Internal Revenue Bulletin 1996-6 (PDF rendition): IRS Revenue Rulings

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Bulletin No. 1996–6
February 5, 1996
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 96–14, page 20.
Federal rates; adjusted federal rates; adjusted federal
long-term rate, and the long-term exempt rate. For
purposes of sections 1274, 1288, 382, and other
sections of the Code, tables set forth the rates for
February 1996.
T.D. 8641, page 4.
Final regulations under sections 597 and 7507 of the
Code relating to the treatment of acquisition of certain
financial institutions and certain tax consequences of
Federal financial assistance to financial institutions.
INTL–3–95, page 29.
Proposed regulations under section 863 of the Code
relating to the source of income from sales of inventory
and natural resources produced in one jurisdiction and
sold in another jurisdiction. A public hearing will be
held on April 16, 1996.
EMPLOYEE PLANS
Notice 96–8, page 23.
Determining amount of single sum distributions from cash
balance plans. This notice provides guidance concerning
the requirements of section 411(a) and 417(e) with
respect to the determination of the amount of a single
sum distribution from a cash balance plan. The notice
also describes proposed guidance to be issued later in
regulations that would provide a list of standard indices
and associated margins for use by cash balance plans
in determining the amount of interest credits.
Notice 96–9, page 26.
Guidelines are set forth for determining for January
1996, the weighted average interest rate and the
resulting permissible range of interest rates used to
calculate current liability for purposes of the full
funding limitation of section 412(c)(7) of the Code as
amended by the Omnibus Budget Reconciliation Act of
1987 and by the Uruguay Round Agreements Act
(GATT).
ADMINISTRATIVE
Notice 96–5, page 22.
Estimated tax payments for individuals. The Service will
waive penalties for individuals who are residents of the
District of Columbia, Connecticut, Delaware, Kentucky,
Maine, Maryland, Massachusetts, New Hampshire, New
Jersey, New York, North Carolina, Pennsylvania, Rhode
Island, Vermont, Virginia, and West Virginia for the 4th
installment payment of estimated tax if that payment
was made on or before 1/22/96.
Notice 96–7, page 22.
Capital expenditures. Public comment is invited on
approaches the Service should consider to address
issues raised under sections 162 and 263 of the Code
particularly in light of INDOPCO vs Commissioner, 503
U.S. 79 (1992).
DL–1–95, page 28.
Proposed regulations under section 6103 of the Code
relate to the disclosure of returns and return informa-
tion in connection with the procurement of property and
services for tax administration purposes.
Finding Lists begin on page 45.
Announcement of Disbarments and Suspensions begin on page 42.
Monthly Index for January begins on page 47.

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

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

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 42.—Low-Income Housing
Credit
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 280G.—Golden Parachute
Payments
Federal short-term, mid-term, and long-term
rates are set forth for the month of February
1996. See Rev. Rul. 96–14, page 20.
Section 382.—Limitation on Net
Operating Loss Carryforwards and
Certain Built-In Losses Following
Ownership Change
The adjusted federal long-term rate is set forth
for the month of February 1996. See Rev. Rul.
96–14, page 20.
Section 412.—Minimum Funding
Standards
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 467.—Certain Payments for
the Use of Property or Services
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 468.—Special Rules for
Mining and Solid Waste Reclamation
and Closing Costs
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 483.—Interest on Certain
Deferred Payments
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 597.—Treatment of
Transactions in Which Federal
Financial Assistance Provided
26 CFR 1.597–1: Definitions
T.D. 8641
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 301 and 602
Treatment of Acquisition of Certain
Financial Institutions; Certain Tax
Consequences of Federal Financial
Assistance to Financial Institutions
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to Federal
financial assistance, as defined in sec-
tion 597(c) of the Internal Revenue
Code, that is received by a financially
troubled bank or thrift institution, and
to acquisitions of financially troubled
bank or thrift institutions in which
Federal financial assistance is provided.
This document also contains final
regulations under section 7507. These
regulations provide guidance concern-
ing the proper tax treatment of various
transactions involving the receipt of
Federal financial assistance.
DATES: These regulations are effective
December 21, 1995.
For dates of applicability, see the
‘‘§1.597-7 Effective date’’ section un-
der the ‘‘SUPPLEMENTARY INFOR-
MATION’’ portion of the preamble and
the effective date provisions (§1.597–7)
of this document.
FOR FURTHER INFORMATION
CONTACT: Steven M. Flanagan at
202-622-7790, Vicki J. Hyche at
202-622-7530, William D. Alexander at
202-622-7710, or Steven R. Glickstein
a t 2 0 2 - 6 2 2 - 4 4 3 9 ( n o t t o l l - f r e e
numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information con-
tained in these final regulations have
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduc-
tion Act (44 U.S.C. 3507) under
control number 1545–1300. Responses
to these collections of information are
required to track deferred income and
its subsequent recapture, elect to dis-
affiliate earlier than would otherwise be
permitted, elect to apply the provisions
of the regulation retroactively, and
report uncollected income tax.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number.
The estimated annual burden per
respondent/recordkeeper varies from 1
hour to 11 hours, depending on individ-
ual circumstances, with an estimated
average of 4.4 hours.
Comments concerning the accuracy
of this burden estimate and suggestions
for reducing this burden should be sent
to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer T:FP,
Washington, DC 20224, and to the
Office of Management and Budget,
Attn: Desk Officer for the Department
of the Treasury, Office of Information
and Regulatory Affairs, Washington,
DC 20503.
Books or records relating to these
collections of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
This document contains final regula-
tions under section 597, as amended by
section 1401 of the Financial Institu-
tions Reform, Recovery, and Enforce-
ment Act of 1989 (Public Law 101–73)
(FIRREA). The regulations provide
guidance for banks and domestic build-
ing and loan associations (Institutions)
and their affiliates in connection with
receipt of Federal financial assistance
(FFA), as defined in section 597(c).
Section 597(a) delegates to the Sec-
retary of the Treasury authority to
prescribe regulations concerning ‘‘any
transaction in which Federal financial
assistance is provided.’’ These regula-

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tions are issued under the authority of
section 597(a).
This document also amends the
regulations under section 7507 to re-
flect the treatment of FFA under
FIRREA.
The IRS published proposed regula-
tions under sections 597 and 7507 on
April 22, 1992 (57 FR 14794, FI–46–
89, 1992–1 C.B. 1037).
Public Comments and the Final
Regulations
The IRS received comments on the
proposed regulations, and a public
hearing was held on July 17, 1992.
After consideration of the comments
and the statements made at the hearing,
the proposed regulations are adopted as
revised by this Treasury decision. The
principal comments and revisions are
discussed below.
§1.597–2 Taxation of FFA
Section 1.597–2 contains rules con-
cerning accounting for FFA as income.
The final regulations retain the pro-
posed rule that, generally, FFA is
income to the failed Institution when it
is received or accrued in accordance
with the Institution’s method of ac-
counting. Section 1.597–2(c) contains
rules permitting certain Institutions to
defer the inclusion of FFA.
Deferral formula without Continuing
Equity. Under the proposed regulations,
unresolved Institutions without Contin-
uing Equity were permitted to defer
inclusion of FFA in excess of amounts
determined under a formula. The pro-
posed formula required current inclu-
sion equal to the sum of liabilities less
aggregate adjusted basis at the begin-
ning of the assistance year (represent-
ing losses already recognized), plus
loss in the current year (disregarding
FFA). The proposed formula generally
allowed the Institution the benefit of
any prior losses of its owners’ equity,
but offset any losses of creditors’
capital by the inclusion of FFA. How-
ever, with respect to losses during the
year FFA is received, the proposed
formula did not distinguish between
losses of owners’ equity and losses of
creditors’ capital and, therefore, offset
losses of owners’ equity by inclusion
of FFA. The formula (together with
related recapture rules) in the final
regulations has been changed to reflect
that the owners’ equity is the first
capital lost and, in a transaction with-
out Continuing Equity, is not offset by
inclusion of FFA.
Deferral formula with Continuing
Equity. The proposed regulations al-
lowed deferral under different condi-
tions where Continuing Equity is pres-
ent. In that case, the Institution must
include currently, in addition to the
normal formula amount, income equal
to all net operating loss carryovers
available to it. Also, an Institution with
Continuing Equity must recapture de-
ferred FFA at least as quickly as pro
rata over a maximum of six years,
regardless of whether it recognizes all
of its built-in losses during that time.
Commentators suggested that the
proposed regulations unfairly limited
deferral for Institutions with Continuing
Equity and recommended the same de-
ferral formula apply in all cases. They
criticized the Continuing Equity con-
cept because it focused on the identity
of the Institution’s shareholders after
the assistance transaction.
Under the definition of Continuing
Equity in the proposed regulations, an
Institution generally would have Con-
tinuing Equity if five percent or more
of its stock at the end of a taxable year
was owned by shareholders who owned
stock before the Institution was placed
in receivership by a supervisory agency
(Agency) or first received FFA. The
five percent reference was misleading
because, under §1.597–5, a 50 percent
change in ownership generally results
in a deemed Taxable Transfer (now
defined in §1.597–5(a)(1)) in which the
failed Institution is treated as a New
Entity. The deferral rules do not apply
after a deemed Taxable Transfer. The
final regulations thus clarify that Con-
tinuing Equity exists only if the Institu-
tion is not (i) a Bridge Bank, (ii) in
Agency receivership, or (iii) treated as
a New Entity. The modification to the
definition of Continuing Equity is not
intended as a substantive change. The
Continuing Equity deferral provisions
apply only to the limited number of
‘‘open bank’’ resolutions not subject to
the deemed Taxable Transfer rules. (As
discussed below, the Taxable Transfer
definitions have also been modified to
clarify that most ‘‘open bank’’ assisted
transactions are treated as Taxable
Transfers.)
The final regulations do not elimi-
nate the special treatment of Institu-
tions with Continuing Equity. The
regulations provide deferral rules to
ameliorate a timing mismatch between
FFA income and related losses. Defer-
ral is not designed to allow built-in
losses to offset operating income in-
stead of FFA or to permit the perma-
nent elimination of any subsidy
provided by Agency. The requirement
that Institutions with Continuing Equity
recapture their deferred FFA within six
years is a reasonable safeguard against
indefinite deferral of FFA income. The
results under these rules are compar-
able in effect to those applicable to
acquirors in Taxable Transfers.
The final regulations do, however,
modify the Continuing Equity formula,
which, in the proposed regulations,
counted some losses twice. Recognized
losses represented in the first prong of
the formula (liabilities minus asset
bases) may comprise part of the third
prong (net operating losses available to
the Institution or its consolidated
group). The final regulations correct
this double counting of losses.
Transfers of money and property to
Agency. The proposed regulations con-
tained rules for taxing FFA if money or
property is also transferred to Agency.
These rules, together with rules for the
treatment of FFA received pursuant to
a Loss Guarantee, have been clarified,
reorganized, and restated in §1.597–
2(d).
The proposed regulations provided
an offset or deduction for payments by
an Institution to Agency to the extent
of previously received FFA. The rule
as proposed provided limited relief for
payments made to Agency by a New
Entity or Acquiring, because they re-
ceive little or no FFA. However, an
assisted acquisition can result in in-
come to a New Entity or Acquiring in
the form of built-in gain. Under section
597(c) and §1.597–3(b), an instrument
issued to Agency by a New Entity or
Acquiring is, in effect, disregarded. If a
New Entity or Acquiring issues its
instrument to Agency in connection
with the acquisition of an Institution,
the value of the instrument is not
included in the purchase price. Conse-
quently, a New Entity or Acquiring
may have a basis shortfall in the assets
acquired (or deemed acquired) from the
failed Institution. The final regulations
provide a New Entity or Acquiring a
purchase price adjustment upon any
transfer to Agency (e.g., in satisfaction
of the disregarded instrument).
In response to comments, the final
regulations also specifically provide for

