Internal Revenue Bulletin 2001-4 (PDF rendition): IRS Revenue Procedures

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

INCOME TAX
T.D. 8915, page 359.
Temporary regulations under section 444 of the Code relate
to the election of a taxable year other than the required tax-
able year. The regulations provide that solely with respect to
an S corporation shareholder, an electing small business
trust (ESBT) and a trust described in section 401(a) or sec-
tion 501(c)(3) that is exempt from taxation under section
501(a) are not deferral entities for purposes of section
1.444–2T.
T.D. 8916, page 360.
Final regulations under section 864 of the Code provide
guidance on the treatment of section 936 corporations for
purposes of allocating expenses in order to calculate the
alternative minimum tax foreign tax credit. Final regulations
under section 904(d) relate to the application of the foreign
tax credit separate categories, including the application of
the look-through rules under section 904(d)(3).
T.D. 8918, page 372.
REG–107176–00, page 428.
Temporary and proposed regulations relate to the deposit of
federal taxes pursuant to section 6302 of the Code.
REG–104683–00, page 407.
Proposed regulations under section 902 of the Code provide
that multi-year pooling of earnings and taxes will stop when
a foreign corporation ceases to have a 10-percent domestic
corporate shareholder. These regulations provide that the
active rents and royalties exception from passive income
treatment is no longer limited to payments from unrelated
payors. The proposed regulations also include other clarifi-
cations regarding the application of section 904(d), guid-
ance on the application of section 904(b), and guidance
regarding section 904(j). A public hearing is scheduled for
April 26, 2001.
REG–106702–00, page 424.
Proposed regulations under section 705 of the Code provide
guidance for making basis adjustments necessary to coordinate
sections 705 and 1032 of the Code in situations in which a cor-
poration acquires an interest in a partnership that holds stock in
that corporation. A public hearing is scheduled for May 3, 2001.
REG–251701–96, page 396.
Proposed regulations under sections 641 and 1361 of the
Code relate to the taxation of electing small business trusts
(ESBTs). A public hearing is scheduled for April 25, 2001.
EMPLOYEE PLANS
Notice 2001–9, page 375.
This notice provides relief from the application of the Code’s
nondiscrimination requirements for certain governmental
and church plans. Notices 98–39 and 99–40 modified.
ADMINISTRATIVE
Notice 2001–7, page 374.
Information returns; payments to attorneys. The
Service intends to further delay the effective date of the reg-
ulations proposed under section 6045(f) of the Code (relat-
ing to the reporting of payments of gross proceeds to attor-
neys). Under this extension, the rules in section 1.6045–5
will apply to payments made during the first calendar year
that begins at least two months after the date of publication
of the final regulations in the Federal Register. Notice 99–53
modified and superseded.
Internal Revenue
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Bulletin No. 2001–4
January 22, 2001
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.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page ii.
(Continued on the next page)

January 22, 20012001–4 I.R.B.
Notice 2001–8, page 374.
Information returns; discharge of indebtedness. The
suspension of penalties under sections 6721 and 6722 of
the Code provided by Notice 2000–22, 2000–16 I.R.B. 902,
for certain organizations newly subject to section 6050P is
being extended. Penalties will not be imposed on such orga-
nizations for failure to file information returns under section
6050P for any discharge of indebtedness that occurs prior
to the first calendar year beginning at least two months after
the date that appropriate guidance is issued. Notice
2000–22 modified and superseded.
Rev. Proc. 2001–16, page 376.
Publication 1245 (Rev. 1–2001) provides specifications for
the filing of Forms W-4, Employee’s Withholding Allowance
Certificate, magnetically or electronically. Rev. Proc. 99–47
superseded.
Announcement 2001–10, page 431.
This document contains a notice of public hearing on pro-
posed regulations (REG–105316–98, 2000–27 I.R.B. 98),
regarding reporting for payments of qualified tuition and pay-
ments of interest on qualified education loans and magnetic
media filing requirements for information returns. The hear-
ing is scheduled for February 13, 2001.
Announcement 2001–11, page 432.
This document withdraws the notice of proposed rulemak-
ing (REG–116733–98, 1999–36 I.R.B. 392) relating to
recognition of gain on certain distributions of stock or secu-
rities of a controlled corporation in connection with an acqui-
sition.

2001–4 I.R.B.January 22, 2001
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
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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,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless oth-
erwise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Ser-
vice personnel in the disposition of other cases. In applying
published rulings and procedures, the effect of subsequent
legislation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same
conclusions in other cases unless the facts and circum-
stances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Ad-
ministrative Rulings. Bank Secrecy Act Administrative Rul-
ings are issued by the Department of the Treasury’s Office
of the Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The first 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 first Bulletin of the succeed-
ing semiannual period, respectively.
The IRS Mission
Provide America’s taxpayers top quality service by help-
ing them understand and meet their tax responsibilities
and by applying the tax law with integrity and fairness to
all.
Introduction
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Section 444.—Election of
Taxable Year Other Than
Required Taxable Year
26 CFR 1.444–4T: Tiered stucture (temporary).
T.D. 8915
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Tiered Structures-Electing Small
Business Trusts
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY:This document contains
temporary regulations amending the tem-
porary regulations under section 444 of
the Internal Revenue Code (Code) relating
to the election of a taxable year other than
the required taxable year. The temporary
regulations provide that solely with
respect to an S corporation shareholder,
an electing small business trust (ESBT)
and a trust that is described in section
401(a) or section 501(c)(3) and is exempt
from taxation under section 501(a) is not
a deferral entity for purposes of
§1.444–2T. The temporary regulations
affect S corporations, ESBTs that own S
corporation stock, and trusts that are
described in section 401(a) or section
501(c)(3) and exempt from taxation under
section 501(a) that own S corporation
stock. The text of these temporary regula-
tions serves as the text of the proposed
regulations set forth in the notice of pro-
posed rulemaking in REG–251701–96,
page 396.
DATES:Effective Date: These regulations
are effective December 29, 2000.
Applicability Dates: For dates of
applicability, see §1.444–4T of these reg-
ulations.
FOR FURTHER INFORMATION CON-
TACT: Bradford Poston and James A.
Quinn (202) 622-3060 (not toll-free num-
bers).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to
the Income Tax Regulations (26 CFR Part
1) relating to the election of a taxable year
other than the required taxable year under
section 444. Section 444(d)(3) and
§1.444–2T generally prohibit an S corpo-
ration that is a member of a tiered struc-
ture from making an election under sec-
tion 444 for taxable years beginning after
December 31, 1986. An S corporation is
considered to be a member of a tiered
structure if the S corporation owns any
portion of a deferral entity, or a deferral
entity owns any portion of an S corpora-
tion. Section 1.444–2T(b)(2) defines
deferral entity to include any entity that is
a trust with the exception of certain
grantor trusts (including qualified sub-
chapter S trusts within the meaning of
section 1361(d)(1)(A)).
Section 1302 of the Small Business Job
Protection Act of 1996, Public Law
104–188 (110 Stat. 1755) (August 20,
1996), modified sections 641 and 1361 of
the Internal Revenue Code (Code) to per-
mit an electing small business trust
(ESBT) to be an S corporation sharehold-
er and also modified section 1361 to allow
an organization (including a trust) that is
described in section 401(a) or section
501(c)(3) and that is exempt from taxation
under section 501(a) to be a shareholder
of an S corporation. The temporary regu-
lations under section 444 are also being
issued as proposed regulations
(REG–251701–96) on page 396 of this
Bulletin.
Explanation of Provisions
The temporary regulations modify the
temporary regulations under section 444
to provide that an ESBT and a trust that is
described in section 401(a) or section
501(c)(3) that is exempt from taxation
under section 501(a) is not a deferral enti-
ty for purposes of §1.444–2T. Therefore,
an S corporation with a section 444 elec-
tion may have an ESBT or a trust that is
described in section 401(a) or section
501(c)(3) that is exempt from taxation
under section 501(a) as a shareholder. An
ESBT is not a deferral entity within the
meaning of §1.444–2T because under sec-
tion 641(c) the portion of the ESBT con-
sisting of stock in one or more S corpora-
tions is taxed to the deemed owner under
subpart E, part I, subchapter J of the Code
or is subject to taxation at the trust level
without a deduction for amounts distrib-
uted or required to be distributed from that
portion of the trust. A trust described in
section 401(a) (other than an employee
stock ownership plan described in section
4975(e)(7)), or a trust described in section
501(c)(3) that is exempt from taxation
under section 501(a) is not a deferral enti-
ty within the meaning of §1.444–2T
because with respect to such trust all
items of income, loss, or deduction taken
into account under section 1366(a) and
any gain or loss on the disposition of the
stock in the S corporation is treated as
unrelated business taxable income of such
trust under section 512(e)(1) and is sub-
ject to taxation under section 511. A trust
described in section 401(a) that is an
employee stock ownership plan described
in section 4975(e)(7) is not a deferral enti-
ty within the meaning of §1.444–2T
because such trust does not defer taxation
but rather is exempt from taxation under
section 501(a) and is not treated as having
unrelated business taxable income pur-
suant to section 512(e)(3). The temporary
regulations are effective as of December
29, 2000. However taxpayers may volun-
tarily apply these temporary regulations to
taxable years of S corporations beginning
after December 31, 1996, for S corpora-
tions that have ESBTs as shareholders,
and for taxable years beginning after
December 31, 1997, for S corporations
that have trusts described in section
401(a) or section 501(c)(3) that are
exempt from taxation under section
501(a) as shareholders.
Special Analyses
It has been determined that this
Treasury decision is not a significant reg-
ulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
2001–4 I.R.B.359January 22, 2001
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

January 22, 20013602001–4 I.R.B.
tions, and, because the regulations do not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code,
these temporary regulations will be sub-
mitted to the Small Business
Administration for comment on the regu-
lation’s impact on small business.
Drafting Information
The principal authors of these regula-
tions are Bradford Poston and James A.
Quinn of the Office of the Associate Chief
Counsel (Passthroughs and Special
Industries). However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.444–4T is also issued under
26 U.S.C. 444(g). * * *
Par. 2. Section 1.444–4T is added
under the undesignated centerheading
“Accounting Periods” to read as follows:
§1.444–4T Tiered structure (temporary).
(a) Electing small business trusts. For
purposes of §1.444–2T, solely with respect
to an S corporation shareholder, the term
deferral entitydoes not include a trust that
is treated as an electing small business trust
under section 1361(e). An S corporation
with an electing small business trust as a
shareholder may make an election under
section 444. This paragraph (a) is applica-
ble beginning December 29, 2000, howev-
er taxpayers may voluntarily apply it to
taxable years of S corporations beginning
after December 31, 1996.
(b) Certain tax-exempt trusts. For pur-
poses of §1.444–2T, solely with respect to
an S corporation shareholder, the term
deferral entitydoes not include a trust that
is described in section 401(a) or section
501(c)(3) that is exempt from taxation
under section 501(a). An S corporation
with a trust that is described in section
401(a) or section 501(c)(3) that is exempt
from taxation under section 501(a) as a
shareholder may make an election under
section 444. This paragraph (b) is applic-
able beginning December 29, 2000, how-
ever taxpayers may voluntarily apply it to
taxable years of S corporations beginning
after December 31, 1997.
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 13, 2000.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on De-
cember 28, 2000, 8:45 a.m., and published in the
issue of the Federal Register for December 29, 2000,
65 F.R. 82926)
Section 904.—Limitation on
Credit
26 CFR 1.904–4: Separate application of section
904 with respect to certain categories of income.
T.D. 8916
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Application of Section 904 to
Income Subject to Separate
Limitations and Section 864(e)
Affiliated Group Expense
Allocation and Apportionment
Rules
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regula-
tions.
SUMMARY:This document contains
Income Tax Regulations relating to the
section 864(e)(5) and (6) rules on affiliat-
ed group interest and other expense allo-
cation and apportionment and to the sec-
tion 904(d) foreign tax credit limitation.
Changes to the applicable laws were made
by the Tax Reform Act of 1986, the
Technical and Miscellaneous Revenue Act
of 1988, the Revenue Reconciliation Act
of 1993, and the Taxpayer Relief Act of
1997. These regulations provide guidance
needed to comply with those changes and
affect individuals and corporations claim-
ing foreign tax credits.
DATES:Effective Date: These regula-
tions are effective January 3, 2001.
ApplicabilityDates: The specific dates
of applicability of these regulations are as
follows:
The amendments to §§1.861–9,
1.861–11, and 1.861–14 generally apply
to taxable years beginning after December
31, 1989. The dates of applicability are
stated in §1.861–9(h)(5)(i) and (ii),
§1.861–11(d)(8), and §1.861–14(d)(1),
(d)(2)(i), and (d)(2)(ii).
The amendment to §1.904–4(b)(1)(i)
applies to taxable years beginning after
December 31, 1992.
The amendments to §1.904–4(e)(3)(ii)
and (e)(3)(iv) apply to taxable years
beginning after December 31, 2000.
The amendments to §1.902–1(d)(3)(ii),
§1.904–4(c)(5)(v), (c)(6)(iv), (c)(7)(ii),
(c)(7)(iii), (c)(8) Example 9, and (g)(3),
and to §1.904–5(d)(2) and (m) apply to
taxable years beginning after December
31, 1986. However, for taxable years
beginning before January 1, 2001, taxpay-
ers may rely on §1.904–4(c)(6)(iv) and
(g)(3)(ii), (iii), and (iv) of regulations pro-
ject REG–209527–92, INTL–1–92, pub-
lished at 1992–1 C.B. 1209. See
§601.601(d)(2) of 26 CFR part 601
revised April 1, 2000.
The amendments to §1.904–5(a)(3),
(g), (h)(4), and (i)(1), (3), and (4) apply to
taxable years beginning after December
31, 2000. However, taxpayers may
choose to apply the rule of §1.904–5(i)(3)
in taxable years beginning after December
31, 1991, provided that the taxpayer
makes appropriate adjustments to elimi-
nate any double benefit arising from the
application of the rule to taxable years
that are not open for assessment.
ADDRESSES:Send submissions to:
Regulations Unit CC (REG–106409–00),
room 5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions
may be hand-delivered between the hours of
8 a.m. and 5 p.m. to Regulations Unit CC
(REG–106409–00),Courier’s Desk,
Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC or sent elec-
tronically, via the IRS Internet site at:
http://www.irs.gov/tax_regs/regslist.html.

FOR FURTHER INFORMATION CON-
TACT: Bethany A. Ingwalson at (202)
622-3850 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On May 14, 1992, a notice of proposed
rulemaking (INTL–1–92, 1992–1 C.B.
1209) was published in the Federal
Register(57 F.R. 20660), proposing
amendments to the temporary Income Tax
Regulations (26 CFR part 1) under section
864(e)(5) and (6) and to the Income Tax
Regulations (26 CFR part 1) under section
904(d). The proposed regulations under
section 864(e)(5) and (6) concern the allo-
cation and apportionment of interest
expense and certain other expenses within
an affiliated group for alternative mini-
mum tax purposes. The proposed regula-
tions under section 904(d) provide rules
for determining a taxpayer’s foreign tax
credit limitation.
Also on May 14, 1992, final regulations
(T.D. 8412, 1992–1 C.B. 271) under sec-
tion 904(d) of the Internal Revenue Code
of 1986 (Code) were published in the
Federal Register(57 F.R. 20639). The
final regulations added provisions that
were reserved in final regulations (T.D.
8214, 1988–2 C.B. 220) published in the
Federal Register(53 F.R. 27006) in 1988
and also made other changes to the 1988
final regulations. Written comments were
received with respect to the final and pro-
posed regulations and a public hearing
was held on September 24, 1992.
On July 8, 1996, additional proposed
amendments to the Income Tax Regulations
under section 904 (REG–209750–95,
1996–2 C.B. 484) were published in the
Federal Register(61 F.R. 35696), address-
ing the grouping rules under §1.904–4(c).
On January 11, 1999, final regulations (T.D.
8805, 1999–1 C.B. 371) were published in
the Federal Register(64 F.R. 1505) finaliz-
ing these amendments and portions of the
1992 proposed regulations, with modifica-
tions.
The significant points raised by the
comments to the 1992 final and proposed
regulations and at the hearing, and the
changes made to the proposed, temporary,
and final regulations, are discussed in the
remainder of the preamble. After consid-
eration of the comments received, the
below-described amendments to the 1992
final regulations under section 904 and to
the final regulations under section 864 are
adopted as modified by this Treasury
decision.
Explanation of Provisions
I. §§1.861–9, 1.861–11, and 1.861–14
The proposed regulations under
§§1.861–9, 1.861–11, and 1.861–14 are
finalized substantially as proposed, and
the corresponding provisions of the tem-
porary regulations are removed. For pur-
poses of the alternative minimum tax
(AMT), for taxable years beginning after
December 31, 1989, the dividends
received deduction under section 243 does
not apply to the portion of a dividend
attributable to income that is exempt from
tax under section 936 or 30A. See section
56(g)(4)(C). Therefore, the exempt por-
tion of the dividend is, in effect, included
in adjusted current earnings (ACE) for
purposes of computing the dividend recip-
ient’s alternative minimum taxable
income. Dividends from a corporation
with respect to which an election is in
effect under section 936 or 30A (a section
936 corporation) are eligible for the divi-
dends received deduction for regular tax
purposes. Section 243(b)(1)(B)(ii).
To the extent included in income, divi-
dends from a section 936 corporation to
an affiliated United States corporation do
not qualify for look-through treatment
under section 904(d)(3) and §1.904–5.
Under sections 904, 861(a)(2)(A), and
862(a)(2), such amounts generally are
treated as foreign source passive income
(except as otherwise provided in section
904(g)). For taxable years beginning after
December 31,1993,section
56(g)(4)(C)(iii)(IV), added to the Code as
part of the Revenue Reconciliation Act of
1993 (Public Law 103–66, 107 Stat. 312)
(RRA 1993), creates an AMT foreign tax
credit separate limitation for dividend
income attributable to income that is
exempt from tax under section 936 or
30A. The separate limitation applies sole-
ly for AMT purposes.
Thus, for taxable years beginning after
December 31, 1989, and before January 1,
1994, the portion of the dividends from
section 936 corporations that are added
back into alternative minimum taxable
income as ACE adjustments are subject to
the separate limitation for passive income
under section 904(d)(2) for AMT foreign
tax credit purposes. For taxable years
beginning after December 31, 1993, divi-
dends from section 936 corporations are
subject to a separate AMT foreign tax
credit limitation. In addition, for taxable
years beginning after December 31, 1995,
corporations eligible for a credit under
section 30A are treated as section 936 cor-
porations, under sections 30A(e) and
56(g)(4)(C)(iii)(VI).
Treasury and the IRS proposed changes
to the temporary regulations in order to
exclude section 936 corporations from the
affiliated group solely for purposes of
allocating expenses in determining the
amount of the group’s foreign source
alternative minimum taxable income,
which affects the AMT foreign tax credit.
This change has the effect of increasing
the amount of interest and other expenses
apportioned to dividend income from a
section 936 corporation. The regulations
were intended to mitigate the treatment,
for AMT foreign tax credit purposes, of
section 936 corporation dividends as pas-
sive income and would similarly mitigate
the treatment of such dividends as sepa-
rate limitation income in post-1993 tax-
able years.
Commentators wrote and testified at
the public hearing that Treasury and the
IRS do not have statutory authority to
issue regulations under section 864(e)(5)
excluding section 936 corporations from
the affiliated group solely for AMT pur-
poses. They contended that the AMT and
regular tax systems must remain parallel
unless a deviation is appropriate for sim-
plification purposes. However, the enact-
ment of a separate limitation category for
certain portions of dividends from section
936 corporations for AMT purposes,
effective for taxable years beginning after
1993, demonstrates that, because of the
ACE adjustment, the AMT and regular tax
foreign tax credit systems cannot operate
exactly alike with respect to dividend
income from section 936 corporations.
The amendments were proposed to
apply to taxable years beginning after
December 31, 1991. In response to a
comment, the applicability date of the
amendments to the regulations under
§§1.861–9, 1.861–11, and 1.861–14 has
been changed to taxable years beginning
after December 31, 1989, to conform to
the effective date of the statutory change.
2001–4 I.R.B.361January 22, 2001

The regulations also provide a definition
of section 936 corporations that reflects
the enactment of section 30A.
In addition, the regulations move the
flush text at the end of §1.861–11T(d)(6)
to a new §1.861–11(d)(7). The new para-
graph (d)(7) provides, among other
things, that the attribution rules of section
1563(e) rather than the rules of section
318 will apply to determine indirect own-
ership for purposes of §1.861–11T(d)(6).
The change in the regulations to refer to
section 1563(e) is consistent with para-
graph 7 of Notice 89–91 (1989–2 C.B.
408), which stated that the IRS intends
that the reference in §1.861–11T(d)(6) to
section 318 should instead be a reference
to section 1563(e), effective for all post-
1986 taxable years.
II.§1.904
A. Changes to the 1992 Proposed
Regulations.
1. Distributions From Controlled Foreign
Corporations That are not Eligible for
Look-Through Treatment
Section 1.904–4(g)(3)(i) provides that dis-
tributions made by a controlled foreign cor-
poration (CFC) from earnings and profits
accumulated before the distributing corpora-
tion became a CFC are treated as dividends
from a noncontrolled section 902 corpora-
tion. The final regulations reorganize the
provisions of §1.904–4(g)(3) and include a
reserved paragraph at §1.904–4(g)(3)(i)(C).
The regulations are proposed to be amended
in a separate document (REG–104683–00)
published on page 407 of this Bulletin to
address the effect of an intervening period
when the corporation was not a CFC on the
eligibility of the distributions for look-
through treatment.
Prior to amendment by the Taxpayer
Relief Act of 1997 (Public Law 105–34,
107 Stat. 312)(TRA 1997), section
904(d)(2)(E)(i) provided that a CFC
would not be treated as a noncontrolled
section 902 corporation with respect to
distributions from earnings and profits
that were accumulated while the corpora-
tion was a CFC and, except as provided in
regulations, the taxpayer was a United
States shareholder in such corporation.
The rule limiting look-through treatment
to earnings and profits accumulated while
the taxpayer was a United States share-
holder was repealed by TRA 1997, applic-
able for distributions after August 5, 1997.
With respect to distributions before
August 6,1997,§1.904–4(g)(3)(ii)
through (iv) of the proposed regulations
significantly limited the circumstances
under which a dividend paid to a new
United States shareholder by a CFC out of
earnings and profits accumulated while it
was a CFC (but before the recipient
became a United States shareholder)
would be treated as dividends from a non-
controlled section 902 corporation. The
final regulations at §1.904–4(g)(3)(ii)(A)
retain the proposed rule denying look-
through treatment only to new United
Sates shareholders that acquire more than
90 percent of a CFC. This rule relaxed the
statutory limitation to the extent necessary
to avoid the administrative burdens that
would arise if more than one United
States shareholder were entitled to look-
through treatment on distributions of post-
1986 undistributed earnings but the look-
through pools for each new shareholder
began in different years.
Commentators argued that the regula-
tions should be further expanded to allow
look-through on pre-acquisition earnings
for all new shareholders that acquire at
least 10 percent of the voting power of the
stock of a CFC, that is, to all new share-
holders entitled to compute a credit for
deemed-paid taxes under section 902 and
section 960. Treasury and the IRS
declined to adopt the suggestion, because
the proposed regulations already relaxed
the statutory requirement to an appropri-
ate extent.
A commentator suggested that the
intra-group acquisition rule in
§1.904–4(g)(3)(ii)(C) of the proposed reg-
ulations (paragraph (g)(3)(ii)(B) of the
final regulations) should be revised to
apply when the new and old shareholders
of a CFC are related under the attribution
rules of sections 318 and 958, rather than
only to transfers within an affiliated
group. Other commentators requested
that the exception be expanded to apply to
nontaxable transfers of stock in which the
new and old shareholders cease to be
members of the same affiliated group.
Treasury and the IRS decline to expand
the scope of the intra-group exception to
the 90-percent shareholder rule, which
applies only for distributions prior to
August 6, 1997. The final regulations
clarify the rule of the proposed regula-
tions that the dividend recipient and the
immediately preceding owner (or owners)
must be members of the same affiliated
group both when the recipient acquires
the stock of the distributing corporation
from the immediately preceding owner
and when the recipient receives the divi-
dend.
In response to a comment, the regula-
tions clarify the LIFO ordering rule in
§1.904–4(g)(3)(iii) of the proposed regu-
lations (paragraph (g)(3)(ii)(C) of the
final regulations) for determining whether
a distribution from a CFC is attributable to
the period after a more-than-90-percent
United States shareholder became a
United States shareholder. The final reg-
ulations state that such a distribution
comes first from the pool of post-acquisi-
tion undistributed earnings, next from the
10/50 pool of post-1986 undistributed
earnings attributable to the pre-acquisition
period, if any, and finally on a LIFO basis
from any pre-acquisition earnings and
profits attributable to pre-1987 accumu-
lated profits.
To reflect the amendments made to sec-
tion 904(d)(2)(E)(i) by TRA 1997, the
final regulations provide at
§1.904–4(g)(3)(ii)(D) that the denial of
look-through treatment to new more-than-
90-percent shareholders for distributions
of earnings and profits accumulated
before the recipient became a United
States shareholder applies only to distrib-
utions made before August 6, 1997.
Section 1.904–4(g)(3) has been reorga-
nized to separate the rules under section
904(d)(2)(E) that are applicable to distrib-
utions after August 5, 1997, from the rules
that are applicable only to distributions on
or before that date.
Rules substantially identical to the pro-
posed section 904 regulations were pro-
posed in 1995 under section 902. See
Prop. Reg. §1.902–1(d)(2)(ii) through (iv)
(69 F.R. 2049; 1995–1 C.B. 959, 970),
and the reserved paragraph at
§1.902–1(d)(3)(ii) (1997). A commenta-
tor noted that the effective date included
in the proposed section 902 regulations
applied to taxable years beginning after
December 31, 1986, while the proposed
applicability date for the substantially
identical regulations proposed under sec-
tion 904(d) applied to taxable years begin-
ning after December 31, 1991. Since sec-
January 22, 20013622001–4 I.R.B.

tion 904(d)(2)(E)(i) applies to all taxable
years beginning after 1986, the final regu-
lations adopt the earlier applicability date,
and amend the reserved paragraph at
§1.902–1(d)(3)(ii) to add a cross refer-
ence to the final section 904 regulations.
2. Succeeding Shareholders’ Treatment
of Additional Taxes on Previously Taxed
Income Recognized by Prior
Shareholders
In response to a comment,
§1.904–4(c)(6)(iv) of the proposed regu-
lations is revised. Section 1.904–4(c)(6)
provides rules for applying the high-tax
kick-out from the passive limitation cate-
gory when additional taxes are paid or
deemed paid with respect to a distribution
of previously taxed passive income that
had been included in income in an earlier
year under section 951(a)(1). Paragraph
(c)(6)(iv) applies when a new shareholder
acquires stock in a controlled foreign cor-
poration after income has been included
in the prior shareholder’s income under
section 951(a)(1) but before the income is
distributed and subjected to additional
foreign tax.
As proposed, paragraph (c)(6)(iv) pro-
vided that new shareholders entitled to
look-through treatment on distributions of
pre-acquisition earnings (U.S. sharehold-
ers that acquired 90 percent or less of the
distributing corporation) would place the
additional taxes in the general limitation
category. However, new shareholders
who were not entitled to look-through
treatment (because the shareholder
acquired more than 90 percent of the dis-
tributing corporation) would place the
taxes in the general limitation or noncon-
trolled section 902 corporation category,
depending on whether or not the associat-
ed income inclusion of the prior share-
holder was high-taxed income.
A commentator argued that the latter
rule’s dependence on whether income was
high-taxed or not in the hands of the pre-
vious shareholder, for purposes of deter-
mining the treatment of the taxes in the
hands of a new 90-percent shareholder,
added unnecessary complexity. In
response to the comment, the regulations
amend §1.904–4(c)(6)(iv) to provide that
a shareholder not entitled to look-through
on pre-acquisition earnings must treat the
additional taxes as allocable to the non-
controlled section 902 corporation divi-
dend category. The revised rule applies to
taxable years beginning after December
31, 1991. However, taxpayers may rely
on the proposed regulations for taxable
years beginning before January 1, 2001.
The final regulations adopt the pro-
posed rule that a shareholder entitled to
look-through treatment on pre-acquisition
earnings treats additional taxes imposed
on distributions of previously taxed pas-
sive income as allocable to the general
limitation category. This rule applies to
all distributions of previously taxed pas-
sive income after August 5, 1997.
3. Special Rules for Dividends Between
CFCs
Section 1.904–5(i)(3) of the proposed
regulations, reducing to ten percent the
common ownership threshold for divi-
dends between CFCs to qualify for look-
through treatment, is finalized as pro-
posed, applicable to taxable years
beginning after December 31, 2000.
However, taxpayers may choose to apply
the rule to taxable years beginning after
December 31, 1991, so long as appropri-
ate adjustments are made to eliminate any
double benefit arising from the applica-
tion of the rule to taxable years that are
not open for assessment. Example 2of
proposed §1.904–5(i)(4) is also finalized,
with modifications described in II B.4 of
this preamble, below, relating to changes
to correct errors in Example 1in the 1992
final regulations.
B.Changes to the 1992 Final
Regulations.
1. Passive Limitation FOGEI Income
Section 1.904–4(b)(1)(i) is amended to
clarify that, for taxable years beginning
after December 31, 1992, passive income
does not exclude foreign oil and gas
extraction income (as defined in section
907(c)). This amendment reflects the
repeal of section 904(d)(2)(A)(iii)(IV),
which excluded FOGEI from the defini-
tion of passive income, by section
13235(a)(2) of RRA 1993.
2. High-tax Kickout
Section 1.904–4(c)(4)(ii) is revised to
reflect the addition of §1.904–4(c)(3)(iv).
3. Reduction in Tax on Distribution of
Previously Taxed Income
The 1992 final regulations, which gen-
erally look to foreign law rules for pur-
poses of determining the year or years to
which a reduction in foreign tax relates,
were intended to apply LIFO default rules
in order to avoid multiple redetermina-
tions under section 905(c) in situations
where a tax reduction applies to a distrib-
ution of previously taxed income that is
treated under foreign law as made out of a
multi-year pool of income. See
§1.905–3T(f) (requiring a redetermination
of deemed paid taxes, in lieu of a pooling
adjustment, when corporate tax is reduced
in connection with a distribution of previ-
ously taxed income).
In response to a comment,
§1.904–4(c)(7)(ii) and §1.904–4(c)(8)
Example 9are revised to clarify that if a
foreign country’s law allocates a foreign
tax reduction to a pool or group contain-
ing income from more than one taxable
year, and that pool or group is defined
based on a characteristic of the income
(for example, the rate of tax paid with
respect to the income) rather than based
on the taxable year in which the income is
derived, then foreign law is not considered
to specify a year or years to which the tax
reduction applies and the last-in first-out
(LIFO) default rule applies.
In response to a comment, a new para-
graph (c)(5)(v) has been added to
§1.904–4 to supply a cross-reference to
the rule that, pursuant to the general rule
of section 904(d)(3)(E), passive income
excluded from foreign personal holding
company income under the subpart F high
tax exception of section 954(b)(4) will be
treated as general limitation income at the
CFC level unless the special rule in
§1.904–4(c)(7)(iii) applies.
4. Examples Illustrating Look-Through
Rules for Dividends and Interest
In response to comments,
§1.904–5(i)(4) Example 1and Prop.
§1.904–5(i)(4) Example 2are revised.
The 1992 version of Example 1was erro-
neous because, although the first-tier CFC
in that example owns only 40 percent of
the second-tier CFC, the second-tier CFC
owns 100 percent of the third-tier CFC.
Therefore, the second- and third-tier
CFCs are related look-through entities
and the look-through rules of
§1.904–5(i)(1) apply to interest payments
between them. The section 904(d)(3)(B)
2001–4 I.R.B.363January 22, 2001

January 22, 20013642001–4 I.R.B.
look-through rule for subpart F inclusions
applies to the U.S. parent’s recognition of
subpart F income of the second-tier CFC,
attributable to the interest paid by the
third-tier CFC.
Example 2of the proposed regulations
reached the correct result but applied an
incorrect rationale. Just as in Example 1,
on the facts of proposed Example 2,the
related look-through entity rules of
§1.904–5(i)(1) would apply to distribu-
tions between the second- and third-tier
CFCs even without the application of the
special rule for dividends in proposed
§1.904–5(i)(3). Examples 1and 2are
revised to illustrate the different owner-
ship thresholds that are required in order
for the look-through rules to apply to
interest and dividends paid between
CFCs. The regulations also add a new
Example 3to further clarify the applica-
tion of §1.904–5(i).
5. Treatment of Section 951(a)(1)(B)
Inclusions as Dividends
Paragraph (m)(4) of §1.904–5 is amend-
ed to clarify that, for purposes of the section
904(g) re-sourcing rules,section
951(a)(1)(B) inclusions are treated as divi-
dends sourced under the pro ratarule of
section 904(g)(4) and §1.904–5(m)(4).
Section 904(g)(2) provides a rule for sourc-
ing section 951(a) inclusions, which literal-
ly include section 956 inclusions described
in section 951(a)(1)(B). Section 904(g)(2)
treats an amount described in section
951(a) as U.S. source income to the extent
it is attributable to items of U.S. source
income of the foreign corporation.
Inclusions under section 951(a)(1)(A) are
measured by tracing the inclusion directly
to the items of income received by a CFC.
Like an actual dividend, an increase in earn-
ings invested in U.S. property that is includ-
ed in income under section 951(a)(1)(B) is
treated as paid pro rata out of all of the
CFC’s earnings and profits. See
§1.904–5(c)(4)(i). The final regulations
amend §1.904–5(m)(4)(i) to clarify that
section 904(g)(2) sources section
951(a)(1)(B) inclusions by applying the pro
ratarules of section 904(g)(4).
6. Treatment of Base Differences in the
Case of Financial Services Entities
A commentator requested that
§1.904–6(a)(1)(iv) be revised to provide
that, in the case of a financial services
entity, if foreign taxes are imposed on
amounts that are not income under United
States tax rules (a base difference), the
foreign taxes will be placed in the limita-
tion category for financial services
income rather than the general limitation
category. The commentator argued that
financial services entities typically have
no general limitation income, and that the
financial services category essentially
serves as the residual basket for financial
services entities.
Treasury and the IRS decline to adopt
the suggested change. Treasury and the
IRS believe that most cases in which for-
eign tax is imposed in the absence of a
concurrent associated income inclusion in
the United States are properly analyzed as
involving a timing difference rather than a
base difference. A timing difference
occurs when foreign tax is imposed on an
item that would be income under United
States tax principles if it were recognized
for U.S. tax purposes in the same year.
Treasury and the IRS believe that base
differences (in which foreign tax is
imposed on an amount that the United
States would never recognize as income,
such as a gift) rarely occur. Accordingly,
a special rule for base differences of
financial services entities is not required.
However, Treasury and the IRS are con-
sidering whether additional rules are need-
ed to clarify the operation of
§1.904–6(a)(1)(iv). For example, Treasury
and the IRS are considering whether the
regulations should be revised to address
explicitly situations in which a foreign
country and the United States recognize
different amounts of income or characterize
the income differently, for example, as a
result of differences in calculating basis.
Other issues under consideration include
the appropriate treatment of situations in
which a timing difference occurs but there
is more than one possible characterization
of the income that might be recognized in
the future for U.S. tax purposes, and situa-
tions in which the United States and anoth-
er country perceive different taxpayers as
realizing the same income (with or without
a timing or characterization difference).
Comments are requested on the appropriate
scope and content of additional guidance on
these types of issues.
Treasury and the IRS are also consider-
ing clarifying §1.904–6(a)(1), which pro-
vides rules for allocating foreign taxes to
separate categories. The current regula-
tions determine the income to which the
foreign taxes relate by reference to for-
eign law (taxes are related to income if the
income is included in the tax base upon
which the foreign tax is imposed).
Foreign taxes are allocated and appor-
tioned to separate categories by reference
to the separate categories to which the
income taxed under foreign law would be
assigned under U.S. tax principles. See
§1.904–6(c) Example 5. Comments are
requested on the manner in which the reg-
ulations could be made easier to under-
stand and apply.
Special Analyses
It has been determined that this
Treasury decision is not a significant reg-
ulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions, and because the notice of proposed
rulemaking preceding the regulations was
issued prior to March 29, 1996, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, the notice of
proposed rulemaking preceding these reg-
ulations was submitted to the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal author of these final reg-
ulations is Rebecca I. Rosenberg of the
Office of Associate Chief Counsel
(International), within the Office of Chief
Counsel, IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding citations for
§§1.861–9, 1.861–ll and 1.861–14 to read
as follows:

2001–4 I.R.B.365January 22, 2001
Authority: 26 U.S.C. 7805 * * *
Section 1.861–9 also issued under 26
U.S.C. 863(a), 26 U.S.C. 864(e), 26
U.S.C. 865(i), and 26 U.S.C. 7701(f). * *
*
Section 1.861–11 also issued under 26
U.S.C. 863(a), 26 U.S.C. 864(e), 26
U.S.C. 865(i), and 26 U.S.C. 7701(f).
Section 1.861–14 also issued under 26
U.S.C. 863(a), 26 U.S.C. 864(e), 26
U.S.C. 865(i), and 26 U.S.C. 7701(f).* *
*
Par. 2. Section 1.861–9 is added to read
as follows:
§1.861–9 Allocation and apportionment
of interest expense.
(a) through (h)(4) [Reserved]. For fur-
ther guidance, see §1.861–9T(a) through
(h)(4).
(h)(5) Characterizing stock in related
persons—(i) General rule. Stock in a
related person held by the taxpayer or by
another related person shall be character-
ized on the basis of the fair market value
of the taxpayer’s pro rata share of assets
held by the related person attributed to
each statutory grouping and the residual
grouping under the stock characterization
rules of §1.861–12T(c)(3)(ii), except that
the portion of the value of intangible
assets of the taxpayer and related persons
that is apportioned to the related person
under §1.861–9T(h)(2) shall be character-
ized on the basis of the net income before
interest expense of the related person
within each statutory grouping or residual
grouping (excluding income that is pas-
sive under §1.904–4(b)).
(ii) Special rule for section 936 corpo-
rations regarding alternative minimum
tax. For purposes of characterizing stock
in a related section 936 corporation in
determining foreign source alternative
minimum taxable income within each
separate category and the alternative min-
imum tax foreign tax credit pursuant to
section 59(a),the rules of
§1.861–9T(g)(3) shall apply and
§1.861–9(h)(5)(i) shall not apply. Thus,
for taxable years beginning after
December 31, 1989, and before January
1, 1994, stock in a related section 936
corporation is characterized for alterna-
tive minimum tax purposes as a foreign
source passive asset because the stock
produces foreign source passive dividend
income under sections 861(a)(2)(A),
862(a)(2), and 904(d)(2)(A) and the regu-
lations under those sections. For taxable
years beginning after December 31, 1993,
stock in a related section 936 corporation
would be characterized for alternative
minimum tax purposes as an asset subject
to the separate limitation for section 936
corporation dividends because the stock
produces foreign source dividend income
that, for alternative minimum tax purpos-
es, is subject to a separate foreign tax
credit limitation under section
56(g)(4)(C)(iii)(IV). However, stock in a
section 936 corporation is characterized
as a U.S. source asset to the extent
required by section 904(g). For the defi-
nition of the term section 936 corporation
see §1.861–11(d)(2)(ii).
(iii) Effective date. This paragraph
(h)(5) applies to taxable years beginning
after December 31, 1989.
Par. 3. In §1.861–9T, paragraph (h)(5)
is revised to read as follows:
§1.861–9T Allocation and apportionment
of interest expense (temporary).
* * * * *
(h) * * *
(5) [Reserved]. For further guidance,
see §1.861–9(h)(5).
* * * * *
Par. 4. Section 1.861–11 is added to
read as follows:
§1.861–11 Special rules for allocating
and apportioning interest expense of an
affiliated group of corporations.
(a) through (c) [Reserved]. For further
guidance, see §1.861–11T(a) through (c).
(d) Definition of affiliated group—(1)
General rule. For purposes of this section,
in general, the term affiliated grouphas
the same meaning as is given that term by
section 1504, except that section 936 cor-
porations are also included within the
affiliated group to the extent provided in
paragraph (d)(2) of this section. Section
1504(a) defines an affiliated group as one
or more chains of includible corporations
connected through 80-percent stock own-
ership with a common parent corporation
which is an includible corporation (as
defined in section 1504(b)). In the case of
a corporation that either becomes or ceas-
es to be a member of the group during the
course of the corporation’s taxable year,
only the interest expense incurred by the
group member during the period of mem-
bership shall be allocated and apportioned
as if all members of the group were a sin-
gle corporation. In this regard, assets held
during the period of membership shall be
taken into account. Other interest
expense incurred by the group member
during its taxable year but not during the
period of membership shall be allocated
and apportioned without regard to the
other members of the group.
(2) Inclusion of section 936 corpora-
tions—(i) Rule—(A) In general. Except
as otherwise provided in paragraph
(d)(2)(i)(B) of this section, the exclusion
of section 936 corporations from the affil-
iated group under section 1504(b)(4) does
not apply for purposes of this section.
Thus, a section 936 corporation that
meets the ownership requirements of sec-
tion 1504(a) is a member of the affiliated
group.
(B) Exception for purposes of alterna-
tive minimum tax. The exclusion from the
affiliated group of section 936 corpora-
tions under section 1504(b)(4) shall be
operative for purposes of the application
of this section solely in determining the
amount of foreign source alternative min-
imum taxable income within each sepa-
rate category and the alternative mini-
mum tax foreign tax credit pursuant to
section 59(a). Thus, a section 936 corpo-
ration that meets the ownership require-
ments of section 1504(a) is not a member
of the affiliated group for purposes of
determining the amount of foreign source
alternative minimum taxable income
within each separate category and the
alternative minimum tax foreign tax cred-
it pursuant to section 59(a).
(ii) Section 936 corporation defined.
For purposes of this section, §1.861–9,
and §1.861–14, the term section 936 cor-
porationmeans, for any taxable year, a
corporation with an election in effect to
be eligible for the credit provided under
section 936(a)(1) or section 30A for the
taxable year.
(iii) Example. This example illustrates
the provisions of paragraph (d)(2)(i) of
this section:
Example—(A) Facts. X owns all of the stock of
Y. XY constitutes an affiliated group of corpora-
tions within the meaning of section 1504(a) and uses
the tax book value method of apportionment. In
2000, Y owns all of the stock of Z, a section 936 cor-

