services
The Regulatory Flexibility Act
(5 U.S.C. 601et seq.) (RFA) imposes
certain requirements with respect to fed-
eral rules that are subject to the notice and
comment requirements of section 553(b)
of the Administrative Procedure Act (5
U.S.C. 551et seq.) and likely to have
a significant economic impact on a sub-
stantial number of small entities. Unless
an agency certifies that a final rule will
not have a significant economic impact
on a substantial number of small entities,
section 604 of the RFA requires that the
agency present a final regulatory flexi-
bility analysis (FRFA) at the time of the
publication of the notice of final rulemak-
ing describing the impact of the rule on
small entities. Small entities include small
businesses, organizations, and govern-
mental jurisdictions.
Because the 2001 interim rules were
issued as final rules and not as a notice
of proposed rulemaking, the RFA did not
apply and the Departments were not re-
quired to either certify that the rule would
not have a significant impact on a substan-
tial number of small entities or conduct
a regulatory flexibility analysis. The De-
partments nonetheless crafted those regu-
lations in careful consideration of effects
on small entities, and conducted an analy-
sis of the likely impact of the rules on small
entities. This analysis was detailed in the
preamble to the interim final rule.
The Departments also conducted an
initial regulatory flexibility analysis in
connection with the proposed regulations
on wellness programs and present here
a FRFA with respect to the final regula-
tions on wellness programs pursuant to
section 604 of the RFA. For purposes of
their unified FRFA, the Departments ad-
heredtoEBSA’sproposeddefinitionof
small entities. The Departments consider
a small entity to be an employee benefit
plan with fewer than 100 participants. The
basis of this definition is found in section
104(a)(2) of ERISA, which permits the
Secretary of Labor to prescribe simpli-
fied annual reports for pension plans that
2007–6 I.R.B.442February 5, 2007

cover fewer than 100 participants. The
Departments believe that assessing the
impact of this final rule on small plans is
an appropriate substitute for evaluating the
effect on small entities as that term is de-
fined in the RFA. This definition of small
entity differs, however, from the defini-
tion of small business based on standards
promulgated by the Small Business Ad-
ministration (13 CFR 121.201) pursuant
to the Small Business Act (15 U.S.C. 631
et seq.). Because of this difference, the
Departments requested comments on the
appropriateness of this size standard for
evaluating the impact of the proposed reg-
ulations on small entities. No comments
were received.
The Departments estimate that 35,000
plans with fewer than 100 participants vary
employee premium contributions or cost-
sharing across similarly situated individu-
als based on health factors.
2
While this rep-
resents just one percent of all small plans,
the Departments believe that because of
the large number of plans, this may con-
stitute a substantial number of small en-
tities. The Departments also note that at
least some premium rewards may be large.
Premium discounts associated with well-
ness programs are believed to range as
high as $920 per affected participant per
year. Therefore, the Departments believe
that the impact of this regulation on at least
some small entities may be significant.
Under these final regulations on well-
ness programs, such programs are not sub-
ject to additional requirements if none of
the conditions for obtaining a reward is
basedonanindividualsatisfyingastan-
dard that is related to a health factor (or if
a wellness program does not provide a re-
ward).
Where a condition for obtaining a re-
ward is based on an individual satisfy-
ing a standard related to a health factor,
the wellness program will not violate the
nondiscrimination provisions if additional
requirements are met. The first require-
ment limits the maximum allowable re-
ward or total of rewards to a maximum of
20 percent of the cost of employee-only
coverage under the plan (with additional
provisions related to rewards that apply
also to classes of dependents). The magni-
tude of the limit is intended to offer plans
maximum flexibility while avoiding the
effect of denying coverage or creating an
excessive financial penalty for individu-
als who cannot satisfy the initial standard
based on a health factor.
The Departments estimate that 4,000
small plans and 22,000 small plan partici-
pants will be affected by this limit.
3
These
plans can comply with this requirement
by reducing the discount to the regulated
maximum. This will result in an increase
in premiums (or decrease in cost-sharing)
by about $1.3 million on aggregate for
those participants receiving qualified pre-
mium discounts.
4
This constitutes an on-
going, annual cost of $338 on average per
affected plan. The regulation does not
limit small plans’ flexibility to shift this
cost to all participants in the form of small
premium increases or benefit cuts.
The second requirement provides that
wellness programs must be reasonably de-
signed to promote health or prevent dis-
ease. Comments received by the Depart-
ments and available literature on employee
wellness programs suggest that existing
wellness programs generally satisfy this
requirement. The requirement therefore
is not expected to compel small plans to
modify existing wellness programs.
The third requirement is that the pro-
gram give individuals eligible for the pro-
gram the opportunity to qualify for the re-
ward at least once per year. This provi-
sion was included within the terms of the
requirements for reasonable design in the
proposed regulations. The Departments
did not anticipate that a cost would arise
from the requirements related to reason-
able design when taken together, but re-
quested comments on their assumptions.
Because no comments were received, the
Departments have not attributed a cost to
this provision of the final rule.
The fourth requirement provides that
rewards under wellness programs must be
available to all similarly situated individ-
uals. Rewards are not available to simi-
larly situated individuals unless a program
allows a reasonable alternative standard
or waiver of the applicable standard, if it
is unreasonably difficult due to a medical
condition or medically inadvisable to at-
tempt to satisfy the otherwise applicable
standard. The Departments believe that
some small plans’ wellness programs do
not currently satisfy this requirement and
will have to be modified.
The Departments estimate that 3,000
small plans’ wellness programs include
initial standards that may be unreasonably
difficult due to a medical condition or
medically inadvisable for some partici-
pants to meet.
5
These plans are estimated
to include 4,000 participants for whom the
standard is in fact unreasonably difficult
due to a medical condition or medically
inadvisable to meet.
6
Satisfaction of alter-
native standards by these participants will
result in cost increases for plans as these
individuals qualify for discounts or avoid
surcharges. If all of these participants
request and then satisfy an alternative
standard, the cost would amount to about
$2 million annually. If one-half request
alternative standards and one-half of those
2
Based on tabulations of the 2003 Medical Expenditure Panel Survey Insurance Component (MEPS-IC) and 1997 Survey of Government Finances (SGF), the Departments estimate that
r
oughly 2.4 million small health plans exist. Of these, 1.2 percent of these plans arebelieved to vary premiums (as suggested in a 1993 study by the Robert Woods Johnson Foundation) while
.5 percent are thought to vary benefits (as suggested in,Spec Summary. United States Salaried Managed Health/Health Promotion Initiatives, 2003–2004, Hewitt Associates, July, 2003.).
Assuming that half of those that vary premiums alsovary benefits, the Departments conclude that 1.5 percent of all small plans are potentially affected by the statute.
3
Simulations run by the Departments suggest that 10.7 percent of all plans exceed the capped premium discount. For the purposes of this analysis, it wasassumed that the affected plans were
proportionally distributed between large and small plans. However, it is likely that larger plans would have more generous welfare programs and therefore, this estimate is likely an upper
bound.
4
Estimate is based on the 2003–04 Hewitt Study and various measures of the general health of the labor force suggest that roughly 30 percent of health plan participants will not qualify for
the discount. While plans exceeding the capped discount could meet the statutes requirements by transferring the excess amount, on average $57, to the non-qualifying participants, given
current trends in the health insurance industry, it is considered more likely that plans would instead lower the amount of the discount given to the 70 percent of participants that qualify. This
transfer would roughly total $1.3 million dollars.
5
The 2003–04 Hewitt Survey finds that 9 percent of its respondents require participants to achieve a certain health standard to be eligible for discounts. Based on assumptions about the
general health of the labor force, approximately 2.3 percent of health plan participants may and 1.5 percent will find these standards difficult to achieve.
6
Many small plans are very small, having fewer than 10 participants. Hence, many small plans will include no participant for whom either of these standards apply.
February 5, 20074432007–6 I.R.B.

meet them, the cost would be $0.5 mil-
lion.
7
In addition to the costs associated with
new participants qualifying for discounts
through alternative standards, small plans
may also incur new economic costs by
simply providing alternative standards.
However, plans can satisfy this require-
ment by providing inexpensive alternative
standards and have the flexibility to select
whatever reasonable alternative standard
is most desirable or cost effective. Plans
not wishing to provide alternative stan-
dards also have the option of eliminating
health status-based variation in employee
premiums or waiving standards for indi-
viduals for whom the program standard
is unreasonably difficult due to a med-
ical condition or medically inadvisable
to meet. The Departments expect that the
economic cost to provide alternatives com-
bined with the associated cost of granting
discounts or waiving surcharges will not
exceed the cost associated with granting
discounts or waiving surcharges for all
participants who qualify for an alterna-
tive. Those costs are estimated here at
$0.5 million to $2 million, or about $160
to $650 per affected plan. Plans have the
flexibility to pass back some or all of this
cost to all participants in the form of small
premium increases or benefit cuts.
The fifth requirement provides that
plan materials describing wellness pro-
gram standards disclose the availability
of reasonable alternative standards. This
requirement will affect the approximately
4,000 small plans that condition rewards
on satisfaction of a standard. These plans
will incur economic costs to revise af-
fected plan materials. The estimated 1,000
to 4,000 small plan participants who will
succeed at satisfying these alternative
standards will benefit from these disclo-
sures. The disclosures need not specify
what alternatives are available unless
the plan describes the initial standard in
writing and the regulation provides sample
language that can be used to satisfy this re-
quirement. Legal requirements other than
this regulation generally require plans and
issuers to maintain accurate materials de-
scribing plans. Plans and issuers generally
update such materials on a regular basis
as part of their normal business practices.
This requirement is expected to represent a
negligible fraction of the ongoing, normal
cost of updating plans’ materials. This
analysis therefore attributes no cost to this
requirement.
Paperwork Reduction Act — Department
of Labor and Department of the Treasury
The 2001 interim rules included an
information collection request (ICR) re-
lated to the notice of the opportunity to
enroll in a plan where coverage had been
denied based on a health factor before
the effective date of HIPAA. That ICR
was approved under OMB control num-
bers 1210–0120 and 1545–1728, and was
subsequently withdrawn from OMB in-
ventory because the notice, if applicable,
was to have been provided only once.
The proposed regulations on wellness
programs did not include an information
collection request. Like the proposed reg-
ulations, the final regulations include a re-
quirement that, if a plan’s wellness pro-
gram requires individuals to meet a stan-
dard related to a health factor in order to
qualify for a reward and if the plan mate-
rials describe this standard, the materials
must also disclose the availability of a rea-
sonable alternative standard. If plan ma-
terials merely mention that a program is
available, the disclosure relating to alter-
natives is not required. The regulations in-
clude samples of disclosures that could be
used to satisfy the requirements of the final
regulations.
In concluding that the proposed rules
did not include an information collection
request, the Departments reasoned that
much of the information required was
likely already provided as a result of state
and local mandates or the usual business
practices of group health plans and group
health insurance issuers in connection with
the offer and promotion of health care cov-
erage. In addition, the sample disclosures
would enable group health plans to make
any modifications necessary with minimal
effort.
Finally, although neither the proposed
or final regulations include a new infor-
mation collection request, the regulations
might have been interpreted to require a
revision to an existing collection of infor-
mation. Administrators of group health
plans covered under Title I of ERISA are
generallyrequiredtomakecertaindisclo-
sures about the terms of a plan and mate-
rial changes in terms through a Summary
Plan Description (SPD) or Summary of
Material Modifications (SMM) pursuant
to sections 101(a) and 102(a) of ERISA
and related regulations. The ICR related to
the SPD and SMM is currently approved
under OMB control number 1210–0039.
While these materials may in some cases
require revisions to comply with the final
regulations, the associated burden is ex-
pected to be negligible, and is in fact al-
ready accounted for in connection with the
SPD and SMM ICR by a burden estima-
tion methodology that anticipates ongoing
revisions. Therefore, any change to the ex-
isting information collection request aris-
ing from these final regulations is not sub-
stantive or material. Accordingly, no ap-
plication for approval of a revision to the
existing ICR has been made to OMB in
connection with these final regulations.
Paperwork Reduction Act — Department
of Health and Human Services
Collection of Information Requirements
Under the Paperwork Reduction Act of
1995, we are required to provide notice
in theFederal Registerand solicit pub-
lic comment before a collection of infor-
mation requirement is submitted to the Of-
fice of Management and Budget (OMB)
for review and approval. In order to fairly
evaluate whether an information collec-
tion should be approved by OMB, section
3506(c)(2)(A) of the Paperwork Reduction
Act of 1995 requires that we solicit com-
ment on the following issues:
•The need for the information collection
and its usefulness in carrying out the
proper functions of our agency.
•The accuracy of our estimate of the
information collection burden.
•The quality, utility, and clarity of the
information to be collected.
•Recommendations to minimize the
information collection burden on the
affected public, including automated
techniques.
7
Simulations run by the Departments find that the average premium discount for all health plans after the cap is enforced will be approximately $450 dollars. This average is then applied to
the upper and lower bounds of those able to pass the alternative standards in small health plans in order to determine the upper and lower bound of the transfer cost.
2007–6 I.R.B.444February 5, 2007

Department regulations in 45 CFR
146.121(i)(4) require that if coverage has
been denied to any individual because
the sponsor of a self-funded nonfederal
governmental plan has elected under 45
CFR Part 146 to exempt the plan from the
requirements of this section, and the plan
sponsor subsequently chooses to bring the
plan into compliance, the plan must: notify
the individual that the plan will be coming
into compliance; afford the individual an
opportunity to enroll that continues for at
least 30 days, specify the effective date
of compliance; and inform the individual
regarding any enrollment restrictions that
mayapplyoncetheplanisincompliance.
The burden associated with this require-
ment was approved by The Office of Man-
agement and Budget (OMB) under OMB
control number 0938–0827, with a current
expiration date of April 30, 2009.
In addition, CMS–2078–P, published in
theFederal Registeron January 8, 2001
(66 FR 1421) describes thebona fidewell-
ness programs and specifies their criteria.
Section 146.121(f)(1)(iv) further stipulates
that the plan or issuer disclose in all plan
materials describing the terms of the pro-
gram the availability of a reasonable alter-
native standard to qualify for the reward
under a wellness program. However, in
plan materials that merely mention that a
program is available, without describing
its terms, the disclosure is not required.
The burden associated with this require-
ment was approved by OMB control num-
ber 0938–0819, with a current expiration
date of April 30, 2009.
Special Analyses — Department of the
Treasury
Notwithstanding the determinations of
the Departments of Labor and of Health
and Human Services, for purposes of the
Department of the Treasury it has been
determined that this Treasury decision is
not a significant regulatory action. There-
fore, a regulatory assessment is not re-
quired. It has also been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and, because
these regulations do not impose a collec-
tion of information on small entities, a
Regulatory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C. chap-
ter 6) is not required. Pursuant to sec-
tion 7805(f) of the Code, the notice of pro-
posed rulemaking preceding these regula-
tions was submitted to the Small Business
Administration for comment on its impact
on small business.
Congressional Review Act
These final regulations are subject to
the Congressional Review Act provisions
of the Small Business Regulatory Enforce-
ment Fairness Act of 1996 (5 U.S.C. 801
et seq.) and have been transmitted to Con-
gress and the Comptroller General for re-
view. These regulations, however, consti-
tute a “major rule,” as that term is defined
in 5 U.S.C. 804, because they are likely to
result in (1) an annual effect on the econ-
omy of $100 million or more; (2) a major
increase in costs or prices for consumers,
individual industries, or federal, State or
local government agencies, or geographic
regions; or (3) significant adverse effects
on competition, employment, investment,
productivity, innovation, or on the ability
of United States-based enterprises to com-
pete with foreign-based enterprises in do-
mestic or export markets.
Unfunded Mandates Reform Act
For purposes of the Unfunded Man-
dates Reform Act of 1995 (Pub. L. 104–4),
as well as Executive Order 12875, these fi-
nal regulations do not include any federal
mandate that may result in expenditures by
state, local, or tribal governments, nor does
it include mandates which may impose an
annual burden of $100 million or more on
the private sector.
Federalism Statement – Department of
Labor and Department of Health and
Human Services
Executive Order 13132 outlines fun-
damental principles of federalism, and
requires the adherence to specific criteria
by federal agencies in the process of their
formulation and implementation of poli-
cies that have “substantial direct effects”
on the States, the relationship between the
national government and States, or on the
distribution of power and responsibilities
among the various levels of government.
Federal agencies promulgating regulations
that have these federalism implications
must consult with State and local officials,
and describe the extent of their consulta-
tion and the nature of the concerns of State
and local officials in the preamble to the
regulation.
In the Departments’ view, these final
regulations have federalism implications,
because they have substantial direct ef-
fects on the States, the relationship be-
tween the national government and States,
or on the distribution of power and respon-
sibilities among various levels of govern-
ment. However, in the Departments’ view,
the federalism implications of these final
regulations are substantially mitigated be-
cause, with respect to health insurance is-
suers, the vast majority of States have en-
acted laws, which meet or exceed the fed-
eral HIPAA standards prohibiting discrim-
ination based on health factors.
In general, through section 514, ERISA
supersedes State laws to the extent that
they relate to any covered employee ben-
efit plan, and preserves State laws that
regulate insurance, banking, or securities.
While ERISA prohibits States from regu-
lating a plan as an insurance or investment
company or bank, HIPAA added a new
preemption provision to ERISA (as well
as to the PHS Act) narrowly preempting
State requirements for group health insur-
ance coverage. With respect to the HIPAA
nondiscrimination provisions, States may
continue to apply State law requirements
except to the extent that such requirements
prevent the application of the portability,
access, and renewability requirements of
HIPAA, which include HIPAA’s nondis-
crimination requirements provisions that
are the subject of this rulemaking.
In enacting these new preemption pro-
visions, Congress intended to preempt
State insurance requirements only to the
extent that those requirements prevent
the application of the basic protections
set forth in HIPAA. HIPAA’s Conference
Report states that the conferees intended
the narrowest preemption of State laws
with regard to health insurance issuers.
H.R. Conf. Rep. No. 736, 104
th
Cong.
2d Session 205 (1996). State insurance
laws that are more stringent than the fed-
eral requirements are unlikely to “prevent
the application of” the HIPAA nondis-
crimination provisions, and be preempted.
Accordingly, States have significant lat-
itude to impose requirements on health
insurance issuers that are more restrictive
than the federal law.
February 5, 20074452007–6 I.R.B.