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repayments to Agency by Institution
affiliates. Moreover, the final regula-
tions provide that if Agency sells an
Institution’s instrument to a third party,
the sales price is treated as a repayment
to Agency by the issuer. Furthermore,
the instrument is treated as having been
newly issued by the issuer to the holder
at that time. The IRS and Treasury
believe that this is an appropriate time
for the issuer to offset FFA or increase
its basis, because the sales price
reasonably fixes the value of the
instrument, and any subsequent cost
associated with the instrument should
be accounted for in accordance with
the nature of the instrument.
§1.597–4(g) Elective disaffiliation
The proposed regulations would al-
low a consolidated group to elect (after
the regulations became final) to ex-
clude an Institution in receivership
from its group. The election potentially
requires the inclusion of a ‘‘toll
charge’’ in the income of those mem-
bers owning the common stock of the
Institution (the member shareholders).
The amount of the toll charge is the
excess of the disaffiliated Institution’s
liabilities over the adjusted basis of its
assets. The toll charge is intended to
reflect the amount that would be
included in income if Agency were to
provide the entire amount of FFA
necessary to restore the Institution’s
solvency at the time of the event
permitting disaffiliation. Commentators
suggested that the final regulations
should include the toll charge in the
income of the disaffiliated Institution
(rather than its member shareholders),
provide the group with a ‘‘toll charge
deduction,’’ and clarify the ability of
the member shareholders to take a
worthless stock deduction.
Toll charge. Commentators sug-
gested that the final regulations include
the toll charge in the income of the
failed Institution rather than its member
shareholders. According to the com-
mentators, including the toll charge in
the income of the member shareholders
may result in disadvantageous state tax
consequences in those states where
banking corporations are not permitted
to file consolidated returns with non-
banking corporations. Under the pro-
posed regulations, a bank holding cor-
poration (the disaffiliated Institution’s
shareholder) would have to include in
income the toll charge without the
benefit of the Institution’s offsetting
losses.
The IRS and Treasury agree that the
toll charge is more appropriately in-
cluded in the income of the Institution
(i.e., the entity that is reimbursed by
Agency for its loss), because the toll
charge represents accelerated FFA in-
come. Thus, the final regulations
provide that the Institution, rather than
its member shareholders, takes the toll
charge into income.
Toll charge deduction. Under the
proposed regulations, the Institution
does not recognize built-in losses on
disaffiliation. One commentator sug-
gested the final regulations provide for
a ‘‘toll charge deduction’’ for the
excess of the Institution’s adjusted
basis over its liabilities. According to
the commentator, such a deduction is
appropriate because the Institution in-
curred economic loss while it was a
member of the consolidated group,
before the Institution was placed in
receivership by Agency.
The commentator’s recommendation
is not adopted in the final regulations
because a toll charge deduction would
accelerate recognition of losses in
advance of realization. Such a deduc-
tion is particularly inappropriate be-
cause federal banking laws now permit
placing solvent institutions in receiver-
ship. In such cases, it is uncertain
whether the loss represented by such a
deduction will ever be realized.
Worthless stock deduction. Under the
proposed regulations, if an election to
disaffiliate is made, the members of the
consolidated group are treated as hav-
ing disposed of their stock in the
Institution. One commentator suggested
that the final regulations clarify that,
upon disaffiliation, the Institution’s
stock is worthless.
The final regulations address the
commentator’s concerns by providing
that, as a consequence of the election,
the members of the consolidated group
treat their stock in the Institution as
worthless if the Institution is factually
insolvent on the date the Institution is
placed in receivership (or on the date
the consolidated group is deemed to
make the election to disaffiliate). This
rule preempts otherwise applicable tests
for worthlessness under section 165
and §1.1502–19. Any worthless stock
deduction is subject to the limitations
of the loss disallowance regulations
(§§1.337(d)–1 and 1.1502–20).
Consistency rule. Under the proposed
regulations, a consolidated group could
elect to disaffiliate a subsidiary Institu-
tion only if the Institution was its first
subsidiary placed in Agency receiver-
ship after the enactment of FIRREA.
The election made for the first subsidi-
ary bound all future subsidiaries placed
in Agency receivership. To address the
concern that the scope of the proposed
consistency rule was too broad, the
final regulations modify the consistency
rule to require, generally, that a consol-
idated group must elect consistently
only for subsidiary Institutions placed
in Agency receivership within five
years of each other.
§1.597–5 Taxable Transfers
Section 597 applies to FFA and
transactions in connection with which
FFA is provided. The proposed regula-
tions generally define a Taxable Trans-
fer as a transfer of deposit liabilities or
stock while an Institution is under
Agency Control. However, IRS and
Treasury now understand that it is
possible for Agency to resolve an
Institution under its control without
providing assistance, or to provide
assistance without placing an Institution
under its control. In light of this
information, the final regulations refine
the definition of a Taxable Transfer.
Under the final regulations, Taxable
Transfers include the transfer of any
deposit liability in connection with
which FFA is provided or the transfer
of any asset for which Agency has an
obligation (e.g., assets covered by Loss
Guarantees). Certain transfers of stock
cause a Taxable Transfer if FFA is
provided in connection with the trans-
fer, if the Institution is a Bridge Bank
or if the Institution has a balance in its
deferred FFA account. The phrase ‘‘in
connection with’’ should be interpreted
broadly. If any party to a transaction
receives FFA, all parties and all related
transactions are within the scope of
these regulations. To provide certainty
regarding tax treatment for purchasers
of stock of subsidiaries of Institutions
under Agency Control, the final regula-
tions treat all transactions in which
such a subsidiary leaves its group as
Taxable Transfers.
§1.597–6 Limitation on collection of
income tax
Limitation where tax is borne by
Agency. The proposed regulations
provided that income tax attributable to
the receipt of FFA or gain on a

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Taxable Transfer would not be col-
lected from an Institution without Con-
tinuing Equity if Agency would bear
the burden of the tax. Commentators
suggested that the limitation on non-
collection in cases of Continuing
Equity is inappropriate because it re-
quires Agency to gross-up any assist-
ance paid to cover the tax thereon.
The final regulations retain the lim-
itation on noncollection in cases of
Continuing Equity. The IRS and Treas-
ury believe that the limitation is
appropriate for transactions in which
Agency assists an Institution while
allowing old shareholders to retain their
ownership. Noncollection should not
inure to the benefit of the Institution’s
old shareholders, who would have use
of the Institution’s losses while escap-
ing responsibility for the tax on related
FFA income. The congressional pur-
pose in FIRREA to eliminate any tax
subsidy for assisted transactions re-
quires that the IRS not waive its rights
as a creditor in cases where all other
creditors and equity holders retain their
rights.
Transferee liability. The proposed
regulations limited the collection of a
failed Institution’s income taxes from a
transferee in a Taxable Transfer (i.e., a
New Entity or Acquiring). This rule
would not apply if (similar to the
Continuing Equity rule discussed above
under the heading ‘‘Deferral formula
with Continuing Equity’’) there is a
five percent overlap in the ownership
of the transferor Institution and the
New Entity or Acquiring.
Commentators suggested that the
final regulations should not include the
five percent overlap exception because
the exception appears to punish former
owners of Institutions, Institutions have
difficulty tracking ownership, and the
exception contains no limits on ag-
gregation.
Because good faith purchasers of
assets for value generally do not have
transferee liability, the final regulations
clarify that Acquiring (the purchaser of
Institution’s assets in an actual Taxable
Transfer) is not subject to such liability
in any case. This rule applies even if
shareholders of Acquiring were share-
holders of the selling Institution.
The final regulations do not, how-
ever, except a New Entity (the resulting
corporation in a deemed Taxable
Transfer) from collection if the Institu-
tion’s previous equity interests remain
outstanding in the New Entity, or are
reacquired or exchanged for considera-
tion. As in those cases in which a
Taxable Transfer does not occur, the
IRS should remain a creditor if all
other creditors retain their interests and
the Institution’s previous equity inter-
ests had retained value. However, by
focusing on whether previous equity
interests retain value, the final regula-
tions eliminate the need to track or
aggregate ownership and do not penal-
ize any particular potential acquirors.
§1.597–7 Effective Date
As proposed, these final regulations
generally apply to taxable years ending
on or after April 22, 1992. However,
the provisions of these regulations do
not apply to FFA received or accrued
for taxable years ending after April 22,
1992, in connection with an Agency
assisted acquisition that occurs before
April 22, 1992. Taxpayers not subject
to these regulations must comply with
an interpretation of the statute that is
reasonable in light of the legislative
history and applicable administrative
pronouncements. For this purpose, the
rules contained in Notice 89–102
(1989–2 C.B. 436) apply to the extent
provided in the Notice.
An irrevocable election is available
to apply the regulations to taxable
years prior to the general effective
date. However, the election cannot be
made if the Institution’s statute of
limitations has expired or a section 338
election was available but not made for
the Institution. In addition, consistent
treatment is required in ‘‘open bank’’
resolutions that would result under the
regulations in deemed Taxable Trans-
fers before April 22, 1992.
The proposed regulations required an
electing taxpayer to extend the statute
of limitations for all items for three
years from the date of filing the
election. The final regulations adopt a
commentator’s suggestion that the tax-
payer extend the statute of limitations
only for items affected by application
of the regulations.
An Institution or consolidated group
makes the election on its first annual
income tax return filed on or after
March 15, 1996. However, to make the
affirmative election to disaffiliate under
§1.597–4(g)(5) for an Institution placed
in Agency receivership in a taxable
year ending before April 22, 1992, a
consolidated group must send the af-
fected Institution the required statement
advising it of the elective disaffiliation
on or before May 31, 1996. In that
case, the consolidated group is deemed
to have elected retroactive application
of these regulations but must neverthe-
less attach the required statement to its
first annual income tax return filed on
or after March 15, 1996.
The final regulations provide that
taxpayers may rely on the provisions of
the proposed regulations to the extent
they acted in reliance on the proposed
regulations prior to December 21,
1995. Such reliance must be reasonable
and transactions with respect to which
such taxpayers rely must be consistent
with the overriding policies of section
597, as expressed in the legislative
history, as well as the overriding
policies of the proposed regulations.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It is hereby
certified that these regulations do not
have a significant economic impact on
a substantial number of small entities.
This certification is based on the fact
that these regulations will generally
only apply to certain financially trou-
bled financial institutions and the con-
solidated groups, if any, to which they
belong. Therefore, a Regulatory Flex-
ibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is
not required. Pursuant to section
7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking
preceding these regulations was submit-
ted to the Chief Counsel for Advocacy
of the Small Business Administration
for comment on its impact on small
business.
Drafting Information
The principal author of these regula-
tions is Steven M. Flanagan, Office of
the Assistant Chief Counsel (Corpo-
rate), IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
******
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1, 301
and 602 are amended as follows:

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PART 1—INCOME TAXES
Paragraph 1. The authority for part 1
is amended by adding the following
citation:
Authority: 26 U.S.C. 7805 * * *
Sections 1.597–1 through 1.597–7 also
issued under 26 U.S.C. 597 and 1502.
Par. 2. Sections 1.597–1 through
1.597–7 are added to read as follows:
§1.597–1 Definitions.
For purposes of the regulations under
section 597—
(a)Unless the context otherwise re-
quires, the terms consolidated group,
member and subsidiary have the mean-
ings provided in §1.1502–1; and
(b)The following terms have the
meanings provided below—
Acquiring. The term Acquiring
means a corporation that is a transferee
in a Taxable Transfer, other than a
deemed transferee in a Taxable Trans-
fer described in §1.597–5(b).
Agency. The term Agency means the
Resolution Trust Corporation, the Fed-
eral Deposit Insurance Corporation, any
similar instrumentality of the United
States government, and any predecessor
or successor of the foregoing (including
the Federal Savings and Loan Insur-
ance Corporation).
Agency Control. An Institution or
entity is under Agency Control if
Agency is conservator or receiver of
the Institution or entity, or if Agency
has the right to appoint any of the
Institution’s or entity’s directors.
Agency Obligation. The term Agency
Obligation means a debt instrument
that Agency issues to an Institution or
to a direct or indirect owner of an
Institution.
Bridge Bank. The term Bridge Bank
means an Institution that is organized
by Agency to hold assets and liabilities
of another Institution and that continues
the operation of the other Institution’s
business pending its acquisition or
liquidation, and that is any of the
following—
(1)A national bank chartered by the
Comptroller of the Currency under sec-
tion 11(n) of the Federal Deposit In-
surance Act (12 U.S.C. 1821(n)) or sec-
tion 21A(b)(10)(A) of the Federal Home
Loan Bank Act (12 U.S.C. 1441a(b)-
(10)(A)) or any successor sections;
(2)A Federal savings association
chartered by the Director of the Office
of Thrift Supervision under section
21A(b)(10)(A) of the Federal Home
Loan Bank Act (12 U.S.C. 1441a(b)-
(10)(A)) or any successor section; or
(3)A similar Institution chartered
under any other statutory provisions.
Consolidated Subsidiary. The term
Consolidated Subsidiary means a mem-
ber of the consolidated group of which
an Institution is a member that bears
the same relationship to the Institution
that the members of a consolidated
group bear to their common parent
under section 1504(a)(1).
Continuing Equity. An Institution has
Continuing Equity for any taxable year
if, on the last day of the taxable year,
the Institution is not (1) a Bridge Bank,
(2) in Agency receivership, or (3)
treated as a New Entity.
Controlled Entity. The term Con-
trolled Entity means an entity under
Agency Control.
Federal Financial Assistance (FFA).
The term Federal Financial Assistance
(FFA), as defined by section 597(c),
means any money or property provided
by Agency to an Institution or to a
direct or indirect owner of stock in an
Institution under section 406(f) of the
National Housing Act (12 U.S.C.
1729(f)), section 21A(b)(4) of the
Federal Home Loan Bank Act (12
U.S.C. 1441a(b)(4)), section 11(f) or
13(c) of the Federal Deposit Insurance
Act (12 U.S.C. 1821(f), 1823(c)), or
under any similar provision of law.
Any such money or property is FFA,
regardless of whether the Institution or
any of its affiliates issues Agency a
note or other obligation, stock, war-
rants, or other rights to acquire stock in
connection with Agency’s provision of
the money or property. FFA includes
Net Worth Assistance, Loss Guarantee
payments, yield maintenance payments,
cost to carry or cost of funds reim-
bursement payments, expense reim-
bursement or indemnity payments, and
interest (including original issue dis-
count) on an Agency Obligation.
Institution. The term Institution
means an entity that is, or immediately
before being placed under Agency
Control was, a bank or domestic
building and loan association within the
meaning of section 597 (including a
Bridge Bank). Except as otherwise
provided in the regulations under sec-
tion 597, the term Institution includes a
New Entity or Acquiring that is a bank
or domestic building and loan associa-
tion within the meaning of section 597.
Loss Guarantee. The term Loss
Guarantee means an agreement pur-
suant to which Agency or a Controlled
Entity guarantees or agrees to pay an
Institution a specified amount upon the
disposition or charge-off (in whole or
in part) of specific assets, an agreement
pursuant to which an Institution has a
right to put assets to Agency or a
Controlled Entity at a specified price,
or a similar arrangement.
Net Worth Assistance. The term Net
Worth Assistance means money or
property (including an Agency Obliga-
tion to the extent it has a fixed
principal amount) that Agency provides
as an integral part of a Taxable
Transfer, other than FFA that accrues
after the date of the Taxable Transfer.
For example, Net Worth Assistance
does not include Loss Guarantee pay-
ments, yield maintenance payments,
cost to carry or cost of funds reim-
bursement payments, or expense reim-
bursement or indemnity payments. An
Agency Obligation is considered to
have a fixed principal amount notwith-
standing an agreement providing for its
adjustment after issuance to reflect a
more accurate determination of the
condition of the Institution at the time
of the acquisition.
New Entity. The term New Entity
means the new corporation that is
treated as purchasing all of the assets
of an Old Entity in a Taxable Transfer
described in §1.597–5(b).
Old Entity. The term Old Entity
means the Institution or Consolidated
Subsidiary that is treated as selling all
of its assets in a Taxable Transfer
described in §1.597–5(b).
Residual Entity. The term Residual
Entity means the entity that remains
after an Institution transfers deposit
liabilities to a Bridge Bank.
Taxable Transfer. The term Taxable
Transfer has the meaning provided in
§1.597–5(a)(1).
§1.597–2 Taxation of Federal
Financial Assistance.
(a)Inclusion in income—(1) In gen-
eral. Except as otherwise provided in
the regulations under section 597, all
FFA is includible as ordinary income
to the recipient at the time the FFA is
received or accrued in accordance with
the recipient’s method of accounting.
The amount of FFA received or ac-
crued is the amount of any money, the
fair market value of any property (other