January 22, 20013662001–4 I.R.B.
poration. Z manufactures widgets in Puerto Rico. Y
purchases these widgets and markets them exclu-
sively in the United States. Of the three corpora-
tions, only Z has foreign source income, which
includes both qualified possessions source invest-
ment income and general limitation income. For
purposes of section 904, Z’s qualified possessions
source investment income constitutes foreign source
passive income. In computing the section 30A ben-
efit, Y and Z have elected the cost sharing method.
Of the three corporations, only X has debt and, thus,
only X incurs interest expense.
(B) Analysis for regular tax. Assume first that X
has no alternative minimum tax liability. Under
paragraph (d)(2) of this section, Z is treated as a
member of the XY affiliated group for purposes of
allocating and apportioning interest expense for reg-
ular tax purposes. As provided in §1.861–11T(b)(2),
section 864(e)(1) and (5) do not apply in computing
the combined taxable income of Y and Z under sec-
tion 936, but these rules do apply in computing the
foreign source taxable income of the XY affiliated
group. The effect of including Z in the affiliated
group is that X, the only debtor corporation in the
group, must, under the asset method described in
§1.861–9T(g), apportion a part of its interest
expense to foreign source passive income and for-
eign source general limitation income. This is
because the assets of Z that generate qualified pos-
sessions source investment income and general lim-
itation income are included in computing the group
apportionment fractions. The result is that, under
section 904(f), X has an overall foreign loss in both
the passive and general limitation categories, which
currently offsets domestic income and must be
recaptured against any subsequent years’ foreign
passive income and general limitation income,
respectively, under the rules of that section.
(C) Analysis for alternative minimum tax.
Assume, alternatively, that X is liable to pay the
alternative minimum tax. Pursuant to section 59(a),
X must compute its alternative minimum tax foreign
tax credit as if section 904 were applied on the basis
of alternative minimum taxable income instead of
taxable income. Under paragraph (d)(2)(i)(B) of this
section, for purposes of the apportionment of inter-
est expense in determining alternative minimum tax-
able income within each limitation category, Z is not
considered a member of the XY affiliated group.
Thus, the stock (and not the assets) of Z are includ-
ed in computing the group apportionment fractions.
Pursuant to sections 59(g)(4)(C)(iii)(IV),
861(a)(2)(A), and 862(a)(2), dividends paid by a
section 936 corporation are foreign source income
subject to a separate foreign tax credit limitation for
alternative minimum tax purposes. Thus, under
§1.861–9T(g)(3), the stock of Z must be considered
attributable solely to the statutory grouping consist-
ing of foreign source dividends from Z. The effect
of excluding Z from the affiliated group is that X
must apportion a part of its interest expense to the
separate category for foreign source dividends from
Z in computing alternative minimum taxable income
within each separate category. If, as a result, under
section 904(f), X has a separate limitation loss or an
overall foreign loss in the category for dividends
from Z for alternative minimum tax purposes, then
that loss must be allocated against X’s other income
(separate limitation or United States source, as the
case may be). The loss must be recaptured in subse-
quent years under the rules of section 904(f) for pur-
poses of the alternative minimum tax foreign tax
credit. * * *
(iv) Effective date. This paragraph
(d)(2) applies to taxable years beginning
after December 31, 1989.
(d)(3) through (6) [Reserved]. For fur-
ther guidance see §1.861–11T(d)(3)
through (6).
(7) Special rules for the application of
§1.861–11T(d)(6). The attribution rules
of section 1563(e) and the regulations
under that section shall apply in determin-
ing indirect ownership under
§1.861–11T(d)(6). The Commissioner
shall have the authority to disregard trusts,
partnerships, and pass-through entities
that break affiliated status. Corporations
described in §1.861–11T(d)(6) shall be
considered to constitute members of an
affiliated group that does not file a consol-
idated return and shall therefore be sub-
ject to the limitations imposed under
§1.861–11T(g). The affiliated group fil-
ing a consolidated return shall be consid-
ered to constitute a single corporation for
purposes of applying the rules of
§1.861–11T(g). For taxable years begin-
ning after December 31,1989,
§1.861–11T(d)(6)(i) shall not apply in
determining foreign source alternative
minimum taxable income within each
separate category and the alternative min-
imum tax foreign tax credit pursuant to
section 59(a) to the extent that such appli-
cation would result in the inclusion of a
section 936 corporation within the affiliat-
ed group. This paragraph (d)(7) applies to
taxable years beginning after December
31, 1986.
(e) through (g) [Reserved]. For further
guidance, see §1.861–11T(e) through (g).
Par. 5. Section 1.861–11T is amended
by:
1. Revising paragraphs (d)(1) and
(d)(2).
2. Removing the concluding text fol-
lowing (d)(6)(ii).
3. Adding paragraph (d)(7).
The revisions and additions read as fol-
lows:
§1.861–11T Special rules for allocating
and apportioning interest expense of an
affiliated group of corporations
(temporary).
* * * * *
(d) (1) and (2) [Reserved]. For further
guidance, see §1.861–11(d)(1) and (2).
* * * * *
(7) Special rules for the application of
§1.861–11T(d)(6). [Reserved]. For spe-
cial rules for the application of
§1.861–11T(d)(6), see §1.861–11(d)(7).
* * * * *
Par. 6. Section 1.861–14 is added to
read as follows:
§1.861–14 Special rules for allocating
and apportioning certain expenses (other
than interest expense) of an affiliated
group of corporations.
(a) through (c) [Reserved]. For further
guidance, see §1.861–14T(a) through (c).
(d) Definition of affiliated group—(1)
General rule. For purposes of this sec-
tion, the term affiliated grouphas the
same meaning as is given that term by
section 1504, except that section 936 cor-
porations (as defined in
§1.861–11(d)(2)(ii)) are also included
within the affiliated group to the extent
provided in paragraph (d)(2) of this sec-
tion. Section 1504(a) defines an affiliated
group as one or more chains of includible
corporations connected through 80%
stock ownership with a common parent
corporation which is an includible corpo-
ration (as defined in section 1504(b)). In
the case of a corporation that either
becomes or ceases to be a member of the
group during the course of the corpora-
tion’s taxable year, only the expenses
incurred by the group member during the
period of membership shall be allocated
and apportioned as if all members of the
group were a single corporation. In this
regard, the apportionment factor chosen
shall relate only to the period of member-
ship. For example, if apportionment on
the basis of assets is chosen, the average
amount of assets (tax book value or fair
market value) for the taxable year shall be
multiplied by a fraction, the numerator of
which is the number of months of the cor-
poration’s taxable year during which the
corporation was a member of the affiliat-
ed group, and the denominator of which is
the number of months within the corpora-
tion’s taxable year. If apportionment on
the basis of gross income is chosen, only
gross income generated during the period
of membership shall be taken into
account. If apportionment on the basis of
units sold or sales receipts is chosen, only

2001–4 I.R.B.367January 22, 2001
units sold or sales receipts during the peri-
od of membership shall be taken into
account. Expenses incurred by the group
member during its taxable year, but not
during the period of membership, shall be
allocated and apportioned without regard
to other members of the group. This
paragraph (d)(1) applies to taxable years
beginning after December 31, 1989.
(2) Inclusion of section 936 corpora-
tions—(i) General rule. Except as other-
wise provided in paragraph (d)(2)(ii) of
this section, the exclusion from the affili-
ated group of section 936 corporations
under section 1504(b)(4) does not apply
for purposes of this section. Thus, a sec-
tion 936 corporation that meets the own-
ership requirements of section 1504(a) is
a member of the affiliated group.
(ii) Exception for purposes of alterna-
tive minimum tax. The exclusion from the
affiliated group of section 936 corpora-
tions under section 1504(b)(4) shall be
operative for purposes of the application
of this section solely in determining the
amount of foreign source alternative min-
imum taxable income within each sepa-
rate category and the alternative minimum
tax foreign tax credit pursuant to section
59(a). Thus, a section 936 corporation
that meets the ownership requirements of
section 1504(a) is not a member of the
affiliated group for purposes of determin-
ing the amount of foreign source alterna-
tive minimum taxable income within each
separate category and the alternative min-
imum tax foreign tax credit pursuant to
section 59(a).
(iii) Effective date. This paragraph
(d)(2) applies to taxable years beginning
after December 31, 1989.
(d)(3) through (j) [Reserved]. For fur-
ther guidance see §1.861–14T(d)(3)
through (j).
Par. 7. In §1.861–14T, paragraph (d) is
revised to read as follows:
§1.861–14T Special rules for allocating
and apportioning certain expenses (other
than interest expense) of an affiliated
group of corporations (temporary).
* * * * *
(d)(1) and (2) [Reserved]. For further
guidance, see §1.861–14(d)(1) and (2).
* * * * *
Par. 8. Section 1.902–1(d)(3)(ii) is
amended by adding text to read as fol-
lows:
§1.902–1 Credit for domestic corporate
shareholder of a foreign corporation for
foreign income taxes paid by the foreign
corporation.
* * * * *
(d) * * *
(3) * * *
(ii) * * * For rules regarding dividend
distributions before August 6, 1997, to
certain more-than-90-percent United
States shareholders of a controlled foreign
corporation, see §1.904–4(g)(3)(ii).
* * * * *
Par. 9. Section 1.904–0 is amended as
follows:
1. Amending the entries for §1.904–4
by:
a. Adding entries for paragraphs
(c)(5)(v), (c)(6)(iv)(A), and (c)(6)(iv)(B).
b. Adding an entry for paragraph
(g)(2)(v).
c. Revising the entries for paragraphs
(g)(3) and (g)(3)(i).
d. Adding entries for paragraphs
(g)(3)(i)(A), (g)(3)(i)(B), (g)(3)(i)(C), and
(g)(3)(i)(D).
e. Revising the entry for paragraph
(g)(3)(ii).
f. Adding entries for paragraphs
(g)(3)(ii)(A), (g)(3)(ii)(B), (g)(3)(ii)(C),
(g)(3)(ii)(D), and (g)(3)(ii)(E).
g. Revising the entries for paragraphs
(g)(3)(iii) and (g)(3)(iv).
h. Adding an entry for paragraph
(g)(3)(v).
i. Removing the entry for paragraph
(g)(4).
The revisions and additions read as fol-
lows:
§1.904–0 Outline of regulation
provisions for section 904.
* * * * *
§1.904–4 Separate application of section
904 with respect to certain categories of
income.
* * * * *
(c) * * *
(5) * * *
(v) Coordination with section 954(b)(4).
(6) * * *
(iv) * * *
(A) General rule.
(B) Exception for U.S. shareholders not
entitled to look-through.
* * * * *
(g) * * *
(2) * * *
(v) Examples.
(3) Special rule for dividends paid by a
controlled foreign corporation.
(i) Distributions out of earnings and prof-
its accumulated when the distributing cor-
poration was not a controlled foreign cor-
poration.
(A) General rule.
(B) Ordering rule.
(C) Effect of intervening noncontrolled
status.
(D) Examples.
(ii) Pre-August 6, 1997, dividend distribu-
tions out of earnings and profits accumu-
lated before a more-than-90-percent
United States shareholder became a
United States shareholder.
(A) General rule.
(B) Exception for intra-group acquisi-
tions.
(C) Ordering rule.
(D) Distributions after August 5, 1997.
(E) Examples.
(iii) Treatment of earnings and profits for
transition year.
(iv) Definitions.
(v) Effective date.
* * * * *
Par. 10. Section 1.904–4 is amended by:
1. Revising the second sentence in
paragraph (b)(1)(i)(B).
2. Revising paragraph (c)(4)(ii).
3. Adding a new paragraph (c)(5)(v).
4. Adding the text to paragraph
(c)(6)(iv).
5. Adding a new sentence at the end of
paragraph (c)(7)(ii).
6. Revising the second sentence of
paragraph (c)(7)(iii).
7. Amending paragraph (c)(8) by revis-
ing the fifth sentence of paragraph (i) of
Example 9, and the fifth sentence of para-
graph (ii) of Example 9.
8. Revising paragraph (e)(3)(ii).
9. Adding the text to paragraph
(e)(3)(iv) Example 2.
10. Redesignating paragraph (g)(4) as
paragraph (g)(2)(v).
11. Revising the heading for paragraph
(d)(3) and revising paragraph (g)(3)(i).
12. Revising the paragraph headings
and adding the text to paragraphs
(g)(3)(ii) through (iv).
13. Adding paragraph (g)(3)(v).
The revisions and additions read as fol-
lows:

January 22, 20013682001–4 I.R.B.
§1.904–4 Separate application of section
904 with respect to certain categories of
income.
* * * * *
(b) * * * (1) * * * (i) * * *
(B) * * * Passive income does not
include any income that is also described
in section 904(d)(1)(B) through (H), any
export financing interest (as defined in
section 904(d)(2)(G) and paragraph (h) of
this section), any high taxed income (as
defined in section 904(d)(2)(F) and para-
graph (c) of this section, or, for taxable
years beginning before January 1, 1993,
any foreign oil and gas extraction income
(as defined in section 907(c)). * * *
* * * * *
(c) * * *
(4) * * *
(ii) Income from sources without the
QBU’s country of operation. Passive
income from sources without the QBU’s
country of operation shall be grouped on
the basis of the tax imposed on that
income as provided in paragraphs (c)(3)(i)
through (iv) of this section.
* * * * *
(5) * * *
(v) Coordination with section
954(b)(4). For rules relating to passive
income of a controlled foreign corpora-
tion that is exempt from subpart F treat-
ment because the income is subject to
high foreign tax, see section 904(d)(3)(E),
§1.904–4(c)(7)(iii), and §1.904–5(d)(2).
(6) * * *
(iv) Increase in taxes paid by succes-
sors—(A) General rule. Except as pro-
vided in paragraph (c)(6)(iv)(B) of this
section, if passive earnings and profits
previously included in income of a United
States shareholder are distributed to a per-
son that was not a United States share-
holder of the distributing corporation in
the year the earnings were included, any
increase in foreign taxes paid or accrued,
or deemed paid or accrued, on that distri-
bution shall be treated as taxes related to
general limitation income, regardless of
whether the previously-taxed income was
considered high-taxed income under sec-
tion 904(d)(2)(F) in the year of inclusion.
(B) Exception for U.S. shareholders
not entitled to look-through. In the case of
a United States shareholder that, by rea-
son of paragraph (g)(3)(ii) of this section
(relating to distributions prior to August 6,
1997, to new shareholders acquiring more
than 90 percent of a controlled foreign
corporation), is not entitled to look-
through treatment with respect to pre-
acquisition earnings and profits of the dis-
tributing corporation, the increase in
foreign taxes described in paragraph
(c)(6)(iv)(A) of this section shall be treat-
ed as taxes related to the noncontrolled
section 902 corporation income of the dis-
tributing corporation.
(C) Effective date. This paragraph
(c)(6)(iv) applies to taxable years begin-
ning after December 31, 1986. However,
for taxable years beginning before
January 1, 2001, taxpayers may rely on
§1.904–4(c)(6)(iv) of regulations project
INTL–1–92, published at 1992–1 C.B.
1209. See §601.601(d)(2) of this chapter.
(7) * * *
(ii) * * * For purposes of this paragraph
(c)(7)(ii), foreign law is not considered to
attribute a reduction in tax to a particular
year or years if foreign law attributes the
tax reduction to a pool or group contain-
ing income from more than one taxable
year and such pool or group is defined
based on a characteristic of the income
(for example, the rate of tax paid with
respect to the income) rather than on the
taxable year in which the income is
derived.
(iii) * * * If a taxpayer excludes passive
income from a controlled foreign corpora-
tion’s foreign personal holding company
income under these circumstances, then,
notwithstanding the general rule of
§1.904–5(d)(2), the income shall be con-
sidered to be passive income until distrib-
ution of that income.* * *
(8) * * *
Example 9. (i) * * * Under country G’s
law, distributions are treated as made out
of a pool of undistributed earnings subject
to the 50% tax rate. * * *
(ii) * * * Country G treats the distribu-
tion of earnings as out of the 50% tax rate
pool of earnings accumulated in 1987 and
1988. * * *
* * * * *
(e) * * *
(3) * * *
(ii) Special rule for affiliated groups.
In the case of any corporation that is not a
financial services entity under paragraph
(e)(3)(i) of this section, but is a member of
an affiliated group, such corporation will
be deemed to be a financial services enti-
ty if the affiliated group as a whole meets
the requirements of paragraph (e)(3)(i) of
this section. For purposes of this para-
graph (e)(3)(ii), affiliated group means an
affiliated group as defined in section
1504(a), determined without regard to
section 1504(b)(3). In counting the
income of the group for purposes of deter-
mining whether the group meets the
requirements of paragraph (e)(3)(i) of this
section, the following rules apply. Only
the income of group members that are
United States corporations or foreign cor-
porations that are controlled foreign cor-
porations in which United States members
of the affiliated group own, directly or
indirectly, at least 80 percent of the total
voting power and value of the stock shall
be included. For purposes of this para-
graph (e)(3)(ii), indirect ownership shall
be determined under section 318 and the
regulations under that section. The
income of the group will not include any
income from transactions with other
members of the group. Passive income
will not be considered to be active financ-
ing income merely because that income is
earned by a member of the group that is a
financial services entity without regard to
the rule of this paragraph (e)(3)(ii). This
paragraph (e)(3)(ii) applies to taxable
years beginning after December 31, 2000.
* * * * *
(iv) * * *
Example 2. Foreign corporation A, which is not
a controlled foreign corporation, owns 100 percent
of the stock of domestic corporation B, which owns
100 percent of the stock of domestic corporation C.
A also owns 100 percent of the stock of foreign cor-
poration D. D owns 100 percent of the stock of
domestic corporation E, which owns 100 percent of
the stock of controlled foreign corporation F. All of
the corporations are members of an affiliated group
within the meaning of section 1504(a) (determined
without regard to section 1504(b)(3)). Pursuant to
paragraph (e)(3)(ii) of this section, however, only the
income of B, C, E, and F is counted in determining
whether the group meets the requirements of para-
graph (e)(3)(i) of this section. For the 2001 taxable
year, B’s income consists of $95 of active financing
income and $5 of passive non-active financing
income. C has $40 of active financing income and
$20 of passive non-active financing income. E has
$70 of active financing income and $15 of passive
non-active financing income. F has $10 of passive
income. B and E qualify as financial services enti-
ties under the entity test of paragraph (e)(3)(i) of this
section. Therefore, B and E are financial services
entities without regard to whether the group as a
whole is a financial services entity and all of the
income of B and E shall be treated as financial ser-
vices income. C and F do not qualify as financial
services entities under the entity test of paragraph

2001–4 I.R.B.369January 22, 2001
(e)(3)(i) of this section. However, under the affiliat-
ed group test of paragraph (e)(3)(ii) of this section, C
and F are financial services entities because at least
80 percent of the group’s total income consists of
active financing income ($205 of active financing
income is 80.4 percent of $255 total income). B’s
and E’s passive income is not treated as active
financing income for purposes of the affiliated group
test of paragraph (e)(3)(ii) of this section even
though it is treated as financial services income
without regard to whether the group satisfies the
affiliated group test. Once C and F are determined
to be financial services entities under the affiliated
group test, however, all of the passive income of the
group is treated as financial services income. Thus,
100 percent of the income of B, C, E, and F for 2001
is financial services income.
* * * * *
(g) * * *
(3) Special rule for dividends paid by a
controlled foreign corporation—(i)
Distributions out of earnings and profits
accumulated when the distributing corpo-
ration was not a controlled foreign corpo-
ration—(A) General rule. Distributions
from a controlled foreign corporation
shall be treated as dividends from a non-
controlled section 902 corporation, and
therefore not subject to the look-through
rules of §1.904–5, to the extent that the
distribution is out of earnings and profits
accumulated during periods when the dis-
tributing corporation was not a controlled
foreign corporation.
(B) Ordering rule. The determination
of the earnings to which a distribution
from a controlled foreign corporation is
attributable shall be made on a last-in
first-out (LIFO) basis. Thus, a distribu-
tion shall be deemed made first from post-
1986 undistributed earnings attributable
to the period after the distributing corpo-
ration became a controlled foreign corpo-
ration (look-through pools), next from the
non-look-through pool of post-1986
undistributed earnings, if any, and finally
on a LIFO basis from pre-1987 accumu-
lated profits.
(C) Effect of intervening noncontrolled
status. [Reserved]
(D) Examples. The following exam-
ples illustrate the application of paragraph
(g)(3)(i):
Example 1. S is a foreign corporation formed in
1980. Until 1992, S had no United States share-
holders. In 1992, P, a domestic corporation, acquires
10 percent of the stock of S. Thus, for 1992 and sub-
sequent years, S is a noncontrolled section 902 cor-
poration. Because the 10-percent ownership require-
ment of section 902(a) was not satisfied until 1992,
earnings accumulated by S before 1992 will be treat-
ed as pre-1987 accumulated profits for purposes of
section 902, and the amount of foreign taxes deemed
paid with respect to any distribution out of such pre-
1987 accumulated profits will be computed on a
year-by-year basis under the rules of section
902(c)(6)(A) and §1.902–1(b)(3). In 2000, P
acquires an additional 45% of the stock of S. Thus,
for 2000 and subsequent years, S is a controlled for-
eign corporation. In 2000, S has no earnings and
profits and pays a dividend out of prior years’ earn-
ings and profits. Pursuant to paragraph (g)(3)(i) of
this section, because S was not a controlled foreign
corporation before 2000, the dividend to P will be
treated as a dividend from a noncontrolled section
902 corporation. The dividend is treated as paid first
out of S’s non-look-through pool of post-1986 undis-
tributed earnings to the extent thereof, and then out
of S’s pre-1987 accumulated profits on a LIFO basis.
The entire dividend will be subject to a single sepa-
rate limitation for dividends from a noncontrolled
section 902 corporation.
Examples 2 through 4. [Reserved]
(ii) Pre-August 6, 1997, dividend distrib-
utions out of earnings and profits accumulat-
ed before a more-than-90-percent United
States shareholder became a United States
shareholder—(A) General rule. Look-
through principles do not apply to distribu-
tions made before August 6, 1997, to a more-
than-90-percent United States shareholder in
the distributing corporation, to the extent the
distributions are made from earnings and
profits accumulated before the taxpayer
became a United States shareholder of the
distributing corporation (pre-acquisition
earnings). Therefore, in the case of a distri-
bution made before August 6, 1997, a divi-
dend shall be treated as a dividend from a
noncontrolled section 902 corporation, and
the look-through rules of section 904(d)(3)
and §1.904–5 shall not apply, if—
(1) The distribution is received by a
United States shareholder, or by an upper-
tier controlled foreign corporation of a
United States shareholder, at a time when
such United States shareholder is a more-
than-90-percent United States shareholder
of the distributing corporation; and
(2) The more-than-90-percent United
States shareholder was not a United States
shareholder at the time the distributed
earnings and profits were accumulated by
the distributing corporation.
(B) Exception for certain intra-group
acquisitions. Notwithstanding paragraph
(g)(3)(ii)(A) of this section, a dividend
recipient shall be entitled to look-through
treatment on a distribution out of pre-
acquisition earnings if—
(1) The dividend recipient is a United
States shareholder of the distributing cor-
poration;
(2) The immediately preceding owner
or owners were entitled to look-through
treatment on distributions from the dis-
tributing corporation (determined after the
application of paragraphs (g)(3)(i) and
(g)(3)(ii)(A) of this section); and
(3) Both at the time of such distribution
and at the time that the dividend recipient
acquired its interest from such immediate-
ly preceding owner or owners, such recip-
ient and such preceding owner or owners
are members of the same affiliated group
(within the meaning of section 1504(a),
determined without regard to section
1504(b)(3)).
(C) Ordering rule. If, under paragraph
(g)(3)(ii) of this section (or under para-
graphs (g)(3)(i)(A) and (g)(3)(ii) of this
section), a shareholder is not entitled to
look-through treatment, the determination
whether a distribution from its controlled
foreign corporation is attributable to pre-
acquisition earnings shall be made on a
last-in first-out (LIFO) basis. Thus, a dis-
tribution shall be deemed made first from
the post-1986 undistributed earnings
attributable to the period after the share-
holder became a United States sharehold-
er in the distributing corporation, and then
from pre-acquisition earnings, in the order
described in paragraph (g)(3)(i)(B) of this
section.
(D) Distributions after August 5, 1997.
Look-through principles shall apply to
distributions made after August 5, 1997,
to a distribution from a controlled foreign
corporation to a more-than-90-percent
United States shareholder out of pre-
acquisition earnings that were accumulat-
ed in years during which the corporation
was a controlled foreign corporation.
Post-1986 undistributed earnings attribut-
able to the period after the shareholder
became a United States shareholder in the
distributing corporation and other post-
1986 undistributed earnings accumulated
while the distributing corporation was a
controlled foreign corporation shall be
combined into a single set of post-1986
undistributed earnings pools for each sep-
arate category described in
§1.904–5(a)(1) as of August 6, 1997.
(E) Examples. The following exam-
ples illustrate the application of this para-
graph (g)(3)(ii):
Example 1. (i) P, a domestic corporation, owns
100 percent of the stock of U, a controlled foreign
corporation. In 1992, P sells 100 percent of the

January 22, 20013702001–4 I.R.B.
stock of U to T, an unrelated domestic corporation.
In 1992, U has no earnings and pays a dividend to T
out of earnings and profits attributable to prior years.
T is not related to P and P’s ownership of U will not
be attributed to T. Because the dividend to T in 1992
is out of post-1986 undistributed earnings that are
pre-acquisition earnings, the dividend will be treated
as a dividend from a noncontrolled section 902 cor-
poration. In 1993, U pays a dividend to T out of cur-
rent earnings and profits. T is entitled to look-
through treatment on the dividend.
(ii) In September 1997, U pays a dividend to T
out of both post-acquisition earnings and pre-acqui-
sition earnings accumulated while U was a con-
trolled foreign corporation. Under paragraph
(g)(3)(ii)(D) of this section, T is entitled to look-
through treatment on the full amount of the dividend.
Example 2. (i) Domestic corporation P has
owned 95 percent of the stock of S, a controlled for-
eign corporation, from the time of S’s organization
in 1990. Domestic corporation R owns the remain-
ing 5 percent of the stock of S. On December 1,
1996, T, an unrelated domestic corporation, acquires
P’s 95 percent interest in S. On December 31, 1996,
S pays a dividend out of current and prior years’
earnings and profits. T is a more-than-90-percent
United States shareholder of S at the time it receives
the dividend, but was not a United States sharehold-
er at the time the distributed earnings were accumu-
lated. Under this paragraph (g)(3)(ii), the portion of
the dividend to T attributable to pre-acquisition earn-
ings will be treated as a dividend from a noncon-
trolled section 902 corporation. Under paragraph
(g)(3)(iii) of this section, T will be entitled to look-
through treatment on the portion of the dividend
attributable to 1996 earnings and profits. Under
paragraph (g)(3)(ii)(C) of this section, the dividend
received by T will be treated as coming first from S’s
post-1986 undistributed earnings attributable to
1996, and then from pre-acquisition earnings.
(ii) On December 31, 1997, S pays a second div-
idend out of current and prior years’ earnings and
profits. Under paragraph (g)(3)(ii)(D) of this sec-
tion, T will be entitled to look-through treatment on
the full amount of the dividend because all of S’s
earnings and profits were accumulated in years dur-
ing which S was a controlled foreign corporation.
The dividends to R will be treated as passive income
because R owns less than 10 percent of the stock of
S and, therefore, is not entitled to look-through treat-
ment.
Example 3. The facts are the same as in Example
2except that R, rather than T, acquires from P an 86
percent interest in S in 1996. Although R was a
shareholder of S before the acquisition, it was not a
United States shareholder because it did not own 10
percent of the voting stock of S. Thus, because R
owns more than 90 percent of the stock of S, and
received a distribution of earnings before August 7,
1997, that were accumulated before it became a
United States shareholder of S, this paragraph
(g)(3)(ii) applies and R is not entitled to look-
through treatment on the 1996 dividend. R is enti-
tled to look-through treatment on the 1997 dividend.
Example 4. Since its organization in 1980, S, a
controlled foreign corporation, has been owned 60
percent by domestic corporation P and 40 percent by
domestic corporation R. On November 15, 1996,
domestic corporation T acquires R’s 40 percent
interest in the stock of S. S has no income in 1996
and pays a dividend on December 15, 1996, out of
prior years’ earnings and profits. This paragraph
(g)(3)(ii) does not apply because T acquired less
than 90 percent of the stock of S. Thus, T is entitled
to look-through treatment on dividends distributed
out of pre-acquisition earnings, because such earn-
ings are attributable to periods in which S was a con-
trolled foreign corporation.
(iii) Treatment of earnings and profits
accumulated in a transition year.
Earnings and profits accumulated in the
taxable year in which a corporation
became a controlled foreign corporation
or in which a more-than-90-percent
United States shareholder became a
United States shareholder shall be consid-
ered earnings and profits accumulated
after the corporation became a controlled
foreign corporation or the shareholder
became a United States shareholder,
respectively.
(iv) Definitions. The following defini-
tions apply for purposes of this paragraph
(g)(3):
(A) More-than-90-percent United
States shareholder. The term more-than-
90-percent United States shareholder
means, with respect to any controlled for-
eign corporation, a United States share-
holder that owns more than 90 percent of
the total combined voting power of all
classes of stock entitled to vote of the con-
trolled foreign corporation. In determin-
ing ownership for purposes of this defini-
tion, the indirect stock ownership rules of
sections 958 and 318 and the regulations
under those sections shall apply.
(B) Non-look-through pool. Except as
otherwise provided, the term non-look-
through poolmeans post-1986 undistrib-
uted earnings accumulated during periods
in which the distributing corporation was
a noncontrolled section 902 corporation
that was not a controlled foreign corpora-
tion.
(C) Post-1986 undistributed earnings.
The term post-1986 undistributed earn-
ingshas the meaning set forth in
§1.902–1(a)(9).
(D) Pre-1987 accumulated profits.
The term pre-1987 accumulated profits
has the meaning set forth in
§1.902–1(a)(10).
(E) Upper tier controlled foreign cor-
poration. The term upper tier controlled
foreign corporationof a United States
shareholder means a controlled foreign
corporation in which the taxpayer is a
United States shareholder and which is an
upper-tier corporation as defined in
§1.902–1(a)(6) with respect to the distrib-
uting corporation.
(v) Effective date. The provisions of
this paragraph (g)(3) apply to taxable
years beginning after December 31, 1986.
However, for taxable years beginning
before January 1, 2001, taxpayers may
rely on §1.904–4(g)(3)(ii), (iii) and (iv) of
regulations project INTL–1–92, published
at 1992–1 C.B. 1209. See §601.601(d)(2)
of this chapter.
* * * * *
Par. 11. Section 1.904–5 is amended as
follows:
1. The last sentence in paragraph (a)(3)
is revised and one new sentence is added.
2. Paragraph (d)(2) is amended by
removing the word “For” at the beginning
of the first sentence and adding the lan-
guage “Except as provided in
§1.904–4(c)(7)(iii) (relating to reductions
in tax upon distribution), for” in its place.
3. Paragraph (g) is revised.
4. Paragraph (h)(4) is amended by
adding three new sentences at the end.
5. Paragraph (i)(1) is amended by:
a. Revising the third sentence.
b. Adding a new sentence at the end.
6. The text to paragraph (i)(3) is added.
7. Paragraph (i)(4) Example 1is
revised.
8. The text to paragraph (i)(4) Example
2is added.
9. Paragraph (i)(4) Example 3is added.
10. The second and third sentences of
paragraph (m)(1) are revised.
11. Paragraph (m)(4)(i) is revised.
12. Paragraph (m)(5) is amended by
removing the language “951(a)” from the
first sentence and adding the language
“951(a)(1)(A)” in its place.
The revisions and additions read as fol-
lows:
§1.904–5 Look-through rules as applied
to controlled foreign corporations and
other entities.
(a) * * *
(3) * * * For this purpose the con-
trolled group is any member of the affili-
ated group within the meaning of section
1504(a)(1) except that “more than 50 per-
cent” shall be substituted for “at least 80
percent” wherever it appears in section
1504(a)(2). For taxable years beginning

2001–4 I.R.B.371January 22, 2001
before January 1, 2001, the preceding sen-
tence shall be applied by substituting “50
percent” for “more than 50 percent”.
* * * * *
(g) Application of look-through rules
to certain domestic corporations. The
principles of section 904(d)(3) and this
section shall apply to any foreign source
interest, rents and royalties paid by a
United States corporation to a related cor-
poration. For this purpose, a United
States corporation and another corpora-
tion are considered to be related if one
owns, directly or indirectly, stock possess-
ing more than 50 percent of the total vot-
ing power of all classes of stock of the
other corporation or more than 50 percent
of the total value of the other corporation.
In addition, a United States corporation
and another corporation shall be consid-
ered to be related if the same United
States shareholders own, directly or indi-
rectly, stock possessing more than 50 per-
cent of the total voting power of all class-
es of stock or more than 50 percent of the
total value of each corporation. For pur-
poses of this paragraph, the constructive
stock ownership rules of section 318 and
the regulations under that section apply.
For taxable years beginning before
January 1, 2001, this paragraph (g) shall
be applied by substituting “50 percent or
more” for “more than 50 percent” each
place it appears.
(h) * * *
(4) * * * Similarly, a partnership (first
partnership) is considered as owning more
than 50 percent of the value of another
partnership (second partnership) if the
first partnership owns more than 50 per-
cent of the capital and profits interests of
the second partnership. For this purpose,
value will be determined at the end of the
partnership’s taxable year. For taxable
years beginning before January 1, 2001,
the second preceding sentence shall be
applied by substituting “50 percent” for
“more than 50 percent”.
(i) * * * (1) * * * In addition, two
look-through entities are related if the
same United States shareholders own,
directly or indirectly, stock possessing
more than 50 percent of the total voting
power of all voting classes of stock (in the
case of a corporation) or more than 50
percent of the total value of each look-
through entity. * * * For taxable years
beginning before January 1, 2001, the
third sentence of this paragraph (i)(1)
shall be applied by substituting “50 per-
cent or more” for “more than 50 percent”
each place it appears.
* * * * *
(3) Special rule for dividends. Solely
for purposes of dividend payments
between controlled foreign corporations
in taxable years beginning after December
31, 2000, two controlled foreign corpora-
tions shall be considered related look-
through entities if the same United States
shareholder owns, directly or indirectly, at
least 10 percent of the total voting power
of all classes of stock of each foreign cor-
poration. Taxpayers may choose to apply
this paragraph (i)(3) in taxable years
beginning after December 31, 1991, pro-
vided that appropriate adjustments are
made to eliminate any double benefit aris-
ing from the application of this paragraph
(i)(3) to taxable years that are not open for
assessment.
(4) Examples. * * *
Example 1. P, a domestic corporation, owns all of
the stock of S, a controlled foreign corporation. S
owns 40 percent of the stock of T, a Country X cor-
poration that is a controlled foreign corporation. The
remaining 60 percent of the stock of T is owned by
V, a domestic corporation. The percentages of value
and voting power of T owned by S and V correspond
to their percentages of stock ownership. T owns 40
percent (by vote and value) of the stock of U, a
Country Z corporation that is a controlled foreign
corporation. The remaining 60 percent of U is
owned by unrelated U.S. persons. U earns exclu-
sively general limitation non-subpart F income. In
2001, U makes an interest payment of $100 to T.
Look-through principles do not apply because T and
U are not related look-through entities under para-
graph (i)(1) of this section (because T does not own
more than 50 percent of the voting power or value of
U). The interest is passive income to T, and is sub-
part F income to P and V. Under paragraph (c)(1) of
this section, look-through principles determine P and
V’s characterization of the subpart F inclusion from
T. P and V therefore must characterize the inclusion
as passive income.
Example 2. The facts are the same as in Example
1except that instead of a $100 interest payment, U
pays a $50 dividend to T in 2001. P and V each own,
directly or indirectly, more than 10 percent of the
voting power of all classes of stock of both T and U.
Pursuant to paragraph (i)(3) of this section, for pur-
poses of applying this section to the dividend from U
to T, U and T are treated as related look-through enti-
ties. Therefore, look-through principles apply to
characterize the dividend income as general limita-
tion income to T. The dividend is subpart F income
of T that is taxable to P and V. The subpart F inclu-
sions of P and V are also subject to look-through
principles, under paragraph (c)(1) of this section,
and are characterized as general limitation income to
P and V because the income is general limitation
income of T.
Example 3. The facts are the same as in Example
1, except that U pays both a $100 interest payment
and a $50 dividend to T, and T owns 80 percent (by
vote and value) of U. Under paragraph (i)(1) of this
section, T and U are related look-through entities,
because T owns more than 50 percent (by vote and
value) of U. Therefore, look-through principles
apply to both the interest and dividend income paid
or accrued by U to T, and T treats both types of
income as general limitation income. Under para-
graph (c)(1) of this section, P and V apply look-
through principles to the resulting subpart F inclu-
sions, which therefore are also general limitation
income to P and V.
* * * * *
(m) * * * (1) * * * For purposes of
determining the portion of a dividend paid
or accrued (or amount treated as a divi-
dend, including amounts described in sec-
tion 951(a)(1)(B)) by a controlled foreign
corporation that is treated as from sources
within the United States under section
904(g)(4), the rules in paragraph (m)(4) of
this section apply. For purposes of deter-
mining the portion of an amount included
in gross income under section
951(a)(1)(A) that is attributable to income
of the controlled foreign corporation from
sources within the United States under
section 904(g)(2), the rules in paragraph
(m)(5) of this section apply. * * *
* * * * *
(4) * * * (i) * * * Any dividend or dis-
tribution treated as a dividend under this
section (including an amount included in
gross income under section 951(a)(1)(B))
that is received or accrued by a United
States shareholder from a controlled for-
eign corporation shall be treated as
income in a separate category derived
from sources within the United States in
proportion to the ratio of the portion of the
earnings and profits of the controlled for-
eign corporation in the corresponding sep-
arate category from United States sources
to the total amount of earnings and profits
of the controlled foreign corporation in
that separate category.
* * * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 13, 2000.
Jonathan Talisman,
Acting Assistant Secretary
(Tax Policy).
(Filed by the Office of the Federal Register on De-
cember 29, 2000, 8:45 a.m., and published in the

January 22, 20013722001–4 I.R.B.
issue of the Federal Register for January 3, 2001, 66
F.R. 268)
Section 6302.—Mode or Time of
Collection
26 CFR 301.6302–1T: Use of Federal Reserve
banks after December 31, 2000.
T.D. 8918
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 301
Removal of Federal Reserve
Banks as Federal Depositaries.
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations
SUMMARY:This document contains
temporary regulations relating to the
deposit of Federal taxes pursuant to sec-
tion 6302 of the Internal Revenue Code.
The regulations remove Federal Reserve
banks as authorized depositaries for
Federal tax deposits. The regulations
affect taxpayers that make Federal tax
deposits using paper Federal Tax Deposit
(FTD) coupons (Form 8109) at Federal
Reserve banks.
DATES:Effective Date: These regulations
are effective December 26, 2000.
Applicability Date: These regulations
apply to deposits made after December
31, 2000.
FOR FURTHER INFORMATION CON-
TACT: Brinton T. Warren (202) 622-4940
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background and Explanation of
Provisions
This document contains amendments
to the Procedure and Administration
Regulations (26 CFR part 301) relating
to Federal tax deposits under section
6302(c) of the Internal Revenue Code
(Code). Section 6302(c) provides that
the Secretary may authorize Federal
Reserve banks, and incorporated banks,
trust companies, domestic building and
loan associations, or credit unions that
are depositaries or financial agents of the
United States, to receive any tax imposed
under the internal revenue laws, in such
manner, at such times, and under such
conditions as the Secretary may pre-
scribe. Pursuant to this authority, various
regulations provide that Federal Reserve
banks, as well as other authorized finan-
cial institutions, may receive certain
Federal tax deposits.
In cooperation with the Treasury
Department’s Financial Management
Service (FMS), the Federal Reserve
System has been streamlining its Treasury
Tax and Loan (TT&L) Operation to
respond to the fact that the overwhelming
majority of Federal Tax Deposits (FTDs)
are now received electronically. The
widespread adoption of electronic
deposits by taxpayers is an important
aspect of improving the efficiency, relia-
bility, and cost-effectiveness of the
Treasury Department’s financial manage-
ment. In general, compared to the uni-
verse of all tax deposits, the percentage of
FTDs made with paper coupons has sig-
nificantly declined. FTDs made with
paper coupons at Federal Reserve banks
now constitute only a tiny percentage of
all tax deposits. For example, in Fiscal
Year 1999, of the approximately 100 mil-
lion Federal tax deposits, made by paper
coupon and electronically, only about
270,000, or less than one half of one per-
cent, were paper coupons presented at
Federal Reserve banks. Additionally, the
number of paper coupons presented at
Federal Reserve banks has declined over
twenty-five percent since 1997.
The Treasury Department has devel-
oped an array of other deposit options that
are more convenient for taxpayers to use,
and more economical to process, than
deposits with Federal Reserve banks.For
example, taxpayers may use their touch
tone telephone or personal computer to
make deposits 24 hours a day through the
Electronic Federal Tax Payment System
(EFTPS). For those taxpayers who still
prefer paper coupons over electronic
deposits, there are now more than 10,000
financial institutions nationwide that are
designated as TT&L depositaries where
taxpayers may make FTD deposits using
paper coupons.
In response to the declining number of
deposits being made with paper coupons
at Federal Reserve banks, the Federal
Reserve Bank of St. Louis was selected,
effective May 1, 2000, to serve as the only
Federal Reserve bank accepting FTDs.
Even after this consolidation, however, it
is no longer cost-effective for the Federal
Reserve bank in St. Louis to process the
small number of paper coupons it receives
annually. Accordingly, these temporary
regulations remove all Federal Reserve
banks as depositaries for Federal taxes.
To mitigate any difficulties for those tax-
payers who still do not wish to use the
deposit alternatives discussed above, the
Treasury Department has authorized a
financial agent to receive and process
FTD payments through the mail, thereby
maintaining a mail-in alternative for tax-
payers who do not have an account with
an authorized financial institution and
who do not wish to use EFTPS. The
address for this mail-in alternative is
Financial Agent, Federal Tax Deposit
Processing, P.O. Box 970030, St. Louis,
Missouri, 63197. The IRS is also issuing
proposed regulations that remove Federal
Reserve banks as depositaries of Federal
taxes. See the notice of proposed rule-
making on this subject (REG–107176–00)
on page 428 of this Bulletin.
Special Analyses
It has been determined that this
Treasury decision is not a significant reg-
ulatory action as defined in Executive
Order 12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions, and because the regulations do not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, these regulations will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on their
impact on small business.
Drafting Information
The principal author of these regulations
is Brinton T. Warren of the Office of
Associate Chief Counsel, Procedure and
Administration (Administrative Provisions
and Judicial Practice Division). However,
other personnel from the IRS and Treasury
Department participated in their develop-
ment.
* * * * *

Amendments to the Regulations
Accordingly, 26 CFR part 301 is
amended as follows:
Paragraph 1. The authority citation for
part 301 continues to read in part as fol-
lows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 301.6302–1T is added
to read as follows:
§301.6302–1T Use of Federal Reserve
banks after December 31, 2000
Federal Reserve banks are not autho-
rized depositaries for Federal tax deposits
made after December 31, 2000.
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 6, 2000.
Jonathan Talisman,
Acting Assistant Secretary
for Tax Policy.
(Filed by the Office of the Federal Register on De-
cember 22, 2000, 8:45 a.m., and published in the
issue of the Federal Register for December 26, 2000,
65 F.R. 81356)
2001–4 I.R.B.373January 22, 2001

Reporting of Gross Proceeds
Payments to Attorneys
Notice 2001–7
This notice informs taxpayers that the
Internal Revenue Service intends to fur-
ther delay the effective date of the regula-
tions proposed under § 6045(f) of the
Internal Revenue Code (relating to the
reporting of payments of gross proceeds
to attorneys). Under this extension, the
rules in § 1.6045–5 will apply to pay-
ments made during the first calendar year
that begins at least two months after the
date of publication of the final regulations
in the Federal Register.
Section 1021 of the Taxpayer Relief
Act of 1997, 1997–4 (Vol. 1) C.B. 1, 136,
added § 6045(f) of the Code, which
requires information reporting for pay-
ments made in the course of a trade or
business to attorneys in connection with
legal services (whether or not such ser-
vices are performed for the payor).
Section 6045(f) applies to payments made
after December 31, 1997. The notice of
proposed rulemaking (NPRM) under
§ 6045(f) was published in the Federal
Register on May 21, 1999 (64 F.R.
27730), 1999–1 C.B. 1193. Section
1.6045–5(h) of the proposed Income Tax
Regulations provides that the rules in
§ 1.6045–5 apply to payments made after
December 31, 1999. However, Notice
99–53, 1999–2 C.B. 565, extended the
effective date of § 1.6045–5 to payments
made after December 31, 2000.
Because the Service is continuing to
study the many comments regarding the
NPRM under § 6045(f), the Service
intends to further delay the effective date
of § 1.6045–5. Accordingly, when final-
ized, the rules in § 1.6045–5 will apply to
payments made during the first calendar
year that begins at least two months after
the date of publication of the final regula-
tions in the Federal Register. Never-
theless, payments of gross proceeds to
attorneys made after December 31, 1997,
are and continue to be reportable on Form
1099–MISC pursuant to § 6045(f); only
the effective date of the regulations that
interpret § 6045(f) will be delayed.
Taxpayers may continue to rely on the
NPRM as a safe harbor providing a rea-
sonable interpretation of the statute.
EFFECT OTHER DOCUMENTS
Notice 99–53 is modified, and as mod-
ified, is superseded.
DRAFTING INFORMATION
The principal author of this notice is
Sara Paige Shepherd of the Office of the
Associate Chief Counsel, Procedure and
Administration (Administrative Provi-
sions and Judicial Practice). For further
information regarding this notice contact
Ms. Shepherd at (202) 622-4910 (not a
toll-free number).
Information Reporting for
Discharges of Indebtedness
Notice 2001–8
PURPOSE
This notice extends the suspension of
penalties under §§ 6721 and 6722 of the
Internal Revenue Code provided by
Notice 2000–22, 2000–16 I.R.B. 902
(April 17, 2000), for certain organizations
newly subject to § 6050P (that is, those
organizations a significant trade or busi-
ness of which is the lending of money and
that are not otherwise described in
§ 6050P(c)(1) or (2)). Under this notice,
penalties will not be imposed on such an
organization for failure to file information
returns under § 6050P for any discharge
of indebtedness that occurs prior to the
first calendar year beginning at least two
months after the date that appropriate
guidance is issued.
BACKGROUND
Generally, § 6050P(a) requires applica-
ble entities that are subject to that section
to file returns with the Service, and to pro-
vide statements to persons whose names
are required to be shown on the returns
(“payees”), setting forth certain informa-
tion regarding discharges of indebtedness
of $600 or more. Sections 6721 and 6722
impose penalties for failure to file correct
information returns or to provide correct
payee statements, respectively, including
those required under § 6050P.
Section 533(a) of the Ticket to Work
and Work Incentives Improvement Act of
1999, Pub. L. No. 106–170, 113 Stat.
1860, 1931 (1999) (“the Act”), amended
§ 6050P of the Code by expanding the
types of entities that are required to report
discharges of indebtedness to include any
organization “a significant trade or busi-
ness of which is the lending of money.”
The Act was signed into law on December
17, 1999. Section 533(a) was made effec-
tive for discharges of indebtedness occur-
ring after December 31, 1999. Notice
2000–22 suspended penalties for failures
to file information returns or to furnish
payee statements for discharges of indebt-
edness by these newly included organiza-
tions occurring prior to January 1, 2001.
PENALTY SUSPENSION
The Service recognizes that, in the
absence of published guidance regarding
the new statutory provision, many organiza-
tions potentially included within the report-
ing provisions of § 6050P by the Act are
unable to determine whether they are in fact
subject to the new reporting provisions.
Furthermore, sufficient time is necessary
after guidance is issued for these affected
organizations to establish recordkeeping
systems needed to capture the information
required to be reported under § 6050P.
Therefore, the Service will not impose
penalties on these organizations for failure
to comply with the requirements of § 6050P
for discharges of indebtedness occurring
prior to the first calendar year beginning at
least two months after the date that appro-
priate guidance is issued.
This notice does not suspend penalties for
any organization that was already subject to
§ 6050P prior to its amendment by the Act.
EFFECT ON OTHER DOCUMENTS
Notice 2000–22 is modified, and, as
modified, is superseded.
DRAFTING INFORMATION
The principal author of this notice is
Sharon L. Hall of the Office of Assistant
Chief Counsel, Income Tax and Account-
ing. For further information regarding
this notice, contact Ms. Hall at (202) 622-
4930 (not a toll-free call).
January 22, 20013742001–4 I.R.B.
Part III. Administrative, Procedural, and Miscellaneous