Guidance conveying this interpretation
was published in theFederal Register
on April 8, 1997. (62 FR 16904) and on
December 30, 2004 (T.D. 9166, 2005–1
C.B. 558 [62 FR 78720]). These final
regulations clarify and implement the
statute’s minimum standards and do not
significantly reduce the discretion given
the States by the statute. Moreover, the
Departments understand that the vast ma-
jority of States have requirements that
meet or exceed the minimum require-
ments of the HIPAA nondiscrimination
provisions.
HIPAA provides that the States may en-
force the provisions of HIPAA as they per-
tain to issuers, but that the Secretary of
Health and Human Services must enforce
any provisions that a State fails to sub-
stantially enforce. To date, HHS has had
occasion to enforce the HIPAA nondis-
crimination provisions in only two States
and currently enforces the nondiscrimina-
tion provisions in only one State in accor-
dance with that State’s specific request to
do so. When exercising its responsibil-
ity to enforce provisions of HIPAA, HHS
works cooperatively with the State for the
purpose of addressing the State’s concerns
and avoiding conflicts with the exercise of
State authority.
8
HHS has developed pro-
cedures to implement its enforcement re-
sponsibilities, and to afford the States the
maximum opportunity to enforce HIPAA’s
requirements in the first instance. HHS’s
procedures address the handling of reports
that States may not be enforcing HIPAA’s
requirements, and the mechanism for allo-
cating enforcement responsibility between
the States and HHS. In compliance with
Executive Order 13132’s requirement that
agencies examine closely any policies that
may have federalism implications or limit
the policy making discretion of the States,
DOL and HHS have engaged in numerous
effortstoconsultwithandworkcooper-
atively with affected State and local offi-
cials.
For example, the Departments sought
and received input from State insurance
regulators and the National Association
of Insurance Commissioners (NAIC). The
NAIC is a non-profit corporation estab-
lished by the insurance commissioners
of the 50 States, the District of Columbia,
and the four U.S. territories. In most States
the Insurance Commissioner is appointed
by the Governor, in approximately 14
States the insurance commissioner is an
elected official. Among other activities,
it provides a forum for the development
of uniform policy when uniformity is ap-
propriate. Its members meet, discuss, and
offer solutions to mutual problems. The
NAIC sponsors quarterly meetings to pro-
vide a forum for the exchange of ideas, and
in-depth consideration of insurance issues
by regulators, industry representatives,
and consumers. CMS and Department of
Labor staff have attended the quarterly
meetings consistently to listen to the con-
cerns of the State Insurance Departments
regarding HIPAA issues, including the
nondiscrimination provisions. In addi-
tion to the general discussions, committee
meetings and task groups, the NAIC spon-
sors the standing CMS/DOL meeting on
HIPAA issues for members during the
quarterly conferences. This meeting pro-
vides CMS and the Department of Labor
with the opportunity to provide updates on
regulations, bulletins, enforcement actions
and outreach efforts regarding HIPAA.
In addition, the Departments specifi-
cally consulted with the NAIC in devel-
oping these final regulations. Through
the NAIC, the Departments sought and
received the input of State insurance de-
partments regarding certain insurance
rating practices and late enrollment issues.
The Departments employed the States’
insights on insurance rating practices in
developing the provisions prohibiting
“list-billing,” and their experience with
late enrollment in crafting the regulatory
provision clarifying the relationship be-
tween the nondiscrimination provisions
and late enrollment. Specifically, the reg-
ulations clarify that while late enrollment,
if offered by a plan, must be available to
all similarly situatedindividuals regard-
less of any health factor, an individual’s
status as a late enrollee is not itself within
the scope of any health factor.
The Departments have also cooperated
with the States in several ongoing outreach
initiatives, through which information on
HIPAA is shared among federal regula-
tors, State regulators, and the regulated
community. In particular, the Department
of Labor has established a Health Bene-
fitsEducationCampaignwithmorethan
70 partners, including CMS, the NAIC
and many business and consumer groups.
CMS has sponsored conferences with the
States — the Consumer Outreach and Ad-
vocacy conferences in March 1999 and
June 2000 and the Implementation and En-
forcement of HIPAA National State-fed-
eral Conferences in August 1999, 2000,
2001, 2002, and 2003. Furthermore, both
the Department of Labor and CMS Web
sites offer links to important State Web
sites and other resources, facilitating coor-
dination between the State and federal reg-
ulators and the regulated community.
Throughout the process of developing
these regulations, to the extent feasible
within the specific preemption provi-
sions of HIPAA, the Departments have
attempted to balance the States’ interests
in regulating health insurance issuers, and
Congress’s intent to provide uniform min-
imum protections to consumers in every
State. By doing so, it is the Departments’
view that they have complied with the
requirements of Executive Order 13132.
Pursuant to the requirements set forth
in section 8(a) of Executive Order 13132,
and by the signatures affixed to these reg-
ulations, the Departments certify that the
Employee Benefits Security Administra-
tion and the Centers for Medicare & Med-
icaid Services have complied with the re-
quirements of Executive Order 13132 for
the attached final regulation, Final Rules
for Nondiscrimination in Health Coverage
in the Group Market (RIN 1210–AA77
and RIN 0938–AI08), in a meaningful and
timely manner.
Unified Analysis of Costs and Benefits
1. Introduction
HIPAA’s nondiscrimination provisions
generally prohibit group health plans and
group health insurance issuers from dis-
criminating against individuals on the ba-
sis of health factors. The primary effect
and intent of the provision is to increase
access to affordable group health cover-
age for individuals with health problems.
This effect, and the economic costs and
benefits attendant to it, primarily flows
8
This authority applies to insurance issued with respect to group health plans generally, including plans covering employees of church organizations. Thus, this discussion of federalism
applies to all group health insurance coverage that is subject to the PHS Act, including those church plans that provide coverage through a health insurance issuer (but not to church plans that
do not provide coverage through a health insurance issuer).
2007–6 I.R.B.446February 5, 2007

from the statutory provisions of HIPAA
that this regulation implements. However,
the statute alone leaves room for vary-
ing interpretations of exactly which prac-
tices are prohibited or permitted at the mar-
gin. These regulations draw on the De-
partments’ authority to clarify and inter-
pret HIPAA’s statutory nondiscrimination
provisions in order to secure the protec-
tions intended by Congress for plan partic-
ipants and beneficiaries. The Departments
crafted them to satisfy this mandate in as
economically efficient a manner as possi-
ble, and believe that the economic benefits
of the regulations justify their costs. The
analysis underlying this conclusion takes
into account both the effect of the statute
and the impact of the discretion exercised
in the regulations.
The nondiscrimination provisions of
the HIPAA statute and of these regulations
generally apply to both group health plans
and group health insurance issuers. Eco-
nomic theory predicts that issuers will pass
their costs of compliance back to plans,
and that plans may pass some or all of
issuers’ and their own costs of compliance
to participants. This analysis is carried out
in light of this prediction.
These final regulations are needed to
clarify and interpret the HIPAA nondis-
crimination provisions under section 702
of ERISA, section 2702 of the PHS Act,
and section 9802 of the Code, and to en-
sure that group health plans and group
health insurance issuers do not discrimi-
nate against individual participants or ben-
eficiaries based on any health factors with
respect to health care coverage and pre-
miums. The 2001 interim rules provided
additional guidance toexplain the applica-
tion of the statute to benefits, to clarify the
relationship between the HIPAA nondis-
crimination provisions and the HIPAA pre-
existing condition exclusion limitations, to
explain the applications of these provi-
sions to premiums, to describe similarly
situated individuals, to explain the applica-
tion of the provisions to actively-at-work
and nonconfinement clauses, to clarify that
more favorable treatment of individuals
with medical needs generally is permit-
ted, and to describe plans’ and issuers’
obligations with respect to plan amend-
ments.
9
These final regulations clarify the
relationship between the source-of-injury
rules and the timing of a diagnosis of a
medical condition and add an example to
illustrate how the benefits rules apply to
the carryover feature of HRAs.
The proposed rules on wellness pro-
grams were issued in order to ensure
that the exception for wellness programs
would not contravene HIPAA’s nondis-
crimination provisions. With respect to
wellness programs, these final regulations
clarify some ambiguities in the proposed
rules, make some changes in terminology
and organization, and add a description
of wellness programs not required to sat-
isfy additional standards. The final rules
also set the maximum reward for wellness
programs that require satisfaction of a
standard at 20 percent of the cost of single
coverage (with additional provisions re-
lated to rewards that apply also to classes
of dependents), where the proposed rules
hadstatedthelimitintermsofarangeof
percentages.
Because the 2001 interim rules and
proposed regulations on wellness pro-
grams were originally issued as separate
rulemaking actions, the Departments esti-
mated their economic impacts separately.
The costs and benefits of the statutory
nondiscrimination provisions and the
2001 interim rules are again described
separately from the wellness program
provisions here, due to both differing
baselines for the measurement of impact,
and to reliance on different types of infor-
mation and assumptions in the analyses.
2. Costs and Benefits of HIPAA’s
Nondiscrimination Provisions
The Departments have evaluated the
impacts of HIPAA’s nondiscrimination
provisions. The nondiscrimination provi-
sions of the 2001 interim final rules were
estimatedtoresultincostsofabout$20
million to amend plans, revise plan infor-
mational materials, and notify employees
previously denied coverage on the basis
of a health factor of enrollment opportuni-
ties. Because these costs were associated
with one-time activities that were required
to be completed by the applicability date
of the 2001 interim rules, these costs have
been fully defrayed.
The primary statutory economic ben-
efits associated with the HIPAA nondis-
crimination provisions derive from in-
creased access to affordable group health
plan coverage for individuals whose health
factors had previously restricted their
participation in such plans. Expanding
access entails both benefits and costs.
Newly-covered individuals, who previ-
ously had to purchase similar services
out-of-pocket, reap a simple and direct
financial gain. In addition, these individ-
uals may be induced to consume more
(or different) health care services, reap-
ing a benefit which has financial value,
and which in some cases will produce
additional indirect benefits both to the
individual (improved health) and possibly
to the economy at large.
10
Inclusion of these newly-covered indi-
viduals, though, will increase both premi-
ums and claims costs incurred by group
health plans. Economic theory predicts
that these costs will ultimately be shifted
to all plan participants or employees,
either through an increased share of insur-
9
T
he Departments’ estimate of the economic impact of the 2001 interim final regulations was published at 66 FR 1393 (January 8, 2001). These one-time costs were already absorbed by
pl
ans and issuers and are not discussed in this analysis. In fact, the only notice requirement in the 2001 interim final regulations was deleted from the final regulations because the time period
fo
r compliance has passed, with one small exception. Certain self-insured, nonfederal governmental plans that had opted out of the HIPAA nondiscrimination provisions under Section 2721
(b
)(2) of the PHS Act and that have since decided to opt back in may be required to send a notice to individuals previously denied coverage due to a health factor. However, to date, only
a
pproximately 550 such plans have notified CMS that they are opting-out of theHIPAA nondiscrimination provisions and CMS does not receive information regarding a plan’s decision to opt
b
ack in. The Departments estimate that the number of plans having done this isvery small and, therefore, estimate that the impact of the notice provisiononsuchplansistoosmalltocalculate.
10
Individuals without health insurance are less likely to get preventive care and less likely to have a regular source of care. A lack of health insurancegenerally increases the likelihood that
needed medical treatment will be forgone or delayed. Forgoing or delayingcare increases the risk of adverse health outcomes. These adverse outcomesin turn generate higher medical costs,
which are often shifted to public funding sources (and therefore to taxpayers) or to other payers. They also erode productivity and the quality of life. Improved access to affordable group health
coverage for individuals with health problems under HIPAA’s nondiscrimination provisions will lead to more insurance coverage, timelier and fuller medical care, better health outcomes, and
improved productivity and quality of life. This is especially true for the individuals most affected by HIPAA’s nondiscrimination provisions — those with adverse health conditions. Denied
insurance, individuals in poorer health are more likely to suffer economic hardship, to forgo badly needed care for financial reasons, and to suffer adverse health outcomes as a result. For them,
gaining insurance is more likely to mean gaining economic security, receiving timely, quality care, and living healthier, more productive lives. For an extensive discussion of the consequences
of uninsurance, see: “The Uninsured and their Access to Health Care” (2004).The Kaiser Commission on Medicaid and the Uninsured, November; “Insuring America’s Health”, (2004).
Institute of Medicine; “Health Policy and the Uninsured” (2004) edited by Catherine G. McLaughlin. Washington, DC: Urban Institute Press; Miller, Wilhelmineet al(2004) “Covering the
Uninsured: What is it Worth,”Health Affairs, March: w157–w167.
February 5, 20074472007–6 I.R.B.

ance costs, or lowered compensation.
11
If
the number of newly-covered individuals
is small relative to the total number of
plan participants and costs are distributed
evenly, then the increased burden for
each individual should be minimal. How-
ever, it is unclear how previously-covered
individuals will respond to subsequent
changes in their benefits package and if
their response will have unforeseen eco-
nomic costs.
12
The HIPAA nondiscrimi-
nation cost is estimated to be substantial.
Annual group health plan costs average
approximately $7,100 per-participant,
13
and it is likely that average costs would
be higher for individuals who had been
denied coverage due to health factors.
Prior to HIPAA’s enactment, less than
one-tenth of one percent of employees, or
roughly 120,000 in today’s labor market,
were denied employment-based coverage
annually because of health factors.
14
A
simple assessment suggests that the total
cost of coverage for such employees could
be $850 million. However, this estimated
statutory transfer is small relative to the
overall cost of employment-based health
coverage. Group health plans will spend
over $620 billion this year to cover ap-
proximately 174 million employees and
their dependents.
15
Estimated costs under
HIPAA’s nondiscrimination provisions
represent a very small fraction of one
percent of total group health plan expen-
ditures.
3. Costs and Benefits of Finalizing the
2001 Interim Rules
P
rohibitingDiscrimination
Many of the provisions of these reg-
ulations serve to specify more precisely
than the statute alone exactly what prac-
tices are prohibited by HIPAA as unlawful
discrimination in eligibility or employee
premiums among similarly situated em-
ployees. For example, under the regula-
tions, eligibility generally may not be re-
stricted based on an individual’s partici-
pation in risky activities, confinement to
an institution, or absence from work on
an individual’s enrollment date due to ill-
ness. The regulations provide that vari-
ous plan features including waiting peri-
ods and eligibility for certain benefits con-
stitute rules for eligibility which may not
vary across similarly situated individuals
based on health factors. They also pro-
vide that plans may not reclassify employ-
ees based on health factors in order to cre-
ate separate groups of similarly situated
individuals among which discrimination
would be permitted.
All of these provisions have the effect
of clarifying and ensuring certain partici-
pants’ right to freedom from discrimina-
tion in eligibility and premium amounts,
thereby securing their access to affordable
group health plan coverage. The costs and
benefits attributable to these provisions re-
semble those attendant to HIPAA’s statu-
tory nondiscrimination provisions. Secur-
ing participants’ access to affordable group
coverage provides economic benefits by
reducing the numbers of uninsured and
thereby improving health outcomes. The
regulations entail a shifting of costs from
the employees whose rights are secured
(and/or from other parties who would oth-
erwise pay for their health care) to plan
sponsors (or to other plan participants if
sponsors pass those costs back to them).
The Departments lack any basis on
which to distinguish these benefits and
costs from those of the statute itself. It is
unclear how many plans were engaging
in the discriminatory practices targeted
for prohibition by these regulatory provi-
sions. Because these provisions operate
largely at the margin of the statutory re-
quirements, it is likely that the effects of
these provisions were far smaller than the
similar statutory effects. The Departments
are confident, however, that by securing
employees’ access to affordable coverage
at the margin, the regulations, like the
statute, have yielded benefits that justify
costs.
C
larifyingRequirements
Additional economic benefits derive di-
rectly from the improved clarity provided
by the regulations. The regulation pro-
vides clarity through both its provisions
and its examples of how those provisions
apply in various circumstances. By clari-
fying employees’ rights and plan sponsors’
obligations under HIPAA’s nondiscrimina-
tion provisions, the regulations reduce un-
certainty and costly disputes over these
11
Th
e voluntary nature of the employment-based healthbenefit system in conjunction with the open and dynamic character of labor markets make explicit aswell as implicit negotiations
on co
mpensation a key determinant of the prevalence of employee benefits coverage. It is likely that 80% to100% of the cost of employee benefits is borne by workers through reduced
wag
es (see for example Jonathan Gruber and Alan B. Krueger, “The Incidence of Mandated Employer-Provided Insurance:Lessons from Workers CompensationInsurance,”TaxPolicyand
Eco
nomy(1991); Jonathan Gruber, “The Incidence of Mandated Maternity Benefits,”American Economic Review, Vol. 84 (June 1994), pp. 622-641; Lawrence H. Summers, “Some Simple
Eco
nomics of Mandated Benefits,”American Economic Review, Vol. 79, No. 2 (May 1989); Louise Sheiner, “Health Care Costs, Wages, and Aging,” Federal Reserve Board of Governors
wo
rking paper, April 1999; and Edward Montgomery,Kathryn Shaw, and Mary Ellen Benedict, “Pensions and Wages: An Hedonic Price Theory Approach,”International Economic Review,
Vo
l. 33 No. 1, Feb. 1992.). The prevalence of benefits is therefore largely dependent on the efficacy of this exchange. If workers perceive that there is the potential for inappropriate denial of
be
nefits they will discount their value to adjust forthis risk. This discount drives a wedge in the compensation negotiation, limiting its efficiency.With workers unwilling to bear the full cost
of
the benefit, fewer benefits will be provided. The extent to which workers perceive a federal regulation supported by enforcement authority to improve the security and quality of benefits,
t
he differential between the employers costs and workers willingness top accept wage offsets is minimized.
12
Research shows that while the share of employers offering insurance is generally stable and eligibility rates have only declined slightly over time,the overall increase in uninsured workers is
due to the decline in worker take-up rates, which workers primarily attribute to cost. Research on elasticity of coverage, however, has focused on getting uninsured workers to adopt coverage
(which appears to require large subsidies) rather than covered workers opting out of coverage. This makes it difficult to ascertain the loss in coverage that would result from a marginal
increase in costs. (See, for example, David M. Cutler “Employee Costs and the Decline in Health Insurance Coverage” NBER Working Paper #9036. July 2002; Gruber, Jonathon and Ebonya
Washington. “Subsidies to Employee Health Insurance Premiums and the Health Insurance Market” NBER Working Paper #9567. March 2003; and Cooper, PF and J. Vistnes. “Workers’
Decisions to Take-up Offered Insurance Coverage: Assessing the Importance of Out-of-Pocket Costs” Med Care 2003, 41 (7 Suppl): III35–43.) Finally,economic discussions on elasticity of
insurance tend to view coverage as a discrete concept and does not consider that the value of coverage may have also changed.
13
Departments’ tabulations using the 2005 Kaiser Family Foundation’s Employer Health Benefits AnnualSurvey. Average employee premium is a weightedaverage of premiums for single,
family, and employee-plus-one health plans. The estimate for Employee-Plus-One health premiums was derived using the 2003 MEPS-IC, as was the shareof employees in each type of plans.
Participants are defined as the workers or primary policy holders.
14
Departments’ tabulations off the February 1997 Current Population Survey (CPS), Contingent Worker Supplement. The estimate was projected to reflect current labor market conditions
by assuming the same share of the employed, civilian force would be affected and using the 2004 CPS table, “Employment status of the civilian noninstitutional population, 1940 to date.”
15
The Departments’ estimate is based on the Office of the Actuary at the Centers for Medicare and Medicaid Services (CMS) projected measure of total personal health expenditures by private
health insurance in 2005. This total ($707.0 billion) is then multiplied by the share of privately insured individuals covered by employer-sponsored health insurance in 2004 as estimated by
the 2005 March CPS (88 percent).
2007–6 I.R.B.448February 5, 2007