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than an Agency Obligation), and the
issue price of any Agency Obligation
(determined under §1.597–3(c)(2)). An
Institution (and not the nominal recip-
ient) is treated as receiving directly any
FFA that Agency provides in a taxable
year to a direct or indirect shareholder
of the Institution, to the extent money
or property is transferred to the Institu-
tion pursuant to an agreement with
Agency.
(2)Cross references. See paragraph
(c) of this section for rules regarding
the timing of inclusion of certain FFA.
See paragraph (d) of this section for
additional rules regarding the treatment
of FFA received in connection with
transfers of money or property to
Agency or a Controlled Entity, or paid
pursuant to a Loss Guarantee. See
§1.597–5(c)(1) for additional rules re-
garding the inclusion of Net Worth
Assistance in the income of an
Institution.
(b)Basis of property that is FFA. If
FFA consists of property, the Institu-
tion’s basis in the property equals the
fair market value of the property (other
than an Agency Obligation) or the
issue price of the Agency Obligation,
as determined under §1.597–3(c)(2).
(c)Timing of inclusion of certain
FFA—(1) Scope. This paragraph (c)
limits the amount of FFA an Institution
must include in income currently under
certain circumstances and provides
rules for the deferred inclusion in
income of amounts in excess of those
limits. This paragraph (c) does not
apply to a New Entity or Acquiring.
(2)Amount currently included in
income by an Institution without Con-
tinuing Equity. The amount of FFA an
Institution without Continuing Equity
must include in income in a taxable
year under paragraph (a)(1) of this
section is limited to the sum of—
(i)The excess at the beginning of
the taxable year of the Institution’s
liabilities over the adjusted bases of the
Institution’s assets; and
(ii)The amount by which the excess
for the taxable year of the Institution’s
deductions allowed by chapter 1 of the
Internal Revenue Code (other than net
operating and capital loss carryovers)
over its gross income (determined
without regard to FFA) is greater than
the excess at the beginning of the
taxable year of the adjusted bases of
the Institution’s assets over the Institu-
tion’s liabilities.
(3)Amount currently included in
income by an Institution with Continu-
ing Equity. The amount of FFA an
Institution with Continuing Equity must
include in income in a taxable year
under paragraph (a)(1) of this section is
limited to the sum of—
(i)The excess at the beginning of
the taxable year of the Institution’s
liabilities over the adjusted bases of the
Institution’s assets;
(ii)The greater of—
(A)The excess for the taxable year
of the Institution’s deductions allowed
by chapter 1 of the Internal Revenue
Code (other than net operating and
capital loss carryovers) over its gross
income (determined without regard to
FFA); or
(B)The excess for the taxable year
of the deductions allowed by chapter 1
of the Internal Revenue Code (other
than net operating and capital loss
carryovers) of the consolidated group
of which the Institution is a member on
the last day of the Institution’s taxable
year over the group’s gross income
(determined without regard to FFA);
and
(iii)The excess of the amount of
any net operating loss carryover of the
Institution (or in the case of a car-
ryover from a consolidated return year
of the Institution’s current consolidated
group, the net operating loss carryover
of the group) to the taxable year over
the amount described in paragraph
(c)(3)(i) of this section.
(4)Deferred FFA—(i) Maintenance
of account. An Institution must
establish a deferred FFA account com-
mencing in the first taxable year in
which it receives FFA that is not
currently included in income under
paragraph (c)(2) or (c)(3) of this
section, and must maintain that account
in accordance with the requirements of
this paragraph (c)(4). The Institution
must add the amount of any FFA that
is not currently included in income
under paragraph (c)(2) or (c)(3) of this
section to its deferred FFA account.
The Institution must decrease the bal-
ance of its deferred FFA account by the
amount of deferred FFA included in
income under paragraphs (c)(4)(ii), (iv)
and (v) of this section. (See also
paragraph (d)(5)(i)(B) of this section
for other adjustments that decrease the
deferred FFA account.) If, under para-
graph (c)(3) of this section, FFA is not
currently included in income in a
taxable year, the Institution thereafter
must maintain its deferred FFA account
on a FIFO (first in, first out) basis
(e.g., for purposes of the first sentence
of paragraph (c)(4)(iv) of this section).
(ii)Deferred FFA recapture. In any
taxable year in which an Institution has
a balance in its deferred FFA account,
it must include in income an amount
equal to the lesser of the amount
described in paragraph (c)(4)(iii) of this
section or the balance in its deferred
FFA account.
(iii)Annual recapture amount—(A)
I n s t i t u t i o n s w i t h o u t C o n t i n u i n g
Equity—(1) In general. In the case of
an Institution without Continuing
Equity, the amount described in this
paragraph (c)(4)(iii) is the amount by
which—
(i) The excess for the taxable year of
the Institution’s deductions allowed by
chapter 1 of the Internal Revenue Code
(other than net operating and capital
loss carryovers) over its gross income
(taking into account FFA included in
income under paragraph (c)(2) of this
section); is greater than
(ii) The Institution’s remaining
equity as of the beginning of the
taxable year.
(2)Remaining equity. The Institu-
tion’s remaining equity is—
(i) The amount at the beginning of
the taxable year in which the deferred
FFA account was established equal to
the adjusted bases of the Institution’s
assets minus the Institution’s liabilities
(which amount may be positive or
negative); plus
(ii) The Institution’s taxable income
(computed without regard to any car-
ryover from any other year) in any
subsequent taxable year or years; minus
(iii) The excess in any subsequent
taxable year or years of the Institu-
tion’s deductions allowed by chapter 1
of the Internal Revenue Code (other
than net operating and capital loss
carryovers) over its gross income.
(B)Institutions with Continuing
Equity. In the case of an Institution
with Continuing Equity, the amount
described in this paragraph (c)(4)(iii) is
the amount by which the Institution’s
deductions allowed by chapter 1 of the
Internal Revenue Code (other than net
operating and capital loss carryovers)
exceed its gross income (taking into
account FFA included in income under
paragraph (c)(3) of this section).
(iv)Additional deferred FFA recap-
ture by an Institution with Continuing
Equity. To the extent that, as of the end
of a taxable year, the cumulative

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amount of FFA deferred under para-
graph (c)(3) of this section that an
Institution with Continuing Equity has
recaptured under this paragraph (c)(4)
is less than the cumulative amount of
FFA deferred under paragraph (c)(3) of
this section that the Institution would
have recaptured if that FFA had been
included in income ratably over the six
taxable years immediately following
the taxable year of deferral, the Institu-
tion must include that difference in
income for the taxable year. An Institu-
tion with Continuing Equity must in-
clude in income the balance of its
deferred FFA account in the taxable
year in which it liquidates, ceases to do
business, transfers (other than to a
Bridge Bank) substantially all of its
assets and liabilities, or is deemed to
transfer all of its assets under §1.597–
5(b).
(v)Optional accelerated recapture
of deferred FFA. An Institution that has
a deferred FFA account may include in
income the balance of its deferred FFA
account on its timely filed (including
extensions) original income tax return
for any taxable year that it is not under
Agency Control. The balance of its
deferred FFA account is income on the
last day of that year.
(5)Exceptions to limitations on use
of losses. In computing an Institution’s
taxable income or alternative minimum
taxable income for a taxable year,
sections 56(d)(1), 382 and 383 and
§§1.1502–15, 1.1502–21 and 1.1502–
22 do not limit the use of the attributes
of the Institution to the extent, if any,
that the inclusion of FFA (including
recaptured FFA) in income results in
taxable income or alternative minimum
taxable income (determined without
regard to this paragraph (c)(5)) for the
taxable year. This paragraph (c)(5)
does not apply to any limitation under
section 382 or 383 or §1.1502–15,
1.1502–21 or 1.1502–22 that arose in
connection with or prior to a corpora-
tion becoming a Consolidated Subsidi-
ary of the Institution.
(6)Operating rules—(i) Bad debt
reserves. For purposes of paragraphs
(c)(2), (c)(3) and (c)(4) of this section,
the adjusted bases of an Institution’s
assets are reduced by the amount of the
Institution’s reserves for bad debts
under section 585 or 593, other than
supplemental reserves under section
593.
(ii)Aggregation of Consolidated
Subsidiaries. For purposes of this para-
graph (c), an Institution is treated as a
single entity that includes the income,
expenses, assets, liabilities, and at-
tributes of its Consolidated Subsidi-
aries, with appropriate adjustments to
prevent duplication.
(iii)Alternative minimum tax. To
compute the alternative minimum tax-
able income attributable to FFA of an
Institution for any taxable year under
section 55, the rules of this section, and
related rules, are applied by using
alternative minimum tax basis, deduc-
tions, and all other items required to be
taken into account. All other alternative
minimum tax provisions continue to
apply.
(7)Earnings and profits. FFA that is
not currently included in income under
this paragraph (c) is included in earn-
ings and profits for all purposes of the
Internal Revenue Code to the extent
and at the time it is included in income
under this paragraph (c).
(d)Transfers of money or property
to Agency, and property subject to a
Loss Guarantee—(1) Transfers of
property to Agency. The transfer of
property to Agency or a Controlled
Entity is a taxable sale or exchange in
which the Institution is treated as
realizing an amount equal to—
(i)The property’s fair market value;
or
(ii)For property subject to a Loss
Guarantee, the greater of the property’s
fair market value or the guaranteed
value or price at which the property
can be put at the time of transfer.
(2)FFA with respect to property
covered by a Loss Guarantee other
than on transfer to Agency. (i) FFA
provided pursuant to a Loss Guarantee
with respect to covered property is
included in the amount realized with
respect to the property to the extent the
total amount realized does not exceed
the greater of—
(A) The property’s fair market
value; or
(B)The guaranteed value or price at
which the property can be put at the
time of transfer.
(ii)For the purposes of this para-
graph (d)(2), references to an amount
realized include amounts obtained in
whole or partial satisfaction of loans,
amounts obtained by virtue of charging
off or marking to market covered
property, and other amounts similarly
related to property, whether or not
disposed of.
(3)Treatment of FFA received in
exchange for property. FFA included in
the amount realized for property under
this paragraph (d) is not includible in
income under paragraph (a)(1) of this
section. The amount realized is treated
in the same manner as if realized from
a person other than Agency or a Con-
trolled Entity. For example, gain at-
tributable to FFA received with respect
to a capital asset retains its character as
capital gain. Similarly, FFA received
with respect to property that has been
charged off for income tax purposes is
treated as a recovery to the extent of
the amount previously charged off. Any
FFA provided in excess of the amount
realized under this paragraph (d) is
includible in income under paragraph
(a)(1) of this section.
(4)Adjustment to FFA—(i) In gen-
eral. If an Institution pays or transfers
money or property to Agency or a Con-
trolled Entity, the amount of money
and fair market value of the property is
an adjustment to its FFA to the extent
the amount paid and transferred ex-
ceeds the amount of money and fair
market value of property Agency or a
Controlled Entity provides in exchange.
(ii)Deposit insurance. This para-
graph (d)(4) does not apply to amounts
paid to Agency with respect to deposit
insurance.
(iii)Treatment of an interest held by
Agency or a Controlled Entity—(A) In
general. For purposes of this paragraph
(d), an interest described in §1.597–
3(b) is not treated as property when
transferred by the issuer to Agency or a
Controlled Entity nor when acquired
from Agency or a Controlled Entity by
the issuer.
(B)Dispositions to persons other
than issuer. On the date Agency or a
Controlled Entity transfers an interest
described in §1.597–3(b) to a holder
other than the issuer, Agency or a
Controlled Entity, the issuer is treated
for purposes of this paragraph (d)(4) as
having transferred to Agency an
amount of money equal to the sum of
the amount of money and the fair
market value of property that was paid
by the new holder as consideration for
the interest.
(iv)Consolidated groups. For pur-
poses of this paragraph (d), an Institu-
tion will be treated as having made any
transfer to Agency or a Controlled
Entity that was made by any other
member of its consolidated group. The
consolidated group must make appro-