Extension of Relief Relating to
Application of Nondiscrimination
Rules for Certain Governmental
Plans and Church Plans
Notice 2001–9
I. PURPOSE
This notice provides relief from the
application of the nondiscrimination
requirements of the Internal Revenue
Code for certain governmental and church
plans.
In particular, this notice provides that
certain governmental plans shall be
deemed to satisfy § 401(a)(4), 401(a)(26),
401(k)(3), and 401(m) of the Code until the
first day of the first plan year beginning on
or after January 1, 2002. In accordance
with this relief, the regulations relating to
these provisions do not apply until plan
years beginning after that date. This relief
is available with respect to governmental
plans within the meaning of § 414(d) other
than plans of State and local governments
or political subdivisions, agencies or
instrumentalities thereof.
In addition, this notice extends, until the
first day of the first plan year beginning on or
after January 1, 2002, the effective date of
certain nondiscrimination regulations for
nonelecting church plans. Specifically, this
notice extends the effective date of the regu-
lations under §§ 401(a)(4), 401(a)(5), 401(l),
and 414(s) of the Internal Revenue Code.
II. BACKGROUND
A. Governmental Plans
Section 414(d) of the Code provides
that the term “governmental plan” means
a plan established and maintained for its
employees by the government of the
United States, by the government of any
State or political subdivision thereof, or
by any agency or instrumentality of any of
the foregoing. The term “governmental
plan” also includes any plan to which the
Railroad Retirement Act of 1935 or 1937
(the “Act”) applies and which is financed
by contributions under that Act and any
plan of an international organization
which is exempt from taxation by reason
of the International Organizations
Immunities Act (59 Stat. 669).
Section 1505 of the Taxpayer Relief Act
of 1997 (“TRA ‘97”) generally provides
that the nondiscrimination rules do not
apply to State and local governmental
plans. In particular, § 1505 amended the
Code to provide that § 401(a)(3), 401(a)(4),
and 401(a)(26) shall not apply to such
plans. Section 1505 of TRA ‘97 amended
§ 401(k) of the Code to provide that State
and local governmental plans shall be treat-
ed as meeting the requirements of
§ 401(k)(3). In addition, § 1505(a)(3) of
TRA ‘97 amended § 410(c) of the Code to
provide that governmental plans shall be
treated as meeting the requirements of
§ 410 for purposes of § 401(a). This
amendment to § 410(c), by its terms, is not
limited to State and local governmental
plans but applies to all governmental plans
within the meaning of § 414(d).
Notice 99–40, 1999–35 I.R.B. 324,
provided that governmental plans, other
than plans maintained by State or local
governments or political subdivisions or
instrumentalities thereof,would be
deemed to satisfy § 401(a)(4), 401(a)(26),
401(k)(3), and 401(m) of the Internal
Revenue Code until the first day of the
first plan year beginning on or after
January 1, 2001. The notice also provid-
ed that the regulations relating to these
provisions would not apply until plan
years beginning on or after that date.
B. Church Plans
Section 414(e)(1) of the Code provides
in general that the term “church plan”
means a plan established and maintained
for its employees (and their beneficiaries)
by a church or by a convention or associ-
ation of churches which is exempt from
tax under § 501. Pursuant to § 410(d), a
church or convention or association of
churches which maintains any church
plan may make an election under § 410(d)
to have certain Code provisions relating to
participation, vesting, and funding, etc.,
apply to such church plan (an “electing
church plan”) as if such provisions did not
contain an exclusion for church plans. A
church plan for which such an election
has not been made (a “nonelecting church
plan”) is not subject to these provisions.
Notice 98–39, 1998–2 C.B. 205, pro-
vided that the regulations under
§§ 401(a)(4), 401(a)(5), 401(l) and 414(s)
apply for nonelecting church plans in plan
years beginning on or after January 1,
2001. For plan years beginning before
that effective date, nonelecting church
plans must be operated in accordance with
a reasonable, good faith interpretation of
these statutory provisions.
III. EXTENSION OF RELIEF
RELATING TO APPLICATION OF
NONDISCRIMINATION RULES
FOR CERTAIN GOVERNMENTAL
PLANS
Under the relief provided by this notice,
governmental plans within the meaning of
§ 414(d), other than those maintained by
State or local governments or political subdi-
visions, agencies or instrumentalities there-
of, shall be treated as satisfying the require-
ments of § 401(a)(4), 401(a)(26), 401(k)(3),
and 401(m) until the first plan year begin-
ning on or after January 1, 2002. In accor-
dance with this relief, the regulations under
§§ 401(a)(4), 401(a)(26), 401(m), 410(b)
and 414(s), and the regulations implement-
ing § 401(k)(3), apply to governmental plans
described in this part only for plan years
beginning on or after January 1, 2002.
IV. EXTENSION OF EFFECTIVE
DATE OF NONDISCRIMINATION
REGULATIONS FOR
NONELECTING CHURCH PLANS
Under the extension provided by this
notice, the regulations under §§ 401(a)(4),
401(a)(5), 401(l), and 414(s) apply to
nonelecting church plans only for plan
years beginning on or after January 1,
2002. For plan years beginning before
this extended effective date, nonelecting
church plans must be operated in accor-
dance with a reasonable, good faith inter-
pretation of these statutory provisions.
V. EFFECT ON OTHER
DOCUMENTS
Notices 98–39 and 99–40 are modified.
DRAFTING INFORMATION
The principal author of this notice is
Diane S. Bloom of the Employee Plans
Division. For further information regard-
ing this notice, please contact the
Employee Plans Division’s taxpayer assis-
tance telephone service at (202) 283-9516
or (202) 283-9517, between the hours of
1:30 p.m. and 3:30 p.m. Eastern Time,
Monday through Thursday. Ms. Bloom
may be reached at (202) 622-6214. These
telephone numbers are not toll-free.
2001–4 I.R.B.375January 22, 2001

January 22, 20013762001–4 I.R.B.
26 CFR 601.602: Tax forms and instructions.
Publication 1245 (Rev.1–2001)
Specifications for Filing Form W-4, Employee’s Withholding Allowance Certificate, Magnetically or
Electronically
Rev. Proc. 2001–16
Reprinted from IR Bulletin 2001–4 dated, January 22, 2001 (and containing copies of Forms 4419,
6466, 6467, and Notice 1027 for taxpayers’ use)
TABLE OF CONTENTS
PART A. GENERAL
Section 1. Purpose
Section 2. Nature of Changes
Section 3. Where to File and How to Contact the IRS, Martinsburg Computing Center
Section 4. Filing Requirements
Section 5. Form 4419, Application for Filing Information Returns Magnetically/Electronically
Section 6. Due Dates
Section 7. Filing Forms W-4 Magnetically/Electronically
Section 8. Replacement Files
Section 9. Effect on Paper Returns
Section 10. Definition of Terms
PART B. MAGNETIC MEDIA SPECIFICATIONS
Section 1. General
Section 2. Tape Specifications
Section 3. Tape Cartridge Specifications
Section 4. 8mm, 4mm, and Quarter-Inch Cartridge Specifications
Section 5. 3 1/2-Inch Diskette Specifications
Section 6. Record Format and Layout
PART C. ELECTRONIC FILING SPECIFICATIONS
Section 1. Background
Section 2. Advantages of Filing Electronically
Section 3. General
Section 4. Electronic Filing Approval Procedure
Section 5. Electronic Submissions
Section 6. Transmittal Requirements
Section 7. Electronic Filing Specifications
Section 8. Dial-up Network/Browser Specifications (Web Interface)
Section 9. Communication Software Specifications (Text Interface)
Section 10. Modem Configuration
Section 11. Common Problems Associated with Electronic Filing
IRS/MCC will no longer return problem media in need of replacement beginning in Tax Year
2001 filed in calendar year 2002. See Part A, Sec. 2 .04 for details. In addition, beginning in
calendar year 2003 for Tax Year 2002, IRS/MCC will no longer accept 9 track tapes for the fil-
ing of Forms W-4. See Part B, Sec. 2.

PART D. MISCELLANEOUS INFORMATION
Section 1. Addresses for Martinsburg Computing Center
Section 2. Telephone Numbers for Contacting IRS/MCC
PART A. GENERAL
SEC. 1. PURPOSE
.01The purpose of this revenue procedure is to update Rev. Proc. 99–47, 1999–49 I.R.B. 624, issued December 6, 1999, (IRS
Pub.1245 Rev. 03–2000), which outlines the requirements and conditions for submitting certain Forms W-4, Employee’s Withholding
Allowance Certificate, magnetically or electronically to the Internal Revenue Service (IRS), Martinsburg Computing Center (MCC).
Rev. Proc. 99–47, (IRS Publication 1245 Rev. 03–2000), is superseded by Rev. Proc. 2001–16, (IRS Pub. 1245 Rev. 1–2001).
.02Revenue procedures are generally revised to reflect legislative and form changes. Comments concerning this revenue proce-
dure or suggestions for making it more helpful can be addressed to Internal Revenue Service, Martinsburg Computing Center,
ATTN: IRB Information Support Section, 230 Murall Dr, Kearneysville, WV 25430. Use this revenue procedure to file Forms W-4
submitted for the quarter ending March 31, 2001, and for all subsequent filings.
.03The following revenue procedures and publications provide more detailed filing procedures for certain information returns
and can be obtained by contacting any IRS office or by calling 1-800-829-3676:
(a)Instructions for Forms 1099, 1098, 5498, and W-2G providing specific instructions on completing and submitting informa-
tion returns to IRS.
(b)Rev. Proc. 84–33, 1984–1 C.B. 502, regarding the optional method for agents to report and deposit backup withholding.
(c)Publication 1179, Rules and Specifications for Private Printing of Substitute Forms 1096, 1098, 1099 Series, 5498, and
W-2G.
(d)Publication 1220, Specifications for Filing Form 1098, 1099, 5498, and W-2G Magnetically or Electronically.
(e)Publication 1239, Specifications for Filing Form 8027, Employer’s Annual Information Return of Tip Income and Allo-
cated Tips, Magnetically or Electronically.
(f)Publication 1187, Specifications for Filing Form 1042S, Foreign Person’s U.S. Source Income Subject to Withholding,
Magnetically or Electronically.
.04Refer to Part A, Sec. 10, for definitions of terms used in this publication.
SEC. 2. NATURE OF CHANGES
Numerous editorial changes have been made to the revenue procedure. Please read the publication carefully and in its entirety be-
fore attempting to prepare your magnetic/electronic file for submission. Major changes are italicized. The changes are as follows:
.01 Part B, Sec. 2, Beginning in calendar year 2003 for Tax Year 2003, IRS/MCC will no longer accept 9 track tapes for the
filing of Forms W-4. This restriction will apply to fourth quarter 2002 Forms W-4 filed in January 2003. See Part B, Sec. 2.
.02Electronic filing specifications are in Part C. Numerous changes have been made to these instructions. Please read this part
carefully.
.03Part D is new and contains information on contacting IRS/MCC in a centralized location within the publication.
.04 Beginning in calendar year 2002 for Tax Year 2001, IRS/MCC will no longer return problem media in need of replace-
ment.Filers will continue to receive a tracking form, listing and letter detailing the reason(s) their media could not be processed.
Filers will be expected to send in replacement media within the prescribed time frame. This makes it imperativethat filers maintain
backup copies and/or recreate capabilities for their information return files.
SEC. 3. WHERE TO FILE AND HOW TO CONTACT THE IRS, MARTINSBURG COMPUTING CENTER
.01All Forms W-4 filed magnetically or electronically are processed at IRS/MCC. Magnetic media containing Forms W-4 is to
be sent to the following address:
IRS-Martinsburg Computing Center
Information Reporting Program
240 Murall Drive
Kearneysville WV 25430
.02Requests for paper forms and publications can be made by calling the “Forms Only Number” listed in your local telephone di-
rectory or by calling the IRS toll-free number 1-800-TAX-FORM (1-800-829-3676).
.03Questions pertaining to magnetic media/electronic filing of Forms W-2 mustbe directed to the Social Security Administration
(SSA). Filers can call 1-800-SSA-6270 to obtain the phone number of the SSA Employer Service Liaison Officer for their area.
.04A taxpayer or authorized representative may request a copy of a tax return or a Form W-2 filed with a return by submitting
2001–4 I.R.B.377January 22, 2001

Form 4506, Request for Copy or Transcript of Tax Form, to IRS. This form may be obtained by calling 1-800-TAX-FORM (1-800-
829-3676).
.05The IRS/MCC Call Site, located in Kearneysville, WV, provides service to the payer/employer community (financial institu-
tions, employers, and other transmitters of information returns). The IRS/MCC Call Site answers questions concerning tax law and
the magnetic/electronic filing of questionable Forms W-4 as well as information returns (Forms 1096, 1098, 1099, 5498, 5498-MSA,
8027, W-2G, and 1042-S), inquiries dealing with backup withholding due to missing and incorrect taxpayer identification numbers
and questions concerning paper filing of Forms W-2 and W-3. Recipients of information returns (payees) should continue to contact
1-800-829-1040 or other numbers specified in the tax return instructions with any questions on how to report information returns.
The Call Site accepts calls from all areas of the country. The number to call is 304-263-8700or Telecommunications Device for
the Deaf (TDD) 304-267-3367.These are toll calls. The Call Site is in operation throughout the year to handle the questions of pay-
ers, transmitters, and employers. Due to the high demand for assistance at the end of January and February, it is advisable to call as
soon as possible to avoid these peak filing seasons.
.06Telephone inquiries may be made Monday through Friday between 8:30 a.m. and 4:30 p.m. Eastern time. The telephone
numbers for magnetic media/electronic inquiries or electronic submissions are:
304-263-8700 - Call Site
304-262-2400 - Electronic Filing
304-267-3367 - TDD (Telecommunication Device for the Deaf)
304-264-5602 - Fax Machine
(These are not toll-free telephone numbers.)
TO OBTAIN FORMS & PUBLICATIONS CALL:
1-800-TAX-FORM (1-800-829-3676)
TO OBTAIN FORMS & PUBLICATIONS VIA INTERNET:
www.irs.gov
SEC. 4. FILING REQUIREMENT
.01Employers are required to send to the IRS quarterly, copies of all Forms W-4 received during the quarter from employees still
employed at the end of that quarter who claim:
(a) More than 10 withholding allowances, or
(b) Exempt status and are expected to earn more than $200 a week.
.02Employers are not required to send other Forms W-4 unless notified by IRS in writing to do so.
.03Employers may submit all information magnetically or electronically; a combination of magnetic/electronic files and paper
documents is acceptable, provided there are no duplications or omissions of documents. However, magnetic/electronic filing is pre-
ferred and strongly encouraged.
.04A Form W-4 with a written statement attached from the employee must be submitted on paper, not on magnetic media. The
employer may send paper Forms W-4 each quarter with their paper Form 941. If the employer submits the paper Forms W-4 at any
time other than quarterly, a cover letter must be submitted giving the employer’s name, address, employer identification number
(EIN), and the number of Forms W-4 included.
NOTE: MCC DOES NOT PROCESS PAPER RETURNS. PAPER RETURNS MUST BE FILED WITH THE APPROPRI-
ATE SERVICE CENTER. SEE FORM 941 INSTRUCTIONS FOR THE APPROPRIATE SERVICE CENTER.
SEC. 5. FORM 4419, APPLICATION FOR FILING INFORMATION RETURNS
MAGNETICALLY/ELECTRONICALLY
.01Employers, or their transmitters, who wish to file Forms W-4 magnetically or electronically, must first submit a Form 4419, Ap-
plication for Filing Information Returns Magnetically/Electronically. Instructions for its completion are on the reverse of the form.
.02Magnetic/electronic files may not be submitted to IRS/MCC until authorization to file is received by the employer. Requests
will be approved or disapproved within 30 days of receipt.
.03Applications of only those employers or transmitters whose equipment meets the specifications in Part B, Sec. 2, 3, 4, 5 or 6
will be approved.
.04Once authorization to file has been granted, a five-character alpha/numeric Transmitter Control Code (TCC) will be assigned.
Approval will continue in effect in succeeding years provided the requirements of the current revenue procedure are met and there
are no equipment changes by the employer or transmitter. Although a TCC may have already been assigned to a transmitter for the
filing of information returns, the Form W-4 requires a separate TCC. This TCC must appear on all transmittal forms submitted with
January 22, 20013782001–4 I.R.B.

2001–4 I.R.B.379January 22, 2001
magnetic/electronic files, as well as other correspondence. The TCC must also be coded into positions 319-323 of the Form W-4
record. (See Part B, Sec. 7.)
.05A new application (Forms 4419) is required if
(a) You discontinue filing magnetically/electronically for two years, in which case your TCC may have been reassigned. You
may call IRS/MCC to verify if your TCC is still valid.
(b) You previously used a service bureau with its own TCC, but you now have computer equipment compatible with that of
IRS, in which case you must request your own TCC.
SEC. 6. DUE DATES
.01Magnetic/electronic reporting of Forms W-4 to IRS must be at least quarterly (monthly reporting is encouraged). The follow-
ing are the quarterly due dates:
Period Cov
eredDue Date
January 1 thru March 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .April 30
April 1 thru June 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .July 31
July 1 thru September 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .October 31
October 1 thru December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .January 31
.02If any due date falls on a Saturday, Sunday, or legal holiday, the Forms W-4 are considered timely if they are filed on the next
day that is not a Saturday, Sunday, or legal holiday.
SEC. 7. FILING FORMS W-4 MAGNETICALLY/ELECTRONICALLY
.01A Magnetic Media/Electronic Reporting Package, which includes the current revenue procedure and the necessary transmittal
forms, will be mailed to approved filers each year.
.02If the employer chooses to file magnetically/electronically, then a Form 6466, Transmittal of Forms W-4 Reported Magneti-
cally/Electronically, must be sent to the IRS/MCC as prescribed in Part A, Sec. 3.
.03Form 6466 MUST be signed by the employer or the transmitter, service bureau, paying agent, or disbursing agent (all here-
after referred to as agent), on behalf of the employer if the agent has the authority to sign the affidavit under an agency agreement
(either oral, written, or implied) that is valid under state law and adds the caption “FOR: (name of employer).”
.04Although a duly authorized agent signs the affidavit, the employer(s) is held responsible for the accuracy of the Forms W-4
filed magnetically or electronically.
.05 DO NOT REPORT THE SAME INFORMATION ON PAPER DOCUMENTS THAT YOU REPORT MAGNETI-
CALLY/ELECTRONICALLY. If you report part of your returns on paper and part magnetically or electronically, be sure that du-
plicate returns are not included on both.
.06Before submitting your magnetic/electronic file, include the following:
(a) A signed Form 6466, Transmittal of Forms W-4 Reported Magnetically/Electronically along with a Form 6467, Transmittal
of Forms W-4 Reported Magnetically/Electronically(Continuation), if you submit data for multiple employers. These
forms must be mailed or faxed the same day electronic files are submitted.
(b) Your media (tape, diskette, or cartridge) with an external identifying label. Notice 1027 describes the information which
should be included on this self-prepared label.
(c) On the outside of the shipping container, affix the label IRB Special Projects. This label is included in the publication.
.07IRS/MCC will not return filers’ magnetic media after it has been successfully processed. Should filers wish to know if their
media was received by IRS/MCC, a delivery service that provides certification of delivery is recommended.
.08IRS cannot accept any Cash-On-Delivery (COD) or Charged-to-IRS shipments of reportable tax information that an individ-
ual or organization is legally required to file. Because of the high volume of data received and shipping cost involved, special ship-
ping containers will not be returned.
.09Use this record format and processing capabilities to file Forms W-4 submitted for the quarter ending March 31, 2001, and for
all subsequent filings.
SEC. 8. REPLACEMENT FILES
THE MAGNETIC MEDIA/ELECTRONIC SPECIFICATIONS CONTAINED IN PART B OF THIS REVENUE PRO-
CEDURE MUST BE STRICTLY ADHERED TO.If files are not processable, they will be returned to you for replacement and
resubmission, or submission of paper Forms W-4. Replacement files must be resubmitted to IRS/MCC within 45 days of the date of
the enclosed letter. The media should be identified as replacement data by writing, typing or printing “Magnetic Media Replace-
ment” on the external label used on the magnetic media and marking the replacement box on the Form 6466. If filing electronically,
you should choose replacement when asked for the type of submission to identify a replacement file before transmission begins.
Note: BEGINNING IN CALENDAR YEAR 2002 FOR TAX YEAR 2001, IRS/MCC WILL NO LONGER RETURN PROB-
LEM MEDIA IN NEED OF REPLACEMENT.Filers will continue to receive a tracking form, listing and letter detailing the rea-

son(s) their media could not be processed. Filers will be expected to send in replacement media within the prescribed time frame.
This makes it imperativethat filers maintain backup copies and/or recreate capabilities for their information return files.
SEC. 9. EFFECT ON PAPER DOCUMENTS
.01Magnetic/electronic reporting to IRS eliminates the need to submit copies of paper Forms W-4.
.02If part of the Forms W-4 are reported magnetically/electronically and the remainder are reported on paper forms, the paper
Forms W-4 must be mailed to the appropriate service center.
SEC. 10. DEFINITION OF TERMS
EmployerGenerally, an employer is a person or organization for whom a worker performs a ser-
vice as an employee. The employer has the right to direct and control the worker. A
person or organization paying wages to a former employee after the work ends is also
considered an employer.
EmployeeOne who performs services for an employer.
EINEmployer Identification Number that has been assigned to the employer by IRS.
FileFor purposes of this procedure, a file consists of all magnetic/electronic records sub-
mitted by an employer or transmitter.
Special Character Any character that is not a numeric, an alpha or a blank.
Social Social Security Number (SSN) that has been assigned to the employee by
Securitythe Social Security Administration.
Number (SSN)
TransmitterPerson or organization preparing and/or submitting magnetic/electronic file(s).
TransmitterA five-character alpha/numeric number assigned by IRS to the transmitter
Control Code prior to actual filing magnetically/electronically. This number is inserted
(TCC) in Positions 319-323 of your files and must be present before the file can be
processed. An application Form 4419 must be filed with IRS to receive this
number.
PART B. MAGNETIC MEDIA SPECIFICATIONS
SEC. 1. GENERAL
.01The specifications contained in this part of the revenue procedure define the required format and content of the records to be
included in the magnetic/electronic file. Use this revenue procedure to file Forms W-4 submitted for the quarter ending March 31,
2001 and all subsequent filings.
.02An external label must appear on each tape, tape cartridge and diskette submitted. Notice 1027 details what information must
be on the label. The diskettes used must be MS/DOS compatible.
SEC. 2. TAPE SPECIFICATIONS
Note:Beginning in calendar year 2003 for Tax Year 2003, IRS/MCC will no longer accept 9 track tapes for the filing of Forms
W-4. Fourth quarter 2002 Forms W-4 filed by January 31, 2003, can NOT be submitted on 9 tack tape.
.01IRS/MCC can process most magnetic tape files if the following specifications are followed:
(a)9-track EBCDIC (Extended Binary Coded Decimal Interchange Code) with
(1)Odd parity
(2)Recording density—1600 or 6250 BPI
(3)If you use UNISYS Series 1100, you must submit an interchange tape.
(b)9-track ASCII (American Standard Coded Information Interchange) with:
January 22, 20013802001–4 I.R.B.

2001–4 I.R.B.381January 22, 2001
(1)Odd parity
(2)Recording density—1600 or 6250 BPI
.02All tape files must have the following characteristics:
(a)0.5 inch (12.7 mm) wide, computer grade magnetic tape,
(b)Tape thickness: 1.0 or 1.5 mils,
(c)Reel diameter: 10.5 inch (26.67 cm), 8.5 inch (21.59 cm), or 7 inch (17.78 cm) and
(d)Reel of tape up to 2400 feet (731.52 m).
.03All records, including Header and Trailer Labels (if used) must be transmitted using the same density.
.04The tape records defined in this revenue procedure may be blocked subject to the following:
(a)A block must not exceed 32,550 tape positions.
(b)If the use of blocked records would result in a short block, all remaining positions of the block must be filled with 9’s; how-
ever, the last block of the file may be filled with 9’s or truncated. Do not pad a block with blanks.
(c)All records, except the header and trailer labels, may be blocked or unblocked. A record may not contain any control fields
or block descriptor fields which describe the length of the block or the logical records within the block. The number of log-
ical records within a block (the blocking factor) must be constant in every block with the exception of the last block which
may be shorter (see item (b) above). The block length must be evenly divisible by 350.
(d)All data records are a fixed record length of 350 positions and may not span blocks.
.05Labeled or unlabeled tapes may be submitted.
.06For the purposes of this revenue procedure the following must be used:
Tape Mark:
(a)Used to signify the physical end of the recording on tape.
(b)For even parity, use BCD configuration 001111(8421).
(c)May follow the header label and precede and/or follow the trailer label.
.07Do not submit an employee Form W-4 record without the required employer identification information. Every record must
contain both employee and employer data.
SEC. 3. TAPE CARTRIDGE SPECIFICATIONS
.01In most instances, IRS/MCC can process tape cartridges that meet the following specifications:
(a)Must be IBM 3480, 3490, 3490E, 3590, 3590E or AS400 compatible.
(b)Must meet American National Standard Institute (ANSI) standards, and have the following characteristics:
(1)Tape cartridges will be 1/2-inch tape contained in plastic cartridges which are approximately 4-inches by 5-inches by
1-inch in dimension.
(2)Magnetic tape will be chromium dioxide particle based 1/2-inch tape.
(3)Cartridges must be 18-track or 36-track parallel (See Note).
(4)Cartridges will contain 37,871 CPI (characters per inch ) or 75,742 CPI.
(5)Mode will be full function.
(6)The data may be compressed using EDRC (Memorex) or IDRC (IBM) compression.
(7)Either EBCDIC (Extended Binary Coded Decimal Interchange Code) or ASCII (American Standard Coded Information
Interchange) may be used.
.02The tape cartridge records defined in this revenue procedure may be blocked subject to the following:
(a)A block must not exceed 32,550 tape positions.
(b)If the use of blocked records would result in a short block, all remaining positions of the block must be filled with 9s; how-
ever, the last block of the file may be filled with 9s or truncated. Do not pad a block with blanks.
(c)All records, except the header and trailer labels, may be blocked or unblocked. A record may not contain any control fields
or block descriptor fields which describe the length of the block or the logical records within the block. The number of log-
ical records within a block (the blocking factor) must be constant in every block with the exception of the last block which
may be shorter (see item (b) above). The block length must be evenly divisible by 350.
(d)Records may not span blocks.
.03Tape cartridges may be labeled or unlabeled.
.04For the purposes of this revenue procedure, the following must be used:
Tape Mark:
(a)Used to signify the physical end of the recording on tape.
(b)For even parity, use BCD configuration 001111(8421).
(c)May follow the header label and precede and/or follow the trailer label.
Note: Filers should indicate on the external media label and transmittal Form 6466 whether the cartridge is 36-track or
18-track.

January 22, 20013822001–4 I.R.B.
SEC. 4. 8MM, 4MM AND QUARTER-INCH CARTRIDGE SPECIFICATIONS
.01In most instances, IRS/MCC can process 8mm tape cartridges that meet the following specifications:
(a)Must meet American National Standard Institute (ANSI) standards, and have the following characteristics:
(1)Created from an AS400 operating system only.
(2)8mm (.315-inch) tape cartridges will be 2 1/2-inch by 3 3/4-inch.
(3)The 8mm tape cartridges must meet the following specifications:
TracksDensityCapacity
120 (43245 BPI)2.3 Gb
121 (45434 BPI)5 Gb
(4)Mode will be full function.
(5)Compressed data is not acceptable.
(6)Either EBCDIC (Extended Binary Coded Decimal Interchange Code) or ASCII (American Standard Coded Information
Interchange) may be used. However,IRS/MCC encourages the use of EBCDIC. This information must appear on the ex-
ternal media label affixed to the cartridge.
.02The 8mm (.315-inch) tape cartridge records defined in this revenue procedure may be blocked subject to the following:
(a)A block must not exceed 32,550 tape positions.
(b)If the use of blocked records would result in a short block, all remaining positions of the block must be filled with 9’s; how-
ever, the last block of the file may be filled with 9’s or truncated. Do not pad a block with blanks.
(c)All records, except the header and trailer labels, may be blocked or unblocked. A record may not contain any control fields
or block descriptor fields which describe the length of the block or the logical records within the block. The number of
logical records within a block (the blocking factor) must be constant in every block with the exception of the last block
which may be shorter (see item (b) above). The block length must be evenly divisible by 350.
(d)Various COPY commands have been successful, however, the SAVE OBJECT COMMAND is not acceptable.
(e)Records may not span blocks.
.03For faster processing, IRS/MCC encourages transmitters to use header labeled cartridges. QWFTAX may be used as a sug-
gested filename.
.04For the purposes of this revenue procedure, the following must be used:
Tape Mark:
(a)Used to signify the physical end of the recording on tape.
(b)For even parity, use BCD configuration 001111(8421).
(c)May follow the header label and precede and/or follow the trailer label.
.05IRS/MCC can only read one data file on a tape. A data file is a group of records which may or may not begin with a tape-
mark, but must end with a trailer label. Any data beyond the trailer label cannot be read by IRS programs.
.064mm (.157-inch) cassettes are acceptable with the following specifications:
(a) 4 mm cassettes will be 2 1/4-inch by 3-inch.
(b) The tracks are 1 (one).
(c) The density is 19 (61000 BPI).
(d) The typical capacity is DDS (DAT data storage) at 1.3 Gb or 2 Gb, or DDS-2 at 4Gb.
(e) The general specifications for 8mm cartridges will also apply to the 4mm cassettes.
.07Various Quarter Inch Cartridges (QIC) (1/4-inch) are also acceptable.
(a)QIC cartridges will be 4” by 6”.
(b)QIC cartridges must meet the following specifications:
SizeTracksDensityCapacity
QIC-248/95 (8000 BPI)45Mb or 60Mb
QIC-1201515 (10000 BPI)120Mb or 200Mb
QIC-1501816 (10000 BPI)150Mb or 250Mb
QIC-5252617 (16000 BPI)525Mb
QIC-10003021 (36000 BPI)1Gb
QIC-2Gb4234 (40640 BPI) 2Gb
*Note: Advanced Metal Evaporated (AME) cartridges are not acceptable.
SEC. 5. 3 1/2-INCH DISKETTE SPECIFICATIONS
.01To be compatible, a diskette file must meet the following specifications:
(a)3 1/2-inches in diameter.
(b)Data must be recorded in standard ASCII code.
(c)Records must be a fixed length of 350 bytes per record.

2001–4 I.R.B.383January 22, 2001
(d)Delimiter character commas (,) must not be used.
(e)Positions 349 and 350 of each record have been reserved for carriage return/line feed (cr/lf) characters.
(f)Filename of QWFTAX must be used. Do not enter any other data in this field. The extension will indicate the sequence of
the diskettes within the file. For example, the first diskette will be named QWFTAX.001, the second diskette will be
QWFTAX.002, etc.
(g)A diskette file may consist of multiple diskettes as long as the file naming conventions are adhered to.
(h)Diskettes must meet one of the following specifications:
CapacityTracksSides/DensitySector Size
1.44 mb96tpihd512
1.44 mb135tpihd512
1.2 mb96tpihd512
.023 1/2-inch diskettes are only acceptable if they were created using MS/DOS.
SEC. 6. FORM W-4 RECORD FORMAT AND LAYOUT
.01This record is used to identify the employer, the employee, number of allowances, and other information that is reported on
the paper Form W-4.
.02ALL RECORDS MUST BE A FIXED LENGTH OF 350 POSITIONS.
.03Do not begin any record at the end of a block or diskette and continue the same record into the next block or diskette.
FORM W-4 RECORD FORMAT
Field
Position Field TitleLengthDescription and Remarks
1–9Employee9REQUIRED. Enter the 9-digit SSN assigned to
Social Securitythe employee. DO NOT ENTER HYPHENS or
Number (SSN)ALPHA CHARACTERS. All zeroes, ones,
twos, etc., will have the effect of an incorrect TIN.
10–44 Employee Name35REQUIRED. Enter the name of the employee
Line 1whose TIN appears in field positions 1-9. Enter the
name in the following order: first name, middle
name (if present), and surname. (Use initials for the
first and middle names where necessary to insure
that the entire employee surname fits in the field.) If
fewer than 35 characters are used, left-justify and fill
unused positions with blanks.
(1) A blank must be surrounded by alphas or con-
tinued to the end of the field (e.g., ab...b, aba).
(2) A hyphen in the first position is to identify an
employee with surname only. Hyphens must be
surrounded by alphas or numerics and must
never occur in the first position of a name unless
immediately followed by a caret.
(3) A caret is used to define an internal name
control. It must immediately precede the em-
ployee surname in place of the blank. A second
caret is used to separate a suffix from the sur-
name (e.g., JOHN J.<BLACK; BILL<OAK<JR;
AMY FERN<BROWN< MD ).
Note: The only allowable characters are alphas, blanks, numerics, ampersands, hyphens, and slashes. A minimum of one
and a maximum of two carets (<) can be used. Punctuation, such as, periods and commas are not allowed and will cause your
file to be returned.
45–79 Employee Name35Optional. This line is designated for an “in
Line 2care of” (c/o) situation. Left-justify and fill unused
positions with blanks. Hyphens and slashes must be

FORM W-4 RECORD FORMAT
Field
Position Field TitleLengthDescription and Remarks
surrounded by alphas or numerics; ampersands must
be surrounded by blanks; blanks must be surrounded
by alphas or numerics or continued to the end of the
field (e.g., ab...b, aba).
Note: The same exceptions apply as set forth in “Employee Name Line 1”; also the use of a percent sign (%) is not valid—use
c/o if necessary.
80–114 Employee Street35R E QUIRED. Enter mailing address of
Addressemployee. Street address should include number,
street, apartment or suite number (or P O Box if mail
is not delivered to street address). Left-justify and
fill unused positions with blanks. Position 80 must
be an alpha or numeric; hyphens and slashes must be
surrounded by alphas or numerics; ampersands must
be surrounded by blanks; blanks must be surrounded
by alphas or numerics or continued to the end of the
field (e.g., ab...b, aba).
Note: The only allowable characters are alphas, blanks, numerics, ampersands, hyphens and slashes. Punctuation such as
periods and commas are not allowed and will cause your file to be returned. For example, the address 210 N. Queen St.,
Suite #300 must be entered as 210 N Queen St Suite 300.
115–139Employee City 25REQUIRED. Enter the city, town, or post office. If
a foreign address, see Note 2.Left-justify and fill
unused positions with blanks. Enter APO or FPO, if
applicable. Do not enter state and ZIP Code informa-
tion in this field. Position 115 must be an alpha or
numeric; hyphens must be surrounded by alphas or
numerics; blanks must be surrounded by alphas or
numerics or continued to the end of the field (e.g.,
ab...b, aba).
Note 1: The only allowable characters are alphas, blanks, numerics, ampersands, hyphens, and slashes. Punctuation such as
periods and commas are not allowed and will cause your file to be returned. For example, the city St. Louis must be entered
as St Louis.
Note 2: For foreign addresses, you may use the 25 position Employee City field to provide the following information: city and
country name.
140–141Employee State2REQUIRED. Enter the two-character location code
of employee address--must be one of the following:
Note: For foreign addresses, enter xx from table below.
January 22, 20013842001–4 I.R.B.

FORM W-4 RECORD FORMAT
Field
Position Field TitleLengthDescription and Remarks
LocationCodeLocationCodeLocationCode
AlabamaALKentuckyKYOhio OH
AlaskaAKLouisianaLAOklahomaOK
American SamoaASMaine MEOregonOR
ArizonaAZMarshall Islands MHPennsylvania PA
ArkansasARMarylandMDPuerto Rico PR
CaliforniaCAMassachusettsMA Rhode Island RI
ColoradoCOMichigan MISouth Carolina SC
ConnecticutCTMinnesotaMN South Dakota SD
DelawareDEMississippiMSTennesseeTN
District of Columbia DCMissouri MOTexasTX
Federated StatesMontana MTUtah UT
of MicronesiaFMNebraskaNEVermontVT
FloridaFL NevadaNVVirginiaVA
GeorgiaGANew Hampshire NHVirgin IslandsVI
GuamGUNew JerseyNJWashingtonWA
HawaiiHINew MexicoNMWest VirginiaWV
IdahoIDNew YorkNYWisconsinWI
IllinoisILNorth CarolinaNCWyomingWY
IndianaINNorth DakotaNDForeign Address,
IowaIANorthernAll OthersXX
Kansas KSMariana IslandsMP
142–150 Employee ZIP Code9REQUIRED. Enter the valid nine-digit ZIP Code of
employee. IF YOU ONLY HAVE FIVE (5) DIG-
ITS AVAILABLE, LEFT-JUSTIFY AND ZERO
FILL.Blank fill only if the employee’s ZIP Code is
unavailable.
151Marital Status 1REQUIRED. Enter appropriate code from the table
below:
Marital StatusCode
Designated
Single S
MarriedM
Married, withhold
at single rateW
No marital status
designatedA
152Exempt Status1REQUIRED. Enter “E” if employee claims exempt
status; otherwise, enter blank.
153BLANK1Enter Blank.
154–156Allowances 3REQUIRED. Must be a three (3) digit numeric field
corresponding to the number of allowances claimed by
employee. (It is necessary to file this Form W-4 with
IRS if the number of allowances is more than ten (10) or
exempt status is claimed.) Field must be right justified
and zero filled. If no entry, or employee claimed exempt
status, enter blanks.
2001–4 I.R.B.385January 22, 2001

FORM W-4 RECORD FORMAT
Field
Position Field TitleLengthDescription and Remarks
157–163Additional Amount7REQUIRED. Enter any additional amount of with-
holding the employee wants deducted from each
pay. Amount must be entered in U.S. dollars and
cents. The right-most two positions represent cents.
Do not enter dollar signs, commas, decimal
points, or negative numbers.Right-justify and
zero fill. If no entry, zero-fill.
164–169 BLANK6 Enter Blanks.
170–178 Employer9R E QUIRED. The 9-digit EIN assigned to
Identificationthe employer. DO NOT ENTER HYPHENS,
Number ALPHA CHARACTERS. All zeroes, ones, twos, etc.,
will have the effect of an incorrect TIN.
179–213 Employer Name35REQUIRED. Enter the name of the employer
Line 1 as it appears on employment tax forms (e.g., Form 941).
Any extraneous information must be deleted from this
name line. Left-justify and fill with blanks. Position
179 must be alpha or numeric; hyphens and slashes
must be surrounded by alphas or numerics; blanks must
be surrounded by alphas or numerics or continued to the
end of the field (e.g., ab...b, aba).
Note: The only allowable characters are alphas, blanks, numerics, ampersands, hyphens, and slashes. Punctuation, such as
periods and commas, are not allowed and will cause your file to be returned.
214–247Employer Name 34If the employer name requires more space
Line 2 than is available in Employer Name Line 1, enter the
remaining portion of the name in this field. Left-justify
and fill with blanks. Position 214 must be alpha or nu-
meric; hyphens must be surrounded by alphas or nu-
merics; blanks must be surrounded by alphas or numer-
ics or continued to the end of the field (e.g., ab...b, aba).
Note: The same exceptions apply as set forth in “Employer Name Line 1”; also, the use of a percent sign (%) is not valid—use
c/o if necessary.
248–282Employer Street35REQUIRED. Enter mailing address of employer.
Street address should include number, street, apartment,
or suite number (or P O Box if mail is not delivered to
street address). Left-justify and fill unused positions
with blanks. Position 248 must be alpha or numeric; hy-
phens must be surrounded by alphas or numerics or
continued to the end of the field (e.g., ab...b, aba).
Note: The only allowable characters are alphas, blanks, numerics, ampersands, hyphens and slashes. Punctuation such as
periods and commas are not allowed and will cause your file to be returned. For example, the address 210 N. Queen St.,
Suite #300 must be entered as 210 N Queen St Suite 300.
283–307 Employer City25REQUIRED. Enter the city, town or post office.
Enter APO or FPO if applicable. Do not enter state
and ZIP Code information in this field. Position 283
must be alpha or numerics; blanks must be numeric;
hyphens must be surrounded by alphas or numerics;
January 22, 20013862001–4 I.R.B.

2001–4 I.R.B.387January 22, 2001
FORM W-4 RECORD FORMAT
Field
Position Field TitleLengthDescription and Remarks
blanks must be surrounded by alphas or numerics or
continued to the end of the field (e.g., ab...b, aba).
Note: The only allowable characters are alphas, blanks, numerics, ampersands, hyphens, and slashes. Punctuation such as periods
and commas are not allowed and will cause your file to be returned. For example, the city St. Louis must be entered as St Louis.
308–309 Employer State 2 REQUIRED. Enter location code of employer.
Code Must use abbreviation shown in the location abbre-
viation table for Employee Location Code (field po-
sitions 140-141).
310–318 Employer ZIP Code 9REQUIRED. Enter the valid nine digit ZIP Code
of employer. IF YOU ONLY HAVE FIVE (5)
DIGITS AVAILABLE, LEFT-JUSTIFY AND
ZERO FILL.Blank fill only if employer’s ZIP
Code is unavailable.
319–323 Transmitter 5REQUIRED. Enter 5-character Transmitter Control
Control Code Code (TCC) assigned by IRS/MCC.
324–331 Form W-4 Date 8REQUIRED. Enter date located on signature line Form
W-4. If no date entered, generate current system date.
Format as YYYYMMDD (e.g.,19991231). Exempt
Status Form W-4 Compare “year effective date” on Line
7 to signature date. If year entered on Line 7 is later than
signature date, use Form W-4 date as a 01/01 receipt for
subsequent calendar year (e.g., Line 7 of Form W-4
shows an exempt status date of 2000 but
signature date is 19991031, use 20000101 as Form W-4
date.)
332–348 BLANK17Enter Blanks.
349–350 BLANK 2Enter blanks, or carriage return/line feed (CR/LF)
characters.
FORM W-4 RECORD LAYOUT
1–910–4445–7980–114115–139
140–141142–150151152153154–156
Employee Social EmployeeEmployee NameEmployee StreetEmployee City
Security Number NameLine 2Address
Line 1
Employee StateEmployee ZipMarital ExemptBLANKAllowances
CodeStatusStatus

FORM W-4 RECORD LAYOUT
157–163164–169170–178179–213214–247
248–282283–307308–309310–318319–323
324–331332–348349–350
PART C. ELECTRONIC FILING SPECIFICATIONS
SEC. 1 BACKGROUND
.01 All electronic filing of information returns are received at IRS/MCC via the FIRE (Filing Information Returns Electronically)
System. The FIRE System can be accessed via analog and ISDN BRI connections. The system is designed to support the electronic
filing of information returns only. The telephone number for electronic filing is (1-304-262-2400). Publications and forms are no
longer available electronically from MCC. Users needing publications and forms will need to download them from the IRS’ Web Site
at www.irs.gov or order them by calling 1-800-TAX-FORM (1-800-829-3676).
SEC. 2. ADVANTAGES OF FILING ELECTRONICALLY
Some of the advantages of filing electronically are as follows:
(1)Results available within 10 workdays as to the acceptability of the data transmitted. It is the filer’s responsibility to dial
back in and check results.
(2)Better customer service due to on-line availability of transmitter’s files for research purposes.
SEC. 3. GENERAL
.01Electronic filing of Forms W-4, originals, and replacements of information returns is offered as an alternative to magnetic
media (tape, tape cartridge, or diskette) or paper submissions, but is not a requirement. Transmitters filing electronically will fulfill
the magnetic media requirements for those withholding agents whom are required to file magnetically. It may also be used by with-
holding agents who are under the filing threshold requirement, but would prefer to file their information returns this way. If the orig-
inal file was sent magnetically, but was returned for replacement, the replacement may be transmitted electronically.
.02The electronic filing of information returns is not affiliated with the Form 1040 electronic filing program. These two pro-
grams are totally independent, and filers must obtain separate approval to participate in each of them. All inquiries concerning the
electronic filing of information returns should be directed to IRS/MCC. IRS/MCC personnel cannot answer questions or assist tax-
payers in the filing of Form 1040 tax returns. Filers with questions of this nature will be directed to the Customer Service toll-free
number (1-800-829-1040) for assistance.
.03Files submitted to IRS/MCC electronically must be in standard ASCII code. No magnetic media or paper forms are to be sub-
mitted with the same information as the electronically submitted file.
.04The format is the same for electronically filed records as they are for 3 1/2-inch diskettes, tapes, and tape cartridges, and must
be in standard ASCII code. For electronically filed documents, each transmission is considered a separate file.
SEC. 4. ELECTRONIC FILING APPROVAL PROCEDURE
.01Filers must obtain, or already have, a Transmitter Control Code (TCC) assigned prior to submitting their files electronically.
(Filers who currently have a TCC for magnetic media filing do not have to request a second TCC for electronic filing.) Refer to Part
January 22, 20013882001–4 I.R.B.
Employer StreetEmployer CityEmployer StateEmployer ZIPTransmitter
CodeCodeControl Code
Line 1
Form W-4 DateBLANKBLANK or
CR/LF
Additional Amount BLANKEmployerEmployerEmployer
IdentificationName Line 1Name Line 2
Number

A, Sec. 5, for information on how to obtain a TCC.
.02Once a TCC is obtained, electronic filers assign their own passwords and do not need prior or special approval.
.03For all passwords, it is the user’s responsibility to remember the password and not allow the password to be compromised.
Passwords are user assigned at first logon and are up to 8 alpha/numerics, which are case sensitive. A filer who forgets their pass-
word, can call 304-263-8700for assistance.
Note: Passwords are case sensitive.
SEC. 5. ELECTRONIC SUBMISSIONS
.01Electronically filed information may be submitted to IRS/MCC 24 hours a day, 7 days a week. Technical assistance will be
available Monday through Friday between 8:30 a.m. and 4:30 p.m. Eastern time by calling 304-263-8700.
.02The FIRE System will be down yearly from December 29 through January 7.This will allow time for IRS/MCC to update
its system to reflect current year changes.
.03Data compression is encouraged when submitting information returns electronically. WinZip and PKZip are acceptable com-
pression packages. UNIX COMPRESS may be acceptable; however, a test file is recommended to verify compatibility. IRS/MCC
cannot accept self-extracting zip files or compressed files containing multiple files.
The time required to transmit information returns electronically will vary depending on the modem speed and the type of data
compression used, if any. The time required to transmit a file can be reduced by as much as 95 percent by using software
compression and hardware compression.
The following are actual transmission rates achieved in test uploads at MCC using compressed files. The actual transmission rates
will vary depending on the modem speeds.
.04Files submitted electronically will be assigned a unique filename by the FIRESystem (the users may name files anything they choose
from their end). The filename assigned by the FIRE Systemwill consist of submission type [ORIG (original), or REPL (replacement)], the
filer’s TCC and a four digit number sequence. The sequence number will be incremented for every file sent. For example, if it is your first
original file for the calendar year and your TCC is 44444, the IRS assigned filename would be ORIG.44444.0001. Record the filename. This
information will be needed by MCC in order to identify the file, if assistance is required, and to complete Form 6466.
.05Filers are advised not to resubmit an entire file if records were omitted from the original transmission. This will result in du-
plicate filing. A new file should be sent consisting of the records that had not previously been submitted.
SEC. 6. TRANSMITTAL REQUIREMENTS
.01The results of the electronic transmission will be available in the File Status area of the electronic system within 10 workdays;
however, no further processing will occur until the signed Form 6466 is received. The Form 6466 must be postmarked by the due
date of the return. No return is considered filed until a Form 6466 is received by IRS/MCC.
.02Form 6466, which is located in the back of this publication, can be ordered by calling the IRS toll-free forms and publications
order number 1-800-TAX-FORM (1-800-829-3676),or it may be computer-generated. It may also be obtained from the IRS’s In-
ternet Web Site at www.irs.gov.If a filer chooses to computer-generate Form 6466, all of the information contained on the original
form, including the affidavit, must also be contained on the computer-generated form.
.03Forms 6466 should be mailed to the following address:
If by Postal Service, air or truck freight:
IRS-Martinsburg Computing Center
Information Reporting Program
Attn: Electronic Filing Coordinator
240 Murall Drive
Kearneysville, WV 25430
Please indicate on the envelope the following message:
CONTAINS FORM 6466 INFORMATION - NO MAGNETIC MEDIA
SEC. 7. ELECTRONIC FILING SPECIFICATIONS
.01The FIRE System is designed exclusively for the filing of Forms 1042-S, 1099, 1098, 5498, 8027, W2-G, and W-4.
.02A transmitter must have a TCC before a file can be transmitted. If you have a TCC for magnetic media filing, that TCC can
also be used for electronic filing.
2001–4 I.R.B.389January 22, 2001
Transmission
Speed in bps1000 Records10,000 Records100,000 Records
19.2K34 Sec.6 Min.60 Min.
56K20 Sec.3 1/2 Min.33 Min.
128K (ISDN)8 Sec.1 Min.10 Min.