rights and obligations. Greater clarity pro-
motes employers’ and employees’ com-
mon understanding of the value of group
health plan benefitsand confidence in the
security and predictability of those bene-
fits, thereby improving labor market effi-
ciency and fostering the establishment and
continuation of group health plans by em-
ployers.
I
mpactoftheFinalRules
As noted earlier in this preamble, the
Departments have not modified the 2001
interim rules in any way that would im-
pact the original cost estimates or the mag-
nitude of the statutory transfers. Accord-
ingly, no impact is attributable to these fi-
nal regulations when measured against the
baseline of the interim final rules. The pro-
visions of the 2001 interim rules offer the
appropriate baseline for this measurement
because these rules were generally appli-
cable for plan years beginning on or after
July 1, 2001.
4. Costs and Benefits of the Rules
Applicable to Wellness Programs
By contrast with the nondiscrimination
regulatory provisions issued as interim fi-
nal rules, the provisions relating to well-
ness programs were issued as proposed
rules. This final regulation will not be-
come effective until its applicability date.
Under the final regulation, health plans
generally may vary employee premium
contributions or benefit levels across simi-
larly situated individuals based on a health
factor only in connection with wellness
programs. The final regulation establishes
five requirements for wellness programs
that vary premiums or benefits based on
participation in the program and condition
a reward involving premiums or benefits
on satisfaction of a standard related to a
health factor. These requirements will,
therefore, apply to only a subset of all
wellness programs.
Available literature, together with
comments received by the Departments,
demonstrate that well-designed wellness
programs can deliver benefits well in ex-
cess of their costs. For example, the U.S.
Centers for Disease Control and Preven-
tion estimate that implementing proven
clinical smoking cessation interventions
can save one year of life for each $2,587
invested.
16
In addition to reduced mor-
tality, benefits of effective wellness pro-
grams can include reduced absenteeism,
improved productivity, and reduced med-
ical costs.
17
The requirements of the final
regulation were crafted to accommodate
and not impair such beneficial programs,
while combating discrimination in eligi-
bility and premiums for similarly situated
individuals as intended by Congress.
Estimation of the economic impacts of
the requirements is difficult because data
on affected plans’ current practices are in-
complete, and because plans’ approaches
to compliance with the requirements and
the effects of those approaches will vary
and cannot be predicted. Nonetheless, the
Departments endeavored to consider the
impacts fully and to develop estimates
based on reasonable assumptions.
The Departments estimate that 1.6
percent of large plans and 1.2 percent
of small plans currently vary employee
premium contributions across similarly
situated individuals due to participation in
a wellness program that provides rewards
based on satisfaction of a standard re-
lated to a health factor.
18
This amounts to
30,000 plans covering 1.1 million partici-
pants. According to survey data reported
by Hewitt Associates,
19
just less than
one-half as many plans vary benefit levels
across similarly situated individuals as
vary premiums. This amounts to 13,000
plans covering 460,000 participants. The
Departments considered the effect of each
of the five requirements on these plans.
For purposes of its estimates, the Depart-
ments assumed that one-half of the plans
in the latter group are also included in
the former, thereby estimating that 37,000
plans covering 1.3 million participants
will be subject to the five requirements for
wellness programs.
L
imitonReward
Under the first requirement, any re-
ward, whether applicable to employee
premiums or benefit levels, must not ex-
ceed 20 percent of the total premium
for employee-only coverage under the
plan (with additional provisions related to
rewards that apply also to classes of de-
pendents). This percentage is the highest
of the three alternative percentages sug-
gested in the proposed rule, and the award
limit used for purposes of the analysis of
the proposed rule, which was 15 percent
— the midpoint of the three alternative
percentages suggested in the proposal.
The estimates here also reflect increases in
average annual premiums and the numbers
of plans and participants since publication
of the proposed rules.
The Departments lack representative
data on the magnitude of the rewards
applied by affected plans today. One con-
sultant practicing in this area suggested
that wellness incentive premium discounts
ranged from about 3 percent to 23 percent,
with an average of about 11 percent.
20
This
suggests that most affected plans, includ-
ing some whose discounts are somewhat
larger than average, already comply with
the first requirement and will not need to
reduce the size of the rewards they apply.
It appears likely, however, that perhaps
a few thousand plans covering approxi-
mately one hundred thousand participants
16
Cromwell,J.,W.J.Bartosch,M.C.Fiore,V.HasselbladandT.Baker.“Cost-Effectiveness of the Clinical Practice Recommendations in the AHCPR Guideline for Smoking Cessation.”
J
ournal of the American Medical Association, vol. 278 (December 3, 1997): 1759–66.
17
The benefits of employer wellness programs are well documented. One study found the annual per participant savings to be $613 while private companieshave reported returns of as
much as $4.50 in lowered medical expenses for every dollar spent on health programs. (See for example, Gregg M. Stateet al, “Quantifiable Impact of the Contract for Health Wellness:
Health Behaviors, Health Care Costs, Disability and Workers’ Compensation,”Journal of Occupational and Environmental Medicine(2003), vol. 45 (2): 109–117; Morgan O’Rourke & Laura
Sullivan, “A Health Return on Employee Investment”Risk Management(2003), vol. 50 (11): 34–38; American Association of HealthPlans and Health Insurance Association of America “The
Cost Savings of Disease Management Programs: Report on a Study of Health Plans,” November, 2003; Rachel Christensen, “Employment-Based Health Promotion and Wellness Programs”
EBRI Notes (2001), vol. 22 (7): 1–6; and Steven G. Aldana “Financial Impact of Wellness Programs: A Comprehensive Review of the Literature,”American Journal of Health Promotions
(2001), vol. 15 (5): 296–320.)
18
Estimates are based on a 1993 survey of employers by the Robert Wood Johnson Foundation. More recent estimates are unavailable.
19
Hewitt Associates, July 2003.
20
This estimate was made in 1998, shortly after the 1997 interim final rule was published. Since then, it appears that wellness programs advocates have been advising health plans to offer
premium discounts in the range of 5 to 11 percent, well below the proposed ceiling. For a full discussion, see Larry Chapman’s, “Increasing ParticipationinWellnessPrograms,”National
Wellness Institute Members ‘Ask the Expert,’July/August 2004.
February 5, 20074492007–6 I.R.B.

will need to reduce the size of their re-
wards in order to comply with the first
requirement.
The Departments considered the po-
tential economic effects of requiring
these plans to reduce the size of their
rewards. These effects are likely to in-
clude a shifting of costs between plan
sponsors and participants, as well as new
economic costs and benefits. Shifts in
costs will arise as plans reduce rewards
where necessary. Plan sponsors can exer-
cise substantial control over the size and
direction of these shifts. Limiting the size
of rewards restricts only the differential
treatment between participants who sat-
isfy wellness program standards and those
who do not. It does not, for example,
restrict plans sponsors’ flexibility to de-
termine the overall respective employer
and employee shares of base premiums.
Possible outcomes include a shifting of
costs to plan sponsors from participants
who satisfy wellness program standards,
from plan sponsors to participants who do
not satisfy the standards, from participants
whosatisfythestandardstothosewhodo
not, or some combination of these.
The Departments developed a very
rough estimate of the total amount of costs
that might derive from this requirement.
The Departments’ estimate assumes that
(1) all rewards take the form of employee
premium discounts; (2) discounts are dis-
tributed evenly within both the low-to-av-
erage range and the average-to-high range,
and are distributed across these ranges
such that their mean equals the assumed
average; and (3) 70 percent of participants
qualify for the discount. The 4,000 af-
fected plans could satisfy this requirement
by reducing the premium discount for
the 100,000 participants who successfully
complete a certifiedwellness program.
When applied to the 2005 average annual
employee-only premium of $4,024,
21
dis-
counts range from $115 to $920, with an
average of $460. The maximum allowable
discount based on 20 percent of current
premium is $805. Reducing all discounts
greater than $805 to that amount will re-
sult in an average annual reduction of
about $57. Applying this reduction to the
100,000 participants assumed to be cov-
ered by 4,000 plans affected by the limit
results in an estimate of the aggregate cost
at $6 million.
New economic costs and benefits may
arise if changes in the size of rewards
result in changes in participant behavior.
Net economic welfare might be lost if
some wellness programs’ effectiveness is
eroded, but the magnitude and incidence
of such effects is expected to be negli-
gible. Consider a wellness program that
discounts premiums for participants who
take part in an exercise program. It is plau-
sible that, at the margin, a few participants
who would take part in order to obtain
an existing discount will not take part to
obtain a somewhat lower discount. This
effect is expected to be negligible, how-
ever. Reductions in discounts are likely
to average about $57 annually, which is
very small when spread over biweekly pay
periods. Moreover, the final regulation
limits only rewards applied to similarly
situated individuals in the context of a
group health plan. It does not restrict
plan sponsors from encouraging healthy
lifestyles in other ways, such as by varying
life insurance premiums.
On the other hand, net economic wel-
fare likely will be gained in instances
where large premium differentials would
otherwise have served to discourage en-
rollment in health plans by employees who
did not satisfy wellness program require-
ments.
The Departments believe that the net
economic gains from prohibiting rewards
so large that they could discourage enroll-
ment based on health factors justify any net
losses that might derive from the negligi-
ble reduction of some employees’ incen-
tive to participate in wellness programs.
R
easonableDesign
Under the second requirement, the pro-
gram must be reasonably designed to pro-
mote health or prevent disease. The De-
partments believe that a program that is
not so designed would not provide eco-
nomic benefits, but would serve merely
to shift costs from plan sponsors to tar-
geted individuals based on health factors.
Comments received by the Departments
and available literature on employee well-
ness programs, however, suggest that ex-
isting wellness programs generally satisfy
this requirement. As was stated in the anal-
ysis of the proposed rule, this requirement
therefore is not expected to compel plans
to modify existing wellness programs or
entail additional economic costs.
A
nnualOpportunitytoQualify
Although this requirement was in-
cluded in the proposal within the require-
ment for reasonable design, it has been re-
organized as a separate provision in these
final regulations. At the time of the pro-
posal, the Departments assumed that most
plans satisfied the requirements for rea-
sonable design, such that they would not
be required to modify existing programs.
Accordingly, no cost was attributed to
the reasonable design requirements when
taken together. The Departments did re-
quest comments on this assumption, but
received no additional information in re-
sponse. Accordingly, the Departments
have not attributed a cost to this provision
of the final regulations.
U
niformAvailability
The fourth requirement provides that
where rewards are conditioned on satisfac-
tion of a standard related to a health fac-
tor, rewards must be available to all simi-
larly situated individuals. A reward is not
available to all similarly situated individu-
als unless the program allows for a reason-
able alternative standard if the otherwise
applicable initial standard is unreasonably
difficult to achieve due to a medical con-
dition or medically inadvisable for the in-
dividual to meet. In particular, the pro-
gram must offer any such individual the
opportunity to satisfy a reasonable alter-
native standard. Comments received by
the Departments and available literature on
employee wellness programs suggest that
some wellness programs do not currently
satisfy this requirement and will have to
be modified. The Departments estimate
that among employers that provide incen-
tives for employees to participate in well-
ness programs, nine percent require em-
ployees to achieve a low risk behavior to
qualify for the incentive, 53 percent re-
quire a pledge of compliance, and 55 per-
cent require participation in a program.
22
21
Average based on the Kaiser Family Foundation/Health Research and Education TrustSurvey of Employer-Sponsored Health Benefits, 2005.
22
Hewitt Associates, July, 2003. The sum of these shares exceeds 100 percent due to some employers using multiple criteria to determine compliance.
2007–6 I.R.B.450February 5, 2007

Depending on the nature of the wellness
program, it might be unreasonably difficult
due to a medical condition or medically
inadvisable for at least some plan partici-
pants to achieve the behavior or to comply
with or participate in the program.
The Departments identified three broad
types of economic impact that might arise
from this requirement. First, affected plans
will incur some economic cost to make
available reasonable alternative standards.
Second, additional economic costs and
benefits may arise depending on the na-
ture of alternatives provided, individuals’
use of these alternatives, and any changes
in the affected individuals’ behavioral and
health outcomes. Third, some costs may
be shifted from individuals who would
fail to satisfy programs’ initial standards,
but who will satisfy reasonable alterna-
tive standards once available (and thereby
qualify for associated rewards), to plan
sponsors (or to other participants in their
plans if plan sponsors elect to pass these
costs back to all participants).
The Departments note that some plans
that offer rewards to similarly situated in-
dividuals based on their ability to meet
a standard related to a health factor (and
are therefore subject to the requirement)
may not need to provide alternative stan-
dards. The requirement provides that al-
ternative standards need not be specified
or provided until a participant for whom it
is unreasonably difficult due to a medical
condition or medicallyinadvisable to sat-
isfy the initial standard seeks such an al-
ternative. Some wellness programs’ ini-
tial standards may be such that no par-
ticipant would ever find them unreason-
ably difficult to satisfy due to a medi-
cal condition or medically inadvisable to
attempt. The Departments estimate that
3,000 potentially affected plans have ini-
tial wellness program standards that might
be unreasonably difficult for some partic-
ipants to satisfy due to a medical condi-
tion or medically inadvisable to attempt.
23
Moreover, because alternatives need not
be made available until they are sought by
qualified plan participants, it might be pos-
sible for some plans to go for years with-
out needing to make available an alterna-
tive standard. This could be particularly
likely for small plans.
24
The Departments estimate that as many
as 27 percent of participants in plans with
rewards that are based on meeting a stan-
dard related to a health factor, or 344,000
individuals, might fail to satisfy wellness
programs’ initial standards because they
are unreasonably difficult due to a medi-
cal condition or medically inadvisable to
meet.
25
Of these, only about 30,000 are in
the 3,000 plans assumed to apply standards
that might be unreasonably difficult due to
a medical condition or medically inadvis-
able for some plan participants to satisfy.
The standards would in fact be unreason-
ably difficult or medically inadvisable to
satisfy for some subset of these individu-
als — roughly two-thirds, or 19,000 by the
Departments’ estimate.
26
Of these, it is as-
sumed that between 5,000 and 19,000 of
those individuals that seek alternative stan-
dards are able to satisfy them.
27
The cost associated with establishing
alternative standards is unknown. How-
ever, the regulation does not prescribe a
particular type of alternative standard that
must be provided. Instead, it permits plan
sponsors flexibility to provide any reason-
able alternative, or to waive the standard,
for individuals for whom the initial stan-
dard is unreasonably difficult due to a med-
ical condition or medically inadvisable to
meet. The Departments expect that plan
sponsors will select alternatives that en-
tail the minimum net costs possible. Plan
sponsors may select low-cost alternatives,
such as requiring an individual for whom
it would be unreasonably difficult to quit
smoking (and thereby qualify for a non-
smoker discount) to attend a smoking ces-
sation program that is available at little or
no cost in the community, or to watch ed-
ucational videos or review educational lit-
erature. Plan sponsors presumably will se-
lect higher-cost alternatives only if they
thereby derive offsetting benefits, such as
a higher smoking cessation success rate.
Although there is considerable uncer-
tainty in these estimates, it seems reason-
able to assume that the net cost sponsors
will incur in the provision of alternatives,
including new economic costs and bene-
fits, will not exceed the cost of provid-
ing discounts (or waiving surcharges) for
all plan participants who qualify for alter-
natives, which is estimated at between $2
million and $9 million.
28
Other economic
costs and benefits might arise where alter-
native standards are made available. For
example, some individuals might receive
a discount for satisfying alternative stan-
dards that turn out to be less beneficial
to overall health than the initial standard
23
Estimate is based on both the share of plans in the 2003–04 Hewitt survey stating that certain health factors or lifestyle choices affect employees’ benefit coverage and the share of employers
requiring employees to achieve a lower-risk behavior to earn incentives. These measures are then combined with the number of workers in the civilian labor force (from 2003 estimates of
the Bureau of Labor Statistics (BLS) suffering from these maladies (as provided by the Centers for Disease Control (CDC) 2004Healthand the National Center for Statistics and Analysis
(NCSA) 2004 estimates of seatbelt use), by demographic group.
24
The most common standards that would be implemented by this provision of the wellness program rules pertain to smoking, blood pressure, and cholesterol levels, according to the Hewitt
su
rvey. Based on data from the CDC, NCSA and BLS, the Departments estimate that among plans with five participants, about one-fourth will not contain anysmokers, one-third will not
co
ntain participants with high blood pressure and two-fifths will not contain any with high cholesterol. Approximately 97 percent of all plans with potentially difficult initial wellness program
s
tandards have fewer than 100 participants.
25
This estimate is considerably lower than that offered in the proposal due to a difference in the formatof the data reported in the 2001 and 2003 Hewitt surveys, and the Departments’ original
adjustment for data reported in the 2001 survey as, “not provided.” The Departments believe in light of the 2003 data that the adjustments thought to beappropriate at the time overestimated
the number of plans with standards that might be unreasonably difficult or medically inadvisable to meet, resulting in more instances in which alternative standards might be established and
met, and greater magnitudes of transfers for individuals who would newlyattain rewards. The Departments have revised their assumptions to account for a smaller number of plans with
standards unreasonably difficult or medically inadvisable to meet, and acorrespondingly larger number of participants who will already have been satisfying these standards. Accordingly,
this results in a reduction of the estimates of transfers in connection with establishing reasonable alternative standards.
26
Having previously determined the share of the working class population suffering from various maladies using CDC, NCSA and BLS estimates and how, according to the Hewitt survey,
these conditions are factored into wellness programs, the Departments were able to estimate that 26.8 percent of plan participants may initially fail to satisfy program standards. Since the
Hewitt study went on to state that 9 percent of employers surveyed required participants to meet the standard in order to receive premium discounts, itwas then concluded that 2.3 percent
mayhave difficulty meeting the standards and 1.5 percentwillhave difficulty meeting the standards.
27
No independent estimates of those satisfying alternative standards were available, so the Departments created an upper bound which assumes all individuals for whom the standards are
unreasonably difficult seek and satisfy an alternative standard, and a lower bound which assumes half of those for whom the standards are unreasonably difficult seek an alternative, and half
of those are able to satisfy it.
28
These estimates are the product of the range of numbers of individuals who might newly attain rewards and the average premium reward. It is likely that many plan sponsors will find more
cost effective ways to satisfy this requirement, and that the true net cost to them will therefore be smaller than this.
February 5, 20074512007–6 I.R.B.