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priate investment basis adjustments to
the extent the member transferring
money or other property is not the
member that received FFA.
(5)Manner of making adjustments to
FFA—(i) Reduction of FFA and de-
ferred FFA. An Institution adjusts its
FFA under paragraph (d)(4) of this
section by reducing in the following
order and in an aggregate amount not
greater than the adjustment—
(A)The amount of any FFA that is
otherwise includible in income for the
taxable year (before application of
paragraph (c) of this section); and
(B)The balance (but not below
zero) in the deferred FFA account, if
any, maintained under paragraph (c)(4)
of this section.
(ii)Deduction of excess amounts. If
the amount of the adjustment exceeds
the sum of the amounts described in
paragraph (d)(5)(i) of this section, the
Institution may deduct the excess to the
extent the deduction does not exceed
the amount of FFA included in income
for prior taxable years reduced by the
amount of deductions allowable under
this paragraph (d)(5)(ii) in prior taxable
years.
(iii)Additional adjustments. Any ad-
justment to FFA in excess of the sum
of the amounts described in paragraphs
(d)(5)(i) and (ii) of this section is
treated—
(A)By an Institution other than a
New Entity or Acquiring, as a deduc-
tion of the amount in excess of FFA
received that is required to be trans-
ferred to Agency under section 11(g) of
the Federal Deposit Insurance Act (12
U.S.C. 1821(g)); or
(B)By a New Entity or Acquiring,
as an adjustment to the purchase price
paid in the Taxable Transfer (see
§1.338(b)–3T).
(e)Examples. The following exam-
ples illustrate the provisions of this
section:
Example 1. Timing of inclusion of FFA in
income. (i) Institution M, a calendar year
taxpayer without Continuing Equity because it is
in Agency receivership, is not a member of a
consolidated group and has not been acquired in
a Taxable Transfer. On January 1, 1997, M has
assets with a total adjusted basis of $100 million
and total liabilities of $120 million. M’s
deductions do not exceed its gross income
(determined without regard to FFA) for 1997.
Agency provides $30 million of FFA to M in
1997. The amount of this FFA that M must
include in income in 1997 is limited by §1.597–
2(c)(2) to $20 million, the amount by which M’s
liabilities ($120 million) exceed the total ad-
justed basis of its assets ($100 million) at the
beginning of the taxable year. Pursuant to
§1.597–2(c)(4)(i), M must establish a deferred
FFA account for the remaining $10 million.
(ii)If Agency instead lends M the $30
million, M’s indebtedness to Agency is dis-
regarded and the results are the same as in
paragraph (i) of this Example 1. Section 597(c);
§§1.597–1(b) (defining FFA) and 1.597–3(b).
Example 2. Transfer of property to Agency. (i)
Institution M, a calendar year taxpayer without
Continuing Equity because it is in Agency
receivership, is not a member of a consolidated
group and has not been acquired in a Taxable
Transfer. At the beginning of 1998, M’s
remaining equity is $0 and M has a deferred
FFA account of $10 million. Agency does not
provide any FFA to M in 1998. During the year,
M transfers property not covered by a Loss
Guarantee to Agency and does not receive any
consideration. The property has an adjusted basis
of $5 million and a fair market value of $1
million at the time of the transfer. M has no
other taxable income or loss in 1998.
(ii)Under §1.597–2(d)(1), M is treated as
selling the property for $1 million, its fair market
value, thus recognizing a $4 million loss ($5
million – $1 million). In addition, because M did
not receive any consideration from Agency,
under §1.597–2(d)(4) M has an adjustment to
FFA of $1 million, the amount by which the fair
market value of the transferred property ($1
million) exceeds the consideration M received
from Agency ($0). Because no FFA is provided
to M in 1998, this adjustment reduces the
balance of M’s deferred FFA account to $9
million ($10 million – $1 million). Section
1.597–2(d)(5)(i)(B). Because M’s $4 million loss
causes M’s deductions to exceed its gross
income by $4 million in 1998 and M has no
remaining equity, under §1.597–2(c)(4)(iii)(A) M
must include $4 million of deferred FFA in
income, and must decrease the remaining $9
million balance of its deferred FFA account by
the same amount, leaving a balance of $5
million.
Example 3. Loss Guarantee. Institution Q, a
calendar year taxpayer, sells an asset covered by
a Loss Guarantee to an unrelated third party for
$4,000. Q’s adjusted basis in the asset at the
time of sale and the asset’s guaranteed value are
both $10,000. Pursuant to the Loss Guarantee,
Agency pays Q $6,000 ($10,000 – $4,000). Q’s
amount realized from the sale of the asset is
$10,000 ($4,000 from the third party and $6,000
from Agency). Section 1.597–2(d)(2). Q realizes
no gain or loss on the sale ($10,000 – $10,000 =
$0), and therefore includes none of the $6,000 of
FFA it receives pursuant to the Loss Guarantee
in income. Section 1.597–2(d)(3).
§1.597–3 Other rules.
(a)Ownership of assets. For all
income tax purposes, an Institution is
treated as the owner of all assets
covered by a Loss Guarantee, yield
maintenance agreement, or cost to carry
or cost of funds reimbursement agree-
ment, regardless of whether Agency (or
a Controlled Entity) otherwise would
be treated as the owner under general
principles of income taxation.
(b)Debt and equity interests re-
ceived by Agency. Debt instruments,
stock, warrants, or other rights to
acquire stock of an Institution (or any
of its affiliates) that Agency or a
Controlled Entity receives in connec-
tion with a transaction in which FFA is
provided are not treated as debt, stock
or other equity interests of or in the
issuer for any purpose of the Internal
Revenue Code while held by Agency
or a Controlled Entity. On the date
Agency or a Controlled Entity transfers
an interest described in this paragraph
(b) to a holder other than Agency or a
Controlled Entity, the interest is treated
as having been newly issued by the
issuer to the holder with an issue price
equal to the sum of the amount of
money and the fair market value of
property paid by the new holder in
exchange for the interest.
(c)Agency Obligations—(1) In gen-
eral. Except as otherwise provided in
this paragraph (c), the original issue
discount rules of sections 1271 et seq.
apply to Agency Obligations.
(2)Issue price of Agency Obliga-
tions provided as Net Worth Assistance.
The issue price of an Agency Obliga-
tion that is provided as Net Worth
Assistance and that bears interest at
either a single fixed rate or a qualified
floating rate (and provides for no
contingent payments) is the lesser of
the sum of the present values of all
payments due under the obligation,
discounted at a rate equal to the
applicable federal rate (within the
meaning of section 1274(d)(1) and (3))
in effect for the date of issuance, or the
stated principal amount of the obliga-
tion. The issue price of an Agency
Obligation that bears a qualified float-
ing rate of interest (within the meaning
of §1.1275–5(b)) is determined by
treating the obligation as bearing a
fixed rate of interest equal to the rate
in effect on the date of issuance under
the obligation.
(3)Adjustments to principal amount.
Except as provided in §1.597–5(d)-
(2)(iv), this paragraph (c)(3) applies if
Agency modifies or exchanges an
Agency Obligation provided as Net
Worth Assistance (or a successor obli-
gation). The issue price of the modified
or new Agency Obligation is deter-
mined under paragraphs (c)(1) and (2)
of this section. If the issue price is
greater than the adjusted issue price of
the existing Agency Obligation, the
difference is treated as FFA. If the
issue price is less than the adjusted
issue price of the existing Agency
Obligation, the difference is treated as

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an adjustment to FFA under §1.597–
2(d)(4).
(d)Successors. To the extent neces-
sary to effectuate the purposes of the
regulations under section 597, an en-
tity’s treatment under the regulations
applies to its successor. A successor
includes a transferee in a transaction to
which section 381(a) applies or a
Bridge Bank to which another Bridge
Bank transfers deposit liabilities.
(e)Loss disallowance. For purposes
of §1.1502–20, FFA and the amount
described in §1.597–4(g)(3) are treated
as an extraordinary gain disposition
within the meaning of §1.1502–20(c)-
(2)(i) and a Taxable Transfer is treated
as an applicable asset acquisition under
section 1060(c) within the meaning of
§1.1502–20(c)(2)(i)(A)(4).
(f)Losses and deductions with re-
spect to covered assets. Prior to the
disposition of an asset covered by a
Loss Guarantee, the asset cannot be
charged off, marked to a market value,
depreciated, amortized, or otherwise
treated in a manner that supposes an
actual or possible diminution of value
below the greater of the asset’s highest
guaranteed value or the highest price at
which the asset can be put.
(g)Anti-abuse rule. The regulations
under section 597 must be applied in a
manner consistent with the purposes of
section 597. Accordingly, if, in struc-
turing or engaging in any transaction, a
principal purpose is to achieve a tax
result that is inconsistent with the
purposes of section 597 and the regula-
tions thereunder, the Commissioner can
make appropriate adjustments to in-
come, deductions and other items that
would be consistent with those
purposes.
§1.597–4 Bridge Banks and Agency
Control.
(a)Scope. This section provides
rules that apply to a Bridge Bank or
other Institution under Agency Control
and to transactions in which an Institu-
t i o n t r a n s f e r s d e p o s i t l i a b i l i t i e s
(whether or not the Institution also
transfers assets) to a Bridge Bank.
(b)Status as taxpayer. A Bridge
Bank or other Institution under Agency
Control is a corporation within the
meaning of section 7701(a)(3) for all
purposes of the Internal Revenue Code
and is subject to all Internal Revenue
Code provisions that generally apply to
corporations, including those relating to
methods of accounting and to require-
ments for filing returns, even if Agency
owns stock of the Institution.
(c)No section 382 ownership
change. The imposition of Agency
Control, the cancellation of Institution
stock by Agency, a transaction in
which an Institution transfers deposit
liabilities to a Bridge Bank, and an
election under paragraph (g) of this
section are disregarded in determining
whether an ownership change has
occurred within the meaning of section
382(g).
(d)Transfers to Bridge Banks—(1)
In general. Except as otherwise
provided in paragraph (g) of this
section, the rules of this paragraph (d)
apply to transfers to Bridge Banks. In
general, a Bridge Bank and its associ-
ated Residual Entity are together
treated as the successor entity to the
transferring Institution. If an Institution
transfers deposit liabilities to a Bridge
Bank (whether or not it also transfers
assets), the Institution recognizes no
gain or loss on the transfer and the
Bridge Bank succeeds to the transfer-
ring Institution’s basis in any trans-
ferred assets. The associated Residual
Entity retains its basis in any assets it
continues to hold. Immediately after
the transfer, the Bridge Bank succeeds
to and takes into account the transfer-
ring Institution’s items described in
section 381(c) (subject to the condi-
tions and limitations specified in sec-
tion 381(c)), taxpayer identification
number (‘‘TIN’’), deferred FFA ac-
count, and account receivable for future
FFA as described in paragraph (g)(4)-
(ii) of this section. The Bridge Bank
also succeeds to and continues the
transferring Institution’s taxable year.
(2)Transfers to a Bridge Bank from
multiple Institutions. If two or more
Institutions transfer deposit liabilities to
the same Bridge Bank, the rules in
paragraph (d)(1) of this section are
modified to the extent provided in this
paragraph (d)(2). The Bridge Bank
succeeds to the TIN and continues the
taxable year of the Institution that
transfers the largest amount of deposits.
The taxable years of the other transfer-
ring Institutions close at the time of the
transfer. If all the transferor Institutions
are members of the same consolidated
group, the Bridge Bank’s carryback of
losses to the Institution that transfers
the largest amount of deposits is not
limited by section 381(b)(3). The lim-
itations of section 381(b)(3) do apply
to the Bridge Bank’s carrybacks of
losses to all other transferor Institu-
tions. If the transferor Institutions are
not all members of the same consoli-
dated group, the limitations of section
381(b)(3) apply with respect to all
transferor Institutions. See paragraph
(g)(6)(ii) of this section for additional
rules that apply if two or more In-
stitutions that are not members of the
same consolidated group transfer de-
posit liabilities to the same Bridge
Bank.
(e)Treatment of Bridge Bank and
Residual Entity as a single entity. A
Bridge Bank and its associated Re-
sidual Entity or Entities are treated as a
single entity for income tax purposes
and must file a single combined income
tax return. The Bridge Bank is respon-
sible for filing all income tax returns
and statements for this single entity and
is the agent of each associated Residual
Entity to the same extent as if the
Bridge Bank were the common parent
of a consolidated group including the
Residual Entity. The term Institution
includes a Residual Entity that files a
combined return with its associated
Bridge Bank.
(f)Rules applicable to members of
consolidated groups—(1) Status as
members. Unless an election is made
under paragraph (g) of this section,
Agency Control of an Institution does
not terminate the Institution’s member-
ship in a consolidated group. Stock of a
subsidiary that is canceled by Agency
is treated as held by the members of
the consolidated group that held the
stock prior to its cancellation. If an
Institution is a member of a consoli-
dated group immediately before it
transfers deposit liabilities to a Bridge
Bank, the Bridge Bank succeeds to the
Institution’s status as the common
parent or, unless an election is made
under paragraph (g) of this section, as a
subsidiary of the group. If a Bridge
Bank succeeds to an Institution’s status
as a subsidiary, its stock is treated as
held by the shareholders of the trans-
ferring Institution, and the stock basis
or excess loss account of the Institution
carries over to the Bridge Bank. A
Bridge Bank is treated as owning stock
owned by its associated Residual En-
tities, including for purposes of deter-
mining membership in an affiliated
group.
(2)No 30-day election to be ex-
cluded from consolidated group. Nei-
ther an Institution nor any of its
Consolidated Subsidiaries may be ex-
cluded from a consolidated group for a

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t a x a b l e y e a r u n d e r § 1 . 1 5 0 2 –
76(b)(5)(ii), as contained in 26 CFR
part 1 edition revised April 1, 1994, if
the Institution is under Agency Control
at any time during the year.
(3)Coordination with consolidated
return regulations. The provisions of
the regulations under section 597 take
precedence over conflicting provisions
in the regulations under section 1502.
(g)Elective disaffiliation—(1) In
general. A consolidated group of which
an Institution is a subsidiary may elect
irrevocably not to include the Institu-
tion in its affiliated group if the
Institution is placed in Agency re-
ceivership (whether or not assets or
deposit liabilities of the Institution are
transferred to a Bridge Bank). See
paragraph (g)(6) of this section for
circumstances under which a consoli-
dated group is deemed to make this
election.
(2)Consequences of election. If the
election under this paragraph (g) is
made with respect to an Institution, the
following consequences occur imme-
diately before the subsidiary Institution
to which the election applies is placed
in Agency receivership (or, in the case
of a deemed election under paragraph
(g)(6) of this section, immediately
before the consolidated group is
deemed to make the election) and in
the following order—
(i)All adjustments of the Institution
and its Consolidated Subsidiaries under
section 481 are accelerated;
(ii)Deferred intercompany gains and
losses with respect to the Institution
and its Consolidated Subsidiaries are
taken into account and the Institution
and its Consolidated Subsidiaries take
into account any other items required
under the regulations under section
1502 for members that become non-
members within the meaning of
§1.1502–32(d)(4);
(iii)The taxable year of the Institu-
tion and its Consolidated Subsidiaries
closes and the Institution includes the
amount described in paragraph (g)(3)
of this section in income as ordinary
income as its last item for that taxable
year;
(iv)The members of the consoli-
dated group owning the common stock
of the Institution include in income any
excess loss account with respect to the
Institution’s stock under §1.1502-19
and any other items required under the
regulations under section 1502 for
members that own stock of corpora-
tions that become nonmembers within
the meaning of §1.1502–32(d)(4); and
(v)If the Institution’s liabilities ex-
ceed the aggregate fair market value of
its assets on the date the Institution is
placed in Agency receivership (or, in
the case of a deemed election under
paragraph (g)(6) of this section, on the
date the consolidated group is deemed
to make the election), the members of
the consolidated group treat their stock
in the Institution as worthless. (See
§§1.337(d)–1 and 1.1502–20 for poten-
tial limitations on the group’s worthless
stock deduction.) In all other cases, the
consolidated group will be treated as
owning stock of a nonmember corpora-
tion until such stock is disposed of or
becomes worthless under rules other-
wise applicable.
(3)Toll charge. The amount de-
scribed in this paragraph (g)(3) is the
excess of the Institution’s liabilities
over the adjusted bases of its assets
immediately before the Institution is
placed in Agency receivership (or, in
the case of a deemed election under
paragraph (g)(6) of this section, imme-
diately before the consolidated group is
deemed to make the election). In
computing this amount, the adjusted
bases of an Institution’s assets are
reduced by the amount of the Institu-
tion’s reserves for bad debts under
section 585 or 593, other than supple-
mental reserves under section 593. For
purposes of this paragraph (g)(3), an
Institution is treated as a single entity
that includes the assets and liabilities of
its Consolidated Subsidiaries, with ap-
propriate adjustments to prevent du-
plication. The amount described in this
paragraph (g)(3) for alternative mini-
mum tax purposes is determined using
alternative minimum tax basis, deduc-
tions, and all other items required to be
taken into account. In computing the
increase in the group’s taxable income
or alternative minimum taxable income,
sections 56(d)(1), 382 and 383 and
§§1.1502–15, 1.1502–21 and 1.1502–
22 do not limit the use of the attributes
of the Institution and its Consolidated
Subsidiaries to the extent, if any, that
the inclusion of the amount described
in this paragraph (g)(3) in income
would result in the group having
taxable income or alternative minimum
taxable income (determined without
regard to this sentence) for the taxable
year. The preceding sentence does not
apply to any limitation under section
382 or 383 or §§1.1502–15, 1.1502–21,
or 1.1502–22 that arose in connection
with or prior to a corporation becoming
a Consolidated Subsidiary of the
Institution.
(4)Treatment of Institutions after
disaffiliation—(i) In general. If the
election under this paragraph (g) is
made with respect to an Institution,
immediately after the Institution is
placed in Agency receivership (or, in
the case of a deemed election under
paragraph (g)(6) of this section, imme-
diately after the consolidated group is
deemed to make the election), the
Institution and each of its Consolidated
Subsidiaries are treated for income tax
purposes as new corporations that are
not members of the electing group’s
affiliated group. Each new corporation
retains the TIN of the corresponding
disaffiliated corporation and is treated
as having received the assets and
liabilities of the corresponding disaffili-
ated corporation in a transaction to
which section 351 applies (and in
which no gain was recognized under
section 357(c) or otherwise). Thus, the
new corporation has no net operating
or capital loss carryforwards. An elec-
tion under this paragraph (g) does not
terminate the single entity treatment of
a Bridge Bank and its Residual Entities
provided in paragraph (e) of this
section.
(ii)FFA. A new Institution is treated
as having a non-interest bearing, non-
transferable account receivable for fu-
ture FFA with a basis equal to the
amount described in paragraph (g)(3)
of this section. If a disaffiliated Institu-
tion has a deferred FFA account at the
time of its disaffiliation, the corre-
sponding new Institution succeeds to
and takes into account that deferred
FFA account.
(iii)Filing of consolidated returns.
If a disaffiliated Institution has Consol-
idated Subsidiaries at the time of its
disaffiliation, the corresponding new
Institution is required to file a consoli-
dated income tax return with the sub-
sidiaries in accordance with the regula-
tions under section 1502.
(iv)Status as Institution. If an Insti-
tution is disaffiliated under this para-
graph (g), the resulting new corporation
is treated as an Institution for purposes
of the regulations under section 597
regardless of whether it is a bank or
domestic building and loan association
within the meaning of section 597.
(v)Loss carrybacks. To the extent a
carryback of losses would result in a
refund being paid to a fiduciary under