.03It is the filer’s responsibility to dial back to verify the acceptability of files submitted by checking the file status area of the sys-
tem.These reports will be available on the electronic system in 10 workdays after the transmission is received by IRS/MCC.
.04Contact the FIRE System by dialing 304-262-2400. This number supports analog connections from 1200bps to 56Kbps or
ISDN BRI 128Kbps connections. The system can be accessed via Dial-up network/web browser (see Section 8)or communications
software (see Section 9). The Dial-up network/web browser will provide an Internet-like look without going through the Internet
(point-to-point). If you do not have this capability, a text interface is provided that can be accessed via communication software such
as Hyperterminal, Procomm, PCAnywhere, etc.
SEC. 8. DIAL-UP NETWORK/BROWSER SPECIFICATIONS (WEB INTERFACE)
.01The following are some general instructions (many of these settings may already be set by default in your software):
Dial-up network settings:
(a)Set dial-up server type to PPP
(b)Set network protocol to TCP/IP
Browser settings:
(a)Set to receive ‘cookies’
(b)Enable JavaScript or Jscript
(c)Browser must be capable of file uploads (i.e., Internet Explorer 4.0, Netscape 2.0 or higher)
(d)Enter the URL address of http://10.225.224.2(Remember, this is a point-to-point connection, not the Internet.)
.02Due to the large number of communication products available, it is impossible to provide specific information on all soft-
ware/hardware configurations. However, since most of our filers use Windows 95, 98 or NT software, the following instructions are
geared toward those products:
UPLOADING FILES WITH DIAL-UP NETWORKING/WEB BROWSER IN WINDOWS 95/98
(1) This is a point-to-point connection - - not the Internet.
(2) Your browser must be capable of file uploads, i.e., Internet Explorer 4.0 or Netscape Navigator 2.0 or higher.
(3) If you currently access the Internet via a LAN or a PROXY server, you will need to disable those options in your browser and
enable ‘Connect to the Internet using a modem’.
SelectPrograms
Accessories
Communications (Windows 98)
Dial-Up Networking
F
irst time connecting with Dial-Up Network(If you have logged on previously, skip to Subsequent Dial-up Network Connections.)
The first time you dial-in, you will need to configure your Dial-Up Networking.
Select‘Make new connection’.
Type a descriptive name for the system you are calling.
Select your modem.
Click ‘Next’.
Enter area code 304and telephone number 262-2400.
Click ‘Next’.
When you receive a message that you have successfully created a new Dial-Up
Networking connection, click ‘Finish’.
Click ‘Connect’to dial. If you are prompted for a user name and password,
complete according to local procedures; otherwise, click ‘OK’.
When you receive the message that you have connected to our system, click on your Web Browser
(remember, you are not connecting via the Internet - - this is a point-to-point connection).
In the URL Address enter http://10.225.224.2 and press ENTER.
Subsequent Dial-Up Netw
ork connections
Click ‘Connect’.
If prompted for user name and password, complete according to local
procedures; otherwise, click ‘OK’.
When you receive ‘Connection Complete’, click ‘OK’.
Click on your Web Browser (remember, you are not connecting via the Internet).
In the URL Address enter http://10.225.224.2and press ENTER.
January 22, 20013902001–4 I.R.B.

First time connection to The FIRE System(If you have logged on previously, skip to Subsequent Connections to the FIRE
System.)
Click ‘Create New Account’.
Fill out the registration form and click ‘Create’.
Enter your logon name(most users logon with their first and last name).
Enter your password(the password is user assigned and is case sensitive).
Click ‘Create’.
If you receive the message ‘account created’, click ‘OK’.
Click ‘Start the Fire Application.’
Subsequent connections to The FIRE System
Click ‘Log On’.
Enter your logon name(most users logon with their first and last name).
Enter your password(the password is user assigned and is case sensitive).
At Menu Options:
Click ‘Information Returns’
Enter your TCC:
Enter your EIN:
Click ‘Submit’.
The system will then display the company name, address, city, state, ZIP code, and phone number.
This information will be used to contact or send any correspondence regarding this transmission.
Update as appropriate and/or click ‘Accept’.
Click one of the following:
Original File
Replacement File(if you select this option, select one of the following):
FIRE Replacement(file was originally transmitted on this system) Click file to be replaced
Magnetic Media Replacement File
Enter the alpha character from Form 9267, Media Tracking Slip, that was returned with your
magnetic media shipment.
Click ‘Submit’.
Enter the drive/path/filenameof the file you want to upload or click ‘Browse’to locate the file.
Click ‘Upload’.
When the upload is complete, the screen will display the total bytes received and the file name to be recorded on your Form 6466,
Box 7b.
If you have more files to upload for that TCC:
Click ‘File Another’; otherwise,
Click ‘Back to Main Menu’.
It is your responsibility to check the acceptability of your file; therefore, be sure to dial back into the system in 10 business days.
At the Main Menu:
Click ‘File Stats’.
Enter your TCC:
Enter your EIN:
Click ‘Search’.
If ‘Results’indicate:
‘File Good’and you agree with the ‘Count of Payees’ and have mailed your Form 6466, you are
finished with this file. (Form 6466 is not needed on a replacement file unless the number of payees
has changed from the original/correction file.)
2001–4 I.R.B.391January 22, 2001

‘File Bad’- Correct the errors and resubmit the file as a ‘replacement’.
‘Not Yet Processed’- File has been received, but we do not have results available yet. Please check
back in a few days.
Click on the desired file for a detailed report of your transmission.
When finished viewing your files, click on ‘Main Menu’.
Click ‘Log Off’.
Close your Web Browser.
IMPORTANT
Go back into your Dial-Up Network and click ‘hang-up’; otherwise, you may stay connected and incur unnecessary phone
charges.
SEC. 9. COMMUNICATION SOFTWARE SPECIFICATIONS (TEXT INTERFACE)
.01Communications software settings must be:
- No parity
- Eight data bits
- One stop bit
.02Terminal Emulation must be VT100.
.03Due to the large number of communication products available, it is impossible to provide spe-
cific information on all software/hardware configurations. However, since most of our filers use
Windows 95, 98 or NT software, the following instructions are geared toward those products (Pro-
comm, PCAnywhere and many other communications packages are also acceptable and the prod-
uct does not necessarily need to be Windows based.):
UPLOADING FILES USING HYPERTERMINAL IN WINDOWS 95, 98 OR NT
Select Programs
Accessories
Communications(Windows 98)
Hyperterminal
The first time you log on, select Hyperterminal,Hypertermor Hyperterm.exe, whichever is avail-
able on your system. Thereafter, you can just select the icon that you have saved.
A box will appear titled ‘Connection Description’.
Enter a name and choose an iconfor the connection:
Country Code: United States of America
Area Code:304
Phone Number:262-2400
Connect Using: (default)
(If you need to modify the phone number, select File, then Propertiesto enter defaults for the area
code, phone numbers, and/or special access codes.)
Click on Dial.
A ‘Connect’box will appear to show the status.
Once you have connected to The FIRE System, if you do not get a menu within a few seconds, press
the ENTERkey one time.
First Time Logon
When you have connected to the system, enter ‘new’to create your logon name and password.
Complete the registration information and enter ‘y’to create account.
Logon Name and Password
Logon Name: Enter a logon name. Most users enter their first and last name as the logon name.
Password: Enter a password of your choosing (1-8 alpha/numerics - case sensitive).
After entering the password, you will go to the Main Menu.
T
ransferring Your Electronic File
Enter ‘A’for Electronic Filing.
After reading Information Notice, press ENTER.
Enter ‘A’for Forms 1098, 1099, 5498, W-2G, 1042-S, 8027 and Questionable Forms W-4.
Press the Tab key to advance to TCC box; otherwise, enter ‘E’to exit.
January 22, 20013922001–4 I.R.B.

Enter your TCC:
Enter your EIN:
The system will then display the company name, address, city, state, ZIP code, and phone number.
This information will be used to contact or send correspondence (if necessary) regarding this
transmission. If you need to update, enter ‘n’to change information; otherwise, enter ‘y’to ac-
cept.
Select one of the following:
‘A’for an Original file
‘B’for a Replacement file
If you selected ‘B’ for a replacement file, select one of the following:
‘A’Replacement Files For This System
This option is to replace an original/correction file that was submitted electronically on this
system but was bad and needs to be replaced. Select the file needing replaced.
‘B’Magnetic media replacement files
Enter the alpha character from Form 9267, Media Tracking Slip, that was returned with your
magnetic media shipment.
Choose one of the following protocols (Hyperterminal is normally set to Zmodem by default):
X - Xmodem
Y- Ymodem
Z- Zmodem (Zmodem will normally give you the fastest transfer rate.)
At this point, you must start the upload from your PC.
To send a file:
Go to the hyperterminal menu bar.
Click on Transfer.
Click on Send file.
A box will appear titled ‘Send File’.
Enter the drive/path/filename or click on Browseto locate your file.
Click on Send.
When the upload is complete, the screen will display the total bytes received and the file name to be recorded on your Form 6466,
Box 7b.
Press ENTERto continue.
If you have more files to send for the same TCC/EIN, enter ‘y’; otherwise, enter ‘n’.
It is your responsibility to check the acceptability of your file; therefore, be sure to dial back into the system in 10 business
days.
At the Main Menu:
Enter ‘B’for file status.
Press the Tab key to advance to TCC box; otherwise, enter ‘E’to exit.
Enter your TCC:
Enter your EIN:
Choose the appropriate option.
Tab to the file you want to look at and press ENTER.
If ‘Results’indicate:
‘File Good’and you agree with the ‘Count of Payees’ and have mailed your Form 6466, you are
finished with this file. (Form 6466 is not needed on a replacement file unless the number of payees
changes from the original/correction file.)
‘File Bad’- Correct the errors and resubmit the file as a replacement.
‘Not Yet Processed’- File has been received, but we do not have results available yet. Please
check back in a few days.
When you are finished, enter ‘E’from the Main Menu to logoff.
Enter ‘2’to hang-up.
2001–4 I.R.B.393January 22, 2001

SEC. 10. MODEM CONFIGURATION
.01Hardware features
(a) Enable hardware flow control
(b) Enable modem error control
(c) Enable modem compression
SEC. 11. COMMON PROBLEMS ASSOCIATED WITH ELECTRONIC FILING
The following are the major non-format errors associated with electronic filing:
1. No Form 6466, Transmittal of Forms W-4 Reported Magnetically/Electronically.
Even though you have sent your information returns electronically, you still need to mail a signed Form 6466 by the due date of the
return. See Part C, Section 6.03, for the mailing address.
2. Transmitter does not dial back to the electronic system to determine file acceptability.
The results of your file transfer are posted to the FIRE System within ten business days. It is your responsibility to verify file ac-
ceptability and, if the file contains errors, you will be mailed a listing of the errors. Date received and number of payee records are
also displayed.
3. Incorrect file is not replaced timely.
If your file is bad, correct the file and timely resubmit as a replacement.
4. Transmitter compresses several files into one.
Only compress one file at a time. For example, if you have 10 uncompressed files to send, compress each file separately and send 10
separate compressed files.
5. Transmitter sends a file and File Status indicates that the file is good, but the transmitter wants to send a replacement file
to replace the original file.
Once a file has been transmitted, you cannot send a replacement file unless File Status indicates the file is bad (10 business
days after file was transmitted). If you do not want us to process the file, you must first contact us at 304-263-8700 to see if
this is a possibility. However, this will count as a replacement.
6. File is formatted as EBCDIC.
All files submitted electronically must be in standard ASCII code.
Part D. Miscellaneous Information
Sec. 1. Addresses for Martinsburg Computing Center
To submit an application to file, Form 6466, correspondence, and magnetic media files, use the following:
Mailing by U. S. Postal Service, truck, or air freight:-Q
IRS—Martinsburg Computing Center
Information Reporting Program
240 Murall Drive
Kearneysville, WV 25430
Sec. 2. Telephone Numbers for Contacting IRS/MCC
Information Reporting Program Call Site: 304-263-8700 &
January 22, 20013942001–4 I.R.B.

Telecommunication Device for the Deaf (TDD): 304-267-3367
Between 8:30 a.m. and 4:30 p.m. Eastern Time
Monday through Friday
Electronic Filing via FIRE - 1-304-262-2400
Information Returns FAX Machine: 304-264-5602
¬
HOURS OF OPERATION – FIRE SYSTEM & FAX
24 HOURS A DAY
7 DAYS A WEEK
This is the end of Publication 1245 for Tax Year 2000.
2001–4 I.R.B.395January 22, 2001

Notice of Proposed Rulemaking;
Notice of Proposed Rulemaking
by Cross Reference to
Temporary Regulations; and
Notice of Public Hearing
Electing Small Business Trust
REG–251701–96
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing; notice of proposed rulemaking by
cross reference to temporary regulations;
and notice of public hearing.
SUMMARY:This document contains
proposed regulations relating to the quali-
fication and treatment of electing small
business trusts (ESBTs). The proposed
regulations interpret the rules added to the
Internal Revenue Code (Code) by section
1302 of the Small Business Job Protection
Act of 1996 and section 1601 of the
Taxpayer Relief Act of 1997. In addition,
the text of the temporary regulations pub-
lished in T.D. 8915, page 359, also serves
as the text of these proposed regulations
with respect to an ESBT or a trust
described in section 401(a) or section
501(c)(3) that is exempt from taxation
under section 501(a) not being treated as a
deferral entity for purposes of §1.444–2T.
The proposed regulations affect S corpo-
rations and certain trusts that own S cor-
poration stock. This document also pro-
vides notice of a public hearing on these
regulations.
DATES: Written or electronic comments
must be received by April 4, 2001.
Requests to speak (with outlines of oral
comments to be discussed) at a public
hearing scheduled for April 25, 2001, at
10 a.m. must be received by April 4, 2001.
ADDRESSES:Send submissions to:
CC:M&SP:RU (REG–251701–96), room
5226, Internal Revenue Service, POB 7604,
Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered
between the hours of 8 a.m. and 5 p.m. to:
CC:M&SP:RU (REG–251701–96),
Courier’s Desk, Internal Revenue Service,
1111 Constitution Avenue,NW.,
Washington, DC. Alternatively, taxpayers
may submit comments electronically via the
Internet by selecting the “Tax Regs” option
on the IRS Home Page, or by submitting
comments directly to the IRS Internet site at
http://www.irs.gov/tax_regs/regslist.html.
The public hearing will be held in the
Internal Revenue Building Auditorium,
1111 Constitution Avenue,NW.,
Washington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, Bradford Poston or James A. Quinn,
(202) 622-3060; concerning submissions
and the hearing, Sonya M. Cruz, (202)
622-7190; (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information in this
notice of proposed rulemaking have been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control numbers
1545–1523 and 1545–1591.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
This document contains proposed
amendments to the Income Tax
Regulations (26 CFR Part 1) relating to S
corporations and electing small business
trusts (ESBTs). Section 1302 of the Small
Business Job Protection Act of 1996,
Public Law 104–188 (110 Stat. 1755)
(August 20, 1996) (the 1996 Act), amend-
ed sections 641 and 1361 of the Code to
permit an ESBT to be an S corporation
shareholder. Further amendments were
made to section 1361(e) by the Taxpayer
Relief Act of 1997, Public Law 105–34
(111 Stat. 1601(c)(1)) (August 5, 1997).
Prior section 641(d) was redesignated as
section 641(c) by the Internal Revenue
Service Restructuring and Reform Act of
1998, Public Law 105–206 (112 Stat.
6007(f)(2)) (July 22, 1998).
Explanation of Provisions
Overview
Prior to the 1996 Act, the only trusts
that were permitted S corporation share-
holders were wholly-owned grantor trusts,
voting trusts, certain grantor trusts after
the grantor’s death, and qualified sub-
chapter S trusts (QSSTs). These trusts are
not taxed at the trust level, and the deemed
owner or owners are taxed directly on the
tax items of the trusts, except for certain
testamentary trusts described in
§1.1361–1(j)(7)(ii). QSSTs are required
to have a single income beneficiary, and
all of the income must be currently dis-
tributed to such beneficiary. The 1996 Act
created ESBTs to allow more flexibility in
the types of trusts that are permitted S cor-
poration shareholders and, in particular, to
facilitate family financial planning.
H. Rep. No. 586, 104
th
Cong., 2d Sess. 82
(1996), S. Rep. No. 281, 104
th
Cong., 2d
Sess. 46 (1996). Unlike a QSST, an
ESBT may have multiple beneficiaries
and may also accumulate trust income.
Section 1361(e)(1) defines the term
electing small business trustas any trust
if: (1) the trust does not have as a benefi-
ciary any person other than an individual,
an estate, or an organization described in
section 170(c)(2) through (5); (2) no inter-
est in the trust was acquired by purchase;
and (3) an election has been made with
respect to the trust.
Section 1361(c)(2)(B)(v) provides that,
for purposes of section 1361(b)(1) (the
S corporation shareholder limitations),
each potential current beneficiary of an
ESBT will be treated as a shareholder.
During any period that there is no poten-
tial current beneficiary of an ESBT, the
trust shall be treated as the shareholder.
ESBT Beneficiaries
Notice 97–49 (1997–2 C.B. 304) clari-
fies the definitions of beneficiary (for pur-
poses of section 1361(e)(1)(A)(i)) and
potential current beneficiary (for purposes
of section 1361(e)(2)) and also clarifies
January 22, 20013962001–4 I.R.B.
Part IV. Items of General Interest

the treatment of ESBT distributions. The
proposed regulations, when finalized, will
modify and replace the rules of Notice
97–49.
Beneficiary
The proposed regulations provide guid-
ance as to who is an ESBT beneficiary.
Generally, a beneficiary includes any per-
son who has a present, remainder, or
reversionary interest in the trust other than
a remote, contingent interest. If an ESBT
makes distributions to another trust (the
distributee trust), the distributee trust is
not treated as a beneficiary of the ESBT.
However, the beneficiaries of the distribu-
tee trust will be counted as beneficiaries
of the ESBT. Persons whose future bene-
ficial interest is so remote as to be negli-
gible are not beneficiaries. Generally,
when the probability that a person will
receive any distribution from the trust is
less than 5 percent, at a particular time,
that person’s interest would be so remote
as to be negligible. Finally, the term ben-
eficiarydoes not include a person in
whose favor a power of appointment may
be exercised until the power is actually
exercised.
Interests Acquired by Purchase
The proposed regulations provide guid-
ance regarding the prohibition on acquir-
ing an interest in an ESBT by purchase.
The proposed regulations provide that the
prohibition applies if any portion of a ben-
eficiary’s basis in the beneficiary’s inter-
est is determined under section 1012.
Thus, a part-gift, part-sale of a beneficial
interest will terminate the trust’s status as
an ESBT. Beneficiaries may not purchase
interests in the trust, but the ESBT itself is
allowed to purchase S corporation stock.
Grantor Trusts
The proposed regulations provide that a
trust, all or a portion of which is treated as
owned by an individual under subpart E,
part I, subchapter J, chapter 1 of the
Internal Revenue Code (Code) (a grantor
trust), may elect to be an ESBT. The
Treasury Department and the IRS believe
that Congress did not intend to preclude
this type of trust, which is a common fam-
ily estate planning tool, from electing
ESBT status. The proposed regulations
provide rules for the treatment of grantor
trusts electing ESBT status.
Potential Current Beneficiaries
The proposed regulations provide that
the term potential current beneficiary
means, with respect to any period, any
person who at any time during such peri-
od is entitled to, or at the discretion of any
person may receive, a distribution from
the principal or income of the trust. In
general, a person who may receive a dis-
tribution from the ESBT under a currently
exercisable power of appointment is a
potential current beneficiary. In addition,
in the case of an ESBT that is a grantor
trust, the proposed regulations provide
that the deemed owner of the grantor trust
is also to be treated as a potential current
beneficiary.
Under the definitions set forth in the
proposed regulations, a potential current
beneficiary is not necessarily a beneficia-
ry of the trust and vice versa. For exam-
ple, a person in whose favor property
could currently be appointed, but to whom
no such appointment has been made, is a
potential current beneficiary, but not a
beneficiary. Conversely, a person who is
a non-contingent remainder beneficiary of
a non-grantor trust is a beneficiary, but not
a potential current beneficiary.
The proposed regulations provide spe-
cial rules if current distributions can be
made to a distributee trust. If the distrib-
utee trust does not qualify to be a share-
holder of an S corporation under section
1361(c)(2)(A), then the trust is considered
the potential current beneficiary and thus
a shareholder. In that case, the corpora-
tion’s S election terminates because the
corporation has an ineligible shareholder.
For this purpose, a trust is deemed to qual-
ify to be a shareholder of an S corporation
under section 1361(c)(2)(A) if it would be
eligible to make a QSST or ESBT election
if it owned S corporation stock.
If the distributee trust does qualify to be
a shareholder of an S corporation under
section 1361(c)(2)(A), in general, the
potential current beneficiaries of the dis-
tributing ESBT will include the potential
current beneficiaries of the distributee
trust. However, if the distributee trust is a
former grantor trust prior to the owner’s
death (that is, a trust described in section
1361(c)(2)(A)(ii)), or is a trust receiving a
distribution of S stock from a decedent’s
estate (that is, a trust described in section
1361(c)(2)(A)(iii)), the estate of the dece-
dent is treated as the only potential current
beneficiary of the trust . In no case will
the same person be counted twice when
determining the number of S corporation
shareholders.
ESBT Election
Notice 97–12 (1997–1 C.B. 385) pro-
vides the procedures for making the
ESBT election. Under that notice, the
ESBT election is required to contain cer-
tain information and representations, and
is required to be filed with the service cen-
ter where the S corporation files its
income tax returns. These proposed regu-
lations, when finalized, will modify and
replace the rules in Notice 97–12.
Under the proposed regulations, the
trustee of an ESBT makes a single ESBT
election by filing a statement with the ser-
vice center where the ESBT files its Form
1041,U.S. Income Tax Return for Estates
and Trusts.This procedure will be more
convenient for taxpayers than the proce-
dures of Notice 97–12 if the ESBT holds
stock in more than one S corporation. No
trust documents are required to be
attached to the election statement.
The proposed regulations provide that
if a trust satisfies the ESBT requirements
and makes an ESBT election, the trust
will be treated as an ESBT for federal
income tax purposes as of the effective
date of the ESBT election. These effec-
tive dates generally follow the rules of
§1.1361–1(j)(6)(iii) for qualified sub-
chapter S trust (QSST) elections.
Protective ESBT elections, which are
intended to become effective only if the
trust fails to satisfy the requirements for a
trust described in section 1361(c)(2)(A)(i)
through (iv), are prohibited. Unlike a pro-
tective QSST election, a protective ESBT
election could result in a change in the
incidence of taxation from the owner of
the trust to the trust itself. If a trust fails
to qualify as an eligible S corporation
shareholder under section 1361(c)(2), and
consequently the S corporation election is
ineffective or terminated, relief may be
available under section 1362(f) for an
inadvertent ineffective S corporation elec-
tion or an inadvertent S corporation termi-
nation.
2001–4 I.R.B.397January 22, 2001

Conversions of QSSTs and ESBTs
Rev. Proc. 98–23 (1998–1 C.B. 662)
provides procedures for the conversion of
a QSST to an ESBT and an ESBT to a
QSST. The proposed regulations, when
finalized, will modify and replace the pro-
cedures of Rev. Proc. 98–23 and provide
rules with respect to these conversions.
The conversion procedure provided in
the proposed regulations differs from that
provided in Rev. Proc. 98–23, in that the
election must be filed with the service
center where the trust files its income tax
return, as well as with the service center
where the S corporation files its income
tax return. The election must be filed in
both service centers if the service center
for the trust is different from the service
center for the S corporation because
QSST elections are filed with the service
center where the S corporation files its
income tax return and ESBT elections
will be filed where the trust files its
income tax return under the new proce-
dures set forth in these proposed regula-
tions, when finalized. The IRS and the
Treasury Department specifically request
comments on whether the rules for filing
QSST elections similarly should be
changed to permit the filing of a QSST
election with the service center where the
trust files its return rather than with the
service center for the S corporation(s).
Consent to the S Corporation Election
Notice 97–12 provides that, for purposes
of the ESBT’s consent to the S corporation
election under section 1362(a), only the
trustee needs to consent to the S corporation
election because the ESBT is taxed on the S
corporation’s income and the trustee makes
the ESBT election. These proposed regula-
tions, when finalized, will modify and
replace the rules in Notice 97–12.
Under the proposed regulations, if the
ESBT is also a grantor trust, the deemed
owner must also consent to the S corpora-
tion election because such owner will be
taxed on all or a portion of the S corpora-
tion’s income. If there is more than one
trustee, the trustee or trustees with author-
ity to legally bind the trust must consent to
the S corporation election.
ESBT Taxation
The proposed regulations provide that,
for federal income tax purposes, an ESBT
consists of an S portion, a non-S portion,
and in some instances a grantor portion.
The items of income, deduction, and cred-
it attributable to any portion of the ESBT
treated as owned by a person under the
grantor trust rules of subpart E, including
S corporation stock and other property
(the grantor portion), are taken into
account on that individual’s tax return
pursuant to the normal rules applicable to
grantor trusts. Other items of income,
deduction, and credit are, pursuant to
these proposed regulations, attributed to
either the S portion, which includes the S
corporation stock, or the non-S portion,
which includes all other assets of the trust.
The S portion is subject to tax under the
special rules of section 641(c), while the
non-S portion is subject to the normal
trust taxation rules of subparts A through
D of subchapter J.
The proposed regulations provide that
if an otherwise allowable deduction of the
S portion is attributable to a charitable
contribution paid by the S corporation, the
contribution will be deemed to be paid by
the S portion pursuant to the terms of the
trust’s governing instrument within the
meaning of section 642(c)(1). The other
requirements of section 642(c)(1) must
also be met for the contribution to be
deductible by the S portion, and the
deduction is limited to the amount of the
gross income of the S portion. If a pay-
ment is made to a charitable organization
by the ESBT pursuant to the terms of its
governing instrument, such payment is
deductible, subject to the provisions of
section 642(c)(1), to the extent it is paid
from the gross income of the non-S por-
tion of the trust. Thus, if the ESBT con-
tributes S corporation stock to a charitable
organization, no deduction is allowed
under section 642(c)(1) because the con-
tribution is not paid out of the gross
income of the non-S portion.
The proposed regulations provide guid-
ance regarding the treatment of proceeds
received by an ESBT from the sale of S cor-
poration stock when income from the sale is
reported on the installment method under
section 453. The income recognized with
respect to the installment proceeds is taken
into account by the S portion. The interest
on the installment obligation is taken into
account by the non-S portion.
The proposed regulations provide that
if a trust holds S corporation stock and is
already an eligible S corporation share-
holder and the trust makes an ESBT elec-
tion during the trust’s taxable year, the
electing trust will be treated as a separate
taxpayer for purposes of allocating S cor-
poration items under section 1377(a)(1).
However, the ESBT election does not
result in the prior trust being treated as
terminating its entire interest in its S cor-
poration stock for purposes of
§1.1377–1(b), unless the prior trust is one
described in section 1361(c)(2)(A)(ii) or
(iii). Therefore, the S corporation is gen-
erally not permitted to make the election
to terminate the taxable year under section
1377(a)(2). The trust will be treated as a
single taxpayer for purposes of determin-
ing the taxation of distributions from the
trust. Thus, distributions made after the
effective date of the ESBT election may
still carry out distributable net income of
the trust earned during the taxable year
before the effective date of the ESBT
election.
The proposed regulations provide that
for purposes of determining whether the
exception to estimated taxes under section
6654(d)(1)(B) applies, the trust will not be
considered a different taxpayer as a result
of the ESBT election. Therefore, if the
ESBT makes estimated tax payments
equal to 100 percent of the prior year’s tax
liability, no penalties will apply.
The proposed regulations provide that
interest expenses paid on loans used to
purchase the S corporation stock must be
allocated to the S portion of the ESBT but
are not deductible by the S portion
because they are not administrative
expenses.
ESBT Terminations
The proposed regulations provide that
generally a trustee must seek the consent
of the Commissioner to revoke its ESBT
election by obtaining a private letter rul-
ing. However, the Commissioner’s con-
sent is granted for revocations that occur
on the conversion of an ESBT to a QSST
under the procedures set forth in the pro-
posed regulations.
The proposed regulations provide that
if an ESBT fails to meet the definitional
requirements of an ESBT under section
1361(e), the trust’s ESBT status termi-
nates immediately upon such failure to
qualify. However, if an ESBT acquires
an ineligible potential current beneficia-
January 22, 20013982001–4 I.R.B.

ry, the ESBT has 60 days in which to dis-
pose of all of its S corporation stock to
prevent termination of the S corporation
election. If the S corporation stock is not
disposed of within the 60-day period,
then the S corporation election will ter-
minate as of the first day that the ineligi-
ble person became a potential current
beneficiary.
Finally, the proposed regulations pro-
vide that an ESBT election generally is
terminated if the ESBT fails to hold any S
corporation stock. However, a trust will
continue to be treated as an ESBT if it is
reporting income from the sale of S cor-
poration stock under the installment
method of section 453.
Section 444 Elections
The text of the temporary regulations
published in T.D. 8915 serves as the text
of these proposed regulations with respect
to an ESBT and a trust described in sec-
tion 401(a) or section 501(c)(3) that is
exempt from taxation under section
501(a). These temporary regulations pro-
vide that an ESBT and a trust described in
section 401(a) or section 501(c)(3) that is
exempt from taxation under section
501(a) are not deferral entities for purpos-
es of §1.444–2T.
Proposed Effective Date
The regulations regarding ESBTs under
§1.641–1(d) through (k), §1.1361–1(h)-
(1)(vi), (h)(3)(i)(F), (j)(12), and (m),
§1.1362–6(b)(2)(iv), §1.1377–1(a)(2)(iii)
and (c) Example 3are proposed to apply
on and after the date the final regulations
are published in the Federal Register.
The IRS and the Treasury Department
have become aware of potentially abusive
transactions involving ESBTs that assume
the applicability of the rules of section
641(c) to the taxation of the grantor por-
tion of such trusts. See Notice 2000–61,
2000–49 I.R.B. 1. Thus, the regulations
regarding taxation of ESBTs under
§1.641(c)–1(a), (b) and (c) are proposed
to be applicable for taxable years of
ESBTs that end on and after the proposed
regulations are filed in the Federal
Register.
Effect on Other Documents
The following documents are proposed
to be superseded as of the date the final
regulations are published in the Federal
Register:
Notice 97–12 (1997–1 C.B. 385).
Notice 97–49 (1997–2 C.B. 304).
Rev. Proc. 98–23 (1998–1 C.B. 662).
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a reg-
ulatory assessment is not required. It is
hereby certified that the collection of
information in the regulations will not
have a significant economic impact on a
substantial number of small entities. This
certification is based upon the fact that the
estimated average burden per trust in
complying with the collections of infor-
mation in §1.1361–1(m) is 1 hour.
Therefore, a Regulatory Flexibility
Analysis under the Regulatory Flexibility
Act (5 U.S.C. chapter 6) is not required.
Pursuant to section 7805(f) of the Code,
this notice of proposed rulemaking will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its impact
on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written com-
ments (a signed original and eight (8)
copies) that are timely submitted to the
IRS. The IRS and Treasury Department
specifically request comments on the
clarity of the proposed regulations and
how they can be made easier to under-
stand. All comments will be available
for public inspection and copying.
A public hearing has been scheduled
for April 25, 2001, at 10:00 a.m. in the
Internal Revenue Building Auditorium,
1111 Constitution Avenue NW.,
Washington, DC. Because of access
restrictions, visitors will not be admitted
beyond the Internal Revenue Building
lobby more than 15 minutes before the
hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral com-
ments at the hearing must submit written
comments by April 4, 2001, and submit an
outline of the topics to be discussed and
the time to be devoted to each topic
(signed original and eight (8) copies) by
April 4, 2001.
A period of 10 minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has passed.
Copies of the agenda will be available free
of charge at the hearing.
Drafting Information
The principal authors of these regula-
tions are Bradford Poston and James A.
Quinn of the Office of Associate Chief
Counsel (Passthroughs and Special
Industries), IRS. However, other person-
nel from the IRS and Treasury
Department participated in their develop-
ment.
* * * * *
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART I—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.444–4 is also issued under 26
U.S.C. 444(g).
Par. 2. Section 1.444–4 is added to read
as follows:
§1.444–4 Tiered structure.
[The text of this proposed section is the
same as the text of §1.444–4T published
T.D. 8915].
Par. 3. Sections 1.641(c)–0 and
1.641(c)–1 are added to read as follows:
§ 1.641(c)–0 Table of contents.
This section lists the following captions
contained in §1.641(c)–1:
§1.641(c)–1 Electing small business
trust.
(a) In general.
(b) Definitions.
(1) Grantor portion.
(2) S portion.
(3) Non-S portion.
(c) Taxation of grantor portion.
2001–4 I.R.B.399January 22, 2001

January 22, 20014002001–4 I.R.B.
(d) Taxation of S portion.
(1) In general.
(2) Section 1366 amounts.
(3) Gains and losses on disposition of
S stock.
(4) State and local income taxes and
administrative expenses.
(e) Tax rates and exemption of S por-
tion.
(1) Income tax rate.
(2) Alternative minimum tax exemp-
tion.
(f) Taxation of non-S portion.
(1) In general.
(2) Dividend income under section
1368(c)(2).
(3) Interest on installment obligations.
(4) Charitable deduction.
(g) Allocation of state and local
income taxes and administration
expenses.
(h) Treatment of distributions from the
trust.
(i) Termination or revocation of ESBT
election.
(j) Effective date.
(k) Examples.
§ 1.641(c)–1 Electing small business
trust.
(a) In general. An electing small busi-
ness trust (ESBT) within the meaning of
section 1361(e) is treated as two separate
trusts for purposes of determining income
tax. The portion of an ESBT that consists
of stock in one or more S corporations
(the S portion) is treated as one trust. The
portion of an ESBT that consists of all the
other assets in the trust is treated as a sep-
arate trust. The grantor or another person
may be treated as the owner of all or a
portion of either or both such trusts under
subpart E, part I, subchapter J, chapter 1
of the Internal Revenue Code. In addi-
tion, the non-S portion may consist of
more than one share pursuant to section
663(c). See § 1.1361–1(m) for the treat-
ment of an ESBT as a single trust for
administrative purposes.
(b) Definitions—(1) Grantor portion.
The grantor portion of an ESBT is the
portion of the trust that is treated as owned
by the grantor or another person under
subpart E.
(2) S portion. The S portion of an
ESBT is the portion of the trust that con-
sists of S corporation stock and that is not
treated as owned by the grantor or anoth-
er person under subpart E.
(3) Non-S portion. The non-S portion
of an ESBT is the portion of the trust that
consists of all assets other than S corpora-
tion stock and that is not treated as owned
by the grantor or another person under
subpart E.
(c) Taxation of grantor portion. The
grantor or another person who is treated
as the owner of a portion of the ESBT
includes in computing taxable income
items of income, deductions, and credits
against tax attributable to that portion of
the ESBT under section 671.
(d) Taxation of S portion—(1) In gener-
al. The taxable income of the S portion is
determined by taking into account only
the items of income, loss, deduction, or
credit specified in paragraphs (d)(2), (3),
and (4) of this section, to the extent not
attributable to the grantor portion.
(2) Section 1366 amounts—(i) In gener-
al. The S portion takes into account the
items of income, loss, deduction, or credit
that are taken into account by an S corpora-
tion shareholder pursuant to section 1366
and the regulations thereunder. Normal
rules applicable to trusts apply in determin-
ing the extent to which any loss, deduction,
or credit may be taken into account in deter-
mining the taxable income of the S portion.
See § 1.1361–1(m)(3)(iv) for allocation of
those items in the taxable year in which the
ESBT election is made if, before the effec-
tive date of the election, the trust was a
shareholder of the S corporation.
(ii) Special rule for charitable contri-
butions. If a deduction described in para-
graph (d)(2)(i) of this section is attribut-
able to a charitable contribution paid by
the S corporation, the contribution will
be deemed to be paid by the S portion
pursuant to the terms of the trust’s gov-
erning instrument within the meaning of
section 642(c)(1) . The other require-
ments of section 642(c)(1) must also be
met for the contribution to be deductible
in computing the taxable income of the S
portion. Such a deduction cannot exceed
the amount of gross income of the S por-
tion.
(iii) Multiple S corporations. If an
ESBT owns stock in more than one S
corporation, items of income, loss,
deduction, or credit from all the S cor-
porations are aggregated for purposes of
determining the S portion’s taxable
income.
(3) Gains and losses on disposition of S
stock—(i) In general. The S portion takes
into account any gain or loss from the dis-
position of S corporation stock. No
deduction is allowed under section
1211(b)(1) and (2) for capital losses that
exceed capital gains.
(ii) Installment method. If income from
the sale or disposition of stock in an S cor-
poration is reported by the trust on the
installment method, the income recog-
nized under this method is taken into
account by the S portion. See paragraph
(f)(3) of this section for the treatment of
interest on the installment obligation. See
§1.1361–1(m)(5)(ii) regarding treatment
of a trust as an ESBT upon the sale of all
S corporation stock using the installment
method.
(iii) Distributions in excess of basis.
Gain recognized under section 1368(b)(2)
from distributions in excess of the ESBT’s
basis in its S corporation stock is taken
into account by the S portion.
(4) State and local income taxes and
administrative expenses—(i) In general.
State and local income taxes and adminis-
trative expenses directly related to the S
portion and those allocated to that portion
in accordance with paragraph (g) are
taken into account by the S portion.
(ii) Special rule for certain interest.
Interest paid by the trust on money bor-
rowed by the trust to purchase stock in an
S corporation is allocated to the S portion
but is not a deductible administrative
expense for purposes of determining the
taxable income of the S portion.
(e) Tax rates and exemption of S por-
tion—(1) Income tax rate. Except for
capital gains, the highest marginal trust
rate provided in section 1(e) is applied to
the taxable income of the S portion. See
section 1(h) for the rates that apply to the
S portion’s net capital gain.
(2) Alternative minimum tax exemption.
The exemption amount of the S portion
under section 55(d) is zero.
(f) Taxation of non-S portion—(1) In
general. The taxable income of the non-S
portion is determined by taking into
account all items of income, deduction,
and credit to the extent not taken into
account by either the grantor portion or
the S portion. The items attributable to
the non-S portion are taxed under subparts
A through D of part I, subchapter J, chap-
ter 1 of the Internal Revenue Code.