might have been, resulting in a net loss of
economic welfare. In other cases, the sat-
isfaction of an alternative standard might
produce the desired health improvement,
which would represent a net gain in eco-
nomic welfare.
Although outcomes are uncertain, the
Departments note that plan sponsors have
strong motivation to identify and provide
alternative standards that have positive net
economic effects. They will be disinclined
to provide alternatives that worsen behav-
ioral and health outcomes, or that make
financial rewards available absent mean-
ingful efforts by participants to improve
their health habits and health. Instead they
will be inclined to provide alternatives
that sustain or reinforce plan participants’
incentive to improve their health habits
and health, and/or that help participants
make such improvements. It therefore
seems likely that gains in economic wel-
fare from this requirement will equal or
justify losses. The Departments anticipate
that the requirement to provide reasonable
alternative standards will reduce instances
where wellness programs serve only to
shift costs to higher risk individuals and
increase instances where programs suc-
ceed at helping individuals with higher
health risks improve their health habits
and health.
D
isclosureRegardingReasonable
AlternativeStandards
The fifth requirement provides that
plan materials describing wellness pro-
gram standards that are related to a health
factor must disclose the availability of
reasonable alternative standards. Under
some wellness programs, an individual
must satisfy a standard related to a health
factor in order to qualify for the reward.
Plans offering wellness programs under
which an individual must satisfy a standard
related to a health factor in order to qual-
ify for the reward must disclose in all plan
materials describing the terms of the pro-
gram the availability of a reasonable alter-
native standard. The regulations provide
sample language for this disclosure. An
actual description of the alternative stan-
dard is not required in such materials. In
plan materials that merely mention that a
wellness program is available but do not
describe its terms, this disclosure of the
availability of an alternative standard is not
required. The Departments generally ac-
count elsewhere for plans’ cost of updating
such materials to reflect changes in plan
provisions as required under various dis-
closure requirements and as is part of usual
business practice. Thisparticular require-
ment is expected to represent a negligible
fraction of the ongoing cost of updating
plans’ materials, and is not separately ac-
counted for here.
Statutory Authority
The Department of the Treasury final
rule is adopted pursuant to the authority
contained in sections 7805 and 9833 of the
Code (26 U.S.C. 7805, 9833).
The Department of Labor final rule
is adopted pursuant to the authority con-
tained in sections 29 U.S.C. 1027, 1059,
1135, 1161–1168, 1169, 1181–1183, 1181
note, 1185, 1185a, 1185b, 1191, 1191a,
1191b, and 1191c, sec. 101(g), Pub-
lic Law 104–191, 110 Stat. 1936; sec.
401(b), Public Law 105–200, 112 Stat.
645 (42 U.S.C. 651 note); Secretary of
Labor’s Order 1–2003, 68 FR 5374 (Feb.
3, 2003).
The Department of Health and Human
Services final rule is adopted pursuant
to the authority contained in sections
2701 through 2763, 2791, and 2792 of
the PHS Act (42 U.S.C. 300gg through
300gg–63, 300gg–91, and 300gg–92), as
added by HIPAA (Public Law 104–191,
110 Stat. 1936), and amended by the
Mental Health Parity Act (MHPA) and the
Newborns’ and Mothers’ Health Protec-
tion Act (NMHPA) (Public Law 104–204,
110 Stat. 2935), and the Women’s Health
and Cancer Rights Act (WHCRA) (Public
Law 105–277, 112 Stat. 2681–436).
*****
Adoption of Amendments to the
Regulations
Internal Revenue Service
26 CFR Chapter I
Accordingly, 26 CFR Part 54 is
amended as follows:
PART 54 — PENSION EXCISE TAXES
Paragraph 1. The authority citation for
part 54 is amended by removing the cita-
tion for §54.9802–1T to read, in part, as
follows:
Authority: 26 U.S.C. 7805. * * *
§54.9802–1T [Removed]
Par. 2. Section 54.9802–1T is removed.
Par. 3. Section 54.9802–1 is revised to
read as follows:
§54.9802–1 Prohibiting discrimination
against participants and beneficiaries
based on a health factor.
(a)Health factors.(1)Thetermhealth
factormeans, in relation to an individual,
any of the following health status-related
factors:
(i) Health status;
(ii) Medical condition (including both
physical and mental illnesses), as defined
in §54.9801–2;
(iii) Claims experience;
(iv) Receipt of health care;
(v) Medical history;
(vi) Genetic information, as defined in
§54.9801–2 of this chapter;
(vii) Evidence of insurability; or
(viii) Disability.
(2) Evidence of insurability includes —
(i) Conditions arising out of acts of do-
mestic violence; and
(ii) Participation in activities such as
motorcycling, snowmobiling, all-terrain
vehicle riding, horseback riding, skiing,
and other similar activities.
(3) The decision whether health cover-
age is elected for an individual (including
the time chosen to enroll, such as under
special enrollment or late enrollment) is
not, itself, within the scope of any health
factor. (However, under §54.9801–6, a
plan must treat special enrollees the same
as similarly situated individuals who are
enrolled when first eligible.)
(b)Prohibited discrimination in rules
for eligibility—(1)In general.(i)Agroup
health plan may not establish any rule for
eligibility (including continued eligibility)
of any individual to enroll for benefits un-
der the terms of the plan that discriminates
based on any health factor that relates to
that individual or a dependent of that in-
dividual. This rule is subject to the pro-
visions of paragraph (b)(2) of this section
(explaining how this rule applies to bene-
fits), paragraph (b)(3) of this section (al-
lowing plans to impose certain preexist-
ing condition exclusions), paragraph (d) of
this section (containing rules for establish-
ing groups of similarly situated individu-
als), paragraph (e) of this section (relating
2007–6 I.R.B.452February 5, 2007

to nonconfinement, actively-at-work, and
other service requirements), paragraph (f)
of this section (relating to wellness pro-
grams), and paragraph (g) of this section
(permitting favorable treatment of individ-
uals with adverse health factors).
(ii) For purposes of this section, rules
for eligibility include, but are not limited
to, rules relating to —
(A) Enrollment;
(B) The effective date of coverage;
(C) Waiting (or affiliation) periods;
(D) Late and special enrollment;
(E) Eligibility for benefit packages (in-
cluding rules for individuals to change
their selection among benefit packages);
(F) Benefits (including rules relating to
covered benefits, benefit restrictions, and
cost-sharing mechanisms such as coinsur-
ance, copayments, and deductibles), as de-
scribed in paragraphs (b)(2) and (3) of this
section;
(G) Continued eligibility; and
(H) Terminating coverage (including
disenrollment) of any individual under the
plan.
(iii) The rules of this paragraph (b)(1)
are illustrated by the following examples:
Example 1.(i)Facts. An employer sponsors a
group health plan that is available to all employees
who enroll within the first 30 days of their employ-
ment. However, employees who do not enroll within
the first 30 days cannot enroll later unless they pass a
physical examination.
(ii)Conclusion. In thisExample 1, the require-
ment to pass a physical examination in order to enroll
in the plan is a rule for eligibility that discriminates
based on one or more health factors and thus violates
this paragraph (b)(1).
Example 2.(i)Facts. Under an employer’s group
health plan, employees who enroll during the first 30
days of employment (and during special enrollment
periods) may choose between two benefit packages:
an indemnity option and an HMO option. However,
employees who enroll during late enrollment are per-
mitted to enroll only in the HMO option and only if
they provide evidence of good health.
(ii)Conclusion. In thisExample 2, the require-
ment to provide evidence of good health in order to
be eligible for late enrollment in the HMO option is a
rule for eligibility that discriminates based on one or
more health factors and thus violates this paragraph
(b)(1). However, if the plan did not require evidence
of good health but limited late enrollees to the HMO
option, the plan’s rules for eligibility would not dis-
criminate based on any health factor, and thus would
not violate this paragraph (b)(1), because the time an
individual chooses to enroll is not, itself, within the
scope of any health factor.
Example 3.(i)Facts. Under an employer’s group
health plan, all employees generally may enroll
within the first 30 days of employment. However,
individuals who participate in certain recreational
activities, including motorcycling, are excluded from
coverage.
(ii)Conclusion. In thisExample 3, excluding
from the plan individuals who participate in recre-
ational activities, such as motorcycling, is a rule
for eligibility that discriminates based on one more
health factors and thus violates this paragraph (b)(1).
Example 4.(i)Facts. A group health plan applies
for a group health policy offered by an issuer. As part
of the application, the issuer receives health informa-
tion about individuals to be covered under the plan.
IndividualAis an employee of the employer main-
taining the plan.AandA’s dependents have a history
of high health claims. Based on the information about
AandA’s dependents, the issuer excludesAandA’s
dependents from the group policy it offers to the em-
ployer.
(ii)Conclusion.SeeExample 4in 29 CFR
2590.702(b)(1) and 45 CFR 146.121(b)(1) for a con-
clusionthattheexclusionbytheissuerofAandA’s
dependents from coverage is a rule for eligibility that
discriminates based on one or more health factors
and violates rules under 29 CFR 2590.702(b)(1) and
45 CFR 146.121(b)(1) similar to the rules under
this paragraph (b)(1). (If the employer is a small
employer under 45 CFR 144.103 (generally, an em-
ployer with 50 or fewer employees), the issuer also
may violate 45 CFR 146.150, which requires issuers
to offer all the policies they sell in the small group
market on a guaranteed available basis to all small
employers and to accept every eligible individual in
every small employer group.) If the plan provides
coverage through this policy and does not pro-
vide equivalent coverage forAand
A’s dependents
through other means, the plan violates this paragraph
(b)(1).
(2)Application to benefits—(i)Gen-
eral rule. (A) Under this section, a group
health plan is not required to provide cov-
erage for any particular benefit to any
group of similarly situated individuals.
(B) However, benefits provided under
a plan must be uniformly available to all
similarly situated individuals (as described
in paragraph (d) of this section). Likewise,
any restriction on a benefit or benefits must
apply uniformly to all similarly situated in-
dividuals and must not be directed at indi-
vidual participants or beneficiaries based
on any health factor ofthe participants or
beneficiaries (determined based on all the
relevant facts and circumstances). Thus,
for example, a plan may limit or exclude
benefits in relation to a specific disease or
condition, limit or exclude benefits for cer-
tain types of treatments or drugs, or limit
or exclude benefits based on a determina-
tion of whether the benefits are experimen-
tal or not medically necessary, but only
if the benefit limitation or exclusion ap-
plies uniformly to all similarly situated in-
dividuals and is not directed at individual
participants or beneficiaries based on any
health factor of the participants or bene-
ficiaries. In addition, a plan may impose
annual, lifetime, or other limits on ben-
efits and may require the satisfaction of
a deductible, copayment, coinsurance, or
other cost-sharing requirement in order to
obtain a benefit if the limit or cost-shar-
ing requirement applies uniformly to all
similarly situated individuals and is not di-
rected at individual participants or bene-
ficiaries based on any health factor of the
participants or beneficiaries. In the case of
a cost-sharing requirement, see also para-
graph (b)(2)(ii) of this section, which per-
mits variances in the application of a cost-
sharing mechanism made available under a
wellness program. (Whether any plan pro-
vision or practice with respect to benefits
complies with this paragraph (b)(2)(i) does
not affect whether the provision or prac-
tice is permitted under ERISA, the Amer-
icans with Disabilities Act, or any other
law, whether State or Federal.)
(C) For purposes of this paragraph
(b)(2)(i), a plan amendment applicable to
all individuals in one or more groups of
similarly situated individuals under the
plan and made effective no earlier than
the first day of the first plan year after the
amendment is adopted is not considered to
be directed at any individual participants
or beneficiaries.
(D) The rules of this paragraph (b)(2)(i)
are illustrated by the following examples:
Example 1.(i)Facts. A group health plan applies
a $500,000 lifetime limit on all benefits to each par-
ticipant or beneficiary covered under the plan. The
limit is not directed at individual participants or ben-
eficiaries.
(ii)Conclusion.InthisExample 1, the limit does
not violate this paragraph (b)(2)(i) because $500,000
of benefits are available uniformly to each participant
and beneficiary under the plan and because the limit
is applied uniformly to all participants and beneficia-
ries and is not directed at individual participants or
beneficiaries.
Example 2.(i)Facts. A group health plan has a $2
million lifetime limit on all benefits (and no other life-
time limits) for participants covered under the plan.
ParticipantBfiles a claim for the treatment of AIDS.
At the next corporate board meeting of the plan spon-
sor, the claim is discussed. Shortly thereafter, the plan
is modified to impose a $10,000 lifetime limit on ben-
efits for the treatment of AIDS, effective before the
beginning of the next plan year.
(ii)Conclusion. The facts of thisExample 2
strongly suggest that the plan modification is di-
rected atBbased onB’s claim. Absent outweighing
evidence to the contrary, the plan violates this para-
graph (b)(2)(i).
Example 3. (i) A group health plan applies for
a group health policy offered by an issuer. Individ-
ualCis covered under the plan and has an adverse
health condition. As part of the application, the issuer
February 5, 20074532007–6 I.R.B.

receives health information about the individuals to
be covered, including information aboutC’s adverse
health condition. The policy form offered by the is-
suer generally provides benefits for the adverse health
condition thatChas, but in this case the issuer offers
the plan a policy modified by a rider that excludes
benefits forCfor that condition. The exclusionary
rider is made effective the first day of the next plan
year.
(ii)Conclusion.SeeExample 3in 29 CFR
2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i) for
a conclusion that the issuer violates rules under 29
CFR 2590.702(b)(2)(i) and 45 CFR 146.121(b)(2)(i)
similar to the rules under this paragraph (b)(2)(i)
because benefits forC’s condition are available to
other individuals in the group of similarly situated
individuals that includesCbut are not available to
C. Thus, the benefits are not uniformly available to
all similarly situated individuals. Even though the
exclusionary rider is made effective the first day of
the next plan year, because the rider does not apply to
all similarly situated individuals, the issuer violates
the rules under 29 CFR 2590.702(b)(2)(i) and 45
CFR 146.121(b)(2)(i). If the plan provides coverage
through this policy and does not provide equivalent
coverage forCthrough other means, the plan violates
this paragraph (b)(2)(i).
Example 4.(i)Facts. A group health plan has
a $2,000 lifetime limit for the treatment of temporo-
mandibular joint syndrome (TMJ). The limit is ap-
plied uniformly to all similarly situated individuals
and is not directed at individual participants or bene-
ficiaries.
(ii)Conclusion.InthisExample 4, the limit does
not violate this paragraph (b)(2)(i) because $2,000 of
benefits for the treatment of TMJ are available uni-
formly to all similarly situated individuals and a plan
may limit benefits covered in relation to a specific
disease or condition if the limit applies uniformly to
all similarly situated individuals and is not directed
at individual participants or beneficiaries. (This ex-
ample does not address whether the plan provision
is permissible under the Americans with Disabilities
Act or any other applicable law.)
Example 5.(i)Facts. A group health plan applies
a $2 million lifetime limit on all benefits. However,
the $2 million lifetime limit is reduced to $10,000 for
any participant or beneficiary covered under the plan
who has a congenital heart defect.
(ii)Conclusion. In thisExample 5,thelower
lifetime limit for participants and beneficiaries with
a congenital heart defect violates this paragraph
(b)(2)(i) because benefits under the plan are not uni-
formly available to all similarly situated individuals
and the plan’s lifetime limit on benefits does not
apply uniformly to all similarly situated individuals.
Example 6.(i)Facts. A group health plan lim-
its benefits for prescription drugs to those listed on a
drug formulary. The limit is applied uniformly to all
similarly situated individuals and is not directed at in-
dividual participants or beneficiaries.
(ii)Conclusion.InthisExample 6, the exclusion
from coverage of drugs not listed on the drug formu-
lary does not violate this paragraph (b)(2)(i) because
benefits for prescription drugs listed on the formulary
are uniformly available to all similarly situated indi-
viduals and because the exclusion of drugs not listed
on the formulary applies uniformly to all similarly sit-
uated individuals and is not directed at individual par-
ticipants or beneficiaries.
Example 7.(i)Facts. Under a group health plan,
doctor visits are generally subject to a $250 annual
deductible and 20 percent coinsurance requirement.
However, prenatal doctor visits are not subject to any
deductible or coinsurance requirement. These rules
are applied uniformly to all similarly situated indi-
viduals and are not directed at individual participants
or beneficiaries.
(ii)Conclusion.InthisExample 7, imposing dif-
ferent deductible and coinsurance requirements for
prenatal doctor visits and other visits does not violate
this paragraph (b)(2)(i) because a plan may establish
different deductibles or coinsurance requirements for
different services if the deductible or coinsurance re-
quirement is applied uniformly to all similarly situ-
ated individuals and is not directed at individual par-
ticipants or beneficiaries.
Example 8.(i)Facts. An employer sponsors a
group health plan that is available to all current em-
ployees. Under the plan, the medical care expenses of
each employee (and the employee’s dependents) are
reimbursed up to an annual maximum amount. The
maximum reimbursement amount with respect to an
employee for a year is $1500 multiplied by the num-
ber of years the employee has participated in the plan,
reduced by the total reimbursements for prior years.
(ii)Conclusion.InthisExample 8,thevariable
annual limit does not violate this paragraph (b)(2)(i).
Although the maximum reimbursement amount for a
year varies among employees within the same group
of similarly situated individuals based on prior claims
experience, employees who have participated in the
plan for the same length of time are eligible for the
same total benefit over that length of time (and the
restriction on the maximum reimbursement amount
is not directed at any individual participants or bene-
ficiaries based on any health factor).
(ii)Exception for wellness programs.A
group health plan may vary benefits, in-
cluding cost-sharing mechanisms (such as
a deductible, copayment, or coinsurance),
based on whether an individual has met the
standards of a wellness program that sat-
isfies the requirements of paragraph (f) of
this section.
(iii)Specific rule relating to source-of-
injury exclusions. (A) If a group health
plan generally provides benefits for a type
of injury, the plan may not deny benefits
otherwise provided for treatment of the in-
jury if the injury results from an act of do-
mestic violence or a medical condition (in-
cluding both physical and mental health
conditions). This rule applies in the case of
an injury resulting from a medical condi-
tion even if the condition is not diagnosed
before the injury.
(B) The rules of this paragraph
(b)(2)(iii) are illustrated by the follow-
ing examples:
Example 1.(i)Facts. A group health plan gen-
erally provides medical/surgical benefits, including
benefits for hospital stays, that are medically neces-
sary. However, the plan excludes benefits for self-
inflicted injuries or injuries sustained in connection
with attempted suicide. Because of depression, Indi-
vidualDattempts suicide. As a result,Dsustains in-
juries and is hospitalized for treatment of the injuries.
Under the exclusion, the plan deniesDbenefits for
treatment of the injuries.
(ii)Conclusion.InthisExample 1, the suicide
attempt is the result of a medical condition (depres-
sion). Accordingly, the denial of benefits for the treat-
ments ofD’s injuries violates the requirements of this
paragraph (b)(2)(iii) because the plan provision ex-
cludes benefits for treatment of an injury resulting
from a medical condition.
Example 2.(i)Facts. A group health plan pro-
vides benefits for head injuries generally. The plan
also has a general exclusion for any injury sustained
while participating in any of a number of recreational
activities, including bungee jumping. However, this
exclusion does not apply to any injury that results
from a medical condition (nor from domestic vio-
lence). ParticipantEsustains a head injury while
bungee jumping. The injury did not result from a
medical condition (nor from domestic violence). Ac-
cordingly, the plan denies benefits forE’s head injury.
(ii)Conclusion. In thisExample 2, the plan pro-
vision that denies benefits based on the source of an
injury does not restrict benefits based on an act of
domestic violence or any medical condition. There-
fore, the provision is permissible under this paragraph
(b)(2)(iii) and does not violate this section. (How-
ever, if the plan did not allowEto enroll in the plan
(or applied different rules for eligibility toE) because
Efrequently participates in bungee jumping, the plan
would violate paragraph (b)(1) of this section.)
(3)Relationship to §54.9801–3.(i)A
preexisting condition exclusion is permit-
ted under this section if it —
(A) Complies with §54.9801–3;
(B) Applies uniformly to all similarly
situated individuals (as described in para-
graph (d) of this section); and
(C) Is not directed at individual par-
ticipants or beneficiaries based on any
health factor of the participants or bene-
ficiaries. For purposes of this paragraph
(b)(3)(i)(C), a plan amendment relating to
a preexisting condition exclusion applica-
ble to all individuals in one or more groups
of similarly situated individuals under the
plan and made effective no earlier than
the first day of the first plan year after the
amendment is adopted is not considered to
be directed at any individual participants
or beneficiaries.
(ii) The rules of this paragraph (b)(3)
are illustrated by the following examples:
Example 1.(i)Facts. A group health plan im-
poses a preexisting condition exclusion on all indi-
viduals enrolled in the plan. The exclusion applies to
conditions for which medical advice, diagnosis, care,
or treatment was recommended or received within the
six-month period ending on an individual’s enroll-
ment date. In addition, the exclusion generally ex-
tends for 12 months after anindividual’s enrollment
2007–6 I.R.B.454February 5, 2007