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section 6402(i), an Institution or Con-
solidated Subsidiary with respect to
which an election under this paragraph
(g) (other than under paragraph (g)(6)-
(ii) of this section) applies is allowed
to carry back losses as if the Institution
or Consolidated Subsidiary had con-
tinued to be a member of the con-
solidated group that made the election.
(5)Affirmative election—(i) Original
Institution—(A) Manner of making
election. Except as otherwise provided
in paragraph (g)(6) of this section, a
consolidated group makes the election
provided by this paragraph (g) by
sending a written statement by certified
mail to the affected Institution on or
before the later of 120 days after its
placement in Agency receivership or
May 31, 1996. The statement must con-
tain the following legend at the top of
the page: ‘‘THIS IS AN ELECTION
UNDER §1.597–4(g) TO EXCLUDE
THE BELOW-REFERENCED INSTI-
TUTION AND CONSOLIDATED
SUBSIDIARIES FROM THE AFFILI-
ATED GROUP,’’ and must include the
names and taxpayer identification num-
bers of the common parent and of the
Institution and Consolidated Subsidi-
aries to which the election applies, and
the date on which the Institution was
placed in Agency receivership. The
consolidated group must send a similar
statement to all subsidiary Institutions
placed in Agency receivership during
the consistency period described in
paragraph (g)(5)(ii) of this section.
(Failure to satisfy the requirement in
the preceding sentence, however, does
not invalidate the election with respect
to any subsidiary Institution placed in
Agency receivership during the consis-
tency period described in paragraph
(g)(5)(ii) of this section.) The consoli-
dated group must include a copy of any
election statement and accompanying
certified mail receipt as part of its first
income tax return filed after the due
date under this paragraph (g)(5) for
such statement. A statement must be
attached to this return indicating that
the individual who signed the election
was authorized to do so on behalf of
the consolidated group. Agency cannot
make this election under the authority
of section 6402(i) or otherwise.
(B)Consistency limitation on affirm-
ative elections. A consolidated group
may make an affirmative election under
this paragraph (g)(5) with respect to a
subsidiary Institution placed in Agency
receivership only if the group made, or
is deemed to have made, the election
under this paragraph (g) with respect to
every subsidiary Institution of the
group placed in Agency receivership on
or after May 10, 1989 and within five
years preceding the date the subject
Institution was placed in Agency
receivership.
(ii)Effect on Institutions placed in
receivership simultaneously or subse-
quently. An election under this para-
graph (g), other than under paragraph
(g)(6)(ii) of this section, applies to the
Institution with respect to which the
election is made or deemed made (the
original Institution) and each subsidiary
Institution of the group placed in
Agency receivership or deconsolidated
in contemplation of Agency Control or
the receipt of FFA simultaneously with
the original Institution or within five
years thereafter.
(6)Deemed Election—(i) Decon-
solidations in contemplation. If one or
more members of a consolidated group
deconsolidate (within the meaning of
§1.1502-19(c)(1)(ii)(B)) a subsidiary
Institution in contemplation of Agency
Control or the receipt of FFA, the
consolidated group is deemed to make
the election described in this paragraph
(g) with respect to the Institution on
the date the deconsolidation occurs. A
subsidiary Institution is conclusively
presumed to have been deconsolidated
in contemplation of Agency Control or
the receipt of FFA if either event
occurs within six months after the
deconsolidation.
(ii)Transfers to a Bridge Bank from
multiple groups. On the day an Institu-
tion’s transfer of deposit liabilities to a
Bridge Bank results in the Bridge Bank
holding deposit liabilities from both a
subsidiary Institution and an Institution
not included in the subsidiary Institu-
tion’s consolidated group, each consoli-
dated group of which a transferring
Institution or the Bridge Bank is a
subsidiary is deemed to make the elec-
tion described in this paragraph (g)
with respect to its subsidiary Institu-
tion. If deposit liabilities of another
Institution that is a subsidiary member
of any consolidated group subsequently
are transferred to the Bridge Bank, the
consolidated group of which the Insti-
tution is a subsidiary is deemed to
make the election described in this
paragraph (g) with respect to that
Institution at the time of the subsequent
transfer.
(h)Examples. The following exam-
ples illustrate the provisions of this
section:
Facts. Corporation X, the common parent of a
consolidated group, owns all the stock (with a
basis of $4 million) of Institution M, an
insolvent Institution with no Consolidated Sub-
sidiaries. At the close of business on April 30,
1996, M has $4 million of deposit liabilities, $1
million of other liabilities, and assets with an
adjusted basis of $4 million and a fair market
value of $3 million.
Example 1. Effect of receivership on consol-
idation. On May 1, 1996, Agency places M in
receivership and begins liquidating M. X does
not make an election under §1.597–4(g). M
remains a member of the X consolidated group
after May 1, 1996. Section 1.597–4(f)(1).
Example 2. Effect of Bridge Bank on
consolidation—(i) Additional facts. On May 1,
1996, Agency places M in receivership and
causes M to transfer all of its assets and deposit
liabilities to Bridge Bank MB.
(ii)Consequences without an election to dis-
affiliate. M recognizes no gain or loss from the
transfer and MB succeeds to M’s basis in the
transferred assets, M’s items described in section
381(c) (subject to the conditions and limitations
specified in section 381(c)) and TIN. Section
1.597–4(d)(1). (If M had a deferred FFA
account, MB would also succeed to that account.
Section 1.597–4(d)(1).) MB continues M’s tax-
able year and succeeds to M’s status as a
member of the X consolidated group after May
1, 1996. Section 1.597–4(d)(1) and (f). MB and
M are treated as a single entity for income tax
purposes. Section 1.597–4(e).
(iii)Consequences with an election to dis-
affiliate. If, on July 1, 1996, X makes an election
under §1.597–4(g) with respect to M, the
following consequences are treated as occurring
immediately before M was placed in Agency
receivership. M must include $1 million ($5
million of liabilities — $4 million of adjusted
basis) in income as of May 1, 1996. Section
1.597–4(g)(2) and (3). M is then treated as a new
corporation that is not a member of the X
consolidated group and that has assets (including
a $1 million account receivable for future FFA)
with a basis of $5 million and $5 million of
liabilities received from disaffiliated corporation
M in a section 351 transaction. New corporation
M retains the TIN of disaffiliated corporation M.
Section 1.597–4(g)(4). Immediately after the
disaffiliation, new corporation M is treated as
transferring its assets and deposit liabilities to
Bridge Bank MB. New corporation M recognizes
no gain or loss from the transfer and MB
succeeds to M’s TIN and taxable year. Section
1.597–4(d)(1). Bridge Bank MB is treated as a
single entity that includes M and has $5 million
of liabilities, an account receivable for future
FFA with a basis of $1 million, and other assets
with a basis of $4 million. Section 1.597–4(d)(1).
§1.597–5 Taxable Transfers.
(a)Taxable Transfers—(1) Defined.
The term Taxable Transfer means—
(i)A transaction in which an entity
transfers to a transferee other than a
Bridge Bank—
(A)Any deposit liability (whether or
not the Institution also transfers assets),
if FFA is provided in connection with
the transaction; or
(B)Any asset for which Agency or
a Controlled Entity has any financial

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obligation (e.g., pursuant to a Loss
Guarantee or Agency Obligation); or
(ii)A deemed transfer of assets
described in paragraph (b) of this
section.
(2)Scope. This section provides
rules governing Taxable Transfers.
Rules applicable to both actual and
deemed asset acquisitions are provided
in paragraphs (c) and (d) of this
section. Special rules applicable only to
deemed asset acquisitions are provided
in paragraph (e) of this section.
(b)Deemed asset acquisitions upon
stock purchase—(1) In general. In a
deemed transfer of assets under this
paragraph (b), an Institution (including
a Bridge Bank or a Residual Entity) or
a Consolidated Subsidiary of the Insti-
tution (the Old Entity) is treated as
selling all of its assets in a single
transaction and is treated as a new
corporation (the New Entity) that pur-
chases all of the Old Entity’s assets at
the close of the day immediately
preceding the occurrence of an event
described in paragraph (b)(2) of this
section. However, such an event results
in a deemed transfer of assets under
this paragraph (b) only if it occurs—
(i)In connection with a transaction
in which FFA is provided;
(ii)While the Old Entity is a Bridge
Bank;
(iii)While the Old Entity has a
positive balance in a deferred FFA
account (see §1.597–2(c)(4)(v) regard-
ing the optional accelerated recapture
of deferred FFA); or
(iv)With respect to a Consolidated
Subsidiary, while the Institution of
which it is a Consolidated Subsidiary is
under Agency Control.
(2)Events. A deemed transfer of
assets under this paragraph (b) results
if the Old Entity—
(i)Becomes a non-member within
the meaning of §1.1502–32(d)(4) of its
consolidated group (other than pursuant
to an election under §1.597–4(g));
(ii)Becomes a member of an affili-
ated group of which it was not
previously a member (other than pur-
suant to an election under §1.597–
4(g)); or
(iii)Issues stock such that the stock
that was outstanding before the imposi-
tion of Agency Control or the occur-
rence of any transaction in connection
with the provision of FFA represents
50 percent or less of the vote or value
of its outstanding stock (disregarding
stock described in section 1504(a)(4)
and stock owned by Agency or a
Controlled Entity).
(3)Bridge Banks and Residual En-
tities. If a Bridge Bank is treated as
selling all of its assets to a New Entity
under this paragraph (b), each associ-
ated Residual Entity is treated as
simultaneously selling its assets to a
New Entity in a Taxable Transfer
described in this paragraph (b).
(c)Treatment of transferor—(1)
FFA in connection with a Taxable
Transfer. A transferor in a Taxable
Transfer is treated as having directly
received immediately before a Taxable
Transfer any Net Worth Assistance that
Agency provides to the New Entity or
Acquiring in connection with the trans-
fer. (See §1.597–2(a) and (c) for rules
regarding the inclusion of FFA in
income and §1.597–2(a)(1) for related
rules regarding FFA provided to share-
holders.) The Net Worth Assistance is
treated as an asset of the transferor that
is sold to the New Entity or Acquiring
in the Taxable Transfer.
(2)Amount realized in a Taxable
Transfer. In a Taxable Transfer de-
scribed in paragraph (a)(1)(i) of this
section, the amount realized is deter-
mined under section 1001(b) by refer-
ence to the consideration paid for the
assets. In a Taxable Transfer described
in paragraph (a)(1)(ii) of this section,
the amount realized is the sum of the
grossed-up basis of the stock acquired
in connection with the Taxable Trans-
fer (excluding stock acquired from the
Old or New Entity), plus the amount of
liabilities assumed or taken subject to
in the deemed transfer, plus other
relevant items. The grossed-up basis of
the acquired stock equals the acquirors’
basis in the acquired stock divided by
the percentage of the Old Entity’s stock
(by value) attributable to the acquired
stock.
(3)Allocation of amount realized—
(i) In general. The amount realized
under paragraph (c)(2) of this section is
allocated among the assets transferred
in the Taxable Transfer in the same
manner as amounts are allocated among
assets under §§1.338(b)–2T(b), (c)(1)
and (2).
(ii)Modifications to general rule.
This paragraph (c)(3)(ii) modifies cer-
tain of the allocation rules of paragraph
(c)(3)(i) of this section. Agency Obli-
gations and assets covered by Loss
Guarantees in the hands of the New
Entity or Acquiring are treated as Class
II assets. Stock of a Consolidated
Subsidiary is treated as a Class II asset
to the extent the fair market value of
the Consolidated Subsidiary’s Class I
and Class II assets exceeds the amount
of its liabilities. The fair market value
of an Agency Obligation is deemed to
equal its adjusted issue price imme-
diately before the Taxable Transfer.
The fair market value of an asset
covered by a Loss Guarantee imme-
diately after the Taxable Transfer is
deemed to be not less than the greater
of the asset’s highest guaranteed value
or the highest price at which the asset
can be put.
(d)Treatment of a New Entity and
Acquiring—(1) Purchase price. The
purchase price for assets acquired in a
Taxable Transfer described in para-
graph (a)(1)(i) of this section is the
cost of the assets acquired. See
§1.1060–1T(c)(1). The purchase price
for assets acquired in a Taxable Trans-
fer described in paragraph (a)(1)(ii) of
this section is the sum of the grossed-
up basis of the stock acquired in
connection with the Taxable Transfer
(excluding stock acquired from the Old
or New Entity), plus the amount of
liabilities assumed or taken subject to
in the deemed transfer, plus other
relevant items. The grossed-up basis of
the acquired stock equals the acquirors’
basis in the acquired stock divided by
the percentage of the Old Entity’s stock
(by value) attributable to the acquired
stock. FFA provided in connection with
a Taxable Transfer is not included in
the New Entity’s or Acquiring’s pur-
chase price for the acquired assets. Any
Net Worth Assistance so provided is
treated as an asset of the transferor sold
to the New Entity or Acquiring in the
Taxable Transfer.
(2)Allocation of basis—(i) In gen-
eral. Except as otherwise provided in
this paragraph (d)(2), the purchase
price determined under paragraph
(d)(1) of this section is allocated
among the assets transferred in the
Taxable Transfer in the same manner
as amounts are allocated among assets
under §1.338(b)–2T(b), (c)(1) and (2).
(ii)Modifications to general rule.
The allocation rules contained in para-
graph (c)(3)(ii) of this section apply to
the allocation of basis among assets
acquired in a Taxable Transfer. No
basis is allocable to Agency’s agree-
ment to provide Loss Guarantees, yield
maintenance payments, cost to carry or
cost of funds reimbursement payments,
or expense reimbursement or indemnity