2001–4 I.R.B.401January 22, 2001
(2) Dividend income under section
1368(c)(2). Any dividend income within
the meaning of section 1368(c)(2) is
includible in the gross income of the non-
S portion.
(3) Interest on installment obligations.
If income from the sale or disposition of
stock in an S corporation is reported by
the trust on the installment method, the
interest on the installment obligation is
includible in the gross income of the non-
S portion. See paragraph (d)(3)(ii) of this
section for the treatment of income from
such a sale or disposition.
(4) Charitable deduction. For purposes
of applying section 642(c)(1) to payments
made by the trust for a charitable purpose,
the amount of gross income of the trust is
limited to the gross income of the non-S
portion. See paragraph (d)(2)(ii) of this
section for special rules concerning chari-
table contributions paid by the S corpora-
tion that are deemed to be paid by the S
portion.
(g) Allocation of state and local
income taxes and administration expens-
es. Whenever state and local income
taxes or administration expenses relate to
more than one portion of an ESBT, they
must be allocated between or among the
portions to which they relate. These
items may be allocated in any manner
that is reasonable in light of all the cir-
cumstances, including the terms of the
governing instrument, local law, and the
practice of the trustee with respect to the
trust if it is reasonable and consistent.
The taxes and expenses apportioned to
each portion of the ESBT are taken into
account by that portion.
(h) Treatment of distributions from the
trust. Distributions to beneficiaries from
the S portion or the non-S portion, includ-
ing distributions of the S corporation
stock, are deductible under section 651 or
661 in determining the taxable income of
the non-S portion, and are included in the
gross income of the beneficiaries under
section 652 or 662. However, the amount
of the deduction or inclusion cannot
exceed the amount of the distributable net
income of the non-S portion. Items taken
into account by the grantor portion or the
S portion are excluded for purposes of
determining the distributable net income
of the non-S portion of the trust.
(i) Termination or revocation of ESBT
election. If the ESBT election of the trust
terminates pursuant to §1.1361–1(m)(5)
or the ESBT election is revoked pursuant
to §1.1361–1(m)(6), the rules contained
in this section are thereafter not applicable
to the trust. If, upon termination or revo-
cation, the S portion has a net operating
loss under section 172; a capital loss car-
ryover under section 1212; or deductions
in excess of gross income; then any such
loss, carryover, or excess deductions shall
be allowed as a deduction, in accordance
with the regulations under section 642(h),
to the trust, or to the beneficiaries suc-
ceeding to the property of the trust if the
entire trust terminates.
(j) Effective date. This section general-
ly is applicable on and after the date the
final regulations are published in the
Federal Register. However, paragraphs
(a), (b) and (c) of this section are applica-
ble for taxable years of ESBTs that end on
and after December 28, 2000.
(k) Examples. The following examples
illustrate the rules of this section:
Example 1. Comprehensive example. (i) Trust
has a valid ESBT election in effect. Under section
678,Bis treated as the owner of a portion of Trust
consisting of a 10% undivided fractional interest in
Trust. No other person is treated as the owner of any
other portion of Trust under subpart E, part I, sub-
chapter J. Trust owns stock in X, an S corporation,
and in Y, a C corporation. During 2000, Trust
receives a distribution from Xof $5,100, of which
$5,000 is applied against Trust’s adjusted basis in the
Xstock in accordance with section 1368(c)(1) and
$100 is a dividend under section 1368(c)(2). Trust
makes no distributions to its beneficiaries during the
year.
(ii) For 2000, Trust has the following items of
income and deduction:
Ordinary income attributable to Xunder section 1366Y . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$5,000
Dividend income from Y . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$900
Dividend from Xrepresenting C corporation earnings and profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$100
Total trust income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$6,000
Charitable contributions attributable to Xunder section1366 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$300
Trustee fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$200
State and local income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$100
(iii) Trust’s items of income and deduction are divided into a grantor portion, an S portion, and a non-S portion for purposes of determining the taxation of those
items. Income is allocated to each portion as follows:
Bmust take into account the items of income attributable to the grantor portion, that is, 10% of each item, as follows:
Ordinary income from X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$500
Dividend income from Y . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$90
Dividend income from X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$10
Total grantor portion income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$600
The total income of the S portion is $4,500, determined as follows:
Ordinary income from X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$5,000
Less: Grantor portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($500)
Total S portion income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$4,500
The total income of the non-S portion is $900 determined as follows:
Dividend income from Y(less grantor portion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$810
Dividend income from X(less grantor portion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$90
Total non-S portion income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$900
(iv) The administrative expenses and the state and local income taxes relate to all three portions and under state law would be allocated ratably to the $6,000 of
trust income. Thus, these items would be allocated 10% (600/6000) to the grantor portion, 75% (4500/6000) to the S portion and 15% (900/6000) to the non-S por-
tion.
(v) Bmust take into account the following deductions attributable to the grantor portion of the trust:
Charitable contributions from X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$30

January 22, 20014022001–4 I.R.B.
Trustee fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$20
State and local income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$10
(vi) The taxable income of the S portion is $4,005, determined as follows:
Ordinary income from X. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$4,500
Less: Charitable contributions from X (less grantor portion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($270)
75% of trustee fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($150)
75% of state and local income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($75)
Taxable income of S portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$4,005
(vii) The taxable income of the non-S portion is $755, determined as follows:
Dividend income from Y . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$810
Dividend income from X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$90
Total non-S portion income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$900
Less: 15 % of trustee fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($30)
15% state and local income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($15)
Personal exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .($100)
Taxable income of non-S portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$755
Example 2. Sale of S stock. Trust has a valid
ESBT election in effect and owns stock in X, an S
corporation. No person is treated as the owner of
any portion of Trust under subpart E, part I, sub-
chapter J. In 2001, Trust sells all of its stock in Xand
recognizes a capital gain of $5,000. This gain is
taken into account by the S portion and is taxed
using the appropriate capital gain rate found in sec-
tion 1(h).
Example 3. (i) Sale of S stock for an installment
note. Assume the same facts as in Example 2, except
that Trust sells its stock in Xfor a $400,000 install-
ment note payable with stated interest over ten years.
After the sale, Trust does not own any S corporation
stock.
(ii) Loss on installment sale. Assume Trust’s
basis in its Xstock was $500,000. Therefore, Trust
sustains a capital loss of $100,000 on the sale. Upon
the sale, the S portion terminates and the excess loss,
after being netted against the other items taken into
account by the S portion, is made available to the
entire trust as provided in section 641(c)(4).
(iii) Gain on installment sale. Assume Trust’s
basis in its Xstock was $300,000 and that the
$100,000 gain will be recognized under the install-
ment method of section 453. Interest income will be
recognized annually as part of the installment pay-
ments. The portion of the $100,000 gain recognized
annually is taken into account by the S portion.
However, the annual interest income is includible in
the gross income of the non-S portion.
Example 4. Charitable lead annuity trust. Trust
is a charitable lead annuity trust which is not treated
as owned by the grantor or another person under sub-
part E. Trust acquires stock in X, an S corporation,
and elects to be an ESBT. During the taxable year,
pursuant to its terms, Trust pays $10,000 to a section
170(c)(2) charitable organization. The non-S por-
tion of Trust receives an income tax deduction for
the charitable contribution under section 642(c) only
to the extent the amount is paid out of the gross
income of the non-S portion. To the extent the
amount is paid from the S portion, no charitable
deduction is available to the S portion.
Example 5. ESBT distributions. (i) As of January
1, 2000, Trust owns stock in X, a C corporation. No
portion of Trust is treated as owned by the grantor or
another person under subpart E. Xelects to be an S
corporation effective January 1, 2001, and Trust
elects to be an ESBT effective January 1, 2001. For
2001, Trust’s share of X’s section 1366 items is
$5,000 of ordinary income. For the year, Trust has
no other income and no expenses or state or local
taxes. On February 1, 2001,Xmakes an $8,000 dis-
tribution to Trust, of which $3,000 is treated as a div-
idend from accumulated earnings and profits under
section 1368(c)(2) and the remainder is applied
against Trust’s basis in the Xstock under section
1368(b). The trustee of Trust makes a distribution of
$4,000 to Beneficiary during 2001.
(ii) For 2001, Trust has $5,000 of taxable income
in the S portion. This income is taxed to Trust at the
maximum rate provided in section 1(e). Trust also
has $3,000 of distributable net income (DNI) in the
non-S portion. The non-S portion of Trust receives
a distribution deduction under section 661(a) of
$3,000, which represents the amount distributed to
the beneficiary during the year ($4,000), not to
exceed the amount of DNI ($3,000). The beneficia-
ry must include this amount in gross income under
section 662(a). As a result, the non-S portion has no
taxable income.
Par. 4. Section 1.1361–0 is amended
by adding entries for § 1.1361–1(j)(12)
and (m) to read as follows:
§ 1.1361–0 Table of contents.
* * * * *
§1.1361–1 S corporation defined.
* * * * *
(j) * * *
(12) Converting a QSST to an ESBT.
* * * * *
(m) Electing small business trust (ESBT).
(1) Definition.
(2) ESBT election.
(3) Effect of ESBT election.
(4) Potential current beneficiaries.
(5) ESBT terminations.
(6) Revocation of ESBT election.
(7) Converting an ESBT to a QSST.
(8) Effective date.
(9) Examples.
* * * * *
Par. 5. Section 1.1361–1 is amended
by:
1. Adding paragraphs (h)(1)(vi),
(h)(3)(i)(F), and (j)(12).
2. Adding a sentence to the end of
paragraph (k)(2)(i).
3. Adding paragraph (m).
The additions read as follows:
§ 1.1361–1 S corporation defined.
* * * * *
(h) * * * (1) * * *
(vi) Electing small business trusts. An
electing small business trust (ESBT)
under section 1361(e). See paragraph (m)
of this section for rules concerning ESBTs
including the manner of making the elec-
tion to be an ESBT under section
1361(e)(3). * * * * *
(3) * * * (i) * * *
(F) If S corporation stock is held by an
ESBT, each potential current beneficiary
is treated as a shareholder. However, if
for any period there is no potential current
beneficiary of the ESBT, the ESBT is
treated as the shareholder during such
period. See paragraph (m)(4) of this sec-
tion for the definition of potential current
beneficiary.
* * * * *
(j) * * *
(12) Converting a QSST to an ESBT.
For a trust that wishes to convert from a
QSST to an ESBT, the consent of the
Commissioner is hereby granted to revoke
the QSST election as of the effective date
of the ESBT election, if all the following
requirements are met:
(i) The trust meets all of the require-
ments to be an ESBT under paragraph
(m)(1) of this section except for the

requirement under paragraph (m)(1)(iv)(A)
of this section that the trust not have a
QSST election in effect.
(ii) The trustee and the current income
beneficiary of the trust sign the ESBT
election. The ESBT election must be filed
with the service center where the S corpo-
ration files its income tax return and also
with the service center where the trust
files its income tax return. This ESBT
election must state at the top of the docu-
ment “ATTENTION ENTITY CON-
TROL—CONVERSION OF A QSST TO
AN ESBT PURSUANT TO SECTION
1.1361–1(j)” and include all information
otherwise required for an ESBT election
under paragraph (m)(2) of this section. A
separate election must be made with
respect to the stock of each S corporation
held by the trust.
(iii) The trust has not converted from an
ESBT to a QSST within the 36-month
period preceding the effective date of the
new ESBT election.
(iv) The date on which the ESBT elec-
tion is to be effective cannot be more than
15 days and two months prior to the date
on which the election is filed and cannot
be more than 12 months after the date on
which the election is filed. If an election
specifies an effective date more than 15
days and two months prior to the date on
which the election is filed, it will be effec-
tive 15 days and two months prior to the
date on which it is filed. If an election
specifies an effective date more than 12
months after the date on which the elec-
tion is filed, it will be effective 12 months
after the date it is filed.
(k) * * *
(2) * * * (i) * * * Paragraphs (h)(1)(vi),
(h)(3)(i)(F), and (j)(12) of this section are
applicable on and after the date the final
regulations are published in the Federal
Register.
* * * * *
(m) Electing small business trust
(ESBT)—(1) Definition—(i) General
rule. An electing small business trust
(ESBT) means any trust if it meets the fol-
lowing requirements: the trust does not
have as a beneficiary any person other
than an individual, an estate, or an organi-
zation described in section 170(c)(2)
through (5); no interest in the trust has
been acquired by purchase; and the trustee
of the trust makes a timely ESBT election
for the trust.
(ii) Qualified beneficiaries—(A) In
general. For purposes of this section, a
beneficiary includes a person who has a
present, remainder, or reversionary inter-
est in the trust other than a remote, con-
tingent interest within the meaning of
paragraph (m)(1)(ii)(D) of this section.
(B) Distributee trusts. Any person who
has a beneficial interest in a distributee
trust is a beneficiary of the ESBT.
However, if the distributee trust is an
organization described in section
170(c)(2) or (3), the distributee trust itself
is the beneficiary of the ESBT. A distrib-
utee trust is a trust that is receiving or may
receive a distribution from an ESBT,
whether the rights to receive the distribu-
tion are fixed or contingent, or immediate
or deferred.
(C) Powers of appointment. A person
in whose favor a power of appointment
could be exercised is not a beneficiary of
an ESBT until the holder of the power of
appointment actually exercises the power
in favor of such person.
(D) Remote beneficiaries. A person
whose interest in the trust is so remote
as to be negligible is not a beneficiary of
an ESBT. With respect to any portion of
the trust, a person’s interest in either the
corpus or the income therefrom is, at
any time, so remote as to be negligible
when the probability that such person
will ever receive a distribution from the
trust is less than 5 percent, taking into
consideration the interests of other enti-
ties and other individuals living at that
time.
(E) Nonresident aliens. A nonresident
alien as defined in section 7701(b)(1)(B)
is an eligible beneficiary of an ESBT.
However, see paragraph (m)(5)(iii) of this
section if the nonresident alien is a poten-
tial current beneficiary of the ESBT.
(iii) Interests acquired by purchase. A
trust does not qualify as an ESBT if any
interest in the trust has been acquired by
purchase. If any portion of a beneficiary’s
basis in the beneficiary’s interest in the
trust is determined under section 1012,
such interest has been acquired by pur-
chase. The trust itself may acquire S cor-
poration stock by purchase.
(iv) Ineligible trusts. An ESBT does
not include—
(A) Any qualified subchapter S trust (as
defined in section 1361(d)(3)) if an elec-
tion under section 1361(d)(2) applies with
respect to any corporation the stock of
which is held by the trust;
(B) Any trust exempt from tax or not
subject to tax under subtitle A; or
(C) Any charitable remainder annuity
trust or charitable remainder unitrust (as
defined in section 664(d)).
(2) ESBT election–(i) In general. The
trustee of the trust must make the ESBT
election by signing and filing, with the
service center where the trust files its
income tax return, a statement that meets
the requirements of paragraph (m)(2)(ii)
of this section. If there is more than one
trustee, the trustee or trustees with author-
ity to legally bind the trust must sign the
election statement. Only one ESBT elec-
tion is made for the trust, regardless of the
number of S corporations whose stock is
held by the ESBT.
(ii) Election statement. The election
statement must include—
(A) The name, address, and taxpayer
identification number of the trust, the
potential current beneficiaries, and the S
corporations in which the trust currently
owns stock;
(B) An identification of the election as
an ESBT election made under section
1361(e)(3);
(C) The first date on which the trust
owned stock in each S corporation;
(D) The date on which the election is to
become effective (not earlier than 15 days
and two months before the date on which
the election is filed); and
(E) Representations signed by the
trustee stating that—
(1) The trust meets the definitional
requirements of section 1361(e)(1); and
(2) All potential current beneficiaries of
the trust meet the shareholder require-
ments of section 1361(b)(1).
(iii) Due date for ESBT election. The
ESBT election must be filed within the
time requirements prescribed in paragraph
(j)(6)(iii) of this section for filing a quali-
fied subchapter S trust (QSST) election.
If the trust and the corporation file their
tax returns with the same service center,
the trustee may attach the ESBT election
to the Form 2553, “Election by a Small
Business Corporation,” in the case of a
newly electing S corporation.
(iv) Election by a trust described in sec-
tion 1361(c)(2)(A)(ii) or (iii). A trust that
is a qualified S corporation shareholder
under section 1361(c)(2)(A)(ii) or (iii)
2001–4 I.R.B.403January 22, 2001

may elect ESBT treatment at any time
during the 2-year period described in
those sections or the 16-day-and-2-month
period beginning on the date after the end
of the 2-year period. If the trust makes an
ineffective ESBT election, the trust will
continue to qualify as an eligible S corpo-
ration shareholder for the remainder of the
period described in section
1361(c)(2)(A)(ii) or (iii).
(v) No protective election. A trust can-
not make a protective ESBT election that
would be effective in the event the trust
fails to meet the requirements for an eligi-
ble trust described in section
1361(c)(2)(A)(i) through (iv). If a trust
attempts to make a protective ESBT elec-
tion and fails to qualify as an eligible S
corporation shareholder under section
1361(c)(2)(A)(i) through (iv), the S cor-
poration election will be ineffective or
will terminate because the corporation
will have an ineligible shareholder. Relief
may be available under section 1362(f) for
an inadvertent ineffective S corporation
election or an inadvertent S corporation
election termination.
(3) Effect of ESBT election—(i)
General rule. If a trust makes a valid
ESBT election, the trust will be treated as
an ESBT for purposes of chapter 1 of the
Internal Revenue Code as of the effective
date of the ESBT election.
(ii) Employer Identification Number.
An ESBT has only one employer identifi-
cation number (EIN). If an existing trust
makes an ESBT election, the trust contin-
ues to use the EIN it currently uses.
(iii) Taxable year. If an ESBT election
is effective on a day other than the first
day of the trust’s taxable year, the ESBT
election does not cause the trust’s taxable
year to close. The trust files one tax return
for the taxable year.
(iv) Allocation of S corporation items.
If an ESBT election is effective on a day
other than the first day of the trust’s tax-
able year, and the trust held S corporation
stock and was an eligible S corporation
shareholder under section 1361(c)-
(2)(A)(i) through (iv) prior to the effective
date of the ESBT election, the S corpora-
tion items are allocated between the two
eligible trusts under section 1377(a). For
purposes of section 1377(a), the first day
the ESBT is a shareholder is the effective
date of the ESBT election, and the last day
the other trust is a shareholder is the day
before the effective date of the ESBT
election. See § 1.1377–1(a)(2)(iii).
(v) Estimated taxes. If an ESBT elec-
tion is effective on a day other than the
first day of the trust’s taxable year, the
trust is considered one trust for purposes
of estimated taxes under section 6654.
(4) Potential current beneficiaries—(i)
In general. For purposes of determining
whether a corporation is a small business
corporation within the meaning of section
1361(b)(1), each potential current benefi-
ciary of an ESBT generally is treated as a
shareholder of the corporation. Subject to
the provisions of this section (m)(4), a
potential current beneficiary generally is,
with respect to any period, any person
who at any time during such period is
entitled to, or in the discretion of any per-
son may receive, a distribution from the
principal or income of the trust.
(ii) Grantor trusts. If all or a portion of
an ESBT is treated as owned by a person
under subpart E, part I, subchapter J,
chapter 1 of the Internal Revenue Code,
such owner is a potential current benefi-
ciary in addition to persons described in
paragraph (m)(4)(i) of this section.
(iii) Special rule for dispositions of
stock. Notwithstanding the provisions of
paragraph (m)(4)(i) of this section, if a
trust disposes of all of its S corporation
stock, any person who first met the defin-
ition of a potential current beneficiary
during the 60-day period ending on the
date of such disposition is not a potential
current beneficiary with respect to that
corporation.
(iv) Distributee trusts—(A) In general.
This paragraph (m)(4)(iv) contains the
rules for determining who are the potential
current beneficiaries of an ESBT if a dis-
tributee trust becomes entitled to, or at the
discretion of any person may receive, a dis-
tribution from principal or income of an
ESBT. A distributee trust does not include
a trust that is not currently in existence.
For this purpose, a trust is not currently in
existence if the trust has no assets and no
items of income, loss, deduction, or credit.
Thus, if a trust instrument provides for a
trust to be funded at some future time, the
future trust is not a distributee trust.
(B) If the distributee trust is not a trust
described in section 1361(c)(2)(A), then
the distributee trust is the potential current
beneficiary of the ESBT and the corpora-
tion’s S corporation election terminates.
(C) If the distributee trust is a trust
described in section 1361(c)(2)(A), the
persons who would be its potential current
beneficiaries (as defined in paragraph
(m)(4)(i) and (ii) of this section) if the dis-
tributee trust were an ESBT are treated as
the potential current beneficiaries of the
ESBT. Notwithstanding the preceding
sentence, however, if the distributee trust
is a trust described in section
1361(c)(2)(A)(ii) or (iii), the estate
described in section 1361(c)(2)(B) (ii) or
(iii) is treated as the potential current ben-
eficiary of the ESBT for the 2-year period
for which such trust is permitted as a
shareholder.
(D) For the purposes of paragraph
(m)(4)(iv)(C) of this section, a trust will
be deemed to be described in section
1361(c)(2)(A) if such trust would be eligi-
ble to make a QSST election under sec-
tion 1361(d) or an ESBT election under
section 1361(e) if it owned S corporation
stock.
(v) Contingent distributions. A person
who is entitled to receive a distribution
only after a specified time or upon the
occurrence of a specified event (such as
the death of the holder of a power of
appointment) is not a potential current
beneficiary until such time or the occur-
rence of such event.
(vi) Current powers of appointment. A
person to whom a distribution is or may
be made during a period pursuant to a
power of appointment is a potential cur-
rent beneficiary. Thus, if any person has a
general lifetime power of appointment
over the trust, the corporation’s S corpora-
tion election will terminate because the
number of potential current beneficiaries
will exceed the 75-shareholder limit of
section 1361(b)(1)(A).
(vii) Number of shareholders. Each
potential current beneficiary of the
ESBT, as defined in paragraphs (m)(4)(i)
through (vi) of this section, is counted as
a shareholder of any S corporation whose
stock is owned by the ESBT. During any
period in which the ESBT has no poten-
tial current beneficiaries, the ESBT is
counted as the shareholder. A person is
counted as only one shareholder of an S
corporation even though that person may
be treated as a shareholder of the S cor-
poration by direct ownership and through
one or more eligible trusts described in
section 1361(c)(2)(A). Thus, for exam-
January 22, 20014042001–4 I.R.B.

ple, if a person owns stock in an S cor-
poration and is a potential current benefi-
ciary of an ESBT that owns stock in the
same S corporation, that person is count-
ed as one shareholder of the S corpora-
tion. Similarly, if a husband owns stock
in an S corporation and his wife is a
potential current beneficiary of an ESBT
that owns stock in the same S corpora-
tion, such husband and wife will be
counted as one shareholder of the S cor-
poration.
(viii) Miscellaneous. Payments made
to a third party on behalf of a beneficiary
are considered to be payments made
directly to the beneficiary. The right of a
beneficiary to assign the beneficiary’s
interest to a third party does not result in
the third party being a potential current
beneficiary until that interest is actually
assigned.
(5) ESBT terminations–(i) Ceasing to
meet ESBT requirements.A trust ceases
to be an ESBT on the first day the trust
fails to meet the definition of an ESBT
under section 1361(e). The last day the
trust is treated as an ESBT is the day
before the date on which the trust fails to
meet the definition of an ESBT.
(ii) Disposition of S stock. In general, a
trust ceases to be an ESBT on the first day
following the day the trust disposes of all
S corporation stock. However, if the trust
is using the installment method to report
income from the sale or disposition of its
stock in an S corporation, the trust ceases
to be an ESBT on the day following the
earlier of the day the last installment pay-
ment is received by the trust or the day the
trust disposes of the installment obliga-
tion.
(iii) Potential current beneficiaries that
are ineligible shareholders. If a potential
current beneficiary of an ESBT is not an
eligible shareholder of a small business
corporation within the meaning of section
1361(b)(1), the S corporation election ter-
minates. For example, the S corporation
election will terminate if a nonresident
alien becomes a potential current benefi-
ciary of an ESBT. Such a potential cur-
rent beneficiary is treated as an ineligible
shareholder beginning on the day such
person becomes a potential current bene-
ficiary, and the S corporation election ter-
minates on that date. However, see the
special rule of paragraph (m)(4)(ii) of this
section. If the S corporation election ter-
minates, relief may be available under
section 1362(f).
(6) Revocation of ESBT election. An
ESBT election may be revoked only with
the consent of the Commissioner. The
application for consent to revoke the elec-
tion must be submitted to the Internal
Revenue Service in the form of a letter
ruling request under the appropriate rev-
enue procedure.
(7) Converting an ESBT to a QSST. For
a trust that wishes to convert from an
ESBT to a QSST, the consent of the
Commissioner is hereby granted to revoke
the ESBT election as of the effective date
of the QSST election, if all the following
requirements are met:
(i) The trust meets all of the require-
ments to be a QSST under section
1361(d).
(ii) The trustee and the current income
beneficiary of the trust sign the QSST
election. The QSST election must be filed
with the service center where the S corpo-
ration files its income tax return and also
with the service center where the trust
files its income tax return. This QSST
election must state at the top of the docu-
ment “ATTENTION ENTITY CON-
TROL—CONVERSION OF AN ESBT
TO A QSST PURSUANT TO SECTION
1.1361–1(m)” and include all information
otherwise required for a QSST election
under § 1.1361–1(j)(6). A separate elec-
tion must be made with respect to the
stock of each S corporation held by the
trust.
(iii) The trust has not converted from a
QSST to an ESBT within the 36-month
period preceding the effective date of the
new QSST election.
(iv) The date on which the QSST elec-
tion is to be effective cannot be more than
15 days and two months prior to the date
on which the election is filed and cannot
be more than 12 months after the date on
which the election is filed. If an election
specifies an effective date more than 15
days and two months prior to the date on
which the election is filed, it will be effec-
tive 15 days and two months prior to the
date on which it is filed. If an election
specifies an effective date more than 12
months after the date on which the elec-
tion is filed, it will be effective 12 months
after the date it is filed.
(8) Effective date. This paragraph (m)
is applicable on and after the date the final
regulations are published in the Federal
Register.
(9) Examples. The provisions of this
paragraph (m) are illustrated by the fol-
lowing examples in which it is assumed,
unless otherwise specified, that all non-
corporate persons are citizens or residents
of the United States:
Example 1. (i) ESBT election with section 663(c)
separate shares. On January 1, 2000,Mcontributes
S corporation stock to Trust for the benefit of M’s
three children A,B, and C. Pursuant to section
663(c), each of Trust’s separate shares for A,B, and
Cwill be treated as separate trusts for purposes of
determining the amount of distributable net income
(DNI) in the application of sections 661 and 662. On
January 15, 2000, the trustee of Trust files a valid
ESBT election for Trust effective January 1, 2000.
Trust will be treated as a single ESBT and will have
a single S portion taxable under section 641(c).
(ii) ESBT acquires stock of an additional S cor-
poration. On February 15, 2000, Trust acquires
stock of an additional S corporation. Because Trust
is already an ESBT, Trust does not need to make an
additional ESBT election.
(iii) Section 663(c) shares of ESBT convert to
separate QSSTs. Effective January 1, 2001,A,B,C,
and Trust’s trustee elect to convert each separate
share of Trust into a separate QSST pursuant to para-
graph (m)(7) of this section. They file a separate
election for each S corporation the stock of which is
held by Trust for each separate share. Each separate
share will be treated as a separate QSST.
Example 2. (i) Invalid potential current beneficia-
ry. Effective January 1, 2000, Trust makes a valid
ESBT election. On January 1, 2001,A, a nonresi-
dent alien, becomes a potential current beneficiary of
Trust. Trust does not dispose of all of its S corpora-
tion stock within 60 days after January 1, 2001. As
of January 1, 2001,Ais a potential current benefi-
ciary of Trust, and therefore is treated as a share-
holder of the S corporation. Because Ais not an eli-
gible shareholder of an S corporation under section
1361(b)(1), the S corporation election of any corpo-
ration in which Trust holds stock terminates effective
January 1, 2001. Relief may be available under sec-
tion 1362(f).
(ii) Invalid potential current beneficiary and dis-
position of S stock. Assume the same facts as in
Example 2(i) except that within 60 days after
January 1, 2001, trustee of Trust disposes of all
Trust’s S corporation stock. Ais not considered a
potential current beneficiary of Trust and therefore is
not treated as an S corporation shareholder of any S
corporation in which Trust previously held stock.
Example 3. Subpart E trust. Mtransfers stock in
X, an S corporation, and other assets to Trust, for the
benefit of Band B’s siblings. Mretains no powers or
interest in Trust. Under section 678(a),Bis treated
as the owner of a portion of Trust which includes a
portion of the Xstock. No beneficiary has acquired
any portion of his or her interest in Trust by purchase
and Trust is not an ineligible trust under paragraph
(m)(1)(iv) of this section. Trust is eligible to make an
ESBT election.
Example 4. Determining ESBT beneficiaries.
Trust holds stock in an S corporation and makes an
ESBT election. Trust’s instrument provides that
2001–4 I.R.B.405January 22, 2001

income is to be paid to Afor A’s life. Upon A’s death
the remainder interest is to be paid to a separate trust
for the benefit of A’s three children. If on A’s death
none of A’s children is alive, then the remainder is to
be paid to A’s ten grandchildren. If on A’s death
none of A’s children or grandchildren is alive, the
remainder will be paid to State exclusively for pub-
lic purposes. A,A’s children, and A’s grandchildren
are all beneficiaries of Trust. Assuming the proba-
bility that State will ever receive any distribution
from Trust is less than 5 percent, State is not consid-
ered a beneficiary for purposes of paragraph
(m)(1)(ii) of this section. If the probability that State
will receive a distribution from Trust ever equals or
exceeds 5 percent, State would then be considered a
beneficiary of the ESBT. Because State is an orga-
nization described in section 170(c)(1), rather than
section 170(c)(2) through (5), State would be an
ineligible beneficiary and the corporation’s S corpo-
ration election would terminate.
Example 5. Potential current beneficiaries and
distributee trusts. (i) Distributee trust holding S cor-
poration stock. Trust-1 has a valid ESBT election in
effect. The trustee of Trust-1 has the power to dis-
tribute to Adirectly or to any trust created for the
benefit of A. On January 1, 2000,Mcreates Trust-2
for the benefit of A. Also on January 1, 2000, the
trustee of Trust-1 distributes some S corporation
stock to Trust-2. The current income beneficiary of
Trust-2 makes a timely and effective election to treat
Trust-2 as a QSST. Because Trust-2 is a valid S cor-
poration shareholder, the distribution to Trust-2 does
not terminate the ESBT election of Trust-1. Trust-2
itself will not be counted toward the 75-shareholder
limit of section 1361(b)(1)(A). Additionally,
because Ais already counted as an S corporation
shareholder because of A’s status as a potential cur-
rent income beneficiary of Trust-1,Ais not counted
again by reason of A’s status as the deemed owner of
Trust-2.
(ii) Distributee trust not holding S corporation
stock. Assume the same facts as in paragraph (i) of
this Example 5, except that no S corporation stock is
distributed to Trust-2. Because Trust-2 would be eli-
gible to make a QSST election or an ESBT election
if it owned S corporation stock, under paragraph
(m)(4)(iv)(D) of this section it is deemed to be a trust
described in section 1361(c)(2)(A). Under para-
graph (m)(4)(iv)(C) of this section, the potential cur-
rent beneficiaries of Trust-2 are considered the
potential current beneficiaries of Trust-1. Because
A, the potential current beneficiary of Trust-2, is
already a potential current beneficiary of Trust-1,A
is not counted twice for purposes of the 75-share-
holder limit of the S corporation.
Example 6. Potential current beneficiaries and
distributee trust. (i) Distributee trust that would
itself qualify as an ESBT. Trust-1 holds stock in X,
an S corporation, and has a valid ESBT election in
effect. Under the terms of the governing instrument
of Trust-1, the trustee has discretion to make distrib-
utions to A,Band Trust-2, a trust for the benefit of
Aand B’s children,C,Dand E. Trust-2 would qual-
ify to be an ESBT, but it owns no S corporation stock
and has made no ESBT election. Under paragraph
(m)(4)(iv) of this section, Trust-2’s potential current
beneficiaries are treated as the potential current ben-
eficiaries of Trust-1 and are counted as shareholders
for purposes of section 1361(b)(1). Thus,A,B,C,D
and Eare potential current beneficiaries of Trust-1
and are counted as shareholders for the purposes of
section 1361(b)(1). Trust-2 itself will not be count-
ed as a shareholder of Trust-1 for purposes of section
1361(b)(1).
(ii) Distributee trust that would not qualify as an
ESBT. Assume the same facts as in Example 6 (i)
except that Dis a non-resident alien. Trust-2 would
not be eligible to make an ESBT or QSST election if
it owned S corporation stock and therefore Trust-2 is
a potential current beneficiary of Trust-1. Since
Trust-2 is not an eligible shareholder,X’s S corpora-
tion election terminates.
(iii) Distributee trust that is a section
1361(c)(2)(A)(ii) trust. Assume the same facts as in
Example 6(i) except that Trust-2 is a trust treated as
owned by Aunder section 676 because Ahad the
power to revoke Trust-2 at any time prior to A’s
death. On January 1, 2001,Adies. Because Trust-2
is a trust described in section 1361(c)(2)(A)(ii) dur-
ing the 2-year period beginning on the day of A’s
death, under paragraph (m)(4)(iv)(C) of this section,
Trust-2’s only potential current beneficiary is the
person listed in section 1361(c)(2)(B)(ii),A’s estate.
Example 7. Potential current beneficiaries and
powers of appointment. Mcreates Trust for the ben-
efit of A. Aalso has a current power to appoint
income or principal to anyone except A,A’s credi-
tors,A’s estate, and A’s estate’s creditors. The poten-
tial current beneficiaries of Trust will be Aand all
other persons except for A’s creditors,A’s estate, and
A’s estate’s creditors. This number will exceed the
75- shareholder limit of section 1361(b)(1)(A). If
Trust holds S corporation stock, the corporation’s S
election will terminate.
Par. 6. Section 1.1362–6 is amended by
revising paragraph (b)(2)(iv) to read as
follows:
§ 1.1362–6 Election and consents.
* * * * *
(b) * * *
(2) * * *
(iv) Trusts. In the case of a trust
described in section 1361(c)(2)(A)
(including a trust treated under section
1361(d)(1)(A) as a trust described in sec-
tion 1361(c)(2)(A)(i) and excepting an
electing small business trust described in
section 1361(c)(2)(A)(v) (ESBT)), only
the person treated as the shareholder for
purposes of section 1361(b)(1) must con-
sent to the election. When stock of the
corporation is held by a trust, both hus-
band and wife must consent to any elec-
tion if the husband and wife have a com-
munity interest in the trust property. See
paragraph (b)(2)(i) of this section for rules
concerning community interests in S cor-
poration stock. In the case of an ESBT,
the trustee and the owner of any portion of
the trust that consists of the stock in one or
more S corporations under subpart E, part
I, subchapter J, chapter 1 of the Internal
Revenue Code must consent to the S cor-
poration election. If there is more than
one trustee, the trustee or trustees with
authority to legally bind the trust must
consent to the S corporation election.
* * * * *
Par. 7. Section 1.1362–7 is amended by
adding a sentence to the end of paragraph
(a) to read as follows:
§ 1.1362–7 Effective date.
(a) * * * Section 1.1362–6(b)(2)(iv) is
applicable on and after the date the final
regulations are published in the Federal
Register.
* * * * *
Par. 8. Section 1.1377–1 is amended
by:
1. Adding paragraph (a)(2)(iii).
2. Adding Example 3to paragraph (c).
The additions read as follows:
§ 1.1377–1 Pro rata share.
(a) * * *
(2) * * *
(iii) Electing small business trust (ESBT)
election. If an ESBT election is effective
on a day other than the first day of trust’s
taxable year, and the trust was already an
eligible S corporation shareholder under a
different provision of section 1361(c)(2),
then section 1377 applies to allocate S cor-
poration income between the two types of
trusts. The first day the ESBT is treated as
an S corporation shareholder is the effec-
tive date of the ESBT election. The ESBT
election does not result in the prior trust
being treated as terminating its entire inter-
est in its S corporation stock for purposes
of paragraph (b) of this section, unless the
prior trust was described in section
1361(c)(2)(A)(ii) or (iii).
* * * * *
(c) * * *
Example 3. Effect of conversion of a qualified
subchapter S trust (QSST) to an electing small busi-
ness trust (ESBT). (i) On January 1, 2000, Trust
receives 100% of the stock of S corporation. Trust’s
current income beneficiary makes a timely QSST
election under section 1361(d)(2), effective January
1, 2000. Later, the trustee and current income bene-
ficiary of Trust elect pursuant to §1.1361–1(j)(12), to
terminate the QSST election and convert to an
ESBT, effective July 1, 2002. In 2002, Trust’s pro
ratashare of S corporation’s nonseparately comput-
ed income is $100,000.
(ii) For purposes of computing the income allo-
cable to the QSST and to the ESBT, Trust is treated
January 22, 20014062001–4 I.R.B.

as a QSST through June 30, 2002, and Trust is treat-
ed as an ESBT beginning July 1, 2002. Pursuant to
section 1377(a)(1), the pro ratashare of S corpora-
tion income allocated to the QSST is $49,589
($100,000 x 181 days/365 days), and the pro rata
share of S corporation income allocated to the ESBT
is $50,411 ($100,000 x 184 days/365 days).
Par. 9. Section 1.1377–3 is amended by
revised to read as follows:
§ 1.1377–3 Effective date.
Section 1.1377–1 and 1.1377–2 apply
to taxable years of an S corporation
beginning after December 31, 1996,
except that § 1.1377–1(a)(2)(iii) and (c)
Example 3are applicable on and after the
date the final regulations are published in
the Federal Register.
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 28, 2000, 8:45 a.m., and published in the
issue of the Federal Register for December 29, 2000,
65 F.R. 82963)
Notice of Proposed Rulemaking
and Notice of Public Hearing
Application of Section 904 to
Income Subject to Separate
Limitations and Computation of
Deemed-Paid Credit under
Section 902
REG–104683–00
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
and notice of public hearing.
SUMMARY:This document contains
proposed Income Tax Regulations relating
to the computation of the section 902
deemed-paid credit, the section 904(d)
foreign tax credit limitation, and to an
example in the section 954 regulations
relating to the exclusion of certain export
financing interest from foreign personal
holding company income. Changes to the
applicable law were made by the Tax
Reform Act of 1986, the Technical and
Miscellaneous Revenue Act of 1988, and
the Taxpayer Relief Act of 1997. These
regulations would provide guidance need-
ed to comply with these changes and
would affect individuals and corporations
reporting subpart F income and claiming
foreign tax credits.
This document also provides a notice of a
public hearing on these proposed regula-
tions.
DATES: Written or electronic comments
must be received by April 2, 2001.
Outlines of topics to be discussed at the
public hearing scheduled for April 26,
2001, at 10 a.m. must be received by April
5, 2001.
ADDRESSES:Send submissions to:
Regulations Unit CC (REG–104683–00),
room 5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions
may be hand-delivered between the hours of
8 a.m. and 5 p.m. to Regulations Unit CC
(REG–104683–00),Courier’s Desk,
Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC or sent elec-
tronically, via the IRS Internet site at:
http://www.irs.gov/tax_regs/regslist.html.
The public hearing will be held in the IRS
Auditorium, 7
th
floor, Internal Revenue
Building, 1111 Constitution Ave., NW.,
Washington, DC. FOR FURTHER INFOR-
MATION CONTACT: Concerning the pro-
posed regulations, Bethany A. Ingwalson
(202) 622-3850; concerning submissions of
comments, the hearing, and/or to be placed
on the building access list to attend the hear-
ing, Sonya Cruse, (202) 622-7180 (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Background
Treasury and the IRS provided guid-
ance regarding section 904(d) (enacted in
1986) in T.D. 8214 (1988–2 C.B. 220),
T.D. 8412 (1992–1 C.B. 271), T.D. 8556
(1994–2 C.B. 165), T.D. 8805 (1999–1
C.B. 371), and in final regulations (T.D.
8916) published on page 360 of this
Bulletin. Final regulations regarding the
computation of the deemed paid credit
under section 902 (also enacted in 1986)
were published as T.D. 8708 (1997–1
C.B. 137). The proposed regulations pro-
vide further guidance with respect to the
application of sections 902 and 904(d).
The proposed regulations also provide
guidance regarding the application of sec-
tion 904(j). The Taxpayer Relief Act of
1997 (Public Law 105–34, 111 Stat. 788)
(TRA 1997) added section 904(j) to the
Internal Revenue Code (Code). Section
904(j) exempts individuals from the for-
eign tax credit limitation of section 904(a)
in certain limited circumstances, and pro-
vides that no foreign taxes may be carried
to or from a year for which a taxpayer has
elected to apply section 904(j).
TRA 1997 also added to the Code sec-
tion 904(b)(2)(C), which provides that
the Secretary may issue regulations to
modify the application of section
904(b)(2) and (3) to properly reflect cap-
ital gain rate differentials under sections
1(h) and 1201(a) and the computation of
net capital gain. The proposed regula-
tions provide guidance for the applica-
tion of section 904(b), including the
application of that section in years in
which section 1(h) provides for more
than one capital gains rate.
Explanation of Provisions
I. Effect of Loss of Domestic Corporate
Shareholder on Pooling of Earnings and
Taxes in Computing Deemed Paid
Credits: §1.902–1
Under section 902(c)(3), the multi-year
pools of post-1986 undistributed earnings
and post-1986 foreign income taxes of a
foreign corporation are determined by
taking into account only periods begin-
ning on and after the first day of the for-
eign corporation’s first taxable year in
which a domestic corporation (a “quali-
fying shareholder”) owns 10 percent or
more of its voting stock or, in the case of
a lower-tier foreign corporation in a
“qualified group” described in section
902(b)(2), owns indirectly at least 5 per-
cent of its voting stock.
Under section 902(c)(6)(B), dividends
are treated as paid first out of the post-
1986 pooled earnings. Pre-1987 accumu-
lated profits (defined in section
902(c)(6)(A) and §1.902–1(a)(10) to
include both earnings accumulated in pre-
1987 years and earnings accumulated in
post-1986 years preceding the year in
which the section 902 ownership require-
ments are met) are treated as distributed
only after the pools are exhausted, and
then out of annual layers of earnings and
taxes on a last-in, first-out basis.
Distributions out of pre-1987 accumulat-
ed profits are governed by the section 902
rules in effect under pre-1987 law.
Section 902(c)(6)(A).
2001–4 I.R.B.407January 22, 2001

The rule limiting the multi-year pools
of earnings and taxes to post-1986 tax-
able years beginning with the year in
which a foreign corporation first has a
qualifying shareholder alleviates the
administrative difficulties such share-
holders face in reconstructing accumulat-
ed earnings and taxes accounts in con-
nection with their acquisition of stock in
a pre-existing foreign corporation.
While section 902 provides that pooling
of earnings and taxes begins only when
the foreign corporation first has a quali-
fying shareholder entitled to compute a
credit for deemed-paid taxes, the statute
does not provide for any change in a for-
eign corporation’s post-1986 undistrib-
uted earnings and taxes pools following a
stock disposition or other transaction
after which the foreign corporation no
longer has a qualifying shareholder.
Section 1.902–1(a)(13)(i) currently pro-
vides that, once a foreign corporation
begins to maintain pools of earnings and
taxes, the pools include periods during
which the stock ownership requirements
of section 902 are not met. Should such
a corporation later again have a qualify-
ing shareholder, such a shareholder
would have to reconstruct the post-1986
undistributed earnings and taxes pools to
include undistributed earnings and taxes
for periods during which there was no
qualifying shareholder, in order to com-
pute deemed-paid credits with respect to
distributions of earnings and profits
accumulated during later periods in
which the ownership requirements were
met.
Treasury and the IRS believe that the
policy concerns underlying the rule
deferring the start of pooling until the
corporation has a qualifying sharehold-
er also apply to the situation where a
foreign corporation once had, but no
longer has,such a shareholder.
Therefore, Treasury and the IRS believe
it is appropriate to stop the multi-year
pooling of earnings and taxes at the for-
eign corporation level when a foreign
corporation no longer has a qualifying
shareholder.
The proposed regulations would
amend §1.902–1(a)(10) to provide that
pre-1987 accumulated profits subject to
the annual layering rules of pre-1987 law
include not only the actual pre-1987 earn-
ings and profits and pre-pooling earnings
and profits described in the current final
regulation, but also formerly pooled earn-
ings and profits of a less-than-10%-U.S.-
owned foreign corporation attributable to
post-1986 years during which the section
902 stock ownership requirements were
met, and post-pooling earnings and prof-
its accumulated during subsequent tax-
able years during which the foreign cor-
poration did not have a qualifying
shareholder. The formerly pooled earn-
ings would be considered pre-1987 accu-
mulated profits of the last taxable year of
the foreign corporation as of the end of
which the ownership requirements were
met. Distributions out of formerly pooled
earnings would be subject to the same
pre-1987 law rules as distributions of
other pre-1987 accumulated profits,
except that the formerly pooled foreign
income taxes related to the formerly
pooled earnings would continue to be
maintained in U.S. dollars. The proposed
regulations would also amend
§1.902–1(a)(13) to provide that pooling
of earnings and taxes would resume in the
first subsequent taxable year as of the end
of which the foreign corporation again
has a qualifying shareholder. Formerly
pooled earnings would continue to be
treated as pre-1987 accumulated profits
even if the foreign corporation later
began to maintain pools of earnings and
taxes again.
Treasury and the IRS believe the pro-
posed rules would be easier for taxpayers
to apply than the current regulations,
which require pooling to continue through
periods when the foreign corporation has
no shareholders entitled to compute a
deemed-paid credit. These proposed
amendments complement the proposed
amendments to the section 904 regula-
tions, described below, concerning the
effect of intervening noncontrolled status
on the look-through pools of post-1986
undistributed earnings and taxes main-
tained by a controlled foreign corporation.
The proposed regulations also would be
consistent with the approach taken in
recently proposed amendments to the reg-
ulations under section 367(b) relating to
the carryover of earnings and taxes
accounts in reorganizations involving for-
eign corporations (REG–116050–99,
2000–48 I.R.B. 520, published in the
Federal Register(65 FR 69138) on
November 15, 2000).
II.Separate Categories: §1.904–4
A. The active rents and royalties
exception
Section 1.904–4(b)(2) sets forth the
active rents and royalties exception to the
separate limitation for passive income.
This exception currently applies only to
payments from unrelated payors.
Several commentators have requested
that Treasury and the IRS amend the reg-
ulations to provide that royalties received
from a member of the recipient’s affiliat-
ed group (including foreign affiliates)
may qualify for the exception if the roy-
alties are derived in the conduct of an
active trade or business and the payor
uses the underlying property in an active
trade or business. As explained below,
Treasury and the IRS propose to adopt a
modified version of the suggested
change.
Section 904(d)(2)(A)(i) defines passive
income as foreign personal holding com-
pany income, as defined in section 954(c).
The section 904(d) active rents and royal-
ties exception derives from section
954(c)(2)(A), which excludes from for-
eign personal holding company income,
and thus from passive income, any rents
or royalties derived in the active conduct
of a trade or business and received from
an unrelated person. The current final
regulations at §1.904–4(b)(2)(ii) modify
this exception to take into account activi-
ties of members of the recipient’s affiliat-
ed group in determining whether the
recipient meets the active trade or busi-
ness prong of the test for section 904(d)
purposes.
Treasury and the IRS have consistently
declined to extend look-through treatment
to payments from foreign non-controlled
payors. See T.D. 8412 (1992–1 C.B. 271,
273). Treasury and the IRS continue to
believe that the nature of the income
earned by a foreign non-controlled payor
from the use of the licensed property
should not determine whether a rent or
royalty payment constitutes income from
the active conduct of a trade or business of
the recipient.
However, Treasury and the IRS have
decided that it is appropriate to eliminate
the distinction between royalties received
from related and unrelated payors in
applying the active rents and royalties
exception for purposes of section 904(d).
January 22, 20014082001–4 I.R.B.