date, but this 12-month period is offset by the num-
ber of days of an individual’s creditable coverage in
accordance with §54.9801–3. There is nothing to in-
dicate that the exclusion is directed at individual par-
ticipants or beneficiaries.
(ii)Conclusion. In thisExample 1, even though
the plan’s preexisting condition exclusion discrimi-
nates against individualsbased on one or more health
factors, the preexisting condition exclusion does not
violate this section because it applies uniformly to all
similarly situated individuals, is not directed at in-
dividual participants or beneficiaries, and complies
with §54.9801–3 (that is, the requirements relating
to the six-month look-back period, the 12-month (or
18-month) maximum exclusion period, and the cred-
itable coverage offset).
Example 2.(i)Facts. A group health plan ex-
cludes coverage for conditions with respect to which
medical advice, diagnosis, care, or treatment was rec-
ommended or received within the six-month period
ending on an individual’s enrollment date. Under
the plan, the preexisting condition exclusion gener-
ally extends for 12 months, offset by creditable cov-
erage. However, if an individual has no claims in the
first six months following enrollment, the remainder
of the exclusion period is waived.
(ii)Conclusion. In thisExample 2, the plan’s
preexisting condition exclusions violate this section
because they do not meet the requirements of this
paragraph (b)(3); specifically, they do not apply uni-
formly to all similarly situated individuals. The plan
provisions do not apply uniformly to all similarly sit-
uated individuals because individuals who have med-
ical claims during the first six months following en-
rollment are not treated the same as similarly situated
individuals with no claims during that period. (Un-
der paragraph (d) of this section, the groups cannot
be treated as two separate groups of similarly situ-
ated individuals because the distinction is based on a
health factor.)
(c)Prohibited discrimination in premi-
ums or contributions—(1)In general.
(i) A group health plan may not require
an individual, as a condition of enroll-
ment or continued enrollment under the
plan, to pay a premium or contribution that
is greater than the premium or contribu-
tion for a similarly situated individual (de-
scribed in paragraph (d) of this section) en-
rolled in the plan based on any health fac-
tor that relates to the individual or a depen-
dent of the individual.
(ii) Discounts, rebates, payments in
kind, and any other premium differen-
tial mechanisms are taken into account in
determining an individual’s premium or
contribution rate. (For rules relating to
cost-sharing mechanisms, see paragraph
(b)(2) of this section (addressing bene-
fits).)
(2)Rules relating to premium rates—
(i)Group rating based on health factors
not restricted under this section.Noth-
ing in this section restricts the aggregate
amount that an employer may be charged
for coverage under a group health plan.
(ii)Listbillingbasedonahealthfactor
prohibited. However, a group health plan
may not quote or charge an employer (or
an individual) a different premium for an
individual in a group of similarly situated
individuals based on a health factor. (But
see paragraph (g) of this section permitting
favorable treatment of individuals with ad-
verse health factors.)
(iii)Examples. The rules of this para-
graph (c)(2) are illustrated by the follow-
ing examples:
Example 1.(i)Facts. An employer sponsors
a group health plan and purchases coverage from a
health insurance issuer. In order to determine the pre-
mium rate for the upcoming plan year, the issuer re-
views the claims experience of individuals covered
under the plan. The issuer finds that IndividualFhad
significantly higher claims experience than similarly
situated individuals in the plan. The issuer quotes
the plan a higher per-participant rate because ofF’s
claims experience.
(ii)Conclusion.SeeExample 1in 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) for a con-
clusion that the issuer does not violate the provisions
of 29 CFR 2590.702(c)(2) and 45 CFR 146.121(c)(2)
similar to the provisions of this paragraph (c)(2) be-
cause the issuer blends the rate so that the employer
is not quoted a higher rate forFthan for a similarly
situated individual based onF’s claims experience.
Example 2.(i)Facts. Same facts asExample 1,
except that the issuer quotes the employer a higher
premium rate forF, because ofF’s claims experience,
than for a similarly situated individual.
(ii)Conclusion.SeeExample 2in 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) for a con-
clusion that the issuer violates provisions of 29 CFR
2590.702(c)(2) and 45 CFR 146.121(c)(2) similar to
the provisions of this paragraph (c)(2). Moreover,
even if the plan purchased the policy based on the
quote but did not require a higher participant contri-
bution forFthan for a similarly situated individual,
seeExample 2in 29 CFR 2590.702(c)(2) and 45
CFR 146.121(c)(2) for a conclusion that the issuer
would still violate 29 CFR 2590.702(c)(2) and 45
CFR 146.121(c)(2) (but in such a case the plan would
not violate this paragraph (c)(2)).
(3)Exception for wellness programs.
Notwithstanding paragraphs (c)(1) and (2)
of this section, a plan may vary the amount
of premium or contribution it requires sim-
ilarly situated individuals to pay based on
whether an individual has met the stan-
dards of a wellness program that satisfies
the requirements of paragraph (f) of this
section.
(d)Similarly situated individuals.The
requirements of this section apply only
within a group of individuals who are
treated as similarly situated individuals.
A plan may treat participants as a group
of similarly situated individuals separate
from beneficiaries. In addition, partic-
ipants may be treated as two or more
distinct groups of similarly situated indi-
viduals and beneficiaries may be treated
as two or more distinct groups of similarly
situated individuals in accordance with the
rules of this paragraph (d). Moreover, if
individuals have a choice of two or more
benefit packages, individuals choosing
one benefit package may be treated as one
or more groups of similarly situated indi-
viduals distinct from individuals choosing
another benefit package.
(1)Participants. Subject to paragraph
(d)(3) of this section, a plan may treat
participants as two or more distinct groups
of similarly situated individuals if the
distinction between or among the groups
of participants is based on abona fide
employment-based classification consis-
tent with the employer’s usual business
practice. Whether an employment-based
classification isbona fideis determined
on the basis of all the relevant facts and
circumstances. Relevant facts and circum-
stances include whether the employer uses
the classification for purposes independent
of qualification for health coverage (for
example, determining eligibility for other
employee benefits or determining other
terms of employment). Subject to para-
graph (d)(3) of this section, examples of
classifications that, based on all the rele-
vant facts and circumstances, may bebona
fideinclude full-time versus part-time sta-
tus, different geographic location, mem-
bership in a collective bargaining unit,
date of hire, length of service, current em-
ployee versus former employee status, and
different occupations. However, a classi-
fication based on any health factor is not
abona fideemployment-based classifica-
tion, unless the requirements of paragraph
(g) of this section are satisfied (permitting
favorable treatment of individuals with
adverse health factors).
(2)Beneficiaries. (i) Subject to para-
graph (d)(3) of this section, a plan may
treat beneficiaries as two or more distinct
groups of similarly situated individuals
if the distinction between or among the
groups of beneficiaries is based on any of
the following factors:
(A) Abona fideemployment-based
classification of the participant through
whom the beneficiary is receiving cover-
age;
February 5, 20074552007–6 I.R.B.

(B) Relationship to the participant (for
example, as a spouse or as a dependent
child);
(C) Marital status;
(D) With respect to children of a partic-
ipant, age or student status; or
(E) Any other factor if the factor is not
a health factor.
(ii) Paragraph (d)(2)(i) of this section
does not prevent more favorable treatment
of individuals with adverse health factors
in accordance with paragraph (g) of this
section.
(3)Discrimination directed at individ-
uals. Notwithstanding paragraphs (d)(1)
and (2) of this section, if the creation or
modification of an employment or cover-
age classification is directed at individual
participants or beneficiaries based on any
health factor of the participants or benefi-
ciaries, the classification is not permitted
under this paragraph (d), unless it is per-
mitted under paragraph (g) of this section
(permitting favorable treatment of individ-
uals with adverse health factors). Thus,
if an employer modified an employment-
basedclassificationtosingleout,basedon
a health factor, individual participants and
beneficiaries and deny them health cover-
age, the new classification would not be
permitted under this section.
(4)Examples. Therulesofthispara-
graph (d) are illustrated by the following
examples:
Example 1.(i)Facts. An employer sponsors a
group health plan for full-time employees only. Un-
der the plan (consistent with the employer’s usual
business practice), employees who normally work at
least 30 hours per week areconsideredto be work-
ing full-time. Other employees are considered to be
workingpart-time. Thereisnoevidencetosuggest
that the classification is directed at individual partic-
ipants or beneficiaries.
(ii)Conclusion. In thisExample 1, treating the
full-time and part-time employees as two separate
groups of similarly situated individuals is permitted
under this paragraph (d) because the classification is
bona fideand is not directed at individual participants
or beneficiaries.
Example 2.(i)Facts. Under a group health
plan, coverage is made available to employees, their
spouses, and their dependent children. However,
coverage is made available to a dependent child only
if the dependent child is under age 19 (or under age
25 if the child is continuously enrolled full-time in
an institution of higher learning (full-time students)).
There is no evidence to suggest that these classi-
fications are directed at individual participants or
beneficiaries.
(ii)Conclusion. In thisExample 2, treating
spouses and dependent children differently by im-
posing an age limitation on dependent children, but
not on spouses, is permitted under this paragraph
(d). Specifically, the distinction between spouses
and dependent children is permitted under paragraph
(d)(2) of this section and is not prohibited under
paragraph (d)(3) of this section because it is not
directed at individual participants or beneficiaries. It
is also permissible to treat dependent children who
are under age 19 (or full-time students under age 25)
as a group of similarly situated individuals separate
from those who are age 25 or older (or age 19 or
older if they are not full-time students) because the
classification is permitted under paragraph (d)(2) of
this section and is not directed at individual partici-
pants or beneficiaries.
Example 3.(i)Facts. A university sponsors a
group health plan that provides one health benefit
package to faculty and another health benefit pack-
age to other staff. Faculty and staff are treated differ-
ently with respect to other employee benefits such as
retirement benefits and leaves of absence. There is
no evidence to suggest that the distinction is directed
at individual participants or beneficiaries.
(ii)Conclusion.InthisExample 3,theclas-
sification is permitted under this paragraph (d)
because there is a distinction based on abona fide
employment-based classification consistent with the
employer’s usual business practice and the distinc-
tion is not directed at individual participants and
beneficiaries.
Example 4.(i)Facts. An employer sponsors a
group health plan that is available to all current em-
ployees. Former employees may also be eligible, but
only if they complete a specified number of years of
service, are enrolled under the plan at the time of ter-
mination of employment, and are continuously en-
rolled from that date. There is no evidence to suggest
that these distinctions are directed at individual par-
ticipants or beneficiaries.
(ii)Conclusion.InthisExample 4,imposing
additional eligibility requirements on former em-
ployees is permitted because a classification that
distinguishes between current and former employees
is abona fideemployment-based classification that
is permitted under this paragraph (d), provided that
it is not directed at individual participants or bene-
ficiaries. In addition, it is permissible to distinguish
between former employees who satisfy the service
requirement and those who do not, provided that the
distinction is not directed at individual participants
or beneficiaries. (However, former employees who
do not satisfy the eligibility criteria may, nonethe-
less, be eligible for continued coverage pursuant to a
COBRA continuation provision or similar State law.)
Example 5.(i)Facts
. An employer sponsors a
group health plan that provides the same benefit pack-
age to all seven employees of the employer. Six of the
seven employees have the same job title and respon-
sibilities, but EmployeeGhas a different job title and
different responsibilities. AfterGfiles an expensive
claim for benefits under the plan, coverage under the
plan is modified so that employees withG’s job ti-
tle receive a different benefit package that includes a
lower lifetime dollar limit than in the benefit package
made available to the other six employees.
(ii)Conclusion. Under the facts of thisExample
5, changing the coverage classification forGbased
on the existing employment classification forGis not
permitted under this paragraph (d) because the cre-
ation of the new coverage classification forGis di-
rected atGbased on one or more health factors.
(e)Nonconfinement and actively-at-
work provisions—(1)Nonconfinement
provisions—(i)General rule. Under
the rules of paragraphs (b) and (c) of this
section, a plan may not establish a rule
for eligibility (as described in paragraph
(b)(1)(ii) of this section) or set any individ-
ual’s premium or contribution rate based
on whether an individual is confined to a
hospital or other health care institution.
In addition, under the rules of paragraphs
(b)and(c)ofthissection,aplanmay
not establish a rule for eligibility or set
any individual’s premium or contribution
rate based on an individual’s ability to
engage in normal life activities, except
to the extent permitted under paragraphs
(e)(2)(ii) and (3) of this section (permit-
ting plans, under certain circumstances,
to distinguish among employees based on
the performance of services).
(ii)Examples. The rules of this para-
graph (e)(1) are illustrated by the follow-
ing examples:
Example 1.(i)Facts. Under a group health plan,
coverage for employees and their dependents gener-
ally becomes effective on the first day of employ-
ment. However, coverage for a dependent who is
confined to a hospital or other health care institution
does not become effective until the confinement ends.
(ii)Conclusion.InthisExample 1, the plan vi-
olates this paragraph (e)(1) because the plan delays
the effective date of coverage for dependents based
on confinement to a hospital or other health care in-
stitution.
Example 2.(i)Facts. In previous years, a group
health plan has provided coverage through a group
health insurance policy offered by IssuerM. How-
ever, for the current year, the plan provides coverage
through a group health insurance policy offered by
IssuerN. Under IssuerN’s policy, items and services
provided in connection with the confinement of a de-
pendent to a hospital or other health care institution
are not covered if the confinement is covered under
an extension of benefits clause from a previous health
insurance issuer.
(ii)Conclusion.SeeExample 2in 29 CFR
2590.702(e)(1) and 45 CFR 146.121(e)(1) for a con-
clusion that IssuerNviolates provisions of 29 CFR
2590.702(e)(1) and 45 CFR 146.121(e)(1) similar to
the provisions of this paragraph (e)(1) because the
group health insurance coverage restricts benefits
based on whether a dependent is confined to a hos-
pital or other health care institution that is covered
under an extension of benefits from a previous issuer.
SeeExample 2in 29 CFR 2590.702(e)(1) and 45
CFR 146.121(e)(1) for the additional conclusions
that under State law IssuerMmay also be responsible
for providing benefits to such a dependent; and that
inacaseinwhichIssuerNhas an obligation under
29 CFR 2590.702(e)(1) or 45 CFR 146.121(e)(1)
to provide benefits and IssuerMhas an obligation
under State law to provide benefits, any State laws
designed to prevent more than 100% reimbursement,
2007–6 I.R.B.456February 5, 2007

such as State coordination-of-benefits laws, continue
to apply.
(2)Actively-at-work and continuous
service provisions—(i)General rule.(A)
Under the rules of paragraphs (b) and (c)
of this section and subject to the excep-
tion for the first day of work described in
paragraph (e)(2)(ii) of this section, a plan
may not establish a rule for eligibility (as
described in paragraph (b)(1)(ii) of this
section) or set any individual’s premium
or contribution rate based on whether an
individual is actively at work (including
whether an individual is continuously em-
ployed), unless absence from work due
to any health factor (such as being absent
from work on sick leave) is treated, for
purposes of the plan, as being actively at
work.
(B) The rules of this paragraph (e)(2)(i)
are illustrated by the following examples:
Example 1.(i)Facts. Under a group health plan,
an employee generally becomes eligible to enroll 30
days after the first day of employment. However, if
theemployeeisnotactivelyatworkonthefirstday
after the end of the 30-day period, then eligibility for
enrollment is delayed until the first day the employee
is actively at work.
(ii)Conclusion.InthisExample 1, the plan vi-
olates this paragraph (e)(2) (and thus also violates
paragraph (b) of this section). However, the plan
would not violate paragraph (e)(2) or (b) of this sec-
tion if, under the plan, an absence due to any health
factor is considered being actively at work.
Example 2.(i)Facts. Under a group health plan,
coverage for an employee becomes effective after 90
days of continuous service; that is, if an employee is
absent from work (for any reason) before completing
90 days of service, the beginning of the 90-day pe-
riod is measured from the day the employee returns
to work (without any credit for service before the ab-
sence).
(ii)Conclusion. In thisExample 2, the plan vio-
lates this paragraph (e)(2) (and thus also paragraph
(b) of this section) because the 90-day continuous
service requirement is a rule for eligibility based on
whether an individual is actively at work. However,
the plan would not violate this paragraph (e)(2) or
paragraph (b) of this section if, under the plan, an ab-
sence due to any health factor is not considered an
absence for purposes of measuring 90 days of contin-
uous service.
(ii)Exception for the first day of work.
(A) Notwithstanding the general rule in
paragraph (e)(2)(i) of this section, a plan
may establish a rule for eligibility that re-
quires an individual to begin work for the
employer sponsoring the plan (or, in the
case of a multiemployer plan, to begin a
job in covered employment) before cover-
age becomes effective, provided that such
a rule for eligibility applies regardless of
the reason for the absence.
(B) The rules of this paragraph (e)(2)(ii)
are illustrated by the following examples:
Example 1.(i)Facts. Under the eligibility pro-
vision of a group health plan, coverage for new em-
ployees becomes effective on the first day that the em-
ployee reports to work. IndividualHis scheduled to
begin work on August 3. However,His unable to
begin work on that day because of illness.Hbegins
working on August 4, andH’s coverage is effective
on August 4.
(ii)Conclusion.InthisExample 1, the plan pro-
vision does not violate this section. However, if cov-
erage for individuals who do not report to work on
the first day they were scheduled to work for a rea-
son unrelated to a health factor (such as vacation or
bereavement) becomes effective on the first day they
were scheduled to work, then the plan would violate
this section.
Example 2.(i)Facts. Under a group health plan,
coverage for new employees becomes effective on the
first day of the month following the employee’s first
day of work, regardless of whether the employee is
actively at work on the first day of the month. In-
dividualJis scheduled to begin work on March 24.
However,Jis unable to begin work on March 24 be-
cause of illness.Jbegins working on April 7 andJ’s
coverage is effective May 1.
(ii)Conclusion.InthisExample 2, the plan pro-
vision does not violate this section. However, as in
Example 1, if coverage for individuals absent from
work for reasons unrelated to a health factor became
effective despite their absence, then the plan would
violate this section.
(3)Relationship to plan provisions
defining similarly situated individuals.(i)
Notwithstanding the rules of paragraphs
(e)(1) and (2) of this section, a plan may
establish rules for eligibility or set any in-
dividual’s premium or contribution rate in
accordance with the rules relating to simi-
larly situated individuals in paragraph (d)
of this section. Accordingly, a plan may
distinguish in rules for eligibility under
the plan between full-time and part-time
employees, between permanent and tem-
porary or seasonal employees, between
current and former employees, and be-
tween employees currently performing
services and employees no longer per-
forming services for the employer, subject
to paragraph (d) of this section. However,
other Federal or State laws (including
the COBRA continuation provisions and
the Family and Medical Leave Act of
1993) may require an employee or the
employee’s dependents to be offered cov-
erage and set limits on the premium or
contribution rate even though the em-
ployee is not performing services.
(ii) The rules of this paragraph (e)(3) are
illustrated by the following examples:
Example 1.(i)Facts. Under a group health plan,
employees are eligible for coverage if they perform
services for the employer for 30 or more hours per
week or if they are on paid leave (such as vacation,
sick, or bereavement leave). Employees on unpaid
leave are treated as a separate group of similarly situ-
ated individuals in accordance with the rules of para-
graph (d) of this section.
(ii)Conclusion. In thisExample 1, the plan pro-
visions do not violate this section. However, if the
plan treated individuals performing services for the
employer for 30 or more hours per week, individu-
als on vacation leave, and individuals on bereavement
leave as a group of similarly situated individuals sep-
arate from individuals on sick leave, the plan would
violate this paragraph (e) (and thus also would violate
paragraph (b) of this section) because groups of simi-
larly situated individuals cannot be established based
on a health factor (including the taking of sick leave)
underparagraph(d)ofthissection.
Example 2.(i)Facts. To be eligible for cover-
age under abona fidecollectively bargained group
health plan in the current calendar quarter, the plan
requires an individual to have worked 250 hours in
covered employment during the three-month period
that ends one month before the beginning of the cur-
rent calendar quarter. The distinction between em-
ployees working at least 250 hours and those working
less than 250 hours in the earlier three-month period
is not directed at individualparticipants or beneficia-
ries based on any health factor of the participants or
beneficiaries.
(ii)Conclusion. In thisExample 2, the plan pro-
vision does not violate this section because, under the
rules for similarly situated individuals allowing full-
time employees to be treated differently than part-
time employees, employees who work at least 250
hours in a three-month period can be treated differ-
ently than employees who fail to work 250 hours in
that period. The result would be the same if the plan
permitted individuals to apply excess hours from pre-
vious periods to satisfy the requirement for the cur-
rent quarter.
Example 3.(i)Facts. Under a group health plan,
coverage of an employee is terminated when the in-
dividual’s employment isterminated, in accordance
with the rules of paragraph (d) of this section. Em-
ployeeBhas been covered under the plan.Bexperi-
ences a disabling illness that preventsBfrom work-
ing.Btakes a leave of absence under the Family
and Medical Leave Act of 1993. At the end of such
leave,Bterminates employment and consequently
loses coverage under the plan. (This termination of
coverage is without regard to whatever rights the em-
ployee (or members of the employee’s family) may
have for COBRA continuation coverage.)
(ii)Conclusion. In thisExample 3, the plan pro-
vision terminatingB’s coverage uponB’s termination
of employment does not violate this section.
Example 4.(i)Facts. Under a group health plan,
coverage of an employee is terminated when the em-
ployee ceases to perform services for the employer
sponsoring the plan, in accordance with the rules of
paragraph (d) of this section. EmployeeCis laid off
for three months. When the layoff begins,C
’s cover-
age under the plan is terminated. (This termination of
coverage is without regard to whatever rights the em-
ployee (or members of the employee’s family) may
have for COBRA continuation coverage.)
(ii)Conclusion.InthisExample 4, the plan provi-
sion terminatingC’s coverage upon the cessation of
February 5, 20074572007–6 I.R.B.