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payments. A New Entity’s basis in
assets it receives from its shareholders
is determined under general principles
of income taxation and is not governed
by this paragraph (d).
(iii)Allowance and recapture of
additional basis in certain cases. If the
fair market value of the Class I and
Class II assets acquired in a Taxable
Transfer is greater than the New
Entity’s or Acquiring’s purchase price
for the acquired assets, the basis of the
Class I and Class II assets equals their
fair market value. The amount by
which the fair market value of the
Class I and Class II assets exceeds the
purchase price is included ratably as
ordinary income by the New Entity or
Acquiring over a period of six taxable
years beginning in the year of the
Taxable Transfer. The New Entity or
Acquiring must include as ordinary
income the entire amount remaining to
be recaptured under the preceding
sentence in the taxable year in which
an event occurs that would accelerate
inclusion of an adjustment under sec-
tion 481.
(iv)Certain post-transfer adjust-
ments—(A) Agency Obligations. If an
adjustment to the principal amount of
an Agency Obligation or cash payment
to reflect a more accurate determination
of the condition of the Institution at the
time of the Taxable Transfer is made
before the earlier of the date the New
Entity or Acquiring files its first post-
transfer income tax return or the due
date of that return (including exten-
sions), the New Entity or Acquiring
must adjust its basis in its acquired
assets to reflect the adjustment. In
making adjustments to the New En-
tity’s or Acquiring’s basis in its ac-
quired assets, paragraph (c)(3)(ii) of
this section is applied by treating an
adjustment to the principal amount of
an Agency Obligation pursuant to the
first sentence of this paragraph
(d)(2)(iv)(A) as occurring immediately
before the Taxable Transfer. (See
§1.597–3(c)(3) for rules regarding other
adjustments to the principal amount of
an Agency Obligation.)
(B)Assets covered by a Loss Guar-
antee. If, immediately after a Taxable
Transfer, an asset is not covered by a
Loss Guarantee but the New Entity or
Acquiring has the right to designate
specific assets that will be covered by a
Loss Guarantee, the New Entity or
Acquiring must treat any asset so
designated as having been subject to
the Loss Guarantee at the time of the
Taxable Transfer. The New Entity or
Acquiring must adjust its basis in the
covered assets and in its other acquired
assets to reflect the designation in the
manner provided by paragraph (d)(2) of
this section. The New Entity or Acquir-
ing must make appropriate adjustments
in subsequent taxable years if the
designation is made after the New
Entity or Acquiring files its first post-
transfer income tax return or the due
date of that return (including exten-
sions) has passed.
(e)Special rules applicable to Tax-
able Transfers that are deemed asset
acquisitions—(1) Taxpayer identifica-
tion numbers. Except as provided in
paragraph (e)(3) of this section, a New
Entity succeeds to the TIN of the
transferor in a deemed sale under
paragraph (b) of this section.
(2)Consolidated Subsidiaries—(i) In
general. A Consolidated Subsidiary
that is treated as selling its assets in a
Taxable Transfer under paragraph (b)
of this section is treated as engaging
immediately thereafter in a complete
liquidation to which section 332 ap-
plies. The consolidated group of which
the Consolidated Subsidiary is a mem-
ber does not take into account gain or
loss on the sale, exchange, or cancella-
tion of stock of the Consolidated
Subsidiary in connection with the Tax-
able Transfer.
(ii)Certain minority shareholders.
Shareholders of the Consolidated Sub-
sidiary that are not members of the
consolidated group that includes the
Institution do not recognize gain or loss
with respect to shares of Consolidated
Subsidiary stock retained by the share-
holder. The shareholder’s basis for that
stock is not affected by the Taxable
Transfer.
(3)Bridge Banks and Residual En-
tities—(i) In general. A Bridge Bank or
Residual Entity’s sale of assets to a
New Entity under paragraph (b) of this
section is treated as made by a single
entity under §1.597–4(e). The New
Entity deemed to acquire the assets of
a Residual Entity under paragraph (b)
of this section is not treated as a single
entity with the Bridge Bank (or with
the New Entity acquiring the Bridge
Bank’s assets) and must obtain a new
TIN.
( i i )T r e a t m e n t o f c o n s o l i d a t e d
groups. At the time of a Taxable
Transfer described in paragraph
(a)(1)(ii) of this section, treatment of a
Bridge Bank as a subsidiary member of
a consolidated group under §1.597–
4(f)(1) ceases. However, the New
Entity deemed to acquire the assets of
a Residual Entity is a member of the
selling consolidated group after the
deemed sale. The group’s basis or
excess loss account in the stock of the
New Entity that is deemed to acquire
the assets of the Residual Entity is the
group’s basis or excess loss account in
the stock of the Bridge Bank imme-
diately before the deemed sale, as
adjusted for the results of the sale.
(4)Certain returns. If an Old Entity
without Continuing Equity is not a
subsidiary of a consolidated group at
the time of the Taxable Transfer, the
controlling Agency must file all income
tax returns for the Old Entity for
periods ending on or prior to the date
of the deemed sale described in para-
graph (b) of this section that are not
filed as of that date.
(5)Basis limited to fair market
value. If all of the stock of the
corporation is not acquired on the date
of the Taxable Transfer, the Commis-
sioner may make appropriate adjust-
ments under paragraphs (c) and (d) of
this section to the extent using a
grossed-up basis of the stock of a
corporation results in an aggregate
amount realized for, or basis in, the
assets other than the aggregate fair
market value of the assets.
(f) Examples. The following exam-
ples illustrate the provisions of this
section:
Example 1. Branch sale resulting in Taxable
Transfer. (i) Institution M is a calendar year
taxpayer in Agency receivership. M is not a
member of a consolidated group. On January 1,
1997, M has $200 million of liabilities (including
deposit liabilities) and assets with an adjusted
basis of $100 million. M has no income or loss
for 1997 and, except as described below,
receives no FFA. On September 30, 1997,
Agency causes M to transfer six branches (with
assets having an adjusted basis of $1 million)
together with $120 million of deposit liabilities
to N. In connection with the transfer, Agency
provides $121 million in cash to N.
(ii)The transaction is a Taxable Transfer in
which M receives $121 million of Net Worth
Assistance. Section 1.597–5(a)(1). (M is treated
as directly receiving the $121 million of Net
Worth Assistance immediately before the Tax-
able Transfer. Section 1.597–5(c)(1).) M trans-
fers branches having a basis of $1 million and is
treated as transferring $121 million in cash (the
Net Worth Assistance) to N in exchange for N’s
assumption of $120 million of liabilities. Thus,
M realizes a loss of $2 million on the transfer.
The amount of the FFA M must include in its
income in 1997 is limited by §1.597–2(c) to
$102 million, which is the sum of the $100
million excess of M’s liabilities ($200 million)
over the total adjusted basis of its assets ($100

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million) at the beginning of 1997, plus the $2
million excess for the taxable year, which results
from the Taxable Transfer, of M’s deductions
(other than carryovers) over its gross income
other than FFA. M must establish a deferred
FFA account for the remaining $19 million of
FFA. Section 1.597–2(c)(4).
(iii)N, as Acquiring, must allocate its $120
million purchase price for the assets acquired
from M among those assets. Cash is a Class I
asset. The branch assets are in Classes III and
IV. N’s adjusted basis in the cash is its amount,
i.e., $121 million. Section 1.597–5(d)(2). Be-
cause this amount exceeds N’s purchase price for
all of the acquired assets by $1 million, N
allocates no basis to the other acquired assets
and, under §1.597–5(d)(2), must recapture the $1
million excess at an annual rate of $166,667 in
the six consecutive taxable years beginning with
1997 (subject to acceleration for certain events).
Example 2. Stock issuance by Bridge Bank
causing Taxable Transfer. (i) On April 1, 1996,
Institution P is placed in receivership and caused
to transfer assets and liabilities to Bridge Bank
PB. On August 31, 1996, the assets of PB con-
sist of $20 million in cash, loans outstanding
with an adjusted basis of $50 million and a fair
market value of $40 million, and other non-
financial assets (primarily branch assets and
equipment) with an adjusted basis of $5 million.
PB has deposit liabilities of $95 million and
other liabilities of $5 million. P, the Residual
Entity, holds real estate with an adjusted basis of
$10 million and claims in litigation having a zero
basis. P retains no deposit liabilities and has no
other liabilities (except its liability to Agency for
having caused its deposit liabilities to be
satisfied).
(ii)On September 1, 1996, Agency causes PB
to issue 100 percent of its common stock for $2
million cash to X. On the same day, Agency
issues a $25 million note to PB. The note bears a
fixed rate of interest in excess of the applicable
federal rate in effect for September 1, 1996.
Agency provides Loss Guarantees guaranteeing
PB a value of $50 million for PB’s loans out-
standing.
(iii)The stock issuance is a Taxable Transfer
in which PB is treated as selling all of its assets
to a new corporation, New PB. Section 1.597–
5(b)(1). PB is treated as directly receiving $25
million of Net Worth Assistance (the issue price
of the Agency Obligation) immediately before
the Taxable Transfer. Section 1.597–3(c)(2);
§1.597–5(c)(1). The amount of FFA PB must in-
clude in income is determined under §1.597–2(a)
and (c). PB in turn is deemed to transfer the note
to New PB in the Taxable Transfer, together
with $20 million of cash, all its loans outstand-
ing (with a basis of $50 million) and its other
non-financial assets (with a basis of $5 million).
The amount realized by PB from the sale is $100
million, the amount of PB’s liabilities deemed to
be assumed by New PB. This amount realized
equals PB’s basis in its assets and thus, PB
realizes no gain or loss on the transfer to New
PB.
(iv)Residual Entity P also is treated as selling
all its assets (consisting of real estate and claims
in litigation) for $0 (the amount of consideration
received by P) to a new corporation (New P) in a
Taxable Transfer. Section 1.597–5(b)(3). (P’s
only liability is to Agency and a liability to
Agency is not treated as a debt under §1.597–
3(b).) Thus, P realizes a $10 million loss on the
transfer to New P. The combined return filed by
PB and P for 1996 will reflect a total loss on the
Taxable Transfer of $10 million ($0 for PB and
$10 million for P). Section 1.597–5(e)(3). That
return also will reflect FFA income from the Net
Worth Assistance, determined under §1.597–2(a)
and (c).
(v)New PB is treated as having acquired the
assets it acquired from PB for $100 million, the
amount of liabilities assumed. In allocating basis
among these assets, New PB treats the Agency
note and the loans outstanding (which are
covered by Loss Guarantees) as Class II assets.
For the purpose of allocating basis, the fair
market value of the Agency note is deemed to
equal its adjusted issue price immediately before
the transfer, $25 million. The fair market value
of the loans is deemed not to be less than the
guaranteed value of $50 million.
(vi)New P is treated as having acquired its
assets for no consideration. Thus its basis in its
assets immediately after the transfer is zero. New
PB and New P are not treated as a single entity.
Section 1.597–5(e)(3).
Example 3. Taxable Transfer of previously dis-
affiliated Institution. (i) Corporation X, the
common parent of a consolidated group, owns all
the stock of Institution M, an insolvent Institu-
tion with no Consolidated Subsidiaries. On April
30, 1996, M has $4 million of deposit liabilities,
$1 million of other liabilities, and assets with an
adjusted basis of $4 million and a fair market
value of $3 million. On May 1, 1996, Agency
places M in receivership. X elects under §1.597–
4(g) to disaffiliate M. Accordingly, as of May 1,
1996, new corporation M is not a member of the
X consolidated group. On May 1, 1996, Agency
causes M to transfer all of its assets and
liabilities to Bridge Bank MB. Under §1.597–
4(e), MB and M are thereafter treated as a single
entity which has $5 million of liabilities, an
account receivable for future FFA with a basis of
$1 million, and other assets with a basis of $4
million. Section 1.597–4(g)(4).
(ii)During May 1996, MB earns $25,000 of
interest income and accrues $20,000 of interest
expense on depositor accounts and there is no
net change in deposits other than the additional
$20,000 of interest expense accrued on depositor
accounts. MB pays $5,000 of wage expenses and
has no other items of income or expense.
(iii)On June 1, 1996, Agency causes MB to
issue 100 percent of its stock to corporation Y.
In connection with the stock issuance, Agency
provides an Agency Obligation for $2 million
and no other FFA.
(iv)The stock issuance results in a Taxable
Transfer. Section 1.597–5(b). MB is treated as
receiving the Agency Obligation immediately
prior to the Taxable Transfer. Section 1.597–
5(c)(1). MB has $1 million of basis in its
account receivable for FFA. This receivable is
treated as satisfied, offsetting $1 million of the
$2 million of FFA provided by Agency in con-
nection with the Taxable Transfer. The status of
the remaining $1 million of FFA as includible
income is determined as of the end of the taxable
year under §1.597–2(c). However, under §1.597–
2(b), MB obtains a $2 million basis in the
Agency Obligation received as FFA.
(v)Under §1.597–5(c)(2), in the Taxable
Transfer, Old Entity MB is treated as selling, to
New Entity MB, all of Old Entity MB’s assets,
having a basis of $6,020,000 (the original $4
million of asset basis as of April 30, 1996, plus
$20,000 net cash from May 1996 activities, plus
$2 million in the Agency Obligation received as
FFA), for $5,020,000, the amount of Old Entity
MB’s liabilities assumed by New Entity MB
pursuant to the Taxable Transfer. Therefore, Old
Entity MB recognizes, in the aggregate, a loss of
$1 million from the Taxable Transfer.
(vi)Because this $1 million loss causes Old
Entity MB’s deductions to exceed its gross
income (determined without regard to FFA) by
$1 million, Old Entity MB must include in its
income the $1 million of FFA not offset by the
FFA receivable. Section 1.597–2(c). (As of May
1, 1996, Old Entity MB’s liabilities ($5,000,000)
did not exceed MB’s $5 million adjusted basis of
its assets. For the taxable year, MB’s deductions
of $1,025,000 ($1,000,000 loss from the Taxable
Transfer, $20,000 interest expense and $5,000 of
wage expense) exceeded its gross income (dis-
regarding FFA) of $25,000 (interest income) by
$1,000,000. Thus, under §1.597–2(c), MB in-
cludes in income the entire $1,000,000 of FFA
not offset by the FFA receivable.)
(vii)Therefore, Old Entity MB’s taxable in-
come for the taxable year ending on the date of
the Taxable Transfer is $0.
(viii)Residual Entity M is also deemed to
engage in a deemed sale of its assets to New
Entity M under §1.597–5(b)(3), but there are no
tax consequences as M has no assets or liabilities
at the time of the deemed sale.
(ix)Under §1.597–5(d)(1), New Entity MB is
treated as purchasing Old Entity MB’s assets for
$5,020,000, the amount of New Entity MB’s
liabilities. Of this, $2,000,000 is allocated to the
$2 million Agency Obligation, and $3,020,000 is
allocated to the other assets New Entity MB is
treated as purchasing in the Taxable Transfer.
Example 4. Loss Sharing. Institution N ac-
quires assets and assumes liabilities of another
Institution in a Taxable Transfer. Among the
assets transferred are three parcels of real estate.
In the hands of the transferring Institution, these
assets had book values of $100,000 each. In
connection with the Taxable Transfer, Agency
agrees to reimburse Institution N for 80 percent
of any loss (based on the original book value)
realized on the disposition or charge-off of the
three properties. This arrangement constitutes a
Loss Guarantee. Thus, in allocating basis, Institu-
tion N treats the three parcels as Class II assets.
By virtue of the arrangement with the Agency,
Institution N is assured that the parcels will not
be worth less to it than $80,000 each, because
even if the properties are worthless, Agency will
reimburse 80 percent of the loss. Although
Institution could obtain payments under the Loss
Guarantee if the properties are worth more, it is
not guaranteed that it will realize more than
$80,000. Accordingly, $80,000 is the highest
guaranteed value of the three parcels. Institution
N will allocate basis to the Class II assets up to
their fair market value. For this purpose, the fair
market value of the three parcels is not less than
$80,000 each. Section 1.597–5(d)(2)(ii); §1.597–
5(c)(3)(ii).
§1.597–6 Limitation on collection of
income tax.
(a)Limitation on collection where
tax is borne by Agency. If an Institution
without Continuing Equity (or any of
its Consolidated Subsidiaries) is liable
for income tax that is attributable to the
inclusion in income of FFA or gain
from a Taxable Transfer, the tax will
not be collected if it would be borne by