Therefore, these regulations propose to
amend prospectively §1.904–4(b)(2) to
provide that for purposes of section 904
(but not for purposes of section 954), the
active rents and royalties exception will
not require that the rents and royalties be
received from an unrelated payor. This
change is proposed to apply to rents and
royalties paid or accrued more than 60
days after the date that these regulations
are published in final form.
B.Restriction of affiliated group special
rule for active rents and royalties
exception
As noted, §1.904–4(b)(2)(ii) provides
that, for purposes of the active rents and
royalties exception from passive income
under section 904, rents or royalties will
be treated as derived in the active conduct
of a trade or business by a United States
person or controlled foreign corporation if
any member of the recipient’s affiliated
group (defined to include foreign corpora-
tions) meets the requirements of section
954(c)(2)(A) with respect to the licensed
property. The proposed regulations would
amend the definition of affiliated group
for purposes of §1.904–4(b)(2)(ii) to
include only U.S. corporations and con-
trolled foreign corporations in which
United States members of the affiliated
group own, directly or indirectly, at least
80 percent of the stock (by vote and
value). This requirement is consistent
with the affiliated group rules of
§1.904–4(e)(3)(ii), which consider the
activities of other members of the affiliat-
ed group for purposes of determining
whether an entity is a financial services
entity. The proposed regulations revise
the affiliated group rule in the active rents
and royalties exception due to administra-
tive concerns regarding the difficulty of
determining whether related, but non-con-
trolled, foreign corporations engage in the
active conduct of a trade or business with
respect to licensed property.
C.Effect of intervening noncontrolled or
less-than-10%-U.S.-owned status on
distributions from a controlled foreign
corporation or other look-through
corporation
Under section 904(d)(2)(E)(i) and
§1.904–4(g)(3)(i), dividends from a con-
trolled foreign corporation (CFC) are
treated as dividends from a noncontrolled
section 902 corporation to the extent that
the distribution is out of earnings and
profits accumulated during periods in
which the distributing corporation was not
a CFC. Proposed §1.904–4(g)(3)(i)(C)(1)
provides rules to address the effect of
intervening noncontrolled status on the
eligibility for look-through treatment of
distributions of pre-2003 accumulations
of pooled earnings and profits from a
CFC. Consistent with the proposed
amendments to §1.902–1(a) previously
discussed,proposed §1.904–4(g)(3)
(i)(C)(2) provides rules to address the
effect of intervening less-than-10%-U.S.-
owned status on the post-1986 undistrib-
uted earnings and taxes pools and pre-
1987 accumulated profits of a foreign
corporation and the application of the
look-through rules to distributions from
such a foreign corporation. The proposed
regulations anticipate to some extent, but
do not provide comprehensive guidance,
regarding the changes to the statutory
look-through rules for 10/50 companies
that become effective for post-2002 tax-
able years. Additional conforming
changes to the provisions of §§1.904–4
and 1.904–5 will be required to reflect the
changes in terminology reflected in the
proposed regulations that are necessitated
by these statutory changes.
The proposed regulations provide that,
when a CFC becomes a non-look-through
10/50 corporation (because it ceases to be
controlled by United States shareholders,
but has at least one qualifying sharehold-
er, in a taxable year beginning before
January 1, 2003), post-1986 undistributed
earnings that were accumulated through
the end of the taxable year preceding the
taxable year in which the decontrolling
event occurred and that were previously
eligible for look-through treatment will be
consolidated in, and constitute the open-
ing balance of, a single non-look-through
pool at the foreign corporation level. The
regulations provide that distributions of
the prior look-through earnings will con-
tinue be treated as dividends from a non-
look-through 10/50 corporation, and will
not be eligible for look-through treatment,
even if the foreign corporation later
becomes a CFC again or becomes eligible
for look-through treatment with respect to
earnings accumulated in post-2002 tax-
able years.
Distributions of post-1986 undistributed
earnings in the non-look-through pool will
be treated as dividends from a non-look-
through 10/50 corporation (10/50 dividend
income) when distributed to a qualifying
shareholder, or as passive income when dis-
tributed to any other shareholder. Pre-1987
accumulated profits distributed after a
decontrolling event will similarly be treated
as 10/50 dividend income or as passive
income when distributed, depending on the
status of, and the amount of stock owned by,
the shareholder at the time of distribution.
Because the separate limitation treatment of
distributions during the taxable year is com-
puted with reference to year-end pools of
post-1986 undistributed earnings under sec-
tion 902, the proposed regulations provide
that distributions to a qualifying shareholder
that are made in the taxable year in which a
decontrolling event occurs are treated as
10/50 dividend income to qualifying share-
holders, or passive income to other share-
holders, whether made before or after the
decontrolling event. Similarly,under
§1.904–4(g)(3)(iii), earnings and profits
accumulated in the year in which a foreign
corporation becomes a CFC are treated as
accumulated after the corporation became a
CFC. Such earnings will be eligible for
look-through treatment when distributed to a
United States shareholder during the taxable
year in which the distributing corporation
becomes a CFC or during any subsequent
taxable year until the distributing corporation
ceases to be a CFC or other look-through
corporation.
As noted, the proposed regulations do
not permit look-through treatment for
earnings and profits accumulated in pre-
2003 taxable years while the distributing
corporation was a CFC if the earnings are
distributed after an intervening period
ending before 2003 during which the cor-
poration was not a CFC, even if the cor-
poration is a CFC or other look-through
corporation at the time of distribution.
Earnings and profits previously eligible
for look-through treatment will be placed
in a single non-look-through pool with
new earnings accumulated in taxable
years beginning before January 1, 2003,
while the corporation is not a CFC. The
proposed rule would eliminate the need to
determine whether distributions made
while the corporation is a non-look-
through 10/50 corporation (or, after 2002,
a 10/50 look-through corporation) are
2001–4 I.R.B.409January 22, 2001

made out of look-through earnings accu-
mulated in pre-2003 years prior to the
decontrolling event or pre-2003 non-look-
through earnings accumulated afterwards.
Treasury and the IRS believe this rule
would be simpler to apply with respect to
pre-2003 periods during which the
records necessary to establish look-
through treatment are less likely to be
maintained by a foreign corporation that
is not controlled by United States share-
holders.
This intervening noncontrolled status
situation differs from the special situation
described in §1.904–4(g)(3)(ii), which
allows look-through treatment on distrib-
utions to a more-than-90-percent United
States shareholder after August 6, 1997,
of earnings and profits that were accumu-
lated while the distributing corporation
was a CFC. In the latter case, pre-acqui-
sition post-1986 undistributed earnings of
a CFC with a more-than-90-percent
United States shareholder were required
to be maintained in a non-look-through
pool prior to the effective date of the
amendment to section 904(d)(2)(E)(i) by
TRA 1997. During the entire period the
non-look-through pool was required to be
maintained, the corporation was a CFC
that was more-than-90-percent-owned by
a single domestic corporation.
Accordingly, the rules governing the
effect of the 1997 repeal of the rule limit-
ing look-through treatment to earnings
accumulated while the more-than-90-per-
cent United States shareholder was a
United States shareholder of the distribut-
ing corporation do not provide an appro-
priate model for resolving the ongoing
issue addressed by the proposed regula-
tions.
Section 904(d)(4) as amended by sec-
tion 1105(b) of TRA 1997 effective for
taxable years beginning after December
31, 2002, will generally extend the look-
through rules to distributions of earnings
accumulated by a 10/50 company in post-
2002 taxable years. Accordingly, non-
look-through 10/50 corporations will not
exist after 2002, although 10/50 look-
through corporations will continue to
maintain non-look-through pools of earn-
ings and taxes accumulated in pre-2003
taxable years. Therefore, if the regula-
tions are finalized prospectively, the effect
of proposed §1.904–4(g)(3)(i)(C)(1) gen-
erally would be limited to situations
involving a CFC that is decontrolled after
the regulations become final but before
January 1, 2003, and to earnings that are
accumulated in taxable years beginning
before January 1, 2003, and that are not
treated as distributed to the CFC’s U.S.
shareholders under section 1248 in con-
nection with the decontrolling event.
Comments are requested as to whether the
simplification objectives of the regulation
could best be met by extending the effec-
tive date to cover decontrolling events that
occurred in prior periods.
Consistent with the proposed amend-
ments to §1.902–1(a) and with the approach
taken with respect to the pre-2003 decontrol
situation, §1.904–4(g)(3)(i)(C)(2) of the
proposed regulations provides that distribu-
tions out of formerly pooled earnings that
are converted to an annual layer of pre-1987
accumulated profits when a foreign corpo-
ration no longer has a qualifying sharehold-
er will be treated as distributions from a
non-look-through 10/50 corporation, even
if the foreign corporation later becomes a
look-through corporation again.
The proposed regulations reserve on
the treatment of distributions from a 10/50
look-through corporation, including the
treatment of distributions out of earnings
and profits accumulated in periods before
the taxpayer acquired its stock. Com-
ments are requested on whether addition-
al guidance is needed to clarify the rules
governing distributions from CFCs, and
on how the regulations should be modi-
fied to reflect the rules of section 1105(b)
of TRA 1997, extending look-through
treatment to distributions from 10/50 cor-
porations out of earnings and profits accu-
mulated in post-2002 taxable years.
D. Additional separate categories
Treasury and the IRS propose to add
a new paragraph (m) to §1.904–4, to
provide that if section 904(a), (b), and
(c) are applied separately to any catego-
ry of income under the Code (for exam-
ple, under section 901(j), 865(h), or
904(g)(10)), that category of income
(additional category) will be treated for
purposes of the Code and regulations
(including, for example, section 904(f))
as if it were a separate category listed in
sections 904(d)(1) and 904(d)(3)(F)(i).
This amendment is intended to clarify
the treatment of such additional sepa-
rate categories without the need for
specific cross-references to such cate-
gories each time a provision refers to
the separate categories listed in section
904(d). Sections 1.904–4(a) and
1.904–5(a)(1) are amended to include a
reference to such additional separate
categories.
III.Allocation and Apportionment of
Taxes to Separate Categories: §1.904–6
Treasury and the IRS propose to amend
§1.904–6(a)(1) to clarify the rules for
determining the amount of income (in
each U.S. separate category) taxed by a
foreign country, in situations in which for-
eign law does not provide expense alloca-
tion rules. In such cases, for purposes of
determining the amount of income taxed
by the foreign country in order to allocate
and apportion foreign taxes to separate
categories, a taxpayer must allocate the
expenses that are deductible under foreign
law using the same methods that the tax-
payer uses to allocate expenses that are
deductible under U.S. law for purposes of
determining the amount of taxable
income.
IV.Capital Gain and Loss Adjustments:
§1.904(b)–1
A.Section 904(b) capital gain and loss
adjustments
The proposed regulations provide guid-
ance regarding the rule of section
904(b)(2)(A) that foreign source capital
gain may not exceed the lesser of capital
gain net income from sources outside the
United States or worldwide capital gain
net income. A similar rule applies with
respect to net capital gain. The regula-
tions also provide guidance regarding the
rule of section 904(b)(2)(B) that capital
gains from foreign and U.S. sources, and
capital losses from foreign sources, must
be adjusted based on capital gain rate dif-
ferential amounts. The proposed regula-
tions exercise the regulatory authority
granted under section 904(b)(2)(C)
(authorizing regulations to modify the
application of section 904(b)(2) and (3) to
properly reflect capital gain rate differen-
tials and the computation of net capital
gain) and section 904(d)(6) (authorizing
such regulations as may be necessary and
appropriate for the purposes of section
904(d)).
January 22, 20014102001–4 I.R.B.

The proposed regulations first provide
guidance concerning the adjustments
required when foreign source capital
gains exceed the lesser of capital gain
net income (or net capital gain) from
sources outside the United States or cap-
ital gain net income (or net capital gain)
from all sources. Section 904(b)(2)(A)
and section 904(b)(2)(B)(i) provide that,
for purposes of section 904, foreign
source capital gains that are included in
foreign source taxable income may not
exceed the lesser of capital gain net
income from sources outside the United
States or capital gain net income from
all sources. Section 904(b)(2)(A),
(3)(A). Similar rules apply for purposes
of determining foreign source net capital
gain. Section 904(b)(3)(B). After the
1986 enactment of separate limitation
categories in section 904(d), the issue
arises as to the extent to which foreign
source capital gains should be adjusted
if the taxpayer has foreign source capital
gains and losses in more than one sepa-
rate category.
The proposed regulations provide that
foreign source capital gains included in
foreign source taxable income in any sep-
arate category are reduced by reason of
section 904(b)(2)(A) and section
904(b)(2)(B)(i) only by foreign source
capital losses in the same separate catego-
ry and by a ratable portion of the excess of
capital gain net income from foreign
sources (in the aggregate, considering all
of the taxpayer’s separate categories) over
capital gain net income from all sources
(considering capital gains and losses from
sources within and outside the United
States, from all of the taxpayer’s separate
categories). Thus, the proposed rule
would reduce capital gain net income
from foreign sources in any separate cate-
gory only if the taxpayer has a net U.S.-
source capital loss, and not in instances
where foreign-source capital gains in one
separate category are offset only by for-
eign-source capital losses from another
separate category. This rule implements
Congress’s intent that section
904(b)(2)(A) and section 904(b)(2)(B)(i)
should prevent foreign-source capital
gains from inappropriately increasing the
numerator of the foreign tax credit limita-
tion fraction under section 904(a) if those
capital gains were offset by U.S.-source
capital losses, while avoiding the potential
for double counting of foreign-source
losses that might result if foreign-source
gains in one separate category were
reduced by reason of foreign-source loss-
es that reduce ordinary income in another
separate category.
The regulations further provide that if
the taxpayer’s capital gain net income
from sources outside the United States
exceeds the taxpayer’s capital gain net
income from all sources (i.e., where there
is a net U.S. capital loss), a pro ratapor-
tion of such excess reduces the capital
gain net income from sources outside the
United States in each of the taxpayer’s
separate limitation categories and, within
each separate category, in each rate group.
The pro rataportion is determined based
on the relative amounts of net capital gain
from sources outside the United States in
each separate category or rate group.
In addition, the proposed regulations
provide guidance on adjusting capital
gains and foreign capital losses to reflect
capital gain rate differentials. Section
904(a) limits the foreign tax credit to the
lesser of 1) foreign tax paid or accrued;
or 2) pre-credit U.S. tax multiplied by a
fraction equal to foreign source taxable
income over worldwide taxable income
(the limitation fraction). Multiplying the
pre-credit U.S. tax by the limitation frac-
tion is meant to determine the portion of
U.S. taxes that are attributable to foreign
source income. Section 904(b)(2)(B)
adjusts capital gains in the numerator and
denominator, and foreign source capital
losses in the numerator, of the limitation
fraction if capital gains are taxed at lower
rates than ordinary income, as is often
the case under current law for individu-
als. Unless capital gains and foreign
capital losses are adjusted to account for
this difference, the limitation fraction
will not accurately reflect the portion of
the total pre-credit U.S. tax that is prop-
erly attributable to foreign source
income.
The rate differential adjustments to
capital gains and foreign source capital
losses, under section 904(b) and the pro-
posed regulations, apply only if the spe-
cific taxpayer has net capital gain that is
subject to reduced tax rates for the taxable
year. Treasury and the IRS request com-
ments with respect to applying on an elec-
tive basis adjustments based on rate dif-
ferentials for taxable years in which the
Code applies reduced tax rates to capital
gains generally, but the specific taxpayer
has capital losses that equal or exceed
capital gains. Any such elective rule
would need to include ordering rules for
determining the source, the separate cate-
gory, and the rate group of the capital
losses that are taken into account for the
current taxable year, including those capi-
tal losses that are currently deductible to
the extent of $3,000 under section 1211(b)
against ordinary income, and those losses
that are subject to the capital loss carry-
over rules.
As noted, section 904(b)(2)(C) grants
regulatory authority to modify the appli-
cation of section 904(b)(2) and (3) “to
the extent necessary to properly reflect
any capital gain rate differential under
section 1(h) or 1201(a) and the computa-
tion of net capital gain.” The proposed
regulations exercise this authority and
adjust the section 904(b)(2)(B) calcula-
tions to reflect the fact that, for taxable
years ending after May 6, 1997, section
1(h) contains multiple capital gains
rates. The proposed regulations thus
require that capital gain net income,
from sources outside the United States
and from all sources, must be adjusted
pursuant to section 904(b)(2)(B)(i) and
(ii) by the rate differential portion of
each rate group of the taxpayer’s net
capital gain from sources outside the
United States and from all sources,
respectively.
The proposed regulations also provide
guidance on adjusting foreign source cap-
ital losses under section 904(b)(2)(B)(iii).
The regulations clarify that such capital
losses (after netting against foreign source
capital gains in the same rate group, as
defined in the regulations) should be
reduced based on the tax rate applicable
under section 1(h) to the net capital gains
that are offset by such net capital losses in
the determination of the taxpayer’s tax-
able income. Although section
904(b)(2)(B)(iii) provides for such adjust-
ment in instances when net foreign losses
have offset U.S. source capital gains, the
existence of multiple separate categories
after 1986 may result in foreign source
capital gains and losses in separate cate-
gories offsetting one another. Therefore,
the regulations require adjustment of for-
eign capital losses that offset foreign
source capital gains associated with dif-
2001–4 I.R.B.411January 22, 2001

ferent capital gains rates, in addition to
foreign capital losses that offset U.S.
source capital gains.
In determining which capital gains are
offset by capital losses from sources out-
side the United States in different rate
groups, the proposed regulations provide
that net capital losses from sources within
the United States will not be taken into
account, in order to simplify this determi-
nation. Treasury and the IRS request
comments regarding whether the regula-
tions should take net capital losses from
sources within the United States into
account for such purposes, and, if so, what
type of ordering rules should be applied.
The IRS is considering providing a
simplified worksheet for performing the
section 904(b)(2)(B) adjustments in the
Form 1116 instructions, for taxpayers
whose capital gains are subject only to 10
or 20 percent tax rates under section 1(h)
(similar to the simplified worksheet pro-
vided in the 1999 Form 1040 instructions
as an alternative to Schedule D for tax-
payers whose capital gains are subject
only to 10 and 20 percent tax rates under
section 1(h)). Treasury and the IRS
request comments on this approach.
B. Appropriate tax rates for AMT foreign
tax credit calculation
The proposed regulations provide that
the alternative minimum tax (AMT) rates,
rather than the regular tax rates, apply for
purposes of carrying out the section
904(b) capital gains rates adjustments for
the AMT foreign tax credit. Section
904(b) generally adjusts capital gains and
foreign source capital losses based on the
difference between the maximum U.S. tax
rate and the tax applicable to capital gains
under section 1(h). This adjustment is
necessary to calculate more accurately the
amount of U.S. tax that is attributable to
foreign source income (as determined by
application of the section 904(a) fraction).
Section 59(a)(1)(B) provides that the
AMT foreign tax credit must be deter-
mined as if “section 904 were applied on
the basis of alternative minimum taxable
income,” and therefore requires the appli-
cation of section 904(b) in determining
the AMT foreign tax credit. In order to
reflect more accurately the amount of pre-
credit tentative minimum tax attributable
to foreign source AMT income, these reg-
ulations provide that, for purposes of
applying section 904(b) in determining
the AMT foreign tax credit, the maximum
AMT rates should be used rather than the
rates specified in section 1.
In addition, the regulations clarify that
section 904(b)(2)(B)(ii) (relating to capi-
tal gains from all sources), as well as sec-
tion 904(b)(2)(B)(i) and (iii) (relating to
foreign source capital gains and losses,
respectively) apply (in modified form, as
provided in section 59) to the determina-
tion of the AMT foreign tax credit. The
regulations also clarify that section 904(b)
applies to taxpayers electing to apply the
simplified foreign tax credit limitation
rules under section 59(a)(4).
V. Coordination of Section 904(j) with
Carryforward and Carryback Rules:
§1.904(j)
Section 904(j) allows a taxpayer to
elect not to apply section 904(a) (the for-
eign tax credit limitation fraction) if the
taxpayer’s creditable foreign taxes paid or
accrued for the year are $300 or less
($600 or less for joint filers), the taxpay-
er’s foreign source gross income consists
entirely of passive income, and such
income and taxes are reported to the tax-
payer on a payee statement. If a taxpayer
elects to apply section 904(j) for any tax-
able year, no foreign taxes paid or accrued
in such year may be carried over to any
other year, and no foreign taxes paid or
accrued in any other year may be carried
over to the section 904(j) election year.
The proposed regulations clarify that a
taxpayer may elect to apply section 904(j)
for a taxable year only if all of the taxes
paid or accrued for the taxable year and for
which a credit is allowable to the taxpayer
under section 901 for the taxable year are
creditable foreign taxes (as defined in sec-
tion 904(j)(3)(B). For example, suppose
that in year 2, the taxpayer accrues and
pays foreign tax that was not shown on a
payee statement furnished to the taxpayer
and that is related to general limitation
income that was recognized and included
in income for U.S. tax purposes in year 1.
If the foreign taxes in the general limitation
category are creditable under section 901
for year 2, the taxpayer may not elect to
apply section 904(j) for year 2, even if all
of the taxpayer’s income in year 2 is quali-
fied passive income.
In addition, taxpayers requested clarifi-
cation on the application of the carryover
provisions in taxable years following sec-
tion 904(j) election years. Because high-
taxed income, as defined in section
904(d)(2)(F), is calculated by reference to
the highest rate of tax specified in section
1 or 11 (whichever is applicable),
Treasury and the IRS expect that some
individual taxpayers who are eligible to
elect the application of section 904(j) may
have foreign tax credit carryovers in the
passive income category.
The proposed regulations clarify that
the amount of a foreign tax credit carry-
over to or from a non-section-904(j)-elec-
tion year is not reduced to account for the
part of the carryover that (but for section
904(j)) could have been used in interven-
ing section 904(j)-election years. Section
904(j) was intended to allow taxpayers to
avoid computing the section 904(a) limi-
tation fraction. See Committee on the
Budget, U.S. House of Representatives,
Report on Revenue Reconciliation Act of
1997, June 24, 1997, at 520-21.
Requiring taxpayers to compute the
amount of carryover that could have been
used in the election year would be incon-
sistent with the statutory purpose of mak-
ing the credit provisions less complex and
less burdensome for taxpayers with small
amounts of solely passive foreign-source
income reported on payee statements.
(Taxpayers may, of course, choose to per-
form the calculations to determine
whether electing the application of section
904(j) would be more advantageous for
them, particularly for years in which a for-
eign tax credit carryover will expire.)
However, the section 904(j) election
does not extend the carryforward and car-
ryback periods under section 904(c). For
example, if a carryforward expires in
2000, and the taxpayer elects the applica-
tion of section 904(j) for the 2000 taxable
year, the carryforward cannot be used in
2000 (pursuant to section 904(j)(1)(C)) or
in any later year (pursuant to the expira-
tion of the carryforward period).
Similarly, the determination of whether
the taxpayer paid or accrued more than
$300 (or $600) of creditable foreign taxes
is made without regard to carryovers. For
example, a single taxpayer who pays $300
of creditable foreign taxes in 2001, and
has a $500 carryover to 2001 from a pre-
January 22, 20014122001–4 I.R.B.

vious year, is eligible to elect the applica-
tion of section 904(j) for the 2001 year.
However, if the election is made, the tax-
payer cannot claim a credit in 2001 for the
$500 otherwise treated as a carryover.
VI.Removal of Example in §1.954–2
The proposed regulations remove
Example 2under §1.954–2(b)(2)(iv),
which was intended to illustrate the appli-
cation of the rules under §1.954–2(b)(2)
for the exception from foreign personal
holding company for certain export
financing interest. Treasury and the IRS
are concerned that the example may be
unintentionally confusing. For this rea-
son, it is being removed. Comments are
invited concerning whether a replacement
example is necessary.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a reg-
ulatory assessment is not required. It also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these
regulations, and because the regulations
do not impose a collection of information
on small entities,the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of
the Code, this notice of proposed rule-
making will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment on
their impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any electronic or written
comments (a signed original and eight (8)
copies) that are submitted timely to the
IRS. The IRS and Treasury Department
request comments on the clarity of the
proposed rules and how they can be made
easier to understand. All comments will
be available for public inspection and
copying.
A public hearing has been scheduled
for April 26, 2001,beginning at 10 a.m.
in the IRS Auditorium, Internal Revenue
Building, 1111 Constitution Avenue,
NW., Washington, DC. Due to building
security procedures, visitors must enter at
the 10
th
Street entrance, located between
Constitution and Pennsylvania Avenues,
NW. In addition, all visitors must present
photo identification to enter the building.
Because of access restrictions, visitors
will not be admitted beyond the immedi-
ate entrance area more than 15 minutes
before the hearing starts. For information
about having your name placed on the
building access list to attend the hearing,
see the “FOR FURTHER INFORMA-
TION CONTACT” section of this pream-
ble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish to
present oral comments at the hearing must
submit electronic or written comments
and an outline of the topics to be dis-
cussed and the time to be devoted to each
topic (signed original and eight (8)
copies) by April 5, 2001. A period of 10
minutes will be allotted to each person for
making comments. An agenda showing
the scheduling of the speakers will be pre-
pared after the deadline for receiving out-
lines has passed. Copies of the agenda
will be available free of charge at the hear-
ing.
Drafting Information
The principal author of these proposed
regulations is Rebecca I. Rosenberg of the
Office of Associate Chief Counsel
(International), within the Office of Chief
Counsel, Internal Revenue Service.
However, other personnel from the IRS
and Treasury 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 TAX; TAXABLE
YEARS BEGINNING AFTER
DECEMBER 31, 1953
Paragraph 1. The authority citation for
part 1 is amended by removing the entry
for “Section 1.902–1 and 902–2” and
§1.904–4 through 1.904–7”, and adding
entries in numerical order to read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.902–1 also issued under 26
U.S.C. 902(c)(7). * * *
Section 1.904–4 also issued under 26
U.S.C. 904(b)(2)(C) and 904(d)(5).
Section 1.904–5 also issued under 26
U.S.C. 904(d)(5).
Section 1.904–6 also issued under 26
U.S.C. 904(d)(5).
Section 1.904–7 also issued under 26
U.S.C. 904(d)(5). * * *
Par. 2. Section 1.902–0 is amended by:
1. Revising the entry for §1.902–1(a)
(13)(ii).
2. Adding an entry for §1.902–1(a)
(13)(iii).
The revisions and additions read as fol-
lows:
§1.902–0 Outline for regulations
provisions for section 902.
* * * * *
§1.902–1 Credit for domestic corporate
shareholder of a foreign corporation for
foreign income taxes paid by the foreign
corporation.
(a) * * *
(13) * * *
(ii) Resumption of pooling.
(iii) Examples.
* * * * *
Par 3. Section 1.902–1 is amended as
follows:
1. Paragraph (a)(8)(ii) is amended by
revising the second sentence.
2. Paragraph (a)(10)(i) is revised.
3. Paragraph (a)(10)(iii) is amended by
revising the last sentence and adding one
sentence.
4. Paragraphs (a)(13)(i)(A) and (a)(13)
(i)(B) are revised.
5. Paragraphs (a)(13)(i)(C) and (a)(13)
(i)(D) are added.
6. Paragraph (a)(13)(ii) is revised.
7. Paragraph (a)(13)(iii) is added.
The revisions and additions read as fol-
lows:
§1.902–1 Credit for domestic corporate
shareholder of a foreign corporation for
foreign income taxes paid by the foreign
corporation.
(a) * * *
(8) * * *
(ii) * * * Foreign income taxes (other
than taxes attributable to formerly pooled
earnings that are maintained in United
States dollars) that are deemed paid with
2001–4 I.R.B.413January 22, 2001

January 22, 20014142001–4 I.R.B.
respect to a distribution of pre-1987 accu-
mulated profits shall be translated from
the functional currency of the lower-tier
corporation into dollars at the spot
exchange rate in effect on the date of the
distribution. * * *
* * * * *
(10) * * * (i) The term pre-1987 accu-
mulated profits means the amount of the
earnings and profits of a foreign corpora-
tion computed in accordance with section
902 and attributable to its taxable years
beginning before January 1, 1987 (pre-
1987 earnings). If the special effective
date of paragraph (a)(13)(i) of this section
applies, pre-1987 accumulated profits also
includes any earnings and profits (com-
puted in accordance with section 964(a)
and 986) attributable to the foreign corpo-
ration’s taxable years beginning after
December 31, 1986, but before the first
day of the first taxable year of the foreign
corporation in which the ownership
requirements of section 902(c)(3)(B) and
paragraphs (a)(1) through (4) of this sec-
tion are met with respect to that corpora-
tion (pre-pooling earnings). Pre-1987
accumulated profits also includes any
post-1986 undistributed earnings formerly
maintained by a less-than-10%-U.S.-
owned foreign corporation (as defined in
§1.904–4(g)(1)) that are attributable to the
foreign corporation’s taxable years begin-
ning after December 31, 1986, as of the
end of which such ownership require-
ments were met (formerly pooled earn-
ings). Such formerly pooled earnings
shall be considered pre-1987 accumulated
profits of the last taxable year of the for-
eign corporation in which such ownership
requirements were met as of the end of the
taxable year. Pre-1987 accumulated prof-
its also includes earnings and profits accu-
mulated during subsequent taxable years
of such a less-than-10%-U.S.-owned for-
eign corporation as of the end of which
such ownership requirements were not
met (post-pooling earnings). All four
types of pre-1987 accumulated profits
described in this paragraph (a)(10)(i) are
also sometimes referred to as pre-pooling
annual layers.
* * * * *
(iii) * * * Foreign income taxes
deemed paid with respect to a distribution
of pre-1987 accumulated profits shall be
translated from the functional currency of
the distributing corporation into United
States dollars at the spot exchange rate in
effect on the date of the distribution,
except that foreign income taxes attribut-
able to formerly pooled earnings
described in the third sentence of para-
graph (a)(10)(i) of this section shall be
maintained in United States dollars as
originally translated in accordance with
section 986(a). Post-1986 foreign income
taxes attributable to such formerly pooled
earnings shall be treated as pre-1987 for-
eign income taxes.
* * * * *
(13) * * * (i) * * *
(A) The post-1986 undistributed earn-
ings and post-1986 undistributed foreign
income taxes of the foreign corporation
shall be determined by taking into account
only consecutive taxable years beginning
on and after the first day of the first tax-
able year of the foreign corporation as of
the end of which the ownership require-
ments of section 902(c)(3)(B) and para-
graphs (a)(1) through (4) of this section
are met and ending before the first day of
a subsequent taxable year in which such
ownership requirements are not met as of
the end of the taxable year;
(B) Earnings and profits accumulated
prior to the first day of the first taxable
year of the foreign corporation as of the
end of which such ownership require-
ments are met shall be considered pre-
1987 accumulated profits (which may
include both pre-pooling earnings and
pre-1987 earnings);
(C) Formerly pooled earnings
described in paragraph (a)(10)(i) of this
section shall be considered pre-1987
accumulated profits of the taxable year
ending immediately before the next tax-
able year in which such ownership
requirements are not met as of the end of
the taxable year; and
(D) Earnings and profits accumulated
on and after the first day of a taxable year
of the foreign corporation as of the end of
which such ownership requirements are
not met shall be considered pre-1987
accumulated profits (post-pooling earn-
ings).
(ii) Resumption of pooling. If the own-
ership requirements of section
902(c)(3)(B) and paragraphs (a)(1)
through (4) of this section are again met
with respect to a foreign corporation that
originally maintained pools of post-1986
undistributed earnings and post-1986 for-
eign income taxes but converted such
pools to pre-1987 accumulated profits
(formerly pooled earnings) and associated
pre-1987 foreign income taxes because
such ownership requirements were not
met as of the close of a subsequent post-
1986 taxable year, then the post-1986
undistributed earnings and post-1986 for-
eign income taxes of the foreign corpora-
tion shall be determined by taking into
account only taxable years beginning on
and after the first day of the first such sub-
sequent taxable year of the foreign corpo-
ration as of the end of which such owner-
ship requirements are met and ending
before the first day of a subsequent tax-
able year in which such ownership
requirements are not met as of the end of
the taxable year. The post-pooling earn-
ings, formerly pooled earnings, pre-pool-
ing earnings, and pre-1987 earnings of
such a foreign corporation shall continue
to be considered pre-1987 accumulated
profits. The rules of paragraph
(a)(13)(i)(B) through (D) of this section
shall apply if such a foreign corporation
again becomes a less-than-10%-U.S.-
owned foreign corporation.
(iii) Examples. The following examples illus-
trate the special effective date rules of this paragraph
(a)(13):
Example 1. As of December 31, 1991, and since
its incorporation, foreign corporation A has owned
100 percent of the stock of foreign corporation B.
Corporation B is not a controlled foreign corpora-
tion. Corporation B uses the calendar year as its tax-
able year, and its functional currency is the u.
Assume 1u equals $1 at all relevant times. On April
1, 1992, Corporation B pays a 200u dividend to
Corporation A and the ownership requirements of
section 902(c)(3)(B) and paragraphs (a)(1) through
(4) of this section are not met at that time. On July
1, 1992, domestic corporation M purchases 10 per-
cent of the Corporation B stock from Corporation A
and, for the first time, Corporation B meets the own-
ership requirements of section 902(c)(3)(B) and
paragraph (a)(2) of this section. Corporation M uses
the calendar year as its taxable year. Corporation B
does not distribute any dividends to Corporation M
during 1992. For its taxable year ending December
31, 1992, Corporation B has 500u of earnings and
profits (after foreign taxes but before taking into
account the 200u distribution to Corporation A) and
pays 100u of foreign income taxes that is equal to
$100. Pursuant to paragraph (a)(13)(i) of this sec-
tion, Corporation B’s post-1986 undistributed earn-
ings and post-1986 foreign income taxes will include
earnings and profits and foreign income taxes attrib-
utable to Corporation B’s entire 1992 taxable year
and all subsequent taxable years beginning before
the date these regulations are published as final reg-
ulations in the Federal Register, as well as later tax-
able years as of the end of which the ownership
requirements of section 902(c)(3)(B) and paragraphs

2001–4 I.R.B.415January 22, 2001
(a)(1) through (4) of this section are met. Thus, the
April 1, 1992, dividend to Corporation A will reduce
post-1986 undistributed earnings to 300u (500u -
200u) under paragraph (a)(9)(i) of this section. The
foreign income taxes attributable to the amount dis-
tributed as a dividend to Corporation A will not be
creditable because Corporation A is not a domestic
shareholder. Post-1986 foreign income taxes, how-
ever, will be reduced by the amount of foreign taxes
attributable to the dividend. Thus, as of the begin-
ning of 1993, Corporation B has $60 ($100- [$100 x
40% (200u/500u)]) of post-1986 foreign income
taxes. See paragraphs (a)(8)(i) and (b)(1) of this sec-
tion.
Example 2. The facts are the same as in Example
1, except that Corporation M sells five percent of the
Corporation B stock to an unrelated buyer on July 1,
2003, so that Corporation B no longer meets the
ownership requirements of section 902(c)(3)(B) and
paragraphs (a)(1) through (4) of this section as of
that date. Thus, as of December 31, 2003,
Corporation B’s earnings and profits all consist of
pre-1987 accumulated profits, comprising pre-1987
earnings for years beginning prior to January 1,
1987, pre-pooling earnings for taxable years 1987
through 1991, no earnings for 1992 through 2001,
formerly pooled earnings for 2002 (comprising
Corporation B’s post-1986 undistributed earnings
for 1992 through 2002), and post-pooling earnings
for 2003. Dividends paid by Corporation B to
Corporation M at any time during 2003 will be con-
sidered paid out of pre-1987 accumulated profits.
See paragraphs (a)(10) and (a)(13)(i) of this section.
However, Corporation M will be eligible to claim a
deemed-paid credit only with respect to dividends
received on or before July 1, 2003. See paragraphs
(a)(1) and (12) of this section and §1.902–3(a)(1)
and (7).
Example 3. The facts are the same as in Example
2, except that Corporation M purchases an addition-
al five percent of the stock of Corporation B on July
1, 2004, so that Corporation B again meets the own-
ership requirements of section 902(c)(3)(B) and
paragraphs (a)(1) through (4) of this section on
December 31, 2004. As of the end of 2004, assume
Corporation B has 500u of post-1986 undistributed
earnings (after foreign taxes but before taking into
account distributions during 2004) and $100 of post-
1986 foreign income taxes attributable to 2004, 500u
of post-pooling earnings and 100u of pre-1987 for-
eign income taxes attributable to 2003, and 1500u of
formerly pooled earnings and $250 of pre-1987 for-
eign income taxes attributable to 2002 (comprising
Corporation B’s post-1986 undistributed earnings
and post-1986 foreign income taxes for 1992
through 2002). Corporation B pays dividends to its
shareholders of 500u on March 1, 2004, and 500u on
September 1, 2004. The March 1, 2004, dividend is
out of Corporation B’s post-1986 undistributed earn-
ings in its entirety, and reduces Corporation B’s post-
1986 undistributed earnings and post-1986 foreign
income taxes to zero, even though no shareholder is
eligible to claim a credit for deemed-paid taxes. See
paragraphs (a)(8)(i) and (b)(1) of this section. The
September 1, 2004, dividend is out of 2003 post-
pooling earnings, and reduces 2003 post-pooling
earnings and foreign income taxes to zero.
Corporation M, which is a 10% domestic sharehold-
er of Corporation B on that date and receives a divi-
dend of 50u, is deemed to have paid 10u of foreign
income taxes (50u/500u x 100u) with respect to the
dividend. Both the dividend and the deemed-paid
taxes are translated into dollars at the spot exchange
rate on the dividend date, under the law in effect
prior to the effective date of the Tax Reform Act of
1986. See paragraphs (a)(10)(i) and (ii) of this sec-
tion.
Par. 4. Section 1.904–0 is amended as
follows:
1. The entries for §1.904–4 are amend-
ed by:
a. Revising the entry for paragraph
(b)(2)(iii).
b. Removing the entry for paragraph
(b)(2)(iv).
c. Revising the entries for paragraph
(g) and (g)(1), adding entries for para-
graph (g)(1)(i) through (g)(1)(iii), and
revising the entry for paragarph
(g)(3)(i)(C).
d. Adding entries for paragraphs
(g)(3)(i)(C)(1), (g)(3)(i)(C)(2), and (g)(4).
e. Adding an entry for paragraph (m).
2. The entries for §1.904(b)–1 are
amended by:
a. Revising section heading and the
entries for all of paragraphs (a), (b), and
(c).
b. Adding entries for paragraphs (d),
(e), (f), (g), and (h).
3. Revising the entries for all of
§1.904(b)–2.
4. Removing all the entries for
§§1.904(b)–3 and 1.904(b)–4.
5. Adding entries for §1.904(j)–1.
The revisions and additions read as fol-
lows:
§1.904–0 Outline of regulation
provisions for section 904.
* * * * *
§1.904–4 Separate application of section
904 with respect to certain categories of
income.
* * * * *
(b) * * *
(2) * * *
(iii) Example.
* * * * *
(g) Noncontrolled section 902 corpora-
tion and non-look-through 10/50 corpora-
tion.
(1) Corporate-level accounts and treat-
ment of distributions to shareholders.
(i) Definitions.
(ii) Accounts at foreign corporation
level.
(iii) Inclusion at shareholder level.
* * * * *
(3) * * *
(i) * * *
(C) Effect of intervening noncontrolled
or less-than-10%-U.S.-owned status.
(1) Pre-2003 decontrolling event.
(2) Pool-terminating event.
* * * * *
(4) Special rule for dividends paid by a
10/50 look-through corporation.
* * * * *
(m) Income treated as allocable to an
additional separate category.
* * * * *
§1.904(b)–1 Special rules for capital
gains and losses.
(a) Capital amounts included in taxable
income from sources outside the United
States.
(1) Limitation on capital gain from
sources outside the United States when
the taxpayer has net capital losses from
sources within the United States.
(i) In general.
(ii) Allocation of reduction among
multiple separate categories or rate
groups.
(2) Capital losses from sources outside
the United States in the same separate
category.
(3) Exclusivity of rules; no reduction
by reason of net capital loss from
sources outside the United States in a
different separate category.
(4) Examples.
(b) Capital gain rate differential.
(1) Application of adjustments only if
capital gain rate differential exists.
(2) Determination of whether capital
gain rate differential adjustment exists.
(c) Rate differential adjustment of cap-
ital gains.
(1) Rate differential adjustment of cap-
ital gains in foreign source taxable
income.
(2) Rate differential adjustment of cap-
ital gains in entire taxable income.
(d) Rate differential adjustment of cap-
ital losses from sources outside the
United States.
(1) In general.
(2) Determination of which net capital
gains are offset by net capital losses
from sources outside the United States.
(e) Definitions.
(1) Alternative tax rate.
(2) Capital gain net income.