C’s performance of services does not violate this sec-
tion.
(f)Wellness programs. A wellness pro-
gram is any program designed to promote
health or prevent disease. Paragraphs
(b)(2)(ii) and (c)(3) of this section pro-
vide exceptions to the general prohibitions
against discrimination based on a health
factor for plan provisions that vary bene-
fits (including cost-sharing mechanisms)
or the premium or contribution for sim-
ilarly situated individuals in connection
with a wellness program that satisfies the
requirements of this paragraph (f). If none
of the conditions for obtaining a reward
under a wellness program is based on an
individual satisfying a standard that is re-
lated to a health factor, paragraph (f)(1)
of this section clarifies that the wellness
program does not violate this section if
participation in the program is made avail-
able to all similarly situated individuals.
If any of the conditions for obtaining a
reward under a wellness program is based
on an individual satisfying a standard that
is related to a health factor, the wellness
program does not violate this section if the
requirements of paragraph (f)(2) of this
section are met.
(1)Wellness programs not subject to re-
quirements. If none of the conditions for
obtaining a reward under a wellness pro-
gram is based on an individual satisfying
a standard that are related to a health fac-
tor (or if a wellness program does not pro-
vide a reward), the wellness program does
not violate this section, if participation in
the program is made available to all simi-
larly situated individuals. Thus, for exam-
ple, the following programs need not sat-
isfy the requirements of paragraph (f)(2) of
this section, if participation in the program
is made available to all similarly situated
individuals:
(i) A program that reimburses all or part
of the cost for memberships in a fitness
center.
(ii) A diagnostic testing program that
provides a reward for participation and
does not base any part of the reward on out-
comes.
(iii) A program that encourages preven-
tive care through the waiver of the copay-
ment or deductible requirement under a
group health plan for the costs of, for ex-
ample, prenatal care or well-baby visits.
(iv) A program that reimburses employ-
ees for the costs of smoking cessation pro-
grams without regard to whether the em-
ployee quits smoking.
(v) A program that provides a reward to
employees for attending a monthly health
education seminar.
(2)Wellness programs subject to re-
quirements. If any of the conditions for
obtaining a reward under a wellness pro-
gram are based on an individual satisfying
a standard that is related to a health fac-
tor, the wellness program does not violate
this section if the requirements of this para-
graph (f)(2) are met.
(i) The reward for the wellness pro-
gram, coupled with the reward for other
wellness programs with respect to the plan
that require satisfaction of a standard re-
lated to a health factor, must not exceed 20
percent of the cost of employee-only cov-
erage under the plan. However, if, in ad-
dition to employees, any class of depen-
dents (such as spouses or spouses and de-
pendent children) may participate in the
wellness program, the reward must not ex-
ceed 20 percent of the cost of the cover-
age in which an employee and any depen-
dents are enrolled. For purposes of this
paragraph (f)(2), the cost of coverage is de-
termined based on the total amount of em-
ployer and employee contributions for the
benefit package under which the employee
is (or the employee and any dependents
are) receiving coverage. A reward can be
in the form of a discount or rebate of a pre-
mium or contribution, a waiver of all or
part of a cost-sharing mechanism (such as
deductibles, copayments, or coinsurance),
the absence of a surcharge, or the value of
a benefit that would otherwise not be pro-
vided under the plan.
(ii) The program must be reasonably de-
signed to promote health or prevent dis-
ease. A program satisfies this standard if
it has a reasonable chance of improving
the health of or preventing disease in par-
ticipating individuals and it is not overly
burdensome, is not a subterfuge for dis-
criminating based on a health factor, and
is not highly suspect in the method chosen
to promote health or prevent disease.
(iii) The program must give individuals
eligible for the program the opportunity to
qualify for the reward under the program
at least once per year.
(iv) The reward under the program must
be available to all similarly situated indi-
viduals.
(A) A reward is not available to all sim-
ilarly situated individuals for a period un-
less the program allows —
(1) A reasonable alternative standard
(or waiver of the otherwise applicable
standard) for obtaining the reward for any
individual for whom, for that period, it is
unreasonably difficult due to a medical
condition to satisfy the otherwise applica-
ble standard; and
(2) A reasonable alternative standard
(or waiver of the otherwise applicable
standard) for obtaining the reward for any
individual for whom, for that period, it is
medically inadvisable to attempt to satisfy
the otherwise applicable standard.
(B) A plan or issuer may seek verifica-
tion, such as a statement from an individ-
ual’s physician, that a health factor makes
it unreasonably difficult or medically inad-
visable for the individual to satisfy or at-
tempt to satisfy the otherwise applicable
standard.
(v) (A) The plan must disclose in all
plan materials describing the terms of the
program the availability of a reasonable
alternative standard (or the possibility of
waiver of the otherwise applicable stan-
dard) required under paragraph (f)(2)(iv)
of this section. However, if plan materi-
als merely mention that a program is avail-
able, without describing its terms, this dis-
closure is not required.
(B) The following language, or sub-
stantially similar language, can be used to
satisfy the requirement of this paragraph
(f)(2)(v): “If it is unreasonably difficult
due to a medical condition for you to
achieve the standards for the reward under
this program, or if it is medically inad-
visable for you to attempt to achieve the
standards for the reward under this pro-
gram, call us at [insert telephone number]
and we will work with you to develop
another way to qualify for the reward.”
In addition, other examples of language
that would satisfy this requirement are set
forth inExamples 3,4,and5of paragraph
(f)(3) of this section.
(3)Examples. The rules of paragraph
(f)(2) of this section are illustrated by the
following examples:
Example 1.(i)Facts. An employer sponsors
a group health plan. The annual premium for em-
ployee-only coverage is $3,600 (of which the em-
ployer pays $2,700 per year and the employee pays
$900 per year). The annual premium for family cov-
erage is $9,000 (of which the employer pays $4,500
per year and the employee pays $4,500 per year). The
2007–6 I.R.B.458February 5, 2007

plan offers a wellness program with an annual pre-
mium rebate of $360. The program is available only
to employees.
(ii)Conclusion. In thisExample 1, the program
satisfies the requirements of paragraph (f)(2)(i) of this
section because the reward for the wellness program,
$360, does not exceed 20 percent of the total annual
cost of employee-only coverage, $720. ($3,600 x
20% = $720.) If any class of dependents is allowed
to participate in the program and the employee is en-
rolled in family coverage, the plan could offer the em-
ployee a reward of up to 20 percent of the cost of fam-
ily coverage, $1,800. ($9,000 x 20% = $1,800.)
Example 2.(i)Facts. A group health plan gives
an annual premium discount of 20 percent of the cost
of employee-only coverage to participants who ad-
here to a wellness program. The wellness program
consists solely of giving an annual cholesterol test to
participants. Those participants who achieve a count
under 200 receive the premium discount for the year.
(ii)Conclusion. In thisExample 2, the program
fails to satisfy the requirement of being available to
all similarly situated individuals because some partic-
ipants may be unable to achieve a cholesterol count
of under 200 and the plan does not make available a
reasonable alternative standard or waive the choles-
terol standard. (In addition, plan materials describing
the program are required to disclose the availability
of a reasonable alternative standard (or the possibil-
ity of waiver of the otherwise applicable standard)
for obtaining the premium discount. Thus, the pre-
mium discount violates paragraph (c) of this section
because it may require an individual to pay a higher
premium based on a health factor of the individual
than is required of a similarly situated individual un-
der the plan.
Example 3.(i)Facts. Same facts asExample 2,
except that the plan provides that if it is unreasonably
difficult due to a medical condition for a participant
to achieve the targeted cholesterol count (or if it is
medically inadvisable for a participant to attempt
to achieve the targeted cholesterol count) within a
60-day period, the plan will make available a rea-
sonable alternative standard that takes the relevant
medical condition into account. In addition, all plan
materials describing the terms of the program include
the following statement: “If it is unreasonably diffi-
cult due to a medical condition for you to achieve a
cholesterol count under 200, or if it is medically in-
advisable for you to attempt to achieve a count under
200, call us at the number below and we will work
with you to develop another way to get the discount.”
IndividualDbegins a diet and exercise program but
is unable to achieve a cholesterol count under 200
within the prescribed period.D’s doctor determines
Drequires prescription medication to achieve a med-
ically advisable cholesterol count. In addition, the
doctor determines thatDmust be monitored through
periodic blood tests to continually reevaluateD’s
health status. The plan accommodatesDby making
the discount available toD, but only ifDfollows
theadviceofD’s doctor’s regarding medication and
blood tests.
(ii)Conclusion. In thisExample 3, the program
is a wellness program because it satisfies the five re-
quirements of paragraph (f)(2) of this section. First,
the program complies with the limits on rewards un-
der a program. Second, it is reasonably designed to
promote health or prevent disease. Third, individuals
eligible for the program are given the opportunity to
qualify for the reward at least once per year. Fourth,
the reward under the program is available to all sim-
ilarly situated individuals because it accommodates
individuals for whom it is unreasonably difficult due
to a medical condition to achieve the targeted count
(or for whom it is medically inadvisable to attempt to
achieve the targeted count) in the prescribed period
by providing a reasonable alternative standard. Fifth,
the plan discloses in all materials describing the terms
of the program the availability of a reasonable alter-
native standard. Thus, the premium discount does not
violate this section.
Example 4. (i) Facts. A group health plan will
waive the $250 annual deductible (which is less than
20 percent of the annual cost of employee-only cover-
age under the plan) for the following year for partici-
pants who have a body mass index between 19 and 26,
determined shortly before the beginning of the year.
However, any participant for whom it is unreasonably
difficult due to a medical condition to attain this stan-
dard (and any participant for whom it is medically in-
advisable to attempt to achieve this standard) during
the plan year is given the same discount if the partic-
ipant walks for 20 minutes three days a week. Any
participant for whom it is unreasonably difficult due
to a medical condition to attain either standard (and
any participant for whom it is medically inadvisable
to attempt to achieve either standard) during the year
is given the same discount if the individual satisfies
an alternative standard that is reasonable in the bur-
den it imposes and is reasonable taking into consider-
ation the individual’s medical situation. All plan ma-
terials describing the terms of the wellness program
include the following statement: “If it is unreason-
ably difficult due to a medical condition for you to
achieve a body mass index between 19 and 26 (or if it
is medically inadvisable for you to attempt to achieve
this body mass index) this year, your deductible will
be waived if you walk for 20 minutes three days a
week. If you cannot follow the walking program,
call us at the number above and we will work with
you to develop another way to have your deductible
waived.” Due to a medical condition, IndividualEis
unable to achieve a BMI of between 19 and 26 and
is also unable to follow the walking program.Epro-
poses a program based on the recommendations of
E’s physician. The plan agrees to make the discount
available toEifEfollows the physician’s recommen-
dations.
(ii)Conclusion.InthisExample 4, the program
satisfies the five requirements of paragraph (f)(2) of
this section. First, the program complies with the lim-
its on rewards under a program. Second, it is reason-
ably designed to promote health or prevent disease.
Third, individuals eligible for the program are given
the opportunity to qualify for the reward at least once
per year. Fourth, the reward under the program is
available to all similarly situated individuals because
it generally accommodates individuals for whom it is
unreasonably difficult due to a medical condition to
achieve (or for whom it is medically inadvisable to
attempt to achieve) the targeted body mass index by
providing a reasonable alternative standard (walking)
and it accommodates individuals for whom it is un-
reasonably difficult due to a medical condition (or for
whom it is medically inadvisable to attempt) to walk
by providing an alternative standard that is reasonable
for the individual. Fifth, the plan discloses in all ma-
terials describing the terms of the program the avail-
ability of a reasonable alternative standard for every
individual. Thus, the waiver of the deductible does
not violate this section.
Example 5.(i)Facts. In conjunction with an an-
nual open enrollment period, a group health plan pro-
vides a form for participants to certify that they have
not used tobacco products in the preceding twelve
months. Participants who do not provide the certi-
fication are assessed a surcharge that is 20 percent
of the cost of employee-only coverage. However, all
plan materials describing the terms of the wellness
program include the following statement: “If it is un-
reasonably difficult due to a health factor for you to
meet the requirements under this program (or if it is
medically inadvisable for you to attempt to meet the
requirements of this program), we will make avail-
able a reasonable alternative standard for you to avoid
this surcharge.” It is unreasonably difficult for In-
dividualFto stop smoking cigarettes due to an ad-
diction to nicotine (a medical condition). The plan
accommodatesFby requiringFto participate in a
smoking cessation program to avoid the surcharge.F
can avoid the surcharge for as long asFparticipates
in the program, regardless of whetherFstops smok-
ing (as long asFcontinues to be addicted to nicotine).
(ii)Conclusion.InthisExample 5, the premium
surcharge is permissible as a wellness program be-
cause it satisfies the five requirements of paragraph
(f)(2) of this section. First, the program complies
with the limits on rewards under a program. Second,
it is reasonably designed to promote health or prevent
disease. Third, individuals eligible for the program
are given the opportunity to qualify for the reward
at least once per year. Fourth, the reward under the
program is available to all similarly situated individ-
uals because it accommodates individuals for whom
it is unreasonably difficult due to a medical condi-
tion (or for whom it is medically inadvisable to at-
tempt) to quit using tobaccoproducts by providing a
reasonable alternative standard. Fifth, the plan dis-
closes in all materials describing the terms of the pro-
gram the availability of a reasonable alternative stan-
dard. Thus, the premium surcharge does not violate
this section.
Example 6.(i)Facts. Same facts asExample 5,
except the plan accommodatesFby requiringFto
view, over a period of 12 months, a 12-hour video se-
ries on health problems associated with tobacco use.
Fcan avoid the surcharge by complying with this re-
quirement.
(ii)Conclusion.InthisExample 6,therequire-
ment to watch the series of video tapes is a reasonable
alternative method for avoiding the surcharge.
(g)More favorable treatment of individ-
uals with adverse health factors permitted
—(1)In rules for eligibility. (i) Nothing
in this section prevents a group health plan
from establishing more favorable rules for
eligibility (describedin paragraph (b)(1)
of this section) for individuals with an ad-
verse health factor, such as disability, than
for individuals without the adverse health
factor. Moreover, nothing in this section
prevents a plan from charging a higher pre-
mium or contribution with respect to in-
February 5, 20074592007–6 I.R.B.

dividuals with an adverse health factor if
they would not be eligible for the cover-
age were it not for the adverse health fac-
tor. (However, other laws, including State
insurance laws, may set or limit premium
rates; these laws are not affected by this
section.)
(ii) The rules of this paragraph (g)(1)
are illustrated by the following examples:
Example 1.(i)Facts. An employer sponsors a
group health plan that generally is available to em-
ployees, spouses of employees, and dependent chil-
dren until age 23. However, dependent children who
are disabled are eligible for coverage beyond age 23.
(ii)Conclusion. In thisExample 1, the plan provi-
sion allowing coverage for disabled dependent chil-
dren beyond age 23 satisfies this paragraph (g)(1)
(and thus does not violate this section).
Example 2.(i)Facts. An employer sponsors a
group health plan, which is generally available to em-
ployees (and members of the employee’s family) un-
til the last day of the month in which the employee
ceases to perform services for the employer. The plan
generally charges employees $50 per month for em-
ployee-only coverage and $125 per month for family
coverage. However, an employee who ceases to per-
form services for the employer by reason of disabil-
ity may remain covered under the plan until the last
day of the month that is 12 months after the month
in which the employee ceased to perform services for
the employer. During this extended period of cover-
age, the plan charges the employee $100 per month
for employee-only coverage and $250 per month for
family coverage. (This extended period of cover-
age is without regard to whatever rights the employee
(or members of the employee’s family) may have for
COBRA continuation coverage.)
(ii)Conclusion. In thisExample 2,theplan
provision allowing extended coverage for disabled
employees and their families satisfies this paragraph
(g)(1) (and thus does not violate this section). In
addition, the plan is permitted, under this paragraph
(g)(1), to charge the disabled employees a higher
premium during the extended period of coverage.
Example 3.(i)Facts. Tocomplywiththere-
quirements of a COBRA continuation provision, a
group health plan generally makes COBRA continu-
ation coverage available for a maximum period of 18
months in connection with a termination of employ-
ment but makes the coverage available for a maxi-
mum period of 29 months to certain disabled indi-
viduals and certain members of the disabled individ-
ual’s family. Although the plan generally requires
payment of 102 percent of the applicable premium
for the first 18 months of COBRA continuation cov-
erage, the plan requires payment of 150 percent of
the applicable premium for the disabled individual’s
COBRA continuation coverage during the disability
extension if the disabled individual would not be en-
titled to COBRA continuation coverage but for the
disability.
(ii)Conclusion. In thisExample 3, the plan provi-
sion allowing extended COBRA continuation cover-
age for disabled individuals satisfies this paragraph
(g)(1) (and thus does not violate this section). In
addition, the plan is permitted, under this paragraph
(g)(1), to charge the disabled individuals a higher pre-
mium for the extended coverage if the individuals
would not be eligible for COBRA continuation cov-
erage were it not for the disability. (Similarly, if the
plan provided an extended period of coverage for dis-
abled individuals pursuant to State law or plan provi-
sion rather than pursuant to a COBRA continuation
coverage provision, the plan could likewise charge
the disabled individuals a higher premium for the ex-
tended coverage.)
(2)In premiums or contributions.(i)
Nothing in this section prevents a group
health plan from charging individuals a
premium or contribution that is less than
the premium (or contribution) for similarly
situated individuals if the lower charge is
basedonanadversehealthfactor,suchas
disability.
(ii) The rules of this paragraph (g)(2)
are illustrated by the following example:
Example.(i)Facts. Under a group health plan,
employees are generallyrequired to pay $50 per
month for employee-only coverage and $125 per
month for family coverage under the plan. How-
ever, employees who are disabled receive coverage
(whether employee-only or family coverage) under
the plan free of charge.
(ii)Conclusion.InthisExample, the plan provi-
sion waiving premium payment for disabled employ-
ees is permitted under this paragraph (g)(2) (and thus
does not violate this section).
(h)No effect on other laws. Compli-
ance with this section is not determina-
tive of compliance with any provision of
ERISA (including the COBRA continua-
tion provisions) or any other State or Fed-
eral law, such as the Americans with Dis-
abilities Act. Therefore, although the rules
of this section would not prohibit a plan
from treating one group of similarly situ-
ated individuals differently from another
(such as providing different benefit pack-
ages to current and former employees),
other Federal or State laws may require
that two separate groups of similarly sit-
uated individuals be treated the same for
certain purposes (such as making the same
benefit package available to COBRA qual-
ified beneficiaries as is made available to
active employees). In addition, although
this section generally does not impose new
disclosure obligations on plans, this sec-
tion does not affect any other laws, includ-
ing those that require accurate disclosures
and prohibit intentional misrepresentation.
(i)Applicability dates. This section ap-
plies for plan years beginning on or after
July 1, 2007.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved June 22, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 12,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 13, 2006, 71 F.R. 75013)
26 CFR 54.9802–2: Special rules for certain church
plans.
T.D. 9299
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 54
Exception to the HIPAA
Nondiscrimination
Requirements for Certain
Grandfathered Church Plans
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations that provide guidance
under section 9802(c) of the Internal
Revenue Code relating to the exception
for certain grandfathered church plans
from the nondiscrimination requirements
applicable to group health plans under
section 9802(a) and (b). Final regulations
(T.D. 9298) relating to the nondiscrimina-
tion requirements under section 9802(a)
and (b) are being published elsewhere in
this issue of the Bulletin. The regula-
tions will generally affect sponsors of and
participants in certain self-funded church
plans that are group health plans, and the
regulations provide plan sponsors and plan
administrators with guidance necessary to
comply with the law.
DATES:Effective Date:These regulations
are effective February 12, 2006.
Applicability Date:These regulations
apply for plan years beginning on or after
July 1, 2007.
FOR FURTHER INFORMATION
CONTACT: Russ Weinheimer at
202–622–6080 (not a toll-free number).
2007–6 I.R.B.460February 5, 2007

SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to
the Miscellaneous Excise Tax Regulations
(26 CFR part 54) relating to the exception
for certain grandfathered church plans
from the nondiscrimination requirements
applicable to group health plans. The
nondiscrimination requirements applica-
ble to group health plans were added to the
Internal Revenue Code (Code), in section
9802, by the Health Insurance Portability
and Accountability Act of 1996 (HIPAA),
Public Law 104–191 (110 Stat. 1936).
HIPAA also added similar nondiscrimina-
tion provisions applicable to group health
plans and health insurance issuers (such
as health insurance companies and health
maintenance organizations) under the Em-
ployee Retirement Income Security Act
of 1974 (ERISA), administered by the
U.S. Department of Labor, and the Public
Health Service Act (PHS Act), adminis-
teredbytheU.S.DepartmentofHealth
and Human Services.
Final regulations relating to the HIPAA
nondiscrimination requirements in para-
graphs (a) and (b) of section 9802 of the
Code are being published elsewhere in this
issue of the Bulletin. Those regulations
are similar to, and have been developed
in coordination with, final regulations
also being published today by the Depart-
ments of Labor and of Health and Human
Services. Guidance under the HIPAA
nondiscrimination requirements is sum-
marized in a joint preamble to the final
regulations.
The exception for certain grandfathered
church plans was added to section 9802,
in subsection (c), by section 1532 of the
Taxpayer Relief Act of 1997, Public Law
105–34 (111 Stat. 788). A notice of
proposed rulemaking on the exception for
certain grandfathered church plans and a
request for comments (REG–114083–00,
2001–1 C.B. 630) was published in the
Federal Registerof January 8, 2001. Two
written comments were received. After
consideration of the comments, the pro-
posed regulations are adopted as amended
by this Treasury decision.
Explanation and Summary of
Comments
One comment was pleased with the
guidance in the proposed rules and asked
that they be published as final rules as soon
as possible. The other comment explained
why the statute needed this exception and
suggested that the proposed regulations
did nothing more than paraphrase the
statute. Neither comment asked for any
change in the proposed regulations.
These final regulations make no signif-
icant substantive change to the proposed
regulations. An effective date has been
supplied and references to the supplanted
temporary regulations have been deleted,
but otherwise no change has been made in
the final regulations.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been deter-
mined that section 553(b) of the Admin-
istrative Procedure Act (5 U.S.C. chapter
5) does not apply to these regulations, and
because the regulations do not impose a
collection of information requirement on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility Anal-
ysis is not required. Pursuant to section
7805(f) of the Code, the notice of pro-
posed rulemaking preceding these regula-
tions was submitted to the Small Business
Administration for comment on its impact
on small business.
Drafting Information
The principal author of these regula-
tions is Russ Weinheimer, Office of the
Operating Division Counsel/Associate
Chief Counsel (Tax Exempt and Govern-
ment Entities). However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 54 is
amended as follows:
PART 54 — PENSION EXCISE TAXES
Paragraph 1. The authority citation for
part 54 is amended by adding an entry in
numerical order to read, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Section 54.9802–2 also issued under 26
U.S.C. 9833. * * *
Par. 2. In §54.9801–1, paragraph (a) is
revised to read as follows:
§54.9801–1 Basis and scope.
(a)Statutory basis. Sections 54.9801–1
through54.9801–6,54.9802–1,
54.9802–2, 54.9811–1T, 54.9812–1T,
54.9831–1, and 54.9833–1 (portability
sections) implement Chapter 100 of
Subtitle K of the Internal Revenue Code
of 1986.
*****
Par. 3. In §54.9801–2, the introductory
text is amended to read as follows:
§54.9801–2 Definitions.
Unless otherwise provided, the defi-
nitions in this section govern in applying
the provisions of §§54.9801–1 through
54.9801–6, 54.9802–1, 54.9802–2,
54.9811–1T, 54.9812–1T, 54.9831–1, and
54.9833–1.
*****
Par. 4. Section 54.9802–2 is added to
read as follows:
§54.9802–2 Special rules for certain
church plans.
(a)Exception for certain church
plans—(1)Church plans in general.A
church plan described in paragraph (b)
of this section is not treated as failing to
meet the requirements of section 9802
or §54.9802–1 solely because the plan
requires evidence of good health for cov-
erage of individuals under plan provisions
described in paragraph (b)(2) or (3) of this
section.
(2)Health insurance issuers.See
sections 2702 and 2721(b)(1)(B) of the
Public Health Service Act (42 U.S.C.
300gg–2 and 300gg–21(b)(1)(B)) and 45
CFR 146.121, which require health insur-
ance issuers providing health insurance
coverage under a church plan that is a
group health plan to comply with nondis-
crimination requirements similar to those
February 5, 20074612007–6 I.R.B.

that church plans are required to comply
with under section 9802 and §54.9802–1
except that those nondiscrimination re-
quirements do not include an exception
for health insurance issuers comparable
to the exception for church plans under
section 9802(c) and this section.
(b)Church plans to which this section
applies—(1)Church plans with certain
coverage provisions in effect on July 15,
1997. This section applies to any church
plan (as defined in section 414(e)) for a
plan year if, on July 15, 1997 and at all
times thereafter before the beginning of
the plan year, the plan contains either the
provisions described in paragraph (b)(2)
of this section or the provisions described
in paragraph (b)(3) of this section.
(2)Plan provisions applicable to indi-
viduals employed by employers of 10 or
fewer employees and self-employed indi-
viduals. (i) A plan contains the provisions
described in this paragraph (b)(2) if it re-
quires evidence of good health of both —
(A) Any employee of an employer of
10 or fewer employees (determined with-
out regard to section 414(e)(3)(C), under
which a church or convention or associ-
ation of churches is treated as the em-
ployer); and
(B) Any self-employed individual.
(ii) A plan does not contain the pro-
visions described in this paragraph (b)(2)
if the plan contains only one of the pro-
visions described in this paragraph (b)(2).
Thus, for example, a plan that requires evi-
dence of good health of any self-employed
individual, but not of any employee of
an employer with 10 or fewer employees,
does not contain the provisions described
in this paragraph (b)(2). Moreover, a plan
does not contain the provision described
in paragraph (b)(2)(i)(A) of this section if
the plan requires evidence of good health
ofanyemployeeofanemployeroffewer
than 10 (or greater than 10) employees.
Thus, for example, a plan does not con-
tain the provision described in paragraph
(b)(2)(i)(A) of this section if the plan re-
quires evidence of good health of any em-
ployee of an employer with five or fewer
employees.
(3)Plan provisions applicable to indi-
viduals who enroll after the first 90 days
of initial eligibility. (i) A plan contains
the provisions described in this paragraph
(b)(3) if it requires evidence of good health
of any individual who enrolls after the first
90 days of initial eligibility under the plan.
(ii) A plan does not contain the pro-
visions described in this paragraph (b)(3)
if it provides for a longer (or shorter) pe-
riod than 90 days. Thus, for example, a
plan requiring evidence of good health of
any individual who enrolls after the first
120 days of initial eligibility under the plan
does not contain the provisions described
in this paragraph (b)(3).
(c)Examples. The rules of this section
are illustrated by the following examples:
Example 1.(i)Facts. A church organization
maintains two church plans for entities affiliated with
the church. One plan is a group health plan that
provides health coverage to all employees (including
ministers and lay workers) of any affiliated church
entity that has more than 10 employees. The other
plan is PlanO, which is a group health plan that
is not funded through insurance coverage and that
provides health coverage to any employee (including
ministers and lay workers) of any affiliated church en-
tity that has 10 or fewer employees and any self-em-
ployed individual affiliated with the church (includ-
ing a self-employed minister of the church). PlanO
requires evidence of good health in order for any indi-
vidual of a church entity that has 10 or fewer employ-
ees to be covered and in order for any self-employed
individual to be covered. On July 15, 1997 and at all
times thereafter before the beginning of the plan year,
PlanOhas contained all the preceding provisions.
(ii)Conclusion.InthisExample 1, because Plan
Ocontains the plan provisions described in paragraph
(b)(2) of this section and because those provisions
were in the plan on July 15, 1997 and at all times
thereafter before the beginning of the plan year, Plan
Owill not be treated as failing to meet the require-
ments of section 9802 or §54.9802–1 for the plan year
solely because the plan requires evidence of good
health for coverage of the individuals described in
those plan provisions.
Example 2.(i)Facts. A church organization
maintains PlanP,whichisachurchplanthatisnot
funded through insurance coverage and that is a group
health plan providing health coverage to individuals
employed by entities affiliated with the church and
self-employed individuals affiliated with the church
(such as ministers). On July 15, 1997 and at all times
thereafter before the beginning of the plan year, Plan
Phas required evidence of good health for coverage
of any individual who enrolls after the first 90 days
of initial eligibility under the plan.
(ii)Conclusion.InthisExample 2, because Plan
Pcontains the plan provisions described in paragraph
(b)(3) of this section and because those provisions
were in the plan on July 15, 1997 and at all times
thereafter before the beginning of the plan year, Plan
Pwill not be treated as failing to meet the require-
ments of section 9802 or §54.9802–1 for the plan year
solely because the plan requires evidence of good
health for coverage of individuals enrolling after the
first 90 days of initial eligibility under the plan.
(d)Effective date.Thissectionisappli-
cable to plan years beginning on or after
July 1, 2007.
Par. 5. Section 54.9831–1 is amended
by revising paragraphs (b) and (c)(1) to
read as follows:
§54.9831–1 Special rules relating to
group health plans.
*****
(b)General exception for certain small
group health plans. The requirements
of §§54.9801–1 through 54.9801–6,
54.9802–1, 54.9802–2, 54.9811–1T,
54.9812–1T, and 54.9833–1 do not ap-
ply to any group health plan for any plan
year if, on the first day of the plan year,
the plan has fewer than two participants
who are current employees.
(c)Excepted benefits—(1)In general.
The requirements of §§54.9801–1 through
54.9801–6, 54.9802–1, 54.9802–2,
54.9811–1T, 54.9812–1T, and 54.9833–1
do not apply to any group health plan in
relation to its provision of the benefits
described in paragraph (c)(2), (3), (4), or
(5) of this section (or any combination of
these benefits).
*****
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved June 22, 2006.
Eric Solomon,
Acting Deputy Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on December 12,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 13, 2006, 71 F.R. 75055)
2007–6 I.R.B.462February 5, 2007

Part IV. Items of General Interest
Notice of Proposed
Rulemaking by
Cross-Reference to
Temporary Regulations
Guidance Necessary to
Facilitate Business Electronic
Filing Under Section 1561
REG–161919–05
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulema
king
by cross-reference to temporary r
egula-
tions.
SUMMARY: In this issue of the Bulletin,
the IRS is issuing temporary regulations
(T.D. 9304) that affect component mem-
bers of controlled groups of corporations
and consolidated groups filing life-nonlife
Federal income tax returns. They provide
guidance regarding the apportionment of
tax benefit items and the amount and type
of information these members are required
to submit with their returns. The text of
those regulations also serves as the text of
these proposed regulations.
DATES: Written or electronic comments,
and a request for a public hearing, must be
received by March 22, 2007.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR(REG–161919–05),
Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may
be hand-delivered Monday through Friday
between the hours of 8 a.m. and 4 p.m.
to CC:PA:LPD:PR (REG–161919–05),
Courier’s Desk, Internal Revenue Service,
1111 Constitution Avenue, NW, Wash-
ington, DC, or sent electronically, via the
IRS internet site atwww.irs.gov/regsor
via the Federal eRulemaking Portal at
www.regulations.gov(indicate IRS and
REG–161919–05).
FOR FURTHER INFORMATION
CONTACT: Concerning the proposed
regulations, Grid Glyer, (202) 622–7930,
concerning submissions of comments and
requests for public hearings, Kelly Banks
(202) 622–7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background and Explanation of
Provisions
Temporary regulations in this issue of
the Bulletin amend 26 CFR Part 1 to add
§§1.1502–43T, 1.1561–1T, 1.1561–2T
and 1.1561–3T, and amend §§1.1502–47T
and 1.1563–1T. The text of those tempo-
rary regulations alsoserves as the text of
these proposed regulations. The preamble
to the temporary regulations explains the
amendments.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a significant
regulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It has also
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to the follow-
ing proposed regulations, §§1.1561–1,
1.1561–3 and 1.1563–1, and because
these regulations do not impose a col-
lection of information on small entities,
the Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. With respect
to the following proposed regulations,
§§1.1502–43, 1.1502–47 and 1.1561–2,
it is hereby certified that these regula-
tions will not have a significant economic
impact on a substantial number of small
entities. This certification is based on the
fact that these regulations primarily affect
large corporations (which are members of
either controlled or consolidated groups).
Therefore, a regulatory flexibility analysis
is not required. Pursuant to section 7805(f)
of the Internal Revenue Code, this notice
of proposed rulemaking will be submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on their impact on small business.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments
(a signed original and eight (8) copies)
or electronic comments that are submitted
timely to the IRS. All comments will be
available for public inspection and copy-
ing. A public hearing may be scheduled
ifrequestedinwritingbyanypersonthat
timely submits written or electronic com-
ments. If a public hearing is scheduled, no-
tice of the date, time,and place for the pub-
lic hearing will be published in theFederal
Register.
Drafting Information
The principal author of these regula-
tions is Grid Glyer of the Office of As-
sociate Chief Counsel (Corporate). Other
personnel from the Treasury Department
and the IRS participated in their develop-
ment.
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is 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 1.1502–43 is amended
by revising paragraph (d) and adding para-
graph (e) to read as follows:
§1.1502–43 Consolidated accumulated
earnings tax.
[The text of the proposed amendment
to §1.1502–43 is the same as the text for
§1.1502–43T published elsewhere in this
issue of the Bulletin].
Par. 3. Section 1.1502–47 is amended
by revising paragraph (s) and adding para-
graph (t) to read as follows:
§1.1502–47 Consolidated returns by
life-nonlife groups.
[The text of the proposed amendment
to §1.1502–47 is the same as the text for
§1.1502–47T published elsewhere in this
issue of the Bulletin].
Par. 4. Section 1.1561–1 is added to
read as follows:
February 5, 20074632007–6 I.R.B.

§1.1561–1 General rules regarding
certain tax benefits available to the
component members of a controlled group
of corporations.
[The text of the proposed §1.1561–1 is
the same as the text for §1.1561–1T pub-
lished elsewhere in this issue of the Bul-
letin].
Par. 5. Section 1.1561–2 is amended by
revising paragraphs (a), (b), (c) and (d) and
adding paragraph (f) to read as follows:
§1.1561–2 Determination of amount of
tax benefits.
[The text of the proposed amendment
to §1.1561–2 is the same as the text for
1.1561–2T published elsewhere in this is-
sue of the Bulletin].
Par. 6. Section 1.1561–3 is added to
read as follows:
§1.1561–3 Allocating the section 1561(a)
tax items.
[The text of the proposed §1.1561–3 is
the same as the text for §1.1561–3T pub-
lished elsewhere in this issue of the Bul-
letin].
Par. 7. Section 1.1563–1 is added to
read as follows:
§1.1563–1 Definition of controlled group
of corporations and component members.
[The text of the proposed §1.1563–1 is
the same as the text for §1.1563–1T pub-
lished elsewhere in this issue of the Bul-
letin].
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on December 21,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 22, 2006, 71 F.R. 76955)
Treatment of Services Under
Section 482; Allocation of
Income and Deductions From
Intangibles; Stewardship
Expense; Correction
Announcement 2007–10
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to final and tempo-
rary regulations.
SUMMARY: This document contains cor-
rections to final and temporary regulations
(T.D. 9278, 2006–34 I.R.B. 256) that was
published in theFederal Registeron Fri-
day, August 4, 2006 (71 FR 44466) regard-
ing the treatment of controlled services
transactions under section 482 and the al-
location of income from intangibles, in
particular with respect to contributions by
a controlled party to the value of an intan-
gible owned by another controlled party.
This document also contains corrections to
final and temporary regulations that mod-
ify the regulations under section 861 con-
cerning stewardship expenses to be consis-
tent with the changes made to the regula-
tions under section 482.
EFFECTIVE DATE: These corrections are
effective on January 1, 2007.
FOR FURTHER INFORMATION
CONTACT: Thomas A. Vidano, (202)
435–5265, or Carol B. Tan (202)
435–5159, for matters relating to sec-
tion 482, and David F. Bergkuist, (202)
622–3850, for matters relating to steward-
ship expenses (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
The final and temporary regulations
(T.D. 9278) that are the subject of these
corrections is under sections 482 and 861
of the Internal Revenue Code.
Need for Correction
As published, final and temporary regu-
lations (T.D. 9278) contain errors that may
prove to be misleading and are in need of
clarification.
Correction of Publication
Accordingly, final and temporary regu-
lations (T.D. 9278) that were the subject of
FR Doc. 06–6497 are corrected as follows:
1. On page 44466, column 1, in the
heading, the subject “Treatment of Ser-
vices Under Section 482; Allocation of
Income and Deductions From Intangi-
bles; Stewardship Expense” is corrected
to read “Treatment of Services Under
Section 482; Allocation of Income and
Deductions From Intangibles; and Appor-
tionment of Stewardship Expense”.
2. On page 44470, column 2, in the
preamble under the paragraph head-
ing “5. Comparable Profits Method
for Services—Temp. Treas. Reg.
§ 1.482–9T(f)”, fifth line from the top
of the column, the language “assets play a
greater role in general” is corrected to read
“assets play a greater role in generating”.
3. On page 44475, column 3, in the pre-
amble under the paragraph heading “Ser-
vices Subject to a Qualified Cost Shar-
ing Arrangement—Temp. Treas. Reg.
§ 1.482–9T(m)(3),“ fourth line from the
top of the column, the language “two pro-
visions, the rule § 1.482–” is corrected to
read “two provisions, the rule in § 1.482–”.
Cynthia Grigsby,
Senior Federal Register Liaison Officer,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on December 21,
2006, 8:45 a.m., and published in the issue of
the Federal
Register for December 22, 2006, 71 F.R. 76913)
Treatment of Services Under
Section 482 Allocation of
Income and Deductions
From Intangibles Stewardship
Expense; Correction
Announcement 2007–11
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to notice of pro-
posedrulemakingbycross-reference to
temporary regulations, notice of proposed
rulemaking, and notice of public hearing.
SUMMARY: This document contains
corrections to a notice of proposed rule-
making by cross-reference to temporary
regulations, notice of proposed rule-
making, and notice of public hearing
(REG–146893–02, 2006–34 I.R.B. 317)
that was published in theFederal Register
on Friday, August 4, 2006 (71 FR 44247)
relating to the treatment of controlled
services transactions under section 482.
These regulations also provide guidance
regarding the allocation of income from
2007–6 I.R.B.464February 5, 2007