January 22, 20014162001–4 I.R.B.
(3) Net capital gain.
(4) Rate group.
(i) Capital gains.
(ii) Capital losses.
(5) Terms used in sections 1(h), 904(b)
or 1222.
(f) Examples.
(g) Coordination with overall foreign
loss recapture rules.
(h) Effective date.
§1.904(b)–2 Special rules for
application of section 904(b) to
alternative minimum tax foreign tax
credit.
(a) Application of section 904(b)(2)(B)
adjustments.
(b) Use of alternative minimum tax
rates.
(1) Taxpayers other than corporations.
(2) Corporate taxpayers.
(c) Effective date.
* * * * *
§1.904(j)–1 Certain individuals exempt
from foreign tax credit limitation.
(a) Election available only if all foreign
taxes are creditable foreign taxes.
(b) Coordination with carryover rules.
(1) No carryovers to or from election
year.
(2) Carryovers to and from other years
determined without regard to election
years.
(3) Determination of amount of cred-
itable foreign taxes.
(c) Examples.
Par. 5. Section 1.904–4 is amended as
follows:
1. Paragraph (a) is amended by remov-
ing the period at the end and adding the
language “, or in §1.904–4(m) (additional
separate categories).”
2. The first sentence of paragraph
(b)(2)(i) is revised.
3. Paragraph (b)(2)(ii) is revised.
4. Paragraph (b)(2)(iii) is removed.
5. Paragraph (b)(2)(iv) is redesignated
as paragraph (b)(2)(iii).
6. The last three sentences of the
Examplein newly designated paragraph
(b)(2)(iii) are revised and three new sen-
tences are added at the end.
7. The paragraph heading for para-
graph (g) is revised.
8. Paragraph (g)(1) is redesignated as
paragraph (g)(1)(i) and a new heading is
added for paragraph (g)(1).
9. Five sentences are added at the end
of newly designated paragraph (g)(1)(i).
10. Paragraphs (g)(1)(ii) and (iii) are
added.
11. The heading of paragraph
(g)(3)(i)(C) is revised and the text to para-
graph (g)(3)(i)(C) is added.
12. The text of Example 2through
Example 4is added to paragraph
(g)(3)(i)(D).
13. Paragraph (g)(4) is added.
14. The language “and” at the end of
paragraph (l)(1)(v) is removed.
15. The period at the end of paragraph
(l)(1)(vi) is removed and “; and” is added
in its place.
16. Paragraph (l)(1)(vii) is added.
17. Paragraph (m) is added.
The revisions and additions read as fol-
lows:
§1.904–4 Separate application of section
904 with respect to certain categories of
income.
* * * * *
(b) * * *
(2) * * * (i) * * * For rents and royal-
ties paid or accrued more than 60 days
after the date these regulations are pub-
lished as final regulations in theFederal
Register, passive income does not include
any rents or royalties that are derived in
the active conduct of a trade or business,
regardless of whether such rents or royal-
ties are received from a related or an unre-
lated person. * * *
(ii) Exception for certain rents and roy-
alties. Rents and royalties are considered
derived in the active conduct of a trade or
business by a United States person or by a
controlled foreign corporation (or other
entity to which the look-through rules
apply) for purposes of section 904 (but not
for purposes of section 954) if the require-
ments of section 954(c)(2)(A) are satis-
fied by one or more corporations that are
members of an affiliated group of corpo-
rations (within the meaning of section
1504(a), determined without regard to
section 1504(b)(3)) of which the recipient
is a member. For purposes of this para-
graph (b)(2)(ii), an affiliated group
includes only United States corporations
and foreign corporations that are con-
trolled foreign corporations in which
United States members of the affiliated
group own, directly or indirectly, at least
80 percent of the total voting power and
value of the stock. For purposes of this
paragraph (b)(2)(ii), indirect ownership
shall be determined under section 318 and
the regulations under that section.
(iii) * * *
Example. * * * Some of the franchisees are unre-
lated to S and P. Other franchisees are related to S
or P and use the licensed property outside of S’s
country of incorporation. S does not satisfy, but P
does satisfy, the active trade or business require-
ments of section 954(c)(2)(A) and the regulations
thereunder. The royalty income earned by S with
regard to both its related and unrelated franchisees is
foreign personal holding company income because S
does not satisfy the active trade or business require-
ments of section 954(c)(2)(A) and, in addition, the
royalty income from the related franchisees does not
qualify for the same country exception of section
954(c)(3). However, all of the royalty income
earned by S is general limitation income to S under
§1.904–4(b)(2)(ii) because P, a member of S’s affili-
ated group (as defined therein), satisfies the active
trade or business test (which is applied without
regard to whether the royalties are paid by a related
person). S’s royalty income that is taxable to P
under subpart F and the royalties paid to P are gen-
eral limitation income to P under the look-through
rules of §1.904–5(c)(1)(i) and (c)(3), respectively.
* * * * *
(g) Noncontrolled section 902 corpo-
ration and non-look-through 10/50 corpo-
ration—(1) Corporate-level accounts and
treatment of distributions to
shareholders—(i) Definitions. * * *
Except as otherwise provided, the term
“look-through corporation” means a for-
eign corporation that is subject to the
look-through rules of section 904(d)(3) or
section 904(d)(4) (as in effect for taxable
years beginning after December 31,
2002). The term “non-look-through 10/50
corporation” means any foreign corpora-
tion that is not a look-through corporation
and with respect to which a domestic cor-
poration meets the stock ownership
requirements of section 902(a), or, for
purposes of applying the look-through
rules described in section 904(d)(3) and
§1.904-5, a domestic corporation meets
the requirements of section 902(b). The
term “less-than-10%-U.S.-owned foreign
corporation” means a foreign corporation
that is neither a look-through corporation
nor a non-look-through 10/50 corpora-
tion. The term “look-through pool”
means the post-1986 undistributed earn-
ings of a foreign corporation that are sub-
ject to the look-through provisions of sec-
tion 904(d)(3) or section 904(d)(4) as in
effect for taxable years beginning after
December 31, 2002. The term “non-look-
through pool” means the post-1986 undis-

2001–4 I.R.B.417January 22, 2001
tributed earnings of a foreign corporation
that were accumulated (or treated as accu-
mulated) while the foreign corporation
was a non-look-through 10/50 corpora-
tion.
(ii)Accounts at foreign corporation
level. The post-1986 undistributed earn-
ings of a controlled foreign corporation or
other look-through corporation may con-
sist of look-through pools (comprising
post-1986 undistributed earnings accumu-
lated during periods when the foreign cor-
poration was, or was treated as, a look-
through corporation, which may include
post-1986 undistributed earnings in one or
more non-look-through pools attributable
to dividends paid to the look-through cor-
poration by each separate non-look-
through 10/50 corporation), as well as one
or more non-look-through pools (includ-
ing post-1986 undistributed earnings
accumulated during periods when the for-
eign corporation was, or was treated as, a
non-look-through 10/50 corporation).
Similarly, a look-through corporation’s
pre-pooling annual layers, as defined in
§1.902–1(a)(10)(i), may or may not be
subject to the look-through rules, depend-
ing on whether the corporation was, or
was treated as, a look-through corporation
at the time the earnings were accumulat-
ed.
(iii) Inclusion at shareholder level. A
particular dividend recipient will be enti-
tled to look-through treatment with
respect to a particular distribution from a
controlled foreign corporation only if the
recipient is a United States shareholder, as
defined in section 951(b) taking into
account section 953(c), of the controlled
foreign corporation at the time it receives
the dividend. Therefore, a dividend distri-
bution from a controlled foreign corpora-
tion to a United States shareholder will be
characterized under the look-through
rules, whereas a dividend distribution to a
less-than-10% shareholder of the con-
trolled foreign corporation will be treated
as passive income. Similarly, under sec-
tion 904(d)(1)(E), only a corporate share-
holder calculates a separate foreign tax
credit limitation for dividends from each
noncontrolled section 902 corporation,
and the look-through rules of section
904(d)(4) as in effect for taxable years
beginning after December 31, 2002, apply
only to applicable dividends out of post-
2002 earnings of a corporation that is a
noncontrolled section 902 corporation
with respect to the taxpayer. Therefore,
dividends paid to an individual sharehold-
er by a non-look-through 10/50 corpora-
tion, or by a controlled foreign corpora-
tion out of a non-look-through pool, will
be treated as passive income. Similarly,
dividends paid to an individual sharehold-
er by a look-through corporation that is
not a controlled foreign corporation will
be treated as passive income to such indi-
vidual, even if the individual owns 10 per-
cent or more of the distributing corpora-
tion’s stock.
* * * * *
(3) * * *
(i) * * *
(C) Effect of intervening noncontrolled
or less-than-10%-U.S.-owned status—(1)
Pre-2003 decontrolling event. If a con-
trolled foreign corporation becomes a non-
look-through 10/50 corporation, for exam-
ple, by reason of the corporation’s issuance
of additional stock or the disposition of
stock by the corporation’s controlling
United States shareholders to foreign per-
sons in a taxable year of the controlled for-
eign corporation beginning before January
1, 2003, (a decontrolling event), and retains
that status as of the end of the foreign cor-
poration’s taxable year, then earnings and
profits that were accumulated before the
decontrolling event during periods when
the corporation was a controlled foreign
corporation will at all times thereafter be
treated as earnings and profits accumulated
by a non-look-through 10/50 corporation.
The corporation’s post-1986 undistributed
earnings (or deficits in post-1986 undistrib-
uted earnings) in each separate category
shall be combined into, and constitute the
opening balance of, a single non-look-
through pool of post-1986 undistributed
earnings accumulated in taxable years
beginning before January 1, 2003. The cor-
poration’s post-1986 foreign income taxes
in each separate category shall similarly be
combined into a single category of post-
1986 foreign income taxes attributable to
the non-look-through pool. Distributions of
such earnings and profits after the decon-
trolling event will not be subject to the look-
through rules of §1.904-5, even if the cor-
poration subsequently becomes a controlled
foreign corporation or other look-through
corporation again. The corporation’s pre-
1987 accumulated profits will also be ineli-
gible for look-through treatment if accumu-
lated prior to, and distributed after, the
decontrolling event. In determining
whether the look-through rules apply to
earnings and profits maintained at the dis-
tributing corporation level, earnings and
profits accumulated or distributed in the
taxable year in which a decontrolling event
occurs shall be considered accumulated or
distributed after the decontrolling event,
respectively. However, in determining
whether a dividend recipient is entitled to
look-through treatment with respect to a
particular distribution, only the sharehold-
er’s status and ownership of stock at the
time it receives the dividend is relevant.
See §1.902–1(a)(1) and paragraph
(g)(1)(iii) of this section.
(2) Pool-terminating event. If a look-
through corporation or a non-look-
through 10/50 corporation becomes a
less-than-10%-U.S.-owned foreign corpo-
ration, for example, by reason of the cor-
poration’s issuance of additional stock or
the disposition of stock by the corpora-
tion’s United States shareholders (a pool-
terminating event), and retains that status
as of the end of the foreign corporation’s
taxable year, then earnings and profits that
were accumulated before the pool-termi-
nating event will at all times thereafter be
treated as pre-1987 accumulated profits
accumulated by a non-look-through 10/50
corporation in accordance with
§1.902–1(a)(10) and (13). Distributions
of such earnings and profits after the pool-
terminating event will not be subject to
the look-through rules of §1.904–5, even
if the corporation subsequently becomes a
look-through corporation again. Earnings
and profits accumulated or distributed in
the taxable year in which a pool-terminat-
ing event occurs shall be considered accu-
mulated or distributed after the pool-ter-
minating event, respectively. However, in
determining whether a dividend recipient
is entitled to look-through treatment with
respect to a particular distribution, only
the shareholder’s status and ownership of
stock at the time it receives the dividend is
relevant. See §1.902–1(a)(1) and para-
graph (g)(1)(iii) of this section.
* * * * *
(D) * * *
Example 2. (i) Facts. X, a domestic corporation,
owns all of the stock of S, a controlled foreign cor-
poration. On March 1, 2002, S pays a dividend to X.
On July 1, 2002, S issues additional shares of stock
to Z, a foreign person, in exchange for a capital con-
tribution. The new stock issuance dilutes X’s inter-

January 22, 20014182001–4 I.R.B.
est in S to 40 percent. Thus, S is a non-look-through
10/50 corporation beginning on July 1, 2002.
(ii) Result.The March 1, 2002, dividend to X is
treated as a dividend from a non-look-through 10/50
corporation. X is not entitled to look-through treat-
ment on the dividend under paragraph (g)(3)(i)(C) of
this section.
Example 3. (i) Facts. X, a domestic corporation,
has owned all of the stock of S, a controlled foreign
corporation, since S was organized in 1980. Both X
and S use the calendar year as the taxable year. On
July 1, 2002, X sells 60 percent of the stock of S to
Z, a foreign person. On July 1, 2003, X repurchases
all of the S stock that it sold to Z in 2002. Thus, S is
a controlled foreign corporation for 1980 through
June 30, 2002, a non-look-through 10/50 corporation
from July 1, 2002, through December 31, 2002, and
a look-through corporation from January 1, 2003,
forward, as well as a controlled foreign corporation
from July 1, 2003, forward.
(ii) Result. Pursuant to paragraph (g)(3)(i)(C) of
this section, X is entitled to look-through treatment
with respect to distributions before January 1, 2002,
of S’s post-1986 undistributed earnings accumulated
through December 31, 2001, and of S’s pre-1987
accumulated profits. Distributions after December
31, 2001, of earnings and profits accumulated before
January 1, 2003, will be treated as dividends from a
non-look-through 10/50 corporation. X is entitled to
look-through treatment on distributions of earnings
and profits accumulated and distributed after
December 31, 2002.
Example 4. (i) Facts. The facts are the same as
in Example 3, except that X sells 95 percent, rather
than 60 percent, of the stock of S to Z. Thus, S is a
controlled foreign corporation for 1980 through June
30, 2002, a less-than-10%-U.S.-owned foreign cor-
poration from July 1, 2002, through June 30, 2003,
and a controlled foreign corporation beginning on
July 1, 2003.
(ii) Result. The result is the same as in Example
3, except that distributions from S made between
July 1, 2002, and June 30, 2003, will be treated as
passive income to X because X owns less than 10
percent of the stock of S during that period.
Distributions from S to X made between January 1,
2002, and June 30, 2002, will be treated as dividends
from a non-look-through 10/50 corporation.
Distributions from S to X made after June 30, 2003,
out of earnings and profits accumulated prior to
January 1, 2003, will be treated as dividends from a
non-look-through 10/50 corporation. X is entitled to
look-through treatment of distributions after June 30,
2003, out of earnings and profits accumulated after
December 31, 2002.
* * * * *
(4) Special rule for dividends paid by a
10/50 look-through corporation.
[Reserved]
* * * * *
(l) * * * (1) * * *
(vii) Income that meets the definitions
of a separate category described in para-
graph (m) of this section and of any other
category of separate limitation income
described in section 904(d)(1)(A) through
(H) will be subject to the separate limita-
tion described in paragraph (m) of this
section and will not be treated as general
limitation income described in section
904(d)(1)(I).
* * * * *
(m) Income treated as allocable to an
additional separate category. If section
904(a), (b), and (c) are applied separately
to any category of income under the
Internal Revenue Code (for example,
under section 56(g)(4)(C)(iii)(IV),
245(a)(10), 865(h), 901(j), or 904(g)(10)),
that category of income will be treated for
all purposes of the Internal Revenue Code
and regulations as if it were a separate cat-
egory listed in section 904(d)(1) and sec-
tion 904(d)(3)(F)(i).
Par. 6. In §1.904–5, paragraph (a)(1) is
revised to read as follows:
§1.904–5 Look-through rules as applied
to controlled foreign corporations and
other entities.
(a) * * *
(1) The term “separate category”
means, as the context requires, any cate-
gory of income described in section
904(d)(1)(A), (B), (C), (D), (E), (F), (G),
(H), or (I) and in §1.904–4(b), (d), (e), (f),
and (g), any category of income described
in §1.904–4(m), or any category of earn-
ings and profits to which income
described in such provisions is attribut-
able.
* * * * *
Par. 7. In §1.904–6, paragraph
(a)(1)(ii) is amended by adding two sen-
tences at the end to read as follows:
§1.904–6 Allocation and apportionment
of taxes.
(a) * * * (1) * * *
(ii) * * * If the taxpayer applies the prin-
ciples of §§1.861–8 through 1.861–14T for
purposes of allocating expenses at the level
of the taxpayer (or at the level of the quali-
fied business unit, foreign subsidiary, or
other entity that paid or accrued the foreign
taxes) under this paragraph (a)(1)(ii), such
principles shall be applied (for such pur-
poses) in the same manner as the taxpayer
applies such principles in determining the
income or earnings and profits for United
States tax purposes of the taxpayer (or of
the qualified business unit, foreign sub-
sidiary, or other entity that paid or accrued
the foreign taxes, as the case may be). For
example, a taxpayer must use the modified
gross income method under §1.861–9T
when applying the principles of that sec-
tion for purposes of this paragraph
(a)(1)(ii) to determine the amount of a con-
trolled foreign corporation’s income, in
each separate category, that is taxed by a
foreign country, if the taxpayer applies the
modified gross income method under
§1.861–9T(f)(3) when applying
§1.861–9T to determine the income and
earnings and profits of the controlled for-
eign corporation for United States tax pur-
poses.
* * * * *
Par. 8. Section 1.904(b)–1 is revised to
read as follows:
§1.904(b)–1 Special rules for capital
gains and losses.
(a) Capital amounts included in tax-
able income from sources outside the
United States—(1) Limitation on capital
gain from sources outside the United
States when the taxpayer has net capital
losses from sources within the United
States—(i) In general. Except as other-
wise provided in this section, for purposes
of section 904 and this section, taxable
income from sources outside the United
States (in all of the taxpayer’s separate
categories in the aggregate) shall include
capital gain net income from sources out-
side the United States (determined by
considering all of the capital gain and loss
items in all of the taxpayer’s separate cat-
egories in the aggregate) only to the extent
of capital gain net income from all
sources. Similarly, except as otherwise
provided in this section, for purposes of
section 904 and this section, net capital
gain from sources outside the United
States (determined by considering all of
the capital gain and loss items in all of the
taxpayer’s separate categories in the
aggregate) shall not exceed net capital
gain from all sources.
(ii) Allocation of reduction among mul-
tiple separate categories or rate groups. If
capital gain net income (or net capital
gain) from sources outside the United
States exceeds capital gain net income (or
net capital gain), and the taxpayer has cap-
ital gain net income (or net capital gain)
from sources outside the United States in
two or more separate categories or in two
or more rate groups, such excess must be

2001–4 I.R.B.419January 22, 2001
apportioned on a pro ratabasis as a reduc-
tion to each such separate category, and
then within each separate category, on a
pro ratabasis among rate groups. For pur-
poses of the preceding sentence,pro rata
means based on the relative amounts of the
capital gain net income (or net capital
gain) from sources outside the United
States in each separate category, or in each
rate group within a separate category.
(2) Capital losses from sources outside
the United States in the same separate
category. Except as otherwise provided in
paragraph (d) of this section, taxable
income from sources outside the United
States in each separate category shall be
reduced by any capital loss that is alloca-
ble or apportionable to sources outside the
United States in such separate category to
the extent such loss is allowable in deter-
mining taxable income for the taxable
year (taking into account losses allowable
under section 1211(b)).
(3) Exclusivity of rules; no reduction
by reason of net capital losses from
sources outside the United States in a dif-
ferent separate category. Capital gains
from sources outside the United States in
any separate category shall be limited by
reason of section 904(b)(2)(A) and the
comparable limitation of section
904(b)(2)(B)(i) only to the extent provid-
ed in paragraph (a)(1) of this section
(relating to limitation on capital gain from
sources outside the United States when
taxpayer has net capital losses from
sources within the United States) and
paragraph (a)(2) of this section (relating
to capital losses from sources outside the
United States in the same separate catego-
ry).
(4) Examples. The following examples
illustrate the application of this paragraph
(a). The examples are as follows:
Example 1. Taxpayer A, a corporation, has a gen-
eral limitation category capital loss of $3,000 from
sources outside the United States, a passive category
capital gain of $3,000 from sources outside the
United States, and a capital loss of $2,000 from
sources within the United States. A has no capital
gain net income from sources outside the United
States (in the aggregate, from all separate cate-
gories), because the $3,000 passive capital gain less
the $3,000 general limitation capital loss yields a net
of zero. From all sources, A also has no capital gain
net income. (The resulting $2,000 net capital loss is
not currently allowable under section 1211(a)
because A is a corporation.) Because A’s capital gain
net income from sources outside the United States
does not exceed A’s capital gain net income from all
sources, paragraph (a)(1) of this section does not
require any reduction of A’s passive category capital
gain.
Example 2. Taxpayer B, a corporation, has $500
of capital gain net income from sources outside the
United States, of which $300 is in the general limi-
tation category and $200 is in the passive category.
B’s capital gain net income from sources outside the
United States is $500 ($300 + $200). Because B also
incurs a capital loss of $100 from sources within the
United States, B’s capital gain net income (from all
sources) is $400 ($300 + $200 - $100). Pursuant to
paragraph (a)(1)(B) of this section, the $100 excess
of capital gain net income from sources outside the
United States over capital gain net income from all
sources ($500 - $400) must be apportioned, as a
reduction, three-fifths ($300/$500 of $100, or $60)
to the general limitation category and two-fifths
($200/$500 of $100, or $40) to the passive category.
Therefore, for purposes of section 904, the general
limitation category includes $240 ($300 - $60) of
capital gain net income from sources outside the
United States and the passive category includes $160
($200 - $40) of capital gain net income from sources
outside the United States.
Example 3. Taxpayer C, a corporation, has a
$10,000 capital loss from sources outside the United
States in the general limitation category, a $4,000
capital gain from sources outside the United States
in the passive category, and a $2,000 capital gain
from sources within the United States. C’s capital
gain net income from sources outside the United
States is zero, since losses exceed gains. C’s capital
gain net income from all sources is also zero. C’s
capital gain net income from sources outside the
United States does not exceed its capital gain net
income from all sources, and therefore paragraph
(a)(1) of this section does not require any reduction
of C’s passive category capital gain. For purposes of
section 904, C’s passive category includes $4,000 of
capital gain net income. C’s general limitation cate-
gory includes a capital loss of $6,000 because only
$6,000 of capital loss is allowable as a deduction in
the current year. The entire $4,000 of capital loss in
excess of the $6,000 of capital loss that offsets capi-
tal gain in the taxable year is carried back or forward
under section 1212(a), and none of such $4,000 is
taken into account under section 904(a) or (b) for the
current taxable year.
(b) Capital gain rate differential—(1)
Application of adjustments only if capital
gain rate differential exists. Section
904(b)(2)(B) and paragraphs (c) and (d)
of this section apply only for taxable years
in which the taxpayer has a capital gain
rate differential.
(2) Determination of whether capital
gain rate differential exists. For purposes
of section 904(b) and this section, a capi-
tal gain rate differential is considered to
exist for the taxable year only if the tax-
payer has a net capital gain for the taxable
year and—
(i) In the case of a taxpayer other than a
corporation, tax is imposed at a reduced
rate under section 1(h) for the taxable
year; or
(ii) In the case of a corporation, tax is
imposed under section 1201(a) on the tax-
payer at a rate less than any rate of tax
imposed on the taxpayer by section 11, 511,
or 831(a) or (b), whichever applies (deter-
mined without regard to the last sentence of
section 11(b)(1)), for the taxable year.
(c) Rate differential adjustment of cap-
ital gains—(1) Rate differential adjust-
ment of capital gains in foreign source
taxable income. In determining taxable
income from sources outside the United
States for purposes of section 904 and this
section, capital gain net income from
sources outside the United States in each
separate category, after any reduction pur-
suant to paragraph (a) of this section, shall
be reduced by the sum of the rate differ-
ential portions (as defined in section
904(b)(3)(E)) of each rate group of net
capital gain from sources outside the
United States in such separate category.
(2) Rate differential adjustment of cap-
ital gains in entire taxable income. For
purposes of section 904 and this section,
the entire taxable income shall include
gains from the sale or exchange of capital
assets only to the extent of capital gain net
income reduced by the sum of the rate dif-
ferential portions (as defined in section
904(b)(3)(E)) of each rate group of net
capital gain.
(d) Rate differential adjustment of cap-
ital losses from sources outside the United
States—(1) In general. In determining
taxable income from sources outside the
United States for purposes of section 904
and this section, any net capital loss from
sources outside the United States included
in a separate category pursuant to para-
graph (a) of this section shall be reduced
by the sum of the rate differential portion
of the net capital gains (from the same rate
group in other separate categories, from
other rate groups in the same or other sep-
arate categories, or from sources within
the United States) that are offset by such
net capital loss in determining the taxpay-
er’s entire taxable income.
(2) Determination of which net capital
gains are offset by net capital losses from
sources outside the United States. For
purposes of paragraph (d)(1) of this sec-
tion, in order to determine which net cap-
ital gains (from any rate group) are offset
by net capital losses from sources outside
the United States, the following rules shall
apply in the following order:

January 22, 20014202001–4 I.R.B.
(i) Capital losses from sources outside
the United States shall first be netted
against capital gains from sources outside
the United States in the same rate group
and the same separate category as the for-
eign source capital losses.
(ii) Net capital losses from each rate
group from sources outside the United
States shall be netted against net capital
gains from sources outside the United
States from the same rate group in other
separate categories, ratably to the extent
that net capital gains and losses in a par-
ticular rate group occur in two or more
separate categories.
(iii) Capital losses from sources within
the United States shall be netted against
capital gains from sources within the
United States in the same rate group.
(iv) The net foreign capital losses from
each rate group, as determined under
paragraph (d)(2)(ii) of this section, shall
be netted against the taxpayer’s remaining
net capital gains from sources within and
outside the United States in the following
order, and without regard to any net capi-
tal losses, from any rate group, from
sources within the United States—
(A) First against net capital gains from
sources within the United States in the
same rate group;
(B) Next, against net capital gains in
other rate groups, in the order in which
capital losses offset capital gains for pur-
poses of determining the taxpayer’s tax-
able income and without regard to
whether such net capital gains derive from
sources within or outside the United
States, as follows:
(1) A short-term capital loss (including
any short-term capital loss carryover) is
used first to offset short-term capital gain
otherwise taxable at ordinary income
rates. Any remaining net short-term capi-
tal loss is used first to offset any net long-
term gain in the 28 percent rate group,
then to offset net long-term gain in the 25
percent rate group, and finally to offset net
long-term gain in the 20 percent rate
group.
(2) A net capital loss in the 28 percent
rate group is used first to offset net capital
gain in the 25 percent rate group, and then
to offset net capital gain in the 20 percent
rate group.
(3) A net capital loss in the 20 percent
rate group is used first to offset net capital
gain in the 28 percent rate group, and then
to offset net capital gain in the 25 percent
rate group.
(v) The net capital losses from sources
outside the United States in any rate
group, to the extent netted against net cap-
ital gains in any other separate category
under paragraph (d)(2)(ii) of this section
or against net capital gains in any other
rate group under paragraph (d)(2)(iv) of
this section, shall be treated as coming pro
ratafrom each separate category that con-
tains net capital losses from sources out-
side the United States in that rate group.
For example, assume that the taxpayer has
$20 of net capital losses in the 20 percent
rate group in the passive category and $40
of net capital losses in the 20 percent rate
group in the general limitation category,
both from sources outside the United
States. Further assume that $50 of the
total $60 net capital losses from sources
outside the United States are netted
against net capital gains in the 28 percent
rate group (from other separate categories
or from sources within the United States).
One-third of the $50 of such capital loss-
es would be treated as coming from the
passive category, and two-thirds of such
$50 would be treated as coming from the
general limitation category.
(vi) The determination of which capital
gains are offset by capital losses from
sources outside the United States under
this paragraph is made solely in order to
determine the appropriate rate-differen-
tial-based adjustments to such capital
losses under this section and section
904(b), and does not change the source,
allocation, or separate category of any
such capital gain or loss for purposes of
computing taxable income from sources
within or outside the United States or for
any other purpose.
(e) Definitions. For purposes of sec-
tion 904(b) and this section, the following
definitions apply:
(1) Alternative tax rate. The term
alternative tax ratemeans, with respect to
any rate group, the rate applicable to that
rate group under section 1(h) (for taxpay-
ers other than corporations) or 1201(a)
(for corporations). For example, the alter-
native tax rate for unrecaptured section
1250 gain is 25 percent.
(2) Capital gain net income. The term
capital gain net incomemeans the excess
of the gains from the sales or exchanges of
capital assets over the losses from such
sales or exchanges. Such term shall
include net section 1231 gain, but shall
not include gains or losses from the sale
or exchange of capital assets to the extent
that such gains are not treated as capital
gains. In determining capital gain net
income, gains and losses which are not
from the sale or exchange of capital assets
but which are treated as capital gains and
losses under the Internal Revenue Code
are included.
(3) Net capital gain. The term net capi-
tal gainmeans the excess of the net long-
term capital gain (including net section
1231 gain) for the taxable year over the net
short-term capital loss for such year, but
shall not include gains or losses from the
sale or exchange of capital assets to the
extent that such gains are not treated as cap-
ital gains. In determining net capital gain,
gains and losses which are not from the sale
or exchange of capital assets but which are
treated as capital gains and losses under the
Internal Revenue Code are included.
(4) Rate group. For purposes of this
section—
(i) Capital gains. With respect to cap-
ital gains, the term rate groupmeans the
amounts subject to a particular rate of tax
under section 1(h). For example, the 20
percent rate group of capital gain net
income from sources outside the United
States consists of the capital gain net
income from sources outside the United
States that is subject to tax at a rate of 20
percent under section 1(h).
(ii) Capital losses. With respect to
capital losses, the rate group shall be
determined as if the sale or exchange that
produced the capital loss had instead pro-
duced a capital gain. For example, if the
sale of an asset held for more than one
year yields a capital loss, but any gain
generated by the sale would have been
subject to tax at a rate of 20 percent under
section 1(h), the capital loss is allocated to
the 20 percent rate group for purposes of
this section.
(5) Terms used in sections 1(h), 904(b)
or 1222. For purposes of this section, any
term used in this section and also used in
section 1(h), section 904(b) or section
1222 shall have the same meaning given
such term by section 1(h), 904(b) or 1222,
respectively, except as otherwise provided
in this section.
(f) Examples. The following examples
illustrate the provisions of this section. In

2001–4 I.R.B.421January 22, 2001
these examples, the adjustment for the
rate differential portion is shown as a frac-
tion, the numerator of which is the alter-
native tax rate percentage and the denom-
inator of which is 39.6 percent (the
current highest applicable tax rate for
individuals under section 1). All of the
examples assume that all capital gains and
losses are long-term capital gains and
losses. (Therefore, in these examples,
capital gain net income equals net capital
gain, and for convenience both are
referred to in the examples as net capital
gain in calculating the rate differential
adjustments). In addition, all dollar
amounts in the examples are abbreviated
from amounts in the thousands (e.g., $50
represents $50,000). The examples are as
follows:
Example 1. (i) A, an individual, has foreign
source items only in the passive category for the
taxable year. A has $1,000 of capital gains from
sources outside the United States, which would be
taxed at a rate of 20 percent under section 1(h). A
has $700 of capital losses from sources outside the
United States, which resulted from the sale of capi-
tal assets held for more than one year. If the sale
had resulted in gain rather than loss, the gain would
have been taxed at a rate of 20 percent under sec-
tion 1(h). For the same taxable year, A has $800 of
capital gains from sources within the United States
that are taxed at a rate of 28 percent under section
1(h). A also has $100 of capital losses from
sources within the United States. If the sale or
exchange generating such capital losses had instead
yielded a capital gain, such gain would have been
subject to tax a rate of 20 percent under section
1(h). A also has $500 of ordinary income from
sources within the United States.
(ii) A’s items of ordinary income, capital gain
and capital loss for the taxable year are summarized
in the following table:
20% rate group($100)$1,000
($700)
25% rate group
28% rate group$800
ordinary income$500
foreign source:
U.S. sourcepassive
foreign source:
U.S. sourcegeneralpassive
(iii) A’s capital gain net income from sources out-
side the United States ($300) does not exceed A’s
capital gain net income from all sources ($1,000).
Therefore, paragraph (a)(1) of this section does not
require any reduction of A’s capital gain net income
in the passive category.
(iv) In computing A’s taxable income from
sources outside the United States in the numerator of
the section 904(a) foreign tax credit limitation frac-
tion for the passive category, capital gains and loss-
es from sources outside the United States are netted
within rate groups and within separate categories.
See paragraphs (a)(2), (c)(1), and (d)(1) of this sec-
tion. The $1,000 of capital gain less the $700 of cap-
ital loss yields $300 of net capital gain in the 20 per-
cent rate group in the passive category. A must
adjust the resulting net capital gain in the passive
category as required under section 904(b)(2)(B)(i)
and paragraph (c)(1) of this section, using 20 percent
as the alternative tax rate,as follows:
$300(20%/39.6%).
(v) In computing A’s entire taxable income in the
denominator of the section 904(a) foreign tax credit
limitation fraction, A must combine the $300 net
capital gain from sources outside the United States
and the $100 net capital loss from sources within the
United States in the same rate group (20 percent). A
must adjust the resulting $200 ($300 - $100) of net
capital gain in the 20 percent rate group as required
under section 904(b)(2)(B)(ii) and paragraph (c)(2)
of this section, using 20 percent as the alternative tax
rate, as follows: $200(20%/39.6%). A must also
adjust the $800 of net capital gain in the 28 percent
rate group, using 28 percent as the alternative tax
rate, as follows: $800(28%/39.6%).
(vi) A’s passive category foreign tax credit limi-
tation is computed as follows:
$300 (20%/39.6%)
$500 + $200 (20%/39.6%) + $800 (28%/39.6%)
Example 2. (i) X, an individual, has the following items of ordinary income, capital gain, and capital loss for the taxable year:
20% rate group$300($500)$100
25% rate group$200
28% rate group$500($300)
ordinary income$1,000$500$500
(ii) X’s capital gain net income from sources out-
side the United States in the aggregate (zero, since
losses exceed gains) does not exceed X’s capital gain
net income from all sources ($300). Therefore, para-
graph (a)(1) of this section does not require any
reduction of X’s capital gain net income in the pas-
sive category.
(iii) In computing X’s taxable income from
sources outside the United States in the numerators
of the section 904(a) foreign tax credit limitation
fractions for the passive and general limitation cate-
gories, X must adjust capital gain net income and net
capital losses as provided in section 904(b)(2)(B)(i)
and (iii) and paragraphs (c)(1) and (d)(1) of this sec-
tion.
(A) First, capital gains and losses from sources
outside the United States are netted within rate
groups and within separate categories. There are no
such amounts to be netted in this case.
(B) Because X has net capital losses in the gen-
eral limitation category, under paragraph (d)(2)(ii) of
this section X’s net capital losses from sources out-
side the United States in each rate group are netted
against net capital gains from sources outside the
United States in other separate categories in the
same rate group. Thus, $100 of the $500 net capital
loss in the 20 percent rate group in the general limi-
tation category offsets $100 of net capital gain in the
20 percent rate group in the passive category. The
$100 net capital gain remains in the passive catego-
ry and is adjusted under paragraph (c)(1) of this sec-
tion as follows: $100(20%/39.6%). The $100 net
capital loss remains in the general limitation catego-

ry and is adjusted under paragraph (d)(1) of this sec-
tion as follows: $100 (20%/39.6%).
(C) Next, under paragraph (d)(2)(iv)(A) of this
section, X’s net capital losses from sources outside
the United States in any rate group and in any sepa-
rate category are netted against net capital gains in
the same rate group from sources within the United
States. Thus, $300 of the $500 net capital loss in the
20 percent rate group in the general limitation cate-
gory offsets $300 of net capital gain in the 20 percent
rate group from sources within the United States.
The $300 of net capital loss remains in the general
limitation category and is adjusted under paragraph
(d)(1) of this section as follows: $300 (20%/39.6%).
Similarly, the $300 of net capital loss in the 28 per-
cent rate group in the general limitation category off-
sets $300 of net capital gain in the 28 percent rate
group from sources within the United States. The
$300 net capital loss remains in the general limita-
tion category and is adjusted under paragraph (d)(1)
of this section as follows: $300(28%/39.6%).
(D) Next, under paragraph (d)(2)(iv)(B) of this
section, the remaining net capital losses in a rate
group are netted against net capital gains from other
rate groups from sources within and outside the
United States. The remaining $100 of the $500 net
capital loss in the 20 percent rate group in the gener-
al limitation category offsets $100 of the remaining
net capital gain in the 28 percent rate group from
sources within the United States. The $100 of net
capital loss remains in the general limitation catego-
ry and is adjusted under paragraph (d)(1) of this sec-
tion as follows: $100 (28%/39.6%).
(iv) In computing X’s entire taxable income in
the denominator of the section 904(a) foreign tax
credit limitation fractions, X must adjust capital gain
net income by netting all of X’s capital gains and
losses, from sources within and outside the United
States, and adjusting any remaining net capital gains,
based on rate category,under section
904(b)(2)(B)(ii) and paragraph (c)(2) of this section.
X must also include foreign source ordinary income
in the numerators, and worldwide ordinary income
in the denominator, of the foreign tax credit limita-
tion fractions. The denominator of X’s foreign tax
credit limitation fractions reflects $2,000 of world-
wide ordinary income, $100 of U.S.-source net cap-
ital gain taxed at the 28% rate and adjusted as fol-
lows: $100 (28%/39.6%), and $200 of U.S.-source
net capital gain taxed at the 25% rate and adjusted as
follows: $200 (25%/39.6%).
(v) X’s general limitation foreign tax credit lim-
itation is computed as follows:
January 22, 20014222001–4 I.R.B.
$500 - $100 (20%/39.6%) - $300 (20%/39.6%) - $300 (28%/39.6%) -$100 (28%/39.6%)
$1,000 + $500 + $500 + $100 (28%/39.6%) + $200 (25%/39.6%)
(vi) X’s passive category foreign tax credit limitation is computed as follows:
$500 + $100 (20%/39.6%)
$1,000 + $500 + $500 + $100 (28%/39.6%) + $200 (25%/39.6%)
Example 3. (i) Y, an individual, has the following items of ordinary income, capital gain, and capital loss for the taxable year:
(ii) Y’s capital gain net income from sources out-
side the United States (zero, since losses exceed
gains) does not exceed Y’s capital gain net income
from all sources ($100). Therefore, paragraph (a)(1)
of this section does not require any adjustment.
(iii) In computing Y’s taxable income from
sources outside the United States in the numerators
of the section 904(a) foreign tax credit limitation
fractions for the passive and general limitation cate-
gories, Y must adjust capital gain net income and net
capital losses as provided in section 904(b)(2)(B)(i)
and (iii) and paragraphs (c)(1) and (d)(1) of this sec-
tion. Since Y has no capital gain net income in any
separate category, the only adjustments are those
required under section 904(b)(2)(B)(iii) and para-
graph (d)(1) of this section.
(A) Under paragraph (d)(2)(ii) of this section,
$50 of Y’s $150 net capital loss in the 28 percent rate
group in the general limitation category offsets $50
of net capital gain in the 28 percent rate group in the
passive category. The $50 of net capital loss remains
in the general limitation category and is adjusted as
follows: $50 (28%/39.6%). The $50 of net capital
gain remains in the passive category and is adjusted
as follows: $50 (28%/39.6%).
(B) Under paragraph (d)(2)(iv)(A) of this sec-
tion, the remaining $100 of net capital loss in the 28
percent rate group in the general limitation category
offsets $100 of net capital gain in the 28 percent rate
group from sources within the United States. The
$100 of net capital loss remains in the general limi-
tation category and is adjusted as follows: $100
(28%/39.6%).
(C) Under paragraph (d)(2)(iv)(A) of this section,
the $300 of net capital gain in the 20 percent rate group
from sources within the United States is reduced pro-
portionately by the net capital losses in the 20 percent
rate group in the passive and general limitation cate-
gories. The proportionate amount of the $720 net cap-
ital loss remains in the general limitation category,
adjusted as follows: $300 ($720/$800) (20%/39.6%).
The proportionate amount of the $80 net capital loss
remains in the passive category, adjusted as follows:
$300 ($80/$800) (20%/39.6%).
(D) Of the remaining $500 of net capital loss in the
20 percent rate group (in the general limitation and pas-
sive categories), $400 offsets the remaining $400 of net
capital gain in the 28 percent rate group from sources
within the United States under paragraph
(d)(2)(iv)(B)(3) of this section. The proportionate
amount of the $720 net capital loss remains in the gen-
eral limitation category, adjusted as follows:$400
($720/$800) (28%/39.6%). The proportionate amount
of the $80 net capital loss remains in the passive cate-
gory, adjusted as follows:$400 ($80/$800)
(28%/39.6%).
(E) Under paragraph (d)(2)(iv)(B)(3) of this sec-
tion, the remaining $100 of net capital loss in the 20
percent rate group (in the general limitation and pas-
sive limitation categories) offsets $100 of net capital
gain in the 25 percent rate group from sources with-
in the United States. The proportionate amount of
the $720 net capital loss remains in the general lim-
itation category, adjusted as follows:$100
($720/$800) (25%/39.6%). The proportionate
amount of the $80 net capital loss remains in the pas-
sive category, adjusted as follows: $100 ($80/$800)
(25%/39.6%).
(iv) In computing Y’s entire taxable income in
the denominator of the section 904(a) foreign tax
credit limitation fractions, Y must adjust capital gain
net income by netting all of Y’s capital gains and
losses, from sources within and outside the United
States, and adjusting any remaining net capital gains,
based on rate category,under section
904(b)(2)(B)(ii) and paragraph (c)(2) of this section.
Y must also include foreign source ordinary income
in the numerators, and worldwide ordinary income
in the denominator, of the foreign tax credit limita-
tion fractions. The denominator of Y’s foreign tax
credit limitation fractions reflects $2,500 of world-
wide ordinary income and $100 of U.S.-source net
capital gain taxed at the 25% rate and adjusted as fol-
lows: $100 (25%/39.6%).
foreign source:
U.S. sourcegeneralpassive
20% rate group$300($720)$80
25% rate group$200
28% rate group$500($150)50
ordinary income$1,000$1,000$500

(vi) Y’s passive category foreign tax credit limitation is computed as follows:
$500 + $50 (28%/39.6%) - $300 ($80/$800) (20%/39.6%) -$400 ($80/$800) (28%/39.6%) - $100 ($80/$800) (25%/39.6%)
$1,000 + $1,000 + $500 + $100 (2.5%/39.6%)
2001–4 I.R.B.423January 22, 2001
(v) Y’s general limitation foreign tax credit limitation is computed as follows:
$1,000 - $50 (28%/39.6) - $100 (28%/39.6%) -$300 ($720/$800) (20%/39.6%) - $400 ($720/$800) (28%/39.6%) - $100 ($720/$800) (25%/39.6%)
$1,000 + $1,000 + $500 + $100 (25%/39.6%)
(g) Coordination with overall foreign
loss recapture rules. Section 904(b) and
this section shall apply before the provi-
sions of section 904(f). Therefore, the
amount of a taxpayer’s separate limitation
income or loss in each separate category,
the amount of overall foreign loss, and the
amount of any additions to or recapture of
separate limitation loss or overall foreign
loss accounts pursuant to section 904(f)
shall be determined after applying section
904(b) and this section to adjust capital
gains and losses in each separate category.
(h) Effective date. This section shall
apply to taxable years beginning after the
date this regulation is published in the
Federal Registeras a final regulation.
Par. 9. Section 1.904(b)-2 is revised to
read as follows:
§1.904(b)-2 Special rules for application
of section 904(b) to alternative minimum
tax foreign tax credit.
(a) Application of section 904(b)(2)(B)
adjustments. Section 904(b)(2)(B) shall
apply for purposes of determining the
alternative minimum tax foreign tax cred-
it under section 59 (regardless of whether
or not the taxpayer has made an election
under section 59(a)(4)).
(b) Use of alternative minimum tax
rates—(1) Taxpayers other than corpora-
tions. In the case of a taxpayer other than
a corporation, for purposes of determining
the alternative minimum tax foreign tax
credit under section 59—
(i) Section 904(b)(3)(D)(i) shall be
applied by substituting “section 55(b)(3)”
for “subsection (h) of section 1”;
(ii) Section 904(b)(3)(E)(ii)(I) shall be
applied by substituting “section
55(b)(1)(A)(i)” for “subsection (a), (b),
(c), (d), or (e) of section 1 (whichever
applies)”; and
(iii) Section 904(b)(3)(E)(iii)(I) shall
be applied by substituting “the alternative
rate of tax determined under section
55(b)(3)” for “the alternative rate of tax
determined under section 1(h)”.
(2) Corporate taxpayers. In the case of a
corporation, for purposes of determining the
alternative minimum tax foreign tax credit
under section 59, section 904(b)(3)(E)(ii)(II)
shall be applied by substituting “section
55(b)(1)(B)” for “section 11(b)”.
(c) Effective date. This section shall
apply to taxable years beginning after the
date this section is published as a final
regulation in the Federal Register.
§§ 1.904(b)–3 and 1.904(b)–4
[Removed]
Par. 10. Sections 1.904(b)–3 and
1.904(b)–4 are removed.
Par. 11. Section 1.904(j)–1 is added to
read as follows:
§1.904(j)–1 Certain individuals exempt
from foreign tax credit limitation.
(a) Election available only if all for-
eign taxes are creditable foreign taxes. A
taxpayer may elect to apply section 904(j)
for a taxable year only if all of the taxes
for which a credit is allowable to the tax-
payer under section 901 for the taxable
year (without regard to carryovers) are
creditable foreign taxes (as defined in sec-
tion 904(j)(3)(B)).
(b) Coordination with carryover
rules—(1) No carryovers to or from elec-
tion year. If the taxpayer elects to apply
section 904(j) for any taxable year, then
no taxes paid or accrued by the taxpayer
during such taxable year may be deemed
paid or accrued under section 904(c) in
any other taxable year, and no taxes paid
or accrued in any other taxable year may
be deemed paid or accrued under section
904(c) in such taxable year.
(2) Carryovers to and from other years
determined without regard to election
years. The amount of the foreign taxes
paid or accrued, and the amount of the
foreign source taxable income, in any year
for which the taxpayer elects to apply sec-
tion 904(j) shall not be taken into account
in determining the amount of any carry-
over to or from any other taxable year.
However, an election to apply section
904(j) to any year does not extend the
number of taxable years to which unused
foreign taxes may be carried under section
904(c) and §1.904–2(b). Therefore, in
determining the number of such carryover
years, the taxpayer must take into account
years to which a section 904(j) election
applies.
(3) Determination of amount of cred-
itable foreign taxes. Otherwise allowable
carryovers of foreign tax credits from
other taxable years shall not be taken into
account in determining whether the
amount of creditable foreign taxes paid or
accrued by an individual during a taxable
year exceeds $300 ($600 in the case of a
joint return) for purposes of section
904(j)(2)(B).
(c) Examples. The following examples
illustrate the provisions of this section:
Example 1. In 2001, X, a single individual using the
cash basis method of accounting for income and for-
eign tax credits, pays $100 of foreign taxes with
respect to general limitation income that was earned
and included in income for United States tax pur-
poses in 2000. The foreign taxes would be cred-
itable under section 901 but are not shown on a
payee statement furnished to X. X’s only income for
2001 from sources outside the United States is qual-
ified passive income, with respect to which X pays
$200 of creditable foreign taxes shown on a payee
statement. X may not elect to apply section 904(j)
for 2001 because some of X’s foreign taxes are not
creditable foreign taxes within the meaning of sec-
tion 904(j)(3)(B).
Example 2. (i) In 2002, A, a single individual
using the cash basis method of accounting for
income and foreign tax credits, pays creditable for-
eign taxes of $250 attributable to passive income.
Under section 904(c), A may also carry forward to
2002 $100 of unused foreign taxes paid in 1998 with
respect to passive income, $300 of unused foreign
taxes paid in 1998 with respect to general limitation
income, $400 of unused foreign taxes paid in 1999
with respect to passive income, and $200 of unused
foreign taxes paid in 1999 with respect to general
limitation income. In 2002, A’s only foreign source

income is passive income described in section
904(j)(3)(A)(i), and this income is reported to A on
a payee statement (within the meaning of section
6724(d)(2)). If A elects to apply section 904(j) for
the 2002 taxable year, the unused foreign taxes paid
in 1998 and 1999 are not deemed paid in 2002, and
A, therefore, cannot claim a foreign tax credit for
those taxes in 2002.
(ii) In 2003, A again is eligible for and elects the
application of section 904(j). The carryforwards
from 1998 expire in 2003. The carryforward period
established under section 904(c) is not extended by
A’s election under section 904(j). In 2004, A does
not elect the application of section 904(j). The $600
of unused foreign taxes paid in 1999 on passive and
general limitation income are deemed paid in 2004,
under section 904(c), without any adjustment for any
portion of those taxes that might have been used as a
foreign tax credit in 2002 or 2003 if section 904(j)
had not prevented A from carrying over taxes to
those years.
(d) Effective date. Section 1.904(j)–1
applies to taxable years beginning after
December 31, 1997.
Par. 12. Section 1.954–2 is amended
by:
1. Revising paragraph (b)(2)(iv),
Example 2.
2. Removing paragraph (b)(2)(iv),
Example 3.
The revision reads as follows:
§1.954–2 Foreign personal holding
company income.
* * * * *
(b) * * *
(2) * * *
(iv) * * *
Example 2. (i) DS, a domestic corporation,
wholly owns two controlled foreign corporations
organized in Country A, CFC1 and CFC2. CFC1
purchases from DS property that DS manufactures in
the United States. CFC1 uses the purchased proper-
ty as a component part of property that CFC1 manu-
factures in Country A within the meaning of
§1.954–3(a)(4). CFC2 provides loans described in
section 864(d)(6) to unrelated persons in Country A
for the purchase of the property that CFC1 manufac-
tures in Country A.
(ii) The interest accrued from the loans by CFC2
is not export financing interest as defined in section
904(d)(2)(G) because the property sold by CFC1 is
not manufactured in the United States under
§1.927(a)–1T(c). No portion of the interest is export
financing interest as defined in this paragraph (b)(2).
The full amount of the interest is, therefore, includ-
ed in foreign personal holding company income
under paragraph (b)(1)(ii) of this section.
* * * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 29, 2000, 8:45 a.m., and published in the
issue of the Federal Register for January 3, 2001, 66
F.R. 319)
Notice of Proposed Rulemaking
and Notice of Public Hearing
Determination of Basis of
Partner’s Interest; Special Rules
REG–106702–00
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
and notice of public hearing.
SUMMARY:This document contains
proposed regulations relating to special
rules on determination of basis of part-
ner’s interest under section 705 of the
Internal Revenue Code. The proposed
regulations are necessary to coordinate
sections 705 and 1032. This document
also provides a notice of public hearing on
these proposed regulations.
DATES:Written comments must be
received by April 12, 2001. Outlines of
topics to be discussed at the public hear-
ing scheduled for May 3, 2001, also must
be received by April 12, 2001.
ADDRESSES:Send submissions to:
CC:M&SP:RU (REG–106702–00), room
5226, Internal Revenue Service, POB 7604,
Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered
Monday through Friday between the hours
of 8 a.m. and 5 p.m. to: CC:M&SP:RU
(REG–106702–00),Courier’s Desk,
Internal Revenue Service,1111
Constitution Avenue, NW., Washington,
DC. Alternatively, taxpayers may submit
comments electronically via the internet by
selecting the “Tax Regs” option on the IRS
Home Page, or by submitting comments
directly to the IRS internet site at
http://www.irs.gov/tax_regs/reglist.html.
The public hearing will be held in room
6718, Internal Revenue Building, 1111
Constitution Avenue, NW., Washington,
DC.
FOR FURTHER INFORMATION CON-
TACT:Concerning the regulations,
Barbara MacMillan, (202) 622-3050; con-
cerning submissions, the hearing, and/or
to be placed on the building access list to
attend the hearing, Sonya Cruse, (202)
622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
In Rev. Rul. 99–57 (1999–2 C.B. 678),
the IRS issued guidance with respect to
the tax consequences for a partnership and
a corporate partner where the corporate
partner contributes its own stock to the
partnership, and the partnership later
exchanges the stock with a third party in a
taxable transaction. Under that ruling,
section 1032 will protect a corporate part-
ner from recognizing gain or loss (to the
extent allocated to such partner) when the
partnership exchanges stock of the corpo-
rate partner in a taxable transaction. The
ruling also concludes that, under section
705, the corporate partner increases its
basis in its partnership interest by an
amount equal to its share of the gain
resulting from the partnership’s sale or
exchange of the stock.
In situations where a corporation
acquires an interest in a partnership that
holds stock in that corporation, a section
754 election is not in effect with respect to
the partnership for the taxable year in
which the corporation acquires the inter-
est, and the partnership later sells or
exchanges the stock, it may be inconsis-
tent with the intent of section 705 to
increase the basis of the corporation’s
partnership interest by the full amount of
the gain that is not recognized.
For instance, assume that a corporation
(A) purchases a 50 percent interest in a
partnership for $100,000. The partner-
ship’s only asset is A stock with a basis of
$100,000 and a value of $200,000. If the
partnership had not made a section 754
election, then when the partnership dis-
poses of the property for $200,000, A
would be allocated $50,000 of gain.
Under section 1032, the gain allocated to
A would not be subject to tax. If A’s basis
in the partnership interest were increased
to $150,000 under section 705(a)(1), A
would recognize a corresponding $50,000
loss (or reduced gain) upon a subsequent
sale of the partnership interest. In this sit-
uation, it would be inconsistent with the
intent of section 705 to increase the basis
of A’s partnership interest for the gain that
is not recognized. To do so would create
a recognizable loss (or reduced gain) in a
situation where no economic loss was
incurred and no offsetting gain had previ-
ously been recognized.
January 22, 20014242001–4 I.R.B.

Accordingly,in Notice 99–57
(1999–2 C.B. 692), the IRS announced
that it intended to promulgate regula-
tions under section 705 to address cer-
tain situations where a corporation
acquires an interest in a partnership that
holds stock in that corporation, and a
section 754 election is not in effect with
respect to the partnership for the taxable
year in which the corporation acquired
the interest. The IRS announced that
rules regarding tiered-entity structures
also would be included in the regula-
tions. The IRS requested comments as to
the appropriate scope of the regulations
regarding other situations where the
price paid for a partnership interest
reflects built-in gain or accrued income
items that will not be subject to tax, or
built-in loss or accrued deductions that
will be permanently denied, when allo-
cated to the transferee partner, and the
partnership has not made an election
under section 754. No formal comments
were received.
Explanation of Provisions
As discussed in Notice 99–57, these
proposed regulations are being issued in
order to prevent inappropriate increases or
decreases in the adjusted basis of a corpo-
rate partner’s interest in a partnership
resulting from the partnership’s disposi-
tion of the corporate partner’s stock.
The proposed regulations set forth a
detailed statement of the purpose for these
regulations which is consistent with the
discussion in Notice 99–57. The pro-
posed regulations then provide a specific
rule implementing this purpose in situa-
tions where a corporate partner holds a
direct interest in a partnership that owns
stock of the corporate partner. This rule
applies where a corporation acquires an
interest in a partnership that holds stock in
that corporation (or the partnership subse-
quently acquires stock in that corporation
in an exchanged basis transaction), the
partnership does not have an election
under section 754 in effect for the year in
which the corporation acquires the inter-
est, and the partnership later sells or
exchanges the stock. In these situations,
the increase (or decrease) in the corpora-
tion’s adjusted basis in its partnership
interest resulting from the sale or
exchange of the stock equals the amount
of gain (or loss) that the corporate partner
would have recognized (absent the appli-
cation of section 1032) if, for the taxable
year in which the corporation acquired the
interest, a section 754 election had been in
effect.
The purpose of these proposed regula-
tions cannot be avoided through the use
of tiered partnerships or other arrange-
ments. For example, the proposed regu-
lations provide that if a corporation
acquires an indirect interest in its own
stock through a chain of two or more
partnerships (either where the corpora-
tion acquires a direct interest in a part-
nership or where one of the partnerships
in the chain acquires an interest in
another partnership), and gain or loss
from the sale or exchange of the stock is
subsequently allocated to the corpora-
tion, then the bases of the interests in the
partnerships included in the chain shall
be adjusted in a manner that is consistent
with the purpose of the proposed regula-
tions. As stated above, the proposed reg-
ulations include a statement describing
the purpose of these regulations which is
intended to guide taxpayers in making
basis adjustments in the tiered partner-
ship context. In addition, the proposed
regulations include two examples illus-
trating the basis adjustments that are
required by the proposed regulations
where a corporation acquires an indirect
interest in its own stock through a chain
of two or more partnerships.
Proposed Effective Date
The regulations shall apply to gain or
loss allocated with respect to sales or
exchanges of stock occurring after
December 6, 1999.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations, and because the reg-
ulations do not impose a collection of
information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) 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 comment on its
impact on small businesses.
Comments and 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) that
are timely submitted to the IRS. The IRS
and the Treasury Department request
comments on the clarity of the proposed
rule and how it may be made easier to
understand. All comments will be avail-
able for public inspection and copying.
A public hearing has been scheduled
for May 3, 2001, beginning at 10 a.m., in
room 6718 of the Internal Revenue
Building. Due to building security proce-
dures, visitors must enter at the 10th
Street entrance,located between
Constitution and Pennsylvania Avenues,
NW. In addition, all visitors must present
photo identification to enter the building.
Because of access restrictions, visitors
will not be admitted beyond the immedi-
ate entrance area more than 15 minutes
before the hearing starts. For information
about having your name placed on the
building access list to attend the hearing,
see the “FOR FURTHER INFORMA-
TION CONTACT” section of the pream-
ble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons that wish to
present oral comments at the hearing must
submit written comments and an outline
of the topics to be discussed and the time
to be devoted to each topic (signed origi-
nal and eight (8) copies) by April 12,
2001.
A period of 10 minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has passed.
Copies of the agenda will be available free
of charge at the hearing.
Drafting Information
The principal author of these proposed
regulations is Matthew Lay of the Office
2001–4 I.R.B.425January 22, 2001

of the Associate Chief Counsel
(Passthroughs and Special Industries).
However, personnel from other offices of
the IRS and the Treasury Department par-
ticipated in their development.
* * * * *
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 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.705–2 also issued under 26
U.S.C. 705. * * *
Par. 2. Section 1.705–1 is amended by
adding paragraph (a)(7) to read as fol-
lows:
§1.705–1 Determination of basis of
partner’s interest.
(a) * * *
(7) For basis adjustments necessary to
coordinate sections 705 and 1032 in cer-
tain situations in which a corporation
directly or indirectly acquires an interest
in a partnership that holds stock in that
corporation, see §1.705–2.
* * * * *
Par. 3. Section 1.705–2 is added to read
as follows:
§1.705–2 Basis adjustments coordinating
sections 705 and 1032.
(a) Purpose. This section is intended to
prevent inappropriate increases or
decreases in the adjusted basis of a corpo-
rate partner’s interest in a partnership
resulting from the partnership’s disposi-
tion of the corporate partner’s stock. The
rules under section 705 generally are
intended to preserve equality between the
adjusted basis of a partner’s interest in a
partnership (outside basis) and such part-
ner’s share of the adjusted basis in part-
nership assets (inside basis). In the situa-
tion where a section 754 election was not
in effect for the year in which the partner
acquired its interest, however, a partner’s
inside basis and outside basis may not be
equal. In this situation, gain or loss allo-
cated to the partner upon disposition of
the partnership assets that is attributable
to the difference between the adjusted
basis of the partnership assets absent the
section 754 election and the adjusted basis
of the partnership assets had a section 754
election been in effect generally will
result in an adjustment to the basis of the
partner’s interest in the partnership under
section 705(a). Such gain (or loss) there-
fore generally will be offset by a corre-
sponding decrease in the gain or increase
in the loss (or increase in the gain or
decrease in the loss) upon the subsequent
disposition by the partner of its interest in
the partnership. Where such a difference
exists with respect to stock of a corporate
partner that is held by the partnership,
gain or loss from the disposition of corpo-
rate partner stock attributable to the dif-
ference is not recognized by the corporate
partner under section 1032. To adjust the
basis of the corporate partner’s interest in
the partnership for this unrecognized gain
or loss would not be appropriate because
it would create an opportunity for the
recognition of taxable gain or loss on a
subsequent disposition of the partnership
interest where no economic gain or loss
has been incurred by the corporate partner
and no corresponding taxable gain or loss
had previously been allocated to the cor-
porate partner by the partnership.
(b) Single partnership—(1) Required
adjustments. This paragraph (b) applies in
situations where a corporation acquires an
interest in a partnership that holds stock in
that corporation (or the partnership subse-
quently acquires stock in that corporation
in an exchanged basis transaction), the
partnership does not have an election under
section 754 in effect for the year in which
the corporation acquires the interest, and
the partnership later sells or exchanges the
stock. In these situations, the increase (or
decrease) in the corporation’s adjusted
basis in its partnership interest resulting
from the sale or exchange of the stock
equals the amount of gain (or loss) that the
corporate partner would have recognized
(absent the application of section 1032) if,
for the year in which the corporation
acquired the interest, a section 754 election
had been in effect.
(2) Example. The provisions of this
paragraph (b) are illustrated by the fol-
lowing example:
Example. (i) A, B, and C form equal partnership
PRS. Each partner contributes $30,000 in exchange
for its partnership interest. PRS has no liabilities.
PRS purchases stock in corporation X for $30,000,
which appreciates in value to $120,000. PRS also
purchases inventory for $60,000, which appreciates
in value to $150,000. A sells its interest in PRS to X
for $90,000 in a year for which an election under
section 754 is not in effect. PRS later sells the X
stock for $150,000. PRS realizes a gain of $120,000
on the sale of the X stock. X’s share of the gain is
$40,000. Under section 1032, X does not recognize
its share of the gain.
(ii) Normally, X would be entitled to a $40,000
increase in the basis of its PRS interest for its allo-
cable share of PRS’s gain from the sale of the X
stock, but a special rule applies in this situation. If a
section 754 election had been in effect for the year in
which X acquired its interest in PRS, X would have
been entitled to a basis adjustment under section
743(b) of $60,000 (the excess of X’s basis for the
transferred partnership interest over X’s share of the
adjusted basis to PRS of PRS’s property). See
§1.743–1(b). Under §1.755–1(b), the basis adjust-
ment under section 743(b) would have been allocat-
ed $30,000 to the X stock (the amount of the gain
that would have been allocated to X from the hypo-
thetical sale of the stock), and $30,000 to the inven-
tory (the amount of the gain that would have been
allocated to X from the hypothetical sale of the
inventory).
(iii) If a section 754 election had been in effect
for the year in which X acquired its interest in PRS,
the amount of gain that X would have recognized
upon PRS’s disposition of X stock (absent the appli-
cation of section 1032) would be $10,000 (X’s share
of PRS’s gain from the stock sale, $40,000, minus
the amount of X’s basis adjustment under section
743(b), $30,000). See §1.743–1(j). Accordingly, the
increase in the basis of X’s interest in PRS is
$10,000.
(c) Tiered partnerships and other
arrangements—(1)Required adjustments.
The purpose of these proposed regulations
as set forth in paragraph (a) of this section
cannot be avoided through the use of
tiered partnerships or other arrangements.
For example, if a corporation acquires an
indirect interest in its own stock through a
chain of two or more partnerships (either
where the corporation acquires a direct
interest in a partnership or where one of
the partnerships in the chain acquires an
interest in another partnership), and gain
or loss from the sale or exchange of the
stock is subsequently allocated to the cor-
poration, then the bases of the interests in
the partnerships included in the chain
shall be adjusted in a manner that is con-
sistent with the purpose of this section.
(2) Examples. The provisions of this
paragraph (c) are illustrated by the follow-
ing examples:
January 22, 20014262001–4 I.R.B.

Example 1. Acquisition of upper-tier partnership
interest by corporation. (i) A, B, and C form a part-
nership (UTP), with each partner contributing
$25,000. UTP and D form a partnership (LTP).
UTP contributes $75,000 in exchange for its interest
in LTP, and D contributes $25,000 in exchange for
D’s interest in LTP. Neither UTP nor LTP has any
liabilities. LTP purchases stock in corporation E for
$100,000, which appreciates in value to $1,000,000.
C sells its interest in UTP to E for $250,000 in a year
for which an election under section 754 is not in
effect for UTP or LTP. LTP later sells the E stock for
$2,000,000. LTP realizes a $1,900,000 gain on the
sale of the E stock. UTP’s share of the gain is
$1,425,000, and E’s share of the gain is $475,000.
Under section 1032, E does not recognize its share of
the gain.
(ii) With respect to the basis of UTP’s interest in
LTP, if all of the gain from the sale of the E stock
(including E’s share) were to increase the basis of
UTP’s interest in LTP, UTP’s basis in such interest
would be $1,500,000 ($75,000 + $1,425,000). The
fair market value of UTP’s interest in LTP is
$1,500,000. Because UTP did not have a section
754 election in effect for the taxable year in which E
acquired its interest in UTP, UTP’s basis in the LTP
interest does not reflect the purchase price paid by E
for its interest. Increasing the basis of UTP’s inter-
est in LTP by the full amount of the gain that would
be recognized (in the absence of section 1032) on the
sale of the E stock preserves the conformity between
UTP’s inside basis and outside basis with respect to
LTP (i.e., UTP’s share of LTP’s cash is equal to
$1,500,000, and UTP’s basis in the LTP interest is
$1,500,000) and appropriately would cause UTP to
recognize no gain or loss on the sale of UTP’s inter-
est in LTP immediately after the sale of the E stock.
Accordingly, increasing the basis of UTP’s interest
in LTP by the entire amount of gain allocated to UTP
(including E’s share) from LTP’s sale of the E stock
is consistent with the purpose of this section. The
$1,425,000 of gain allocated by LTP to UTP will
increase the adjusted basis of UTP’s interest in LTP
under section 705(a)(1). The basis of UTP’s interest
in LTP immediately after the sale of the E stock is
$1,500,000.
(iii) With respect to the basis of E’s interest in
UTP, if E’s share of the gain allocated to UTP and
then to E were to increase the basis of E’s interest in
UTP, E’s basis in such interest would be $725,000
($250,000 + $475,000) and the fair market value of
such interest would be $500,000, so that E would
recognize a loss of $225,000 if E sold its interest in
UTP immediately after LTP’s disposition of the E
stock. It would be inappropriate for E to recognize a
taxable loss of $225,000 upon a disposition of its
interest in UTP because E would not incur an eco-
nomic loss in the transaction, and E did not recog-
nize a taxable gain upon LTP’s disposition of the E
stock that appropriately would be offset by a taxable
loss on the disposition of its interest in UTP.
Accordingly, increasing E’s basis in its UTP interest
by the entire amount of gain allocated to E from the
sale of the E stock is not consistent with the purpose
of this section. (Conversely, because A and B were
allocated taxable gain on the disposition of the E
stock, it would be appropriate to increase A’s and B’s
bases in their respective interests in UTP by the full
amount of the gain allocated to them.)
(iv) The appropriate basis adjustment for E’s
interest in UTP upon the disposition of the E stock
by LTP can be determined as the amount of gain that
E would have recognized (in the absence of section
1032) upon the sale by LTP of the E stock if both
UTP and LTP had made section 754 elections for the
taxable year in which E acquired the interest in UTP.
If section 754 elections had been in effect for UTP
and LTP for the year in which E acquired E’s inter-
est in UTP, the following would occur. E would be
entitled to a $225,000 positive basis adjustment
under section 743(b) with respect to the property of
UTP. The entire basis adjustment would be allocat-
ed to UTP’s only asset, its interest in LTP. In addi-
tion, the sale of C’s interest in UTP would be treated
as a deemed sale of E’s share of UTP’s interest in
LTP for purposes of sections 754 and 743. The
deemed selling price of E’s share of UTP’s interest
in LTP would be $250,000 (E’s share of UTP’s
adjusted basis in LTP, $25,000, plus E’s basis adjust-
ment under section 743(b) with respect to the assets
of UTP, $225,000). The deemed sale of E’s share of
UTP’s interest in LTP would trigger a basis adjust-
ment under section 743(b) of $225,000 with respect
to the assets of LTP (the excess of E’s share of UTP’s
adjusted basis in LTP, including E’s basis adjustment
($225,000), $250,000, over E’s share of the adjusted
basis of LTP’s property, $25,000). This $225,000
adjustment by LTP would be allocated to LTP’s only
asset, the E stock, and would be segregated and allo-
cated solely to E. The amount of LTP’s gain from
the sale of the E stock (before considering section
743(b)) would be $1,900,000. E’s share of this gain,
$475,000, would be offset in part by the $225,000
basis adjustment under section 743(b), so that E
would recognize gain equal to $250,000 in the
absence of section 1032.
(v) If the basis of E’s interest in UTP were
increased by $250,000, the total basis of E’s interest
would equal $500,000. This would conform to E’s
share of UTP’s basis in the LTP interest ($1,500,000
x 1/3 = $500,000) as well as E’s indirect share of the
cash held by LTP ((1/3 x 3/4) x $2,000,000 =
$500,000). Such a basis adjustment does not create
the opportunity for the recognition of an inappropri-
ate loss by E on a subsequent disposition of E’s
interest in UTP and is consistent with the purpose of
this section. Accordingly, under paragraph (c) of
this section, of the $475,000 gain allocated to E, only
$250,000 will apply to increase the adjusted basis of
E in UTP under section 705(a)(1). E’s adjusted basis
in its UTP interest following the sale of the E stock
is $500,000
Example 2. Acquisition of lower-tier partnership
interest by upper-tier partnership. (i) A, B, and C
form an equal partnership (UTP), with each partner
contributing $100,000. D, E, and F also form an
equal partnership (LTP), with each partner contribut-
ing $30,000. LTP purchases stock in corporation B
for $90,000, which appreciates in value to $900,000.
LTP has no liabilities. UTP purchases D’s interest in
LTP for $300,000. LTP does not have an election
under section 754 in effect for the taxable year of
UTP’s purchase. LTP later sells the B stock for
$900,000. UTP’s share of the gain is $270,000, and
B’s share of that gain is $90,000. Under section
1032, B does not recognize its share of the gain.
(ii) With respect to the basis of UTP’s interest in
LTP, if all of the gain from the sale of the B stock
(including B’s share) were to increase the basis of
UTP’s interest in LTP, UTP’s basis in the LTP inter-
est would be $570,000 ($300,000 + $270,000), and
the fair market value of such interest would be
$300,000, so that B would be allocated a loss of
$90,000 (($570,000 - $300,000) x 1/3) if UTP sold
its interest in LTP immediately after LTP’s disposi-
tion of the B stock. It would be inappropriate for B
to recognize a taxable loss of $90,000 upon a dispo-
sition of UTP’s interest in LTP. B would not incur an
economic loss in the transaction, and B was not allo-
cated a taxable gain upon LTP’s disposition of the B
stock that appropriately would be offset by a taxable
loss on the disposition of UTP’s interest in LTP.
Accordingly, increasing UTP’s basis in its LTP inter-
est by the gain allocated to B from the sale of the B
stock is not consistent with the purpose of this sec-
tion. (Conversely, because E and F were allocated
taxable gain on the disposition of the B stock, it
would be appropriate to increase E’s and F’s bases in
their respective interests in LTP by the full amount of
such gain.)
(iii) The appropriate basis adjustment for UTP’s
interest in LTP upon the disposition of the B stock by
LTP can be determined as the amount of gain that
UTP would have recognized (in the absence of sec-
tion 1032) upon the sale by LTP of the B stock if the
portion of the gain allocated to UTP that subse-
quently is allocated to B were determined as if LTP
had made an election under section 754 for the tax-
able year in which UTP acquired its interest in LTP.
If a section 754 election had been in effect for LTP
for the year in which UTP acquired its interest in
LTP, then with respect to B, the following would
occur. UTP would be entitled to a $90,000 positive
basis adjustment under section 743(b), allocable to
B, in the property of LTP. The entire basis adjust-
ment would be allocated to LTP’s only asset, its B
stock. The amount of LTP’s gain from the sale of the
B stock (before considering section 743(b)) would
be $810,000. UTP’s share of this gain, $270,000,
would be offset, in part, by the $90,000 basis adjust-
ment under section 743(b), so that UTP would rec-
ognize gain equal to $180,000.
(iv) If the basis of UTP’s interest in LTP were
increased by $180,000, the total basis of UTP’s part-
nership interest would equal $480,000. This would
conform to the sum of UTP’s share of the cash held
by LTP (1/3 x $900,000 = $300,000) and the taxable
gain recognized by A and C on the disposition of the
B stock that appropriately may be offset on the dis-
position of their interests in UTP ($90,000 + $90,000
= $180,000). Such a basis adjustment does not inap-
propriately create the opportunity for the allocation
of a loss to B on a subsequent disposition of UTP’s
interest in LTP and is consistent with the purpose of
this section. Accordingly, of the $270,000 gain allo-
cated to UTP, only $180,000 will apply to increase
the adjusted basis of UTP in LTP under section
705(a)(1). UTP’s adjusted basis in its LTP interest
following the sale of the B stock is $480,000.
(v) With respect to B’s interest in UTP, if B’s
share of the gain allocated to UTP and then to B
were to increase the basis of B’s interest in UTP,
B would have a UTP partnership interest with an
adjusted basis of $190,000 ($100,000 + $90,000)
and a value of $100,000, so that B would recog-
nize a loss of $90,000 if B sold its interest in UTP
immediately after LTP’s disposition of the B
2001–4 I.R.B.427January 22, 2001

stock. It would be inappropriate for B to recog-
nize a taxable loss of $90,000 upon a disposition
of its interest in UTP because B would not incur
an economic loss in the transaction, and B did not
recognize a taxable gain upon LTP’s disposition
of the B stock that appropriately would be offset
by a taxable loss on the disposition of its interest
in UTP. Accordingly, increasing B’s basis in its
UTP interest by the gain allocated to B from the
sale of the B stock is not consistent with the pur-
pose of this section. (Conversely, because A and
C were allocated taxable gain on the disposition
of the B stock that is a result of LTP not having a
section 754 election in effect, it would be appro-
priate for A and C to recognize an offsetting tax-
able loss on the disposition of A’s and C’s inter-
ests in UTP. Accordingly, it would be appropriate
to increase A’s and C’s bases in their respective
interests in UTP by the amount of gain recog-
nized by A and C.)
(vi) The appropriate basis adjustment for B’s
interest in UTP upon the disposition of the B
stock by LTP can be determined as the amount of
gain that B would have recognized (in the
absence of section 1032) upon the sale by LTP of
the B stock if the portion of the gain allocated to
UTP that is subsequently allocated to B were
determined as if LTP had made an election under
section 754 for the taxable year in which UTP
acquired its interest in LTP. If a section 754 elec-
tion had been in effect for LTP for the year in
which UTP acquired its interest in LTP, then with
respect to B, the following would occur. UTP
would be entitled to a basis adjustment under sec-
tion 743(b) in the property of LTP of $90,000.
The entire basis adjustment would be allocated to
LTP’s only asset, its B stock. The amount of
UTP’s gain from the sale of the B stock (before
considering section 743(b)) would be $810,000.
UTP’s share of this gain, $270,000, would be off-
set, in part, by the $90,000 basis adjustment
under section 743(b), so that UTP would recog-
nize gain equal to $180,000. The $90,000 basis
adjustment would completely offset the gain that
otherwise would be allocated to B.
(vii) If no gain were allocated to B so that the
basis of B’s interest in UTP was not increased,
the total basis of B’s interest would equal
$100,000. This would conform to B’s share of
UTP’s basis in the LTP interest (($480,000 -
$180,000 (i.e., A’s and C’s share of the basis that
should offset taxable gain recognized as a result
of LTP’s failure to have a section 754 election)) x
1/3 = $100,000) as well as B’s indirect share of
the cash held by LTP ((1/3 x 1/3) x $900,000 =
$100,000). Such a basis adjustment does not cre-
ate the opportunity for the recognition of an inap-
propriate loss by B on a subsequent disposition of
B’s interest in UTP and is consistent with the pur-
pose of this section. Accordingly, under para-
graph (c) of this section, of the $90,000 gain allo-
cated to B, none will apply to increase the
adjusted basis of B in UTP under section
705(a)(1). B’s adjusted basis in its UTP interest
following the sale of the B stock is $100,000.
(d) Effective date. This section applies
to gain or loss allocated with respect to
sales or exchanges of stock occurring
after December 6, 1999.
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 29, 2000, 8:45 a.m., and published in the
issue of the Federal Register for January 3, 2001, 66
F.R. 315)
Notice of Proposed Rulemaking
Removal of Federal Reserve
Banks as Federal Depositaries
REG–107176–00
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing.
SUMMARY:This document contains
proposed regulations which remove the
Federal Reserve banks as authorized
depositaries for Federal tax deposits. The
regulations affect taxpayers who make
Federal tax deposits using paper Federal
Tax Deposit (FTD) coupons (Form 8109)
at Federal Reserve banks.
DATES: Written or electronically generat-
ed comments and requests for a public
hearing must be received by March 26,
2001.
ADDRESSES: Send submissions to: CC
(REG–107176–00), room 5226, Internal
Revenue Service, POB 7604, Ben
Franklin Station, Washington, DC 20044.
Submissions may be hand delivered
Monday through Friday between the
hours of 8 a.m. and 5 p.m. to: CC
(REG–107176–00),Courier’s Desk,
Internal Revenue Service,1111
Constitution Avenue, NW., Washington,
DC. Alternatively, taxpayers may submit
comments electronically via the Internet
by selecting the “Tax Regs” option on the
IRS Home Page, or by submitting com-
ments directly to the IRS Internet site at
http://www.irs.gov/tax_regs/regslist.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, Brinton T. Warren, (202) 622-
4940; concerning submissions of
comments and requests for a public hear-
ing, Treena Garrett of the Regulations
Unit at (202) 622-7180 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION
Background and Explanation of
Provisions
This document contains proposed
amendments to 26 CFR parts 1, 31, 35,
36, 40, 301, and 601 relating to Federal
tax deposits under section 6302(c) of the
Internal Revenue Code (Code). Section
6302(c) provides that the Secretary may
authorize Federal Reserve banks, and
incorporated banks, trust companies,
domestic building and loan associations,
or credit unions that are depositaries or
financial agents of the United States, to
receive any tax imposed under the internal
revenue laws, in such manner, at such
times, and under such conditions as the
Secretary may prescribe. Pursuant to this
authority, various regulations provide that
Federal Reserve banks, as well as other
authorized financial institutions, may
receive certain Federal tax deposits.
In cooperation with the Treasury
Department’s Financial Management
Service (FMS), the Federal Reserve System
has been streamlining its Treasury Tax and
Loan (TT&L) Operation to respond to the
fact that the overwhelming majority of
Federal Tax Deposits (FTDs) are now
received electronically. The widespread
adoption of electronic deposits by taxpayers
is an important aspect of improving the effi-
ciency, reliability, and cost-effectiveness of
the Treasury Department’s financial man-
agement. In general, compared to the uni-
verse of all tax deposits, the percentage of
FTDs made with paper coupons has signif-
icantly declined. FTDs made with paper
coupons at Federal Reserve banks now con-
stitute only a tiny percentage of all tax
deposits. For example, in Fiscal Year 1999,
of the approximately 100 million Federal
tax deposits, made by paper coupon and
electronically, only about 270,000, or less
than one half of one percent, were paper
coupons presented at Federal Reserve
banks. Additionally, the number of paper
coupons presented at Federal Reserve
banks has declined over twenty-five percent
since 1997.
The Treasury Department has developed
an array of other deposit options that are
more convenient for taxpayers to use, and
more economical to process, than deposits
with Federal Reserve banks.For example,
taxpayers may use their touch tone tele-
phone or personal computer to make
January 22, 20014282001–4 I.R.B.

deposits 24 hours a day through the
Electronic Federal Tax Payment System
(EFTPS). For those taxpayers who still pre-
fer paper coupons over electronic deposits,
there are now more than 10,000 financial
institutions nationwide that are designated
as TT&L depositaries where taxpayers may
make FTD deposits using paper coupons.
In response to the declining number of
deposits being made with paper coupons at
Federal Reserve banks, the Federal Reserve
Bank of St. Louis was selected, effective
May 1, 2000, to serve as the only Federal
Reserve bank accepting FTDs. Even after
this consolidation, however, it is no longer
cost-effective for the Federal Reserve bank
in St. Louis to process the small number of
paper coupons it receives annually.
Accordingly, these proposed regulations
remove all Federal Reserve banks as deposi-
taries for Federal taxes. To mitigate any dif-
ficulties for those taxpayers who still do not
wish to use the deposit alternatives discussed
above, the Treasury Department has autho-
rized a financial agent to receive and process
FTD payments through the mail, thereby
maintaining a mail-in alternative for taxpay-
ers who do not have an account with an
authorized financial institution and who do
not wish to use EFTPS. The address for this
mail-in alternative is Financial Agent,
Federal Tax Deposit Processing, P.O. Box
970030, St. Louis, Missouri, 63197.
Proposed Effective Date
The regulations, as proposed, apply to
any deposits of Federal taxes made after
the date of publication of a Treasury deci-
sion adopting these rules as final regula-
tions in the Federal Register.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a reg-
ulatory assessment is not required. It also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these
regulations, and because the regulations
do not impose a collection of information
on small entities,the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of
the Internal Revenue Code, these regula-
tions will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment on
their impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written (a signed orig-
inal and 8 copies) and electronic com-
ments that are submitted timely to the
IRS. The IRS and Treasury Department
request comments on the clarity of the
proposed rules and how they can be made
easier to understand. All comments will
be available for public inspection and
copying. A public hearing will be sched-
uled if requested in writing by any person
that timely submits comments. If a public
hearing is scheduled, notice of the date,
time, and place for the public hearing will
be published in the Federal Register.
Drafting Information
The principal author of these regula-
tions is Brinton T. Warren of the Office of
Associate Chief Counsel, Procedure and
Administration (Administrative Provi-
sions and Judicial Practice Division).
However, other personnel from the IRS
and Treasury Department participated in
their development.
* * * * *
Proposed Amendments to the
Regulations
Accordingly, and under the authority of
26 U.S.C. 7805 and 5 U.S.C. 301, 26 CFR
parts 1, 31, 35, 36, 40, 301 and 601 are
proposed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.6302–1 is amended by
removing the fifth sentence in paragraph
(b)(1).
Par. 3. Section 1.6302–2 is amended by
removing the third sentence in paragraph
(b)(1).
PART 31—EMPLOYMENT TAXES
AND COLLECTION OF INCOME TAX
AT SOURCE
Par. 4. The authority citation for part 31
continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 5. Section 31.6302–1 is amended
by removing the fourth sentence in para-
graph (i)(3).
Par. 6. Section 31.6302(c)–3 is amend-
ed by removing the third sentence in para-
graph (b)(2).
PARTS 1, 31, 35, 36, 40, 301,
601–[AMENDED]
Par. 7. In the list below, for each sec-
tion indicated in the left column, remove
the language in the middle column and
add, if any, the language in the right col-
umn:
2001–4 I.R.B.429January 22, 2001
SectionRemoveAdd
1.1461–1(a),a Federal reserve bank oran
effective January 1, 2001
1.1502–5(a)(1)commercial dispositary orfinancial institution
Federal Reserve Bank
1.6151–1(d)(1)Federal Reserve Banks or - - - - - - - - - - - -
1.6302–1(b)(1)214 or, at the election of the203
fourth sentencecorporation, to a Federal
Reserve bank

SectionRemoveAdd
1.6302–1(b)(1)(asthe Federal Reserve bank or - - - - - - - - - - - -
amended by paragraph 2)
fifth sentence
1.6302–2(a)(1)(i)a Federal Reserve bank oran
1.6302–2(a)(1)(ii)a Federal Reserve bank oran
1.6302–2(a)(1)(iv)a Federal Reserve bank oran
1.6302–2(b)(1)214 or, at the election of the203
second sentencewithholding agent, to a
Federal Reserve bank
1.6302–2(b)(1)(asthe Federal Reserve bank or - - - - - - - - - - - -
amended by paragraph 3)
third sentence
1.6302–3(a)or with a Federal Reserve Bank - - - - - - - - - - - -
31.6071(a)–1(a)(1)or by a Federal Reserve bank - - - - - - - - - - - -
31.6071(a)–1(c)a Federal Reserve bank or by - - - - - - - - - - - -
31.6151–1(b)Federal Reserve banks and - - - - - - - - - - - -
31.6302–1(c)(1)a Federal Reserve bank oran
31.6302–1(c)(2)(i)a Federal Reserve bank oran
31.6302–1(c)(3)a Federal Reserve bank oran
31.6302–1(i)(3)214 or, at the election of the203
employer, to a Federal
Reserve bank
31.6302–1(i)(5)the Federal Reserve bank or - - - - - - - - - - - -
31.6302(c)–2A(b)(1)(i)with a Federal Reserve bank or - - - - - - - - - - - -
31.6302(c)–2A(b)(3)with a Federal Reserve bank or - - - - - - - - - - - -
31.6302(c)–3(a)(1)(i)with a Federal Reserve bank or - - - - - - - - - - - -
31.6302(c)–3(a)(1)(ii)with a Federal Reserve bank or - - - - - - - - - - - -
31.6302(c)–3(a)(3)with a Federal Reserve bank or - - - - - - - - - - - -
31.6302(c)–3(b)(2)214 or, at the election of the 203
second sentenceemployer, to a Federal
Reserve bank
31.6302(c)–3(b)(2)the Federal Reserve bank or - - - - - - - - - - - -
(as amended by paragraph 6)
third sentence
35.3405–1T(e–10)a Federal Reserve Bank or - - - - - - - - - - - -
36.3121(l)(10)–4a Federal Reserve bank oran
40.6302(c)–1(d)(1)214) or to a Federal Reserve bank203)
301.6302–1(a)Federal Reserve banks and authorizedauthorized financial
commercial banksinstitutions
301.6302–1(b)(1)Federal Reserve banks or authorizedauthorized financial
commercial banksinstitutions
January 22, 20014302001–4 I.R.B.

SectionRemoveAdd
301.6302–1(b)(2)Federal Reserve banks or authorizedauthorized financial
commercial banksinstitutions
301.9100–5T(c)(3)Federal Reserve banks and - - - - - - - - - - - -
601.401(a)(5)Federal Reserve banks and - - - - - - - - - - - -
heading
601.401(a)(5)(iii)a Federal Reserve bank oran
first sentence
601.401(a)(5)(iii)a Federal Reserve bank oran
second sentence
601.401(a)(5)(iv)a Federal Reserve bank or aan authorized
financial institution authorizedfinancial institution
in accordance with Treasury
Department Circular No. 1079,
revised, to accept remittances of
these taxes for transmission to a
Federal Reserve bank
2001–4 I.R.B.431January 22, 2001
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 22, 2000, 8:45 a.m., and published in the
issue of the Federal Register for December 26, 2000,
65 F.R. 81453)
Information Reporting for
Payments of Qualified Tuition
and Payments of Interest on
Qualified Education Loans;
Magnetic Media Filing
Requirements for Information
Returns; Public Hearing
Announcement 2001–10
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of public hearing on
proposed rulemaking.
SUMMARY: This document contains a
notice of public hearing on proposed reg-
ulations relating to reporting for payments
of qualified tuition and payments of inter-
est on qualified education loans and mag-
netic filing requirements for information
returns.
DATES: The public hearing is being held
on Tuesday, February 13, 2001, at 10 a.m.
The IRS must receive outlines of the top-
ics to be discussed at the hearing by
January 23, 2001.
ADDRESSES: The public hearing is
being held in the auditorium, Room 7218,
Internal Revenue Building,1111
Constitution Avenue NW., Washington,
DC. Due to building security procedures,
visitors must enter at the 10
th
Street
entrance, located between Constitution
and Pennsylvania Avenues, NW. In addi-
tion, all visitors must present photo iden-
tification to enter the building.
Mail outlines to: Regulations Unit CC
(REG–105316–98), Room 5226, Internal
Revenue Service, POB 7604, Ben Franklin
Station, Washington, DC 20044. Hand
deliver outlines Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
Regulations Unit CC (REG–105316–98),
Courier’s Desk, Internal Revenue Service,
1111 Constitution Avenue NW.,
Washington, DC. Submit electronic out-
lines of oral comments directly to the IRS
Internet site at:
http://www.irs.gov/tax_regs/regslist.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning submissions of com-
ments, the hearing, and/or to be placed on
the building access list to attend the hear-
ing, Guy Traynor, (202) 622-7180 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
The subject of the public hearing is pro-
posed regulations (REG–105316–98,
2000–27 I.R.B. 98) that were published in
theFederal Registeron Friday, June 16,
2000 (65 F.R. 37728).
The rules of §601.601(a)(3) apply to
the hearing.
Persons who have submitted written
comments and wish to present oral com-
ments at the hearing, must submit an out-
line of the topics to be discussed and the
amount of time to be devoted to each topic
(signed original and eight (8) copies) by
January 23, 2001.
A period of 10 minutes is allotted to
each person for presenting oral com-
ments.
After the deadline for receiving out-
lines has passed, the IRS will prepare an
agenda containing the schedule of
speakers. Copies of the agenda will be
made available, free of charge, at the
hearing.
Because of access restrictions, the IRS
will not admit visitors beyond the imme-
diate entrance area more than 15 minutes
before the hearing starts. For information
about having your name placed on the
building access list to attend the hearing,
see the “FOR FURTHER INFORMA-
TION CONTACT” section of this docu-
ment.

Cynthia E. Grigsby,
Chief, Regulations Unit,
Office of Special Counsel
(Modernization & Strategic Planning).
(Filed by the Office of the Federal Register on De-
cember 19, 2000, 8:45 a.m., and published in the
issue of the Federal Register for December 20, 2000,
65 F.R. 79788)
Guidance Under Section 355(e);
Recognition of Gain on Certain
Distributions of Stock or
Securities in Connection With an
Acquisition; Withdrawal of
Proposed Rulemaking
Announcement 2001–11
AGENCY:Internal Revenue Service
(IRS), Treasury.
ACTION: Withdrawal of notice of pro-
posed rulemaking.
SUMMARY: This document withdraws
the notice of proposed rulemaking relat-
ing to recognition of gain on certain dis-
tributions of stock or securities of a con-
trolled corporation in connection with an
acquisition that was published in the
Federal Registeron August 24, 1999.
The withdrawal is in response to written
comments received and oral comments
presented at a public hearing.
EFFECTIVE DATE: These regulations
are effective January 2, 2001.
FOR FURTHER INFORMATION CON-
TACT: Brendan O’Hara, (202) 622-7530
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On August 24, 1999, the IRS issued pro-
posed regulations (REG–116733–98,
1999–2 C.B. 392) in the Federal Register
(64 F.R. 46155) under section 355(e), relat-
ing to the recognition of gain on certain
distributions of stock or securities in con-
nection with an acquisition of stock of the
distributing corporation or of stock of the
corporation whose stock is distributed. In
response to written comments received and
comments presented at a public hearing,
these proposed regulations are being with-
drawn. New proposed regulations (REG–
107566–00) covering the same matters as
the withdrawn proposed regulations were
being issued in 2001–3 I.R.B. 346.
* * * * *
Withdrawal of Notice of Proposed
Rulemaking
Accordingly, under the authority of 26
U.S.C. 7805 and 26 U.S.C. 355(e)(5), the
notice of proposed rulemaking
(REG–116733–98) that was published in
the Federal Registeron August 24, 1999
(64 F.R. 46155) is withdrawn.
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 29, 2000, 8:45 a.m., and published in the
issue of the Federal Register for January 2, 2001, 66
F.R. 76)
January 22, 20014322001–4 I.R.B.

2001–4 I.R.B.iJanuary 22, 2001
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”)
that have an effect on previous rulings
use the following defined terms to de-
scribe the effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it ap-
plies to both A and B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example,modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms

January 22, 2001ii2001–4 I.R.B.
Numerical Finding List
1
Bulletins 2001–1 through 2001–3
Announcements:
2001–1, 2001–2 I.R.B. 277
2001–2, 2001–2 I.R.B. 277
2001–3, 2001–2 I.R.B. 278
2001–4, 2001–2 I.R.B. 286
2001–5, 2001–2 I.R.B. 286
2001–6, 2001–3 I.R.B. 357
2001–7, 2001–3 I.R.B. 357
2001–8, 2001–3 I.R.B. 357
2001–9, 2001–3 I.R.B. 357
Notices:
2001–1, 2001–2 I.R.B. 261
2001–2, 2001–2 I.R.B. 265
2001–3, 2001–2 I.R.B. 267
2001–4, 2001–2 I.R.B. 267
2001–5, 2001–3 I.R.B. 327
2001–6, 2001–3 I.R.B. 327
2001–12, 2001–3 I.R.B. 328
Proposed Regulations:
REG–107566–00, 2001–3, I.R.B. 346
Railroad Retirement Quarterly Rates:
2001–2 I.R.B. 258
Revenue Procedures:
2001–1, 2001–1 I.R.B. 1
2001–2, 2001–1 I.R.B. 79
2001–3, 2001–1 I.R.B. 111
2001–4, 2001–1 I.R.B. 121
2001–5, 2001–1 I.R.B. 164
2001–6, 2001–1 I.R.B. 194
2001–7, 2001–1 I.R.B. 236
2001–8, 2001–1 I.R.B. 239
2001–9, 2001–3 I.R.B. 328
2001–10, 2001–2 I.R.B. 272
2001–11, 2001–2 I.R.B. 275
2001–12, 2001–3 I.R.B. 335
2001–13, 2001–3 I.R.B. 337
2001–14, 2001–3 I.R.B. 343
Revenue Rulings:
2001–2, 2001–2 I.R.B. 255
2001–3, 2001–3 I.R.B. 319
2001–4, 2001–3 I.R.B. 295
Treasury Decisions:
8910, 2001–2 I.R.B. 258
8911, 2001–3 I.R.B. 321
8913, 2001–3 I.R.B. 300
1
A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2000–27 through
2000–52 is in Internal Revenue Bulletin 2001–1,
dated January 2, 2001.

2001–4 I.R.B.iiiJanuary 22, 2001
Finding List of Current Actions on
Previously Published Items
1
Bulletins 2001–1 through 2001–3
Announcements:
98–99
Modified by
Ann. 2001–9, 2001–3 I.R.B. 357
99–79
Superseded by
Ann. 2001–3, 2001–2 I.R.B. 278
2000–97
Corrected by
Ann. 2001–7, 2001–3 I.R.B. 357
Cumulative Bulletin:
1998–2
Corrected by
Ann. 2001–5, 2001–2 I.R.B. 286
Notices:
2000–21
Superseded by
Notice 2001–1, 2001–2 I.R.B. 261
Revenue Procedures:
96–17
Modified by
Rev. Proc. 2001–9, 2001–3 I.R.B. 328
99–49
Modified and Amplified by
Rev. Proc. 2001–10, 2001–2 I.R.B. 272
2000–1
Superseded by
Rev. Proc. 2001–1, 2001–1 I.R.B. 1
2000–2
Superseded by
Rev. Proc. 2001–2, 2001–1 I.R.B. 79
2000–3
Superseded by
Rev. Proc. 2001–3, 2001–1 I.R.B. 111
2000–4
Superseded by
Rev. Proc. 2001–4, 2001–1 I.R.B. 121
2000–5
Superseded by
Rev. Proc. 2001–5, 2001–1 I.R.B. 164
2000–6
Superseded by
Rev. Proc. 2001–6, 2001–1 I.R.B. 194
2000–7
Superseded by
Rev. Proc. 2001–7, 2001–1 I.R.B. 236
2000–8
Superseded by
Rev. Proc. 2001–8, 2001–1 I.R.B. 239
2000–22
Modified and superseded by
Rev. Proc. 2001–10, 2001–2 I.R.B. 272
2001–13
Clarified by
Notice 2001–12, 2001–3 I.R.B. 328
Treasury Decisions:
8889
Corrected by
Ann. 2001–14, 2001–2 I.R.B. 286
1
A cumulative list of current actions on previously
published items in Internal Revenue Bulletins
2000–27 through 2000–52 is in Internal Revenue
Bulletin 2001–1, dated January 2, 2001.

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