intangibles, in particular with respect to
contributions by a controlled party to the
value of an intangible owned by another
controlled party, as it relates to controlled
services transactions, and modify the reg-
ulations under section 861 concerning
stewardship expenses to be consistent
with the changes made to the regulations
under section 482.
FOR FURTHER INFORMATION
CONTACT: Thomas A. Vidano, (202)
435–5265, or Carol B. Tan (202)
435–5159, for matters relating to sec-
tion 482, and David F. Bergkuist, (202)
622–3850, for matters relating to steward-
ship expenses (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
The notice of proposed rulemaking
(REG–146893–02, REG–115037–00 and
REG–138603–03) by cross-reference to
temporary regulations that is the subject
of this correction is under section 482 and
861 of the Internal Revenue Code.
Need for Correction
As published, the notice of pro-
posed rulemaking (REG–146893–02,
REG–115037–00 and REG–138603–03)
by cross-reference to temporary regula-
tions contains errors that may prove to be
misleading and are in need of clarification.
Correction of Publication
Accordingly, the notice of pro-
posed rulemaking (REG–146893–02,
REG–138603–03 and REG–115037–00)
by cross-reference to temporary regula-
tions that were the subject of FR Doc.
06–6674, is corrected as follows:
1. On page 44247, column 2, in the
heading, the subject “Treatment of Ser-
vices Under Section 482 Allocation of
Income and Deductions From Intangi-
bles Stewardship Expense” is corrected
to read, “Treatment of Services Under
Section 482; Allocation of Income and
Deductions From Intangibles; and Appor-
tionment of Stewardship Expense”.
2. On page 44248, column 2, instruc-
tional Par. 3., number 2 is corrected to read
as follows:
“2. Paragraphs (d)(3)(ii)(C),Example
4,Example 5,Example 6and (j)(6) are
added.”
§ 1.482–1 [Corrected]
3.On page 44248, column 3,
§ 1.482–1(j), lines 2 and 3, the lan-
guage “amendment to § 1.482–1(j) is
the same as the text of § 1.482–1T(j)(1)
and (2)” is corrected to read “amendment
to § 1.482–1(j)(6) is the same as the text
of § 1.482–1T(j)(6)”.
§ 1.482–8 [Corrected]
4.On page 44249, column 2,
§ 1.482–8(a), line 1, the language “(a)
Example 10. Cost of services plus”iscor-
rected to read “(b) * * *Example 10. Cost
of services plus”.
5.On page 44249, column 2,
§ 1.482–8, paragraph (b) followingEx-
ample 12. is removed.
§ 1.482–9 [Corrected]
6.On page 44249, column 2,
§ 1.482–9(m)(6), last line, the language
“operation as defined in § 1.482–8”. is
corrected to read “operation as defined in
the proposed § 1.482–8.”.
§ 1.861–8 [Corrected]
7.On page 44249, column 3,
§ 1.861–8(f)(4), line 3, the language
“same as the text of § 1.861–8T(c)(4)(i)”
is corrected to read “same as the text of
§ 1.861–8T(f)(4)(i)”.
8.On page 44249, column 3,
§ 1.861–8(h), line 3, the language “as the
text of § 1.861–8T(h)(1) published” is cor-
rected to read “as the text of § 1.861–8T(h)
published”.
Cynthia Grigsby,
Senior Federal Register Liaison Officer,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on December 21,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 22, 2006, 71 F.R. 46956)
Application of Separate
Limitations to Dividends From
Noncontrolled Section 902
Corporations; Correction
Announcement 2007–12
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correcting amendments.
SUMMARY: This document contains cor-
rections to final and temporary regulations
(T.D. 9260, 2006–23 I.R.B. 1001) that
were published in theFederal Register
on Tuesday, April 25, 2006 (71 FR 24516)
concerning the application of separate
foreign tax credit limitations to dividends
received from noncontrolled section 902
corporations under section 904(d)(4).
DATES: These corrections are effective
April 25, 2006.
FOR FURTHER INFORMATION
CONTACT: Ginny Chung (202) 622–3850
(not a toll-free call).
SUPPLEMENTARY INFORMATION:
Background
The final and temporary regulations
(T.D. 9260) that are the subject of these
corrections are under sections 902, 904,
and 964 of the Internal Revenue Code.
Need for Correction
As published, T.D. 9260 contains errors
that may prove to be misleading and are in
need of clarification.
*****
Correction of Publication
Accordingly, 26 CFR part 1 is cor-
rected by making the following correcting
amendments:
PART 1—INCOME TAXES
Paragraph 1. The authority for part 1 is
amended and continues to read in part:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.902–1 is amended
by adding a heading to paragraph (a)(4)(i)
February 5, 20074652007–6 I.R.B.

introductory text and revising the heading
for paragraph (c)(8) to read as follows:
§ 1.902–1 Credit for domestic corporate
shareholder of a foreign corporation for
foreign income taxes paid by the foreign
corporation.
(a) * * *
(4)Third- or lower-tier corpora-
tion—(i)Third-tier corporation.***
*****
(c) * * *
(8)Effect of certain liquidations, re-
organizations, or similar transactions on
certain foreign taxes paid or accrued in
taxable years beginning on or before Au-
gust 5, 1997.
***
*****
Par. 3. Section 1.902–1T is amended
by revising the first sentence of paragraph
(a)(7) to read as follows:
§ 1.902–1T Credit for domestic corporate
shareholder of a foreign corporation for
foreign income taxes paid by the foreign
corporation (temporary).
(a) * * *
(7) * * * The termforeign income taxes
means income, war profits, and excess
profits taxes as defined in § 1.902–1(a),
and taxes included in the term income, war
profits, and excess profits taxes by reason
of section 903, that are imposed by a for-
eign country or a possession of the United
States, including any such taxes deemed
paid by a foreign corporation under this
section. * * *
*****
Par. 4. Section 1.902–2 is amended
by revising the first sentence of paragraph
(a)(1) to read as follows:
§ 1.902–2 Treatment of deficits in
post-1986 undistributed earnings and
pre-1987 accumulated profits of a first-
or lower-tier corporation for purposes
of computing an amount of foreign taxes
deemed paid under § 1.902–1.
(a)***(1)***Forpurposesofcom-
puting foreign income taxes deemed paid
under § 1.902–1(b) with respect to divi-
dends paid by a first- or lower-tier corpo-
ration, when there is a deficit in the post-
1986 undistributed earnings of that corpo-
ration and the corporation makes a distri-
bution to shareholders that is a dividend
or would be a dividend if there were cur-
rent or accumulated earnings and profits,
then the post-1986 deficit shall be carried
back to the most recent pre-effective date
taxable year of the first- or lower-tier cor-
poration with positive accumulated profits
computed under section 902. * * *
*****
Par. 5. Section 1.904–0 is amended
by adding the entries for paragraphs (o)(1)
and (o)(2) under § 1.904–5 to read as fol-
lows:
§ 1.904–0 Outline of regulations
provisions for section 904.
*****
§ 1.904–5 Look-through rules as applied
to controlled foreign corporations and
other entities.
*****
(o) * * *
(1) Rules for controlled foreign corpo-
rations and other look-through entities.
(2) Rules for noncontrolled section 902
corporations.
*****
Par. 6. Section 1.904–4 is amended by
revising paragraph (c)(4) introductory text
and adding paragraphs (c)(4)(i) through
(c)(4)(iii) to read as follows:
§ 1.904–4 Separate application of section
904 with respect to certain categories of
income.
*****
(c) * * *
(3) and (4) [Reserved]. For further
guidance, see § 1.904–4T(c)(3) and (4) in-
troductory text.
(4)(i)Income from sources within the
QBU’s country of operation.Passive
income from sources within the QBU’s
country of operation shall be treated as
one item of income.
(ii)Income from sources without the
QBU’s country of operation. Passive in-
come from sources without the QBU’s
country of operation shall be grouped on
the basis of the tax imposed on that in-
come as provided in § 1.904–4T(c)(3)(i)
through (iv).
(iii)Determination of the source of
income. For purposes of this paragraph
(c)(4), income will be determined to be
from sources within or without the QBU’s
country of operation under the laws of the
foreign country of the payor of the income.
*****
Par. 7. Section 1.904–5 is amended by
revising paragraphs (a) introductory text
and (a)(1) and addingExamples 4and5to
paragraph (i)(5) to read as follows:
§ 1.904–5 Look-through rules as applied
to controlled foreign corporations and
other entities.
(a) and (a)(1) [Reserved]. For further
guidance, see § 1.904–5T(a) introductory
text and (a)(1).
*****
(i) * * *
(5) * * *
Examples 4and5[Reserved]. For fur-
ther guidance, see § 1.904–5T(i)(5)Exam-
ples 4and
5.
*****
Par. 8. Section 1.904(f)–12T is
amended by revising the heading for
paragraph (g)(1) to read as follows:
§ 1.904(f)–12T Transition rules
(temporary).
*****
(g)***(1)Recapture of separate limi-
tation loss or overall foreign loss in a sep-
arate category for dividends from a non-
controlled section 902 corporation.
***
*****
Par. 9. Section 1.964–1 is amended by:
1. Redesignating paragraphs (a) in-
troductory text, (a)(1), (a)(2) and (a)(3)
as paragraphs (a)(1) introductory text,
(a)(1)(i), (a)(1)(ii) and (a)(1)(iii), respec-
tively.
2. Designating the undesignated text
following newly-designated paragraph
(a)(1)(iii) as paragraph (a)(2).
3. Removing the comma following the
word “shall” from newly designated para-
graph (a)(1) introductory text.
4. Removing the last sentence in newly-
designated paragraph (a)(1)(i).
5. Revising newly-designated para-
graph (a)(2), and the text of paragraphs
2007–6 I.R.B.466February 5, 2007

(b)(1) introductory text and (c)(1) intro-
ductory text.
The revisions read as follows:
§ 1.964–1 Determination of the earnings
and profits of a foreign corporation.
(a) * * *
(2)Required adjustments.Thecom-
putation described in paragraph (a)(1) of
this section shall be made in the foreign
corporation’s functional currency (deter-
mined under section 985 and the regula-
tions under that section) and may be made
by following the procedures described in
paragraphs (a)(1)(i) through (a)(1)(iii) of
this section in an order other than the one
listed, as long as the result so obtained
would be the same. In determining earn-
ings and profits, or the deficit in earnings
and profits, of a foreign corporation un-
der section 964, the amount of an illegal
bribe, kickback, or other payment (within
the meaning of section 162(c), as amended
by section 288 of the Tax Equity and Fiscal
Responsibility Act of 1982 in the case of
payments made after September 3, 1982,
and these regulations) paid after Novem-
ber 3, 1976, by or on behalf of the corpo-
ration during the taxable year of the cor-
poration directly or indirectly to an offi-
cial, employee, or agent in fact of a gov-
ernment shall not be taken into account to
decrease such earnings and profits or to in-
crease such deficit. No adjustment shall
be required under paragraph (a)(1)(ii) or
(iii) of this section unless it is material.
Whether an adjustment is material depends
on the facts and circumstances of the par-
ticular case, including the amount of the
adjustment, its size relative to the general
level of the corporation’s total assets and
annual profit or loss, the consistency with
which the practice has been applied, and
whether the item to which the adjustment
relates is of a recurring or merely a nonre-
curring nature. For the treatment of earn-
ings and profits whose distribution is pre-
vented by restrictions and limitations im-
posed by a foreign government, see section
964(b) and these regulations. For rules for
determining the earnings and profits (or
deficit in earnings and profits) of a for-
eign corporation for taxable years begin-
ning before January 1, 1987, for purposes
of sections 951 through 964, see 26 CFR
1.964–1(a) (revised as of April 1, 2006).
(b)***(1)***Theaccounting
principles to be applied in making the ad-
justments required by paragraph (a)(1)(ii)
of this section shall be those account-
ing principles generally accepted in the
United States for purposes of reflecting
in the financial statements of a domestic
corporation the operations of its foreign
affiliates, including the following:
*****
(c)***(1)***Thetaxaccounting
standards to be applied in making the ad-
justments required by paragraph (a)(1)(iii)
of this section shall be the following:
*****
Par. 10. Section 1.964–1T is amended
by revising the first sentence of paragraph
(c)(2) and the last sentence of paragraph
(c)(5)(i) to read as follows:
§ 1.964–1T Determination of the earnings
and profits of a foreign corporation
(temporary).
*****
(c) * * *
(2) * * * For the first taxable year of a
foreign corporation beginning after April
25, 2006, in which such foreign corpora-
tion first qualifies as a controlled foreign
corporation (as defined in section 957 or
953) or a noncontrolled section 902 corpo-
ration(asdefinedinsection904(d)(2)(E)),
any method of accounting or taxable
year allowable under this section may be
adopted, and any election allowable under
this section may be made, by such foreign
corporation or on its behalf notwithstand-
ing that, in previous years, its books or
financial statements were prepared on a
different basis, and notwithstanding that
such election is required by the Internal
Revenue Code or regulations to be made
in a prior taxable year. * * *
*****
(5)***(i)***Intheeventthat
the United States shareholders of the con-
trolled foreign corporation do not, in the
aggregate, own (within the meaning of sec-
tion 958(a)) more than 50 percent of the to-
tal combined voting power of all classes of
the stock of such foreign corporation enti-
tled to vote, the controlling United States
shareholders of the controlled foreign cor-
poration shall be all those United States
shareholders who own (within the mean-
ing of section 958(a)) stock of such corpo-
ration.
*****
Cynthia Grigsby,
Senior Federal Register Liaison Officer,
Publications and Regulations Branch,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on December 22,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 26, 2006, 71 F.R. 77264)
February 5, 20074672007–6 I.R.B.

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 ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
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 withmodi-
fied,below).
Clarifiedis 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
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modifiedis 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
withamplifiedandclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings 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.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is self
contained. In this case, the previously pub-
lished ruling is first modified and then, as
modified, is superseded.
Supplementedis 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 rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis used in rare situations
to show that the previous published rul-
ings will not be applied pending some
future action such as the issuance of new
or amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
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—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
2007–6 I.R.B.iFebruary 5, 2007

Numerical Finding List
1
Bulletins 2007–1 through 2007–6
Announcements:
2007-1, 2007-1 I.R.B.243
2007-2, 2007-2 I.R.B.263
2007-3, 2007-4 I.R.B.376
2007-5, 2007-4 I.R.B.376
2007-6, 2007-4 I.R.B.376
2007-7, 2007-4 I.R.B.377
2007-8, 2007-5 I.R.B.416
2007-9, 2007-5 I.R.B.417
2007-10, 2007-6 I.R.B.464
2007-11, 2007-6 I.R.B.464
2007-12, 2007-6 I.R.B.465
Notices:
2007-1, 2007-2 I.R.B.254
2007-2, 2007-2 I.R.B.254
2007-3, 2007-2 I.R.B.255
2007-4, 2007-2 I.R.B.260
2007-5, 2007-3 I.R.B.269
2007-6, 2007-3 I.R.B.272
2007-7, 2007-5 I.R.B.395
2007-8, 2007-3 I.R.B.276
2007-9, 2007-5 I.R.B.401
2007-10, 2007-4 I.R.B.354
2007-11, 2007-5 I.R.B.405
2007-12, 2007-5 I.R.B.409
2007-13, 2007-5 I.R.B.410
Proposed Regulations:
REG-152043-05, 2007-2 I.R.B.263
REG-161919-05, 2007-6 I.R.B.463
REG-125632-06, 2007-5 I.R.B.415
Revenue Procedures:
2007-1, 2007-1 I.R.B.1
2007-2, 2007-1 I.R.B.88
2007-3, 2007-1 I.R.B.108
2007-4, 2007-1 I.R.B.118
2007-5, 2007-1 I.R.B.161
2007-6, 2007-1 I.R.B.189
2007-7, 2007-1 I.R.B.227
2007-8, 2007-1 I.R.B.230
2007-9, 2007-3 I.R.B.278
2007-10, 2007-3 I.R.B.289
2007-11, 2007-2 I.R.B.261
2007-12, 2007-4 I.R.B.354
2007-13, 2007-3 I.R.B.295
2007-14, 2007-4 I.R.B.357
2007-15, 2007-3 I.R.B.300
2007-16, 2007-4 I.R.B.358
2007-17, 2007-4 I.R.B.368
2007-18, 2007-5 I.R.B.413
Revenue Rulings:
2007-1, 2007-3 I.R.B.265
2007-2, 2007-3 I.R.B.266
2007-3, 2007-4 I.R.B.350
2007-4, 2007-4 I.R.B.351
2007-5, 2007-5 I.R.B.378
2007-6, 2007-5 I.R.B.393
2007-9, 2007-6 I.R.B.422
Treasury Decisions:
9298, 2007-6 I.R.B.434
9299, 2007-6 I.R.B.460
9300, 2007-2 I.R.B.246
9301, 2007-2 I.R.B.244
9302, 2007-5 I.R.B.382
9303, 2007-5 I.R.B.379
9304, 2007-6 I.R.B.423
9306, 2007-6 I.R.B.420
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin
2006–52, dated December 26, 2006.
February 5, 2007ii2007–6 I.R.B.

Finding List of Current Actions on
Previously Published Items
1
Bulletins 2007–1 through 2007–6
Notices:
2005-29
Modified and superseded by
Notice 2007-4, 2007-2 I.R.B.260
2006-2
Modified and superseded by
Notice 2007-4, 2007-2 I.R.B.260
2006-50
Amplified, clarified, and modified by
Notice 2007-11, 2007-5 I.R.B.405
Proposed Regulations:
REG-141901-05
Corrected by
Ann. 2007-7, 2007-4 I.R.B.377
REG-142270-05
Corrected by
Ann. 2007-2, 2007-2 I.R.B.263
REG-127819-06
Corrected by
Ann. 2007-5, 2007-4 I.R.B.376
REG-136806-06
Corrected by
Ann. 2007-6, 2007-4 I.R.B.376
Revenue Procedures:
98-20
Superseded by
Rev. Proc. 2007-12, 2007-4 I.R.B.354
2000-38
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
2000-50
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
2002-9
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
Modified and amplified by
Rev. Proc. 2007-14, 2007-4 I.R.B.357
2004-11
Superseded by
Rev. Proc. 2007-16, 2007-4 I.R.B.358
2005-12
Superseded by
Rev. Proc. 2007-17, 2007-4 I.R.B.368
Revenue Procedures— Continued:
2005-69
Superseded by
Rev. Proc. 2007-15, 2007-3 I.R.B.300
2006-1
Superseded by
Rev. Proc. 2007-1, 2007-1 I.R.B.1
2006-2
Superseded by
Rev. Proc. 2007-2, 2007-1 I.R.B.88
2006-3
Superseded by
Rev. Proc. 2007-3, 2007-1 I.R.B.108
2006-4
Superseded by
Rev. Proc. 2007-4, 2007-1 I.R.B.118
2006-5
Superseded by
Rev. Proc. 2007-5, 2007-1 I.R.B.161
2006-6
Superseded by
Rev. Proc. 2007-6, 2007-1 I.R.B.189
2006-7
Superseded by
Rev. Proc. 2007-7, 2007-1 I.R.B.227
2006-8
Superseded by
Rev. Proc. 2007-8, 2007-1 I.R.B.230
Revenue Rulings:
2003-43
Modified by
Notice 2007-2, 2007-2 I.R.B.254
2005-76
Supplemented and superseded by
Rev. Rul. 2007-4, 2007-4 I.R.B.351
Treasury Decisions:
9278
Corrected by
Ann. 2007-10, 2007-6 I.R.B.464
Ann. 2007-9, 2007-5 I.R.B.417
9286
Corrected by
Ann. 2007-8, 2007-5 I.R.B.416
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin 2006–52, dated December 26,
2006.
2007–6 I.R.B.iiiFebruary 5, 2007

February 5, 20072007–6 I.R.B.

2007–6 I.R.B.February 5, 2007

February 5, 20072007–6 I.R.B.

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