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Agency. The final determination of
whether the tax would be borne by
Agency is within the sole discretion of
the Commissioner. In determining
whether tax would be borne by
Agency, the Commissioner will dis-
regard indemnity, tax-sharing, or simi-
lar obligations of Agency, an Institu-
tion, or its Consolidated Subsidiaries.
Collection of the several income tax
liability under §1.1502–6 from mem-
bers of an Institution’s consolidated
group other than the Institution or its
Consolidated Subsidiaries is not af-
fected by this section. Income tax will
continue to be subject to collection
except as specifically limited in this
section. This section does not apply to
taxes other than income taxes.
(b)Amount of tax attributable to
FFA or gain on a Taxable Transfer.
For purposes of paragraph (a) of this
section, the amount of income tax in a
taxable year attributable to the inclu-
sion of FFA or gain from a Taxable
Transfer in the income of an Institution
(or a Consolidated Subsidiary) is the
excess of the actual income tax liability
of the Institution (or the consolidated
group in which the Institution is a
member) over the income tax liability
of the Institution (or the consolidated
group in which the Institution is a
member) determined without regard to
FFA or gain or loss on the Taxable
Transfer.
(c)Reporting of uncollected tax. A
taxpayer must specify on the front page
of Form 1120 (U.S. Corporate Income
Tax Return), to the left of the space
provided for ‘‘Total Tax,’’ the amount
of income tax for the taxable year that
is potentially not subject to collection
under this section. If an Institution is a
subsidiary member of a consolidated
group, the amount specified as not
subject to collection is zero.
(d)Assessments of tax to offset
refunds. Income tax that is not col-
lected under this section will be as-
sessed and, thus, used to offset any
claim for refund made by or on behalf
of the Institution, the Consolidated
Subsidiary or any other corporation
with several liability for the tax.
(e)Collection of taxes from Acquir-
ing or a New Entity—(1) Acquiring.
No income tax liability (including the
several liability for taxes under
§1.1502–6) of a transferor in a Taxable
Transfer will be collected from
Acquiring.
(2)New Entity. Income tax liability
(including the several liability for taxes
under §1.1502–6) of a transferor in a
Taxable Transfer will be collected from
a New Entity only if stock that was
outstanding in the Old Entity remains
outstanding as stock in the New Entity
or is reacquired or exchanged for
consideration.
(f)Effect on section 7507. This
section supersedes the application of
section 7507, and the regulations there-
under, for the assessment and collec-
tion of income tax attributable to FFA.
§1.597–7 Effective date.
(a)FIRREA effective date. Section
597, as amended by section 1401 of the
Financial Institutions Reform, Recov-
ery, and Enforcement Act of 1989
(FIRREA), Public Law 101–73, is
generally effective for any FFA re-
ceived or accrued by an Institution on
or after May 10, 1989, and for any
transaction in connection with which
such FFA is provided, unless the FFA
is provided in connection with an
acquisition occurring prior to May 10,
1989. See §1.597–8 for rules regarding
FFA received or accrued on or after
May 10, 1989, that relates to an
acquisition that occurred before May
10, 1989.
(b)Effective date of regulations.
Except as otherwise provided in this
section, §§1.597–1 through 1.597–6
apply to taxable years ending on or
after April 22, 1992. However, the
provisions of §§1.597–1 through
1.597–6 do not apply to FFA received
or accrued for taxable years ending on
or after April 22, 1992, in connection
with an Agency assisted acquisition
within the meaning of Notice 89–102
(1989–2 C.B. 436; see §601.601(d)(2))
(which does not include a transfer to a
Bridge Bank), that occurs before April
22, 1992. Taxpayers not subject to
§§1.597–1 through 1.597–6 must com-
ply with an interpretation of the statute
that is reasonable in light of the
legislative history and applicable ad-
ministrative pronouncements. For this
purpose, the rules contained in Notice
89–102 apply to the extent provided in
the Notice.
(c)Elective application to prior
years and transactions—(1) In general.
Except as limited in this paragraph (c),
an election is available to apply
§§1.597–1 through 1.597–6 to taxable
years prior to the general effective date
of these regulations. A consolidated
group may elect to apply §§1.597–1
through 1.597–6 for all members of the
group in all taxable years to which
section 597, as amended by FIRREA,
applies. The common parent makes the
election for the group. An entity that is
not a member of a consolidated group
may elect to apply §§1.597–1 through
1.597–6 to all taxable years to which
section 597, as amended by FIRREA,
applies for which it is not a member of
a consolidated group. The election is
irrevocable.
(2)Election unavailable in certain
cases—(i) Statute of limitations closed.
The election cannot be made if the
period for assessment and collection of
tax has expired under the rules of
section 6501 for any taxable year in
which §§1.597–1 through 1.597–6
would affect the determination of the
electing entity’s or group’s income,
deductions, gain, loss, basis, or other
items.
(ii)No section 338 election under
Notice 89–102. The election cannot be
made with respect to an Institution if,
under Notice 89–102, it was a Target
with respect to which a qualified stock
purchase was made, a timely election
under section 338 was not made, and
on April 22, 1992, a timely election
under section 338 could not be made.
(iii)Inconsistent treatment of Institu-
tion that would be New Entity. If,
under §1.597–5(b), an Institution would
become a New Entity before April 22,
1992, the election cannot be made with
respect to that Institution unless elec-
tions are made by all relevant persons
such that §§1.597–1 through §1.597–6
apply both before and after the deemed
sale under §1.597–5. However, this
requirement does not apply if, under
§§1.597–1 through §1.597–6, the Insti-
tution would not have Continuing
Equity prior to the deemed sale.
(3)Expense reimbursements. Notice
89–102, 1989–2 C.B. 436, provides
that reimbursements paid or accrued
pursuant to an expense reimbursement
or indemnity arrangement are not in-
cluded in income but the taxpayer may
not deduct, or otherwise take into
account, the item of cost or expense to
which the reimbursement or indemnity
payment relates. With respect to an
Agency assisted acquisition within the
meaning of Notice 89–102 that occurs
before April 22, 1992, a taxpayer that
elects to apply these regulations retro-
actively under this paragraph (c) may
continue to account for these items
under the rules of Notice 89–102.

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(4)Procedural rules—(i) Manner of
making election. An Institution or
consolidated group makes the election
provided by this paragraph (c) by
attaching a written statement to, and
including it as a part of, the taxpayer’s
or consolidated group’s first annual
income tax return filed on or after
March 15, 1996. The statement must
contain the following legend at the top
of the page: ‘‘THIS IS AN ELECTION
UNDER §1.597–7(c),’’ and must con-
tain the name, address and employer
identification number of the taxpayer or
common parent making the election.
The statement must include a declara-
tion that ‘‘TAXPAYER AGREES TO
EXTEND THE STATUTE OF LIMI-
TATIONS ON ASSESSMENT FOR
THREE YEARS FROM THE DATE
OF THE FILING OF THIS ELEC-
TION UNDER §1.597–7(c), IF THE
LIMITATIONS PERIOD WOULD EX-
PIRE EARLIER WITHOUT SUCH
EXTENSION, FOR ANY ITEMS AF-
FECTED IN ANY TAXABLE YEAR
BY THE FILING OF THIS ELEC-
TION,’’ and a declaration that either
‘‘AMENDED RETURNS WILL BE
FILED FOR ALL TAXABLE YEARS
AFFECTED BY THE FILING OF
THIS ELECTION WITHIN 180 DAYS
OF MAKING THIS STATEMENT,
UNLESS SUCH REQUIREMENT IS
WAIVED IN WRITING BY THE
DISTRICT DIRECTOR OR HIS DEL-
EGATE’’ or ‘‘ALL RETURNS PRE-
VIOUSLY FILED ARE CONSISTENT
W I T H T H E P R O V I S I O N S O F
§§1.597–1 THROUGH 1.597–6,’’ and
be signed by an individual who is
authorized to make the election under
this paragraph (c) on behalf of the
taxpayer. An election with respect to a
consolidated group must be made by
the common parent of the group, not
Agency, and applies to all members of
the group.
(ii)Effect of elective disaffiliation.
To make the affirmative election de-
scribed in §1.597–4(g)(5) for an Insti-
tution placed in Agency receivership in
a taxable year ending before April 22,
1992, the consolidated group must send
the affected Institution the statement
described in §1.597–4(g)(5) on or
before May 31, 1996. Notwithstanding
the requirements of paragraph (c)(4)(i)
of this section, a consolidated group
sending such a statement is deemed to
make the election described in, and to
agree to the conditions contained in,
this paragraph (c). The consolidated
group must nevertheless attach the
statement described in paragraph
(c)(4)(i) of this section to its first
annual income tax return filed on or
after March 15, 1996.
(d)Reliance on prior guidance—(1)
Notice 89–102. Taxpayers may rely on
Notice 89–102, 1989–2 C.B. 436, to
the extent they acted in reliance on that
Notice prior to April 22, 1992. Such
reliance must be reasonable and trans-
actions with respect to which taxpayers
rely must be consistent with the over-
riding policies of section 597, as
expressed in the legislative history.
(2)Notice FI–46–89—(i) In general.
Notice FI–46–89 was published in the
Federal Register on April 23, 1992 (57
FR 14804). Taxpayers may rely on the
provisions of §§1.597–1 through
1.597–6 of that notice to the extent
they acted in reliance on those provi-
sions prior to December 21, 1995. Such
reliance must be reasonable and trans-
actions with respect to which taxpayers
rely must be consistent with the over-
riding policies of section 597, as
expressed in the legislative history, as
well as the overriding policies of notice
FI–46–89.
(ii)Taxable Transfers. Any taxpayer
described in this paragraph (d) that,
under notice FI–46–89, would be a
New Entity or Acquiring with respect
to a Taxable Transfer on or after April
22, 1992, and before December 21,
1995, may apply the rules of that no-
tice with respect to such transaction.
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 3. The authority citation for part
301 is amended by adding entries in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 301.7507–1 also issued un-
der 26 U.S.C. 597.
Section 301.7507–9 also issued un-
der 26 U.S.C. 597. * * *
Par. 4. Section 301.7507–1 is
amended by adding paragraph (b)(4) to
read as follows:
§301.7507–1 Banks and trust
companies covered.
******
(b)* * *
(4)The term ceased to do business
means the bank no longer accepts
deposits or makes loans and discounts,
and is winding up its affairs and is in
the process of liquidating its assets to
pay depositors. A bank will not be
considered to have ceased to do busi-
ness on account of a transaction in
which the bank—
(i)Transfers assets and liabilities to
a Bridge Bank in a transfer described
in §1.597–4 of this chapter;
(ii)Transfers assets and liabilities to
any person in a transaction to which
section 381(a) applies or in which the
transferee receives property with a
transferred basis;
(iii)Transfers assets or liabilities to
any person in a transaction in which
Federal Financial Assistance (as de-
fined in section 597) is provided to any
party to the transaction, unless all the
Federal Financial Assistance is deposit
insurance under §301.7507–9(d); or
(iv)Transfers assets or liabilities to
any person in a transaction similar to
any transaction described in paragraphs
(b)(4)(i) through (iii) of this section.
This paragraph (b)(4) applies to taxable
years ending on or after April 22,
1992.
Par. 5. Section 301.7507–9 is
amended by adding a sentence to the
end of paragraph (d) to read as follows:
§301.7507–9 Termination of
immunity.
******
(d)* * * For taxable years ending
on or after April 22, 1992, deposit
insurance does not include Federal
Financial Assistance (as defined in
section 597) and other payments de-
scribed in section 597(a) prior to its
amendment by the Financial Institu-
tions Reform, Recovery, and Enforce-
ment Act of 1989 and, therefore, such
payments must be taken into account to
determine whether a bank’s assets are
sufficient to meet claims of depositors.
******
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 6. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 7. In §602.101, paragraph (c) is
amended by adding entries in numeri-
cal order to the table to read as
follows:

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§602.101 OMB Control numbers.
******
(c)* * *
CFR part or sectionCurrent OMB
where identifiedcontrol number
and described
******
1.597–2................ 1545–1300
1.597–4................ 1545–1300
1.597–6................ 1545–1300
1.597–7................ 1545–1300
******
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
Approved December 4, 1995.
Cynthia G. Beerbower,
Deputy Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on
December 20, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 21, 1995, 60 F.R. 66091)
Section 807.—Rules for Certain
Reserves
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 846.—Discounted Unpaid
Losses Defined
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 1274.—Determination of
Issue Price in the Case of Certain
Debt Instruments Issued for Property
(Also Sections 42, 280G, 382, 412, 467, 468,
483, 807, 846, 1288, 7520, 7872.)
Federal rates; adjusted federal
rates; adjusted federal long-term rate,
and the long-term exempt rate. For
purposes of sections 1274, 1288, 382,
and other sections of the Code, tables
set forth the rates for February 1996.
Rev. Rul. 96–14
This revenue ruling provides various
prescribed rates for federal income tax
purposes for February 1996 (the current
month). Table 1 contains the short-
term, mid-term, and long-term applica-
ble federal rates (AFR) for the current
month for purposes of section 1274(d)
of the Internal Revenue Code. Table 2
contains the short-term, mid-term, and
long-term adjusted applicable federal
rates (adjusted AFR) for the current
month for purposes of section 1288(b).
Table 3 sets forth the adjusted federal
long-term rate and the long-term tax-
exempt rate described in section 382(f).
Table 4 contains the appropriate per-
centages for determining the low-
income housing credit described in
section 42(b)(2) for buildings placed in
service during the current month. Fi-
nally, Table 5 contains the federal rate
for determining the present value of an
annuity, an interest for life or for a
term of years, or a remainder or a
reversionary interest for purposes of
section 7520.
REV. RUL. 96–14 TABLE 1
Applicable Federal Rates (AFR) for February 1996
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-Term
AFR5.32%5.25%5.22%5.19%
110% AFR5.86%5.78%5.74%5.71%
120% AFR6.40%6.30%6.25%6.22%
Mid-Term
AFR5.61%5.53%5.49%5.47%
110% AFR6.17%6.08%6.03%6.00%
120% AFR6.75%6.64%6.59%6.55%
150% AFR8.47%8.30%8.22%8.16%
175% AFR9.91%9.68%9.57%9.49%
Long-Term
AFR6.09%6.00%5.96%5.93%
110% AFR6.71%6.60%6.55%6.51%
120% AFR7.33%7.20%7.14%7.09%

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REV. RUL. 96–14 TABLE 2
Adjusted AFR for February 1996
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-term
adjusted AFR3.66%3.63%3.61%3.60%
Mid-term
adjusted AFR4.42%4.37%4.35%4.33%
Long-term
adjusted AFR5.27%5.20%5.17%5.14%
REV. RUL. 95–79 TABLE 3
Rates Under Section 382 for February 1996
Adjusted federal long-term rate for the current month5.27%
Long-term tax-exempt rate for ownership changes during the current month (the highest of the
adjusted federal long-term rates for the current month and the prior two months).5.46%
REV. RUL. 96–14 TABLE 4
Appropriate Percentages Under Section 42(b)(2)
for February 1996
Appropriate percentage for the 70% present value low-income housing credit8.37%
Appropriate percentage for the 30% present value low-income housing credit3.59%
REV. RUL. 96–14 TABLE 5
Rate Under Section 7520 for February 1996
Applicable federal rate for determining the present value of an annuity, an interest for life or
a term of years, or a remainder or reversionary interest6.8%
Section 1288.—Treatment of Original
Issue Discount on Tax-Exempt
Obligations
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 7520.—Valuation Tables
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.
Section 7872.—Treatment of Loans
with Below-Market Interest Rates
The adjusted applicable federal short-term,
mid-term, and long-term rates are set forth for
the month of February 1996. See Rev. Rul. 96–
14, page 20.

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Part III. Administrative, Procedural, and Miscellaneous
Estimated Tax Payments for
Individuals
Notice 96–5
This notice provides that the Internal
Revenue Service will waive penalties
for certain individuals for the 4th
installment payment of estimated tax if
that payment is made on or before
January 22, 1996. Under §6654(c) of
the Internal Revenue Code, the due
date for the 4th installment payment of
estimated tax by individuals is January
15 of the following taxable year. Be-
cause January 15, 1996, is a Federal
holiday, a payment of the 4th install-
ment of estimated tax made on January
16, 1996, is considered timely.
Due to the blizzard that occurred on
January 7 and 8, 1996, the 4th
installment payment of estimated tax
made by individuals who are residents
of the District of Columbia, Connecti-
cut, Delaware, Kentucky, Maine, Mary-
land, Massachusetts, New Hampshire,
New Jersey, New York, North Car-
olina, Pennsylvania, Rhode Island, Ver-
mont, Virginia, and West Virginia will
be considered timely if made on or
before January 22, 1996. The waiver is
automatic for these individuals.
Alternatively, under §6654(h), all
individuals who file their 1995 individ-
ual income tax returns on or before
January 31, 1996, and pay the entire
balance due with the return, do not
have to make the 4th installment pay-
ment of estimated tax.
DRAFTING INFORMATION
The principal author of this notice is
Margaret A. Owens of the Office of
Assistant Chief Counsel (Income Tax
and Accounting). For further informa-
tion regarding this notice, contact Ms.
Owens on (202) 622-6232 (not a toll-
free call).
Request for Comments on Further
Capitalization Guidance
Notice 96–7
This notice invites public comment
on approaches the Service should con-
sider to address issues raised under
§§162 and 263 of the Internal Revenue
Code particularly in light of INDO-
PCO, Inc. v. Commissioner, 503 U.S.
79 (1992).
BACKGROUND
Section 162(a) allows a deduction for
all the ordinary and necessary expenses
paid or incurred during the taxable year
in carrying on any trade or business.
Section 263 generally prohibits de-
ductions for capital expenditures. Sec-
tion 263(a)(1) provides that no deduc-
tion is allowed for any amount paid out
for new buildings or for permanent
improvements or betterments made to
increase the value of any property or
estate. Under §263(a)(2), no deduction
is allowed for any amount expended in
restoring property or in making good
the exhaustion thereof for which an
allowance is or has been made in the
form of a deduction for depreciation,
amortization, or depletion.
In INDOPCO, the Supreme Court of
the United States concluded that certain
legal and professional fees incurred by
a corporation to facilitate a friendly
acquisition of the corporation created
significant long-term benefits for the
taxpayer and, therefore, were capital
expenditures. In reaching this decision,
the Court specifically rejected the
argument that its decision in Commis-
sioner v. Lincoln Savings & Loan
Association, 403 U.S. 345 (1971),
should be read as holding ‘‘that only
expenditures that create or enhance
separate and distinct assets are to be
capitalized under §263.’’ INDOPCO at
86–87 (emphasis in original). The
Court further stated that ‘‘[a]lthough
the mere presence of an incidental
future benefit—‘some future aspect’—
may not warrant capitalization, a tax-
payer’s realization of benefits beyond
the year in which the expenditure is
incurred is undeniably important in
determining whether the appropriate tax
treatment is immediate deduction or
capitalization.’’ INDOPCO at 87
(emphasis in original).
The Service believes that the INDO-
PCO decision did not change the
fundamental legal principles for deter-
mining whether a particular expenditure
may be deducted or must be cap-
italized. Since the decision in INDO-
PCO, the Service has issued a variety
of revenue rulings applying §§162(a)
and 263(a) to specific expenditures. For
example, the Service ruled that the
INDOPCO decision did not change the
treatment of advertising costs (Rev.
Rul. 92–80, 1992–2 C.B. 57), inciden-
tal repair costs (Rev. Rul. 94–12,
1994–1 C.B. 36), or severance pay-
ments (Rev. Rul. 94–77, 1994–2 C.B.
19), all of which are generally deduct-
ible under §162.
REQUEST FOR PUBLIC COMMENT
The Service continues to receive
numerous informal inquiries regarding
issues of capitalization. Taxpayers
should be aware that, in appropriate
circumstances, they can receive private
letter rulings on the deductibility or
capitalization of specific expenditures.
The Service welcomes comments on
possible changes to the private letter
ruling process that would facilitate
advance resolution of these issues. In
addition, the Service requests com-
ments concerning: (1) whether general
guidance clarifying the fundamental
principles of capitalization would aid in
resolving capitalization issues; (2) what
specific approaches, principles, or is-
sues such guidance should address; and
(3) whether safe-harbor amortization
periods should be provided for certain
capitalizable expenditures and what
data would support any suggested
periods.
Written comments should be submit-
ted by May 6, 1996. Written comments
should be sent to: Internal Revenue
Service, Attn: CC:DOM:CORP:R (IA-
Branch 5), Room 5228, P.O. Box 7604,
Ben Franklin Station, Washington, D.C.
20044. All materials submitted will be
available for public inspection and
copying. During its review of the
comments, the Service will continue to
process private letter rulings and con-
tinue to resolve issues under §§162
and 263(a) raised in examinations.
DRAFTING INFORMATION
The principal author of this notice is
John Moriarty of the Office of Assist-
ant Chief Counsel (Income Tax and
Accounting). For further information
regarding this notice, contact Mr. Mor-
iarty on (202) 622-4950 (not a toll-free
call).

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Cash Balance Pension Plans
Notice 96–8
I. Purpose
This notice describes and requests
comments on proposed guidance con-
cerning the application of sections 411
and 417(e) to single sum distributions
under defined benefit pension plans
that are cash balance plans. The pro-
posed guidance is being described in
this notice in order to permit advance
public comment in anticipation of the
publication of regulations that incorpo-
rate the proposed guidance.
II.Background
A.General description of cash
balance plans
In general terms, a cash balance plan
is a defined benefit pension plan that
defines benefits for each employee by
reference to the amount of the
employee’s hypothetical account bal-
ance. An employee’s hypothetical ac-
count balance is credited with hypo-
thetical allocations and hypothetical
earnings determined under a formula
selected by the employer and set forth
in the plan. These hypothetical alloca-
tions and hypothetical earnings are
designed to mimic the allocations of
actual contributions and actual earnings
to an employee’s account that would
occur under a defined contribution
plan. Cash balance plans often specify
that hypothetical earnings (referred to
in this notice as interest credits) are
determined using an interest rate or rate
of return under a variable outside index
(e.g., the annual yield on one-year
Treasury securities). Most cash balance
plans also are designed to permit, after
termination of employment, a distribu-
tion of an employee’s entire accrued
benefit in the form of a single sum
distribution equal to the employee’s
hypothetical account balance as of the
date of the distribution. Many cash
balance plans also provide that if
distribution is in the form of an
annuity, the amount of the annuity is
determined by dividing the hypothetical
account balance by an annuity conver-
sion factor.
As explained below, in order to
comply with sections 411(a) and 417(e)
in calculating the amount of a single
sum distribution under a cash balance
plan, the balance of the employee’s
hypothetical account must be projected
to normal retirement age and then the
employee must be paid at least the
present value, determined in accord-
ance with section 417(e), of that
projected hypothetical account balance.
If a cash balance plan provides interest
credits using an interest rate that is
higher than the section 417(e) applica-
ble interest rate, payment of a single
sum distribution equal to the hypotheti-
cal account balance as a complete
distribution of the employee’s accrued
benefit may result either in a violation
of section 417(e) or a forfeiture in
violation of section 411(a). This is
because, in such a case, the present
value of the employee’s accrued bene-
fit, determined using the section 417(e)
applicable interest rate, will generally
exceed the hypothetical account bal-
ance. The following example illustrates
this potential problem.
Example. A cash balance plan provides for
interest credits at a fixed rate of 8% per annum
that are not conditioned on continued employ-
ment, and for annuity conversions using the
section 417(e) applicable interest rate and mor-
tality table. A fully vested employee with a
hypothetical account balance of $45,000 termi-
nates employment at age 45 and elects an
immediate single sum distribution. At the time of
the employee’s termination, the section 417(e)
applicable interest rate is 6.5%.
The projected balance of the employee’s
hypothetical account as of normal retirement age
is $209,743. If $209,743 is discounted to age 45
at 6.5% (the section 417(e) applicable interest
rate), the present value equals $59,524.
Accordingly, if the plan paid the hypothetical
account balance of $45,000, instead of $59,524,
the employee would receive $14,524 less than
the amount to which the employee is entitled.
Even if a cash balance plan provides
interest credits using an interest rate
that exceeds the section 417(e) applica-
ble interest rate, the plan can satisfy
sections 417(e) and 411(a). Such a plan
would provide that the amount of any
single sum distribution is equal to the
present value of the employee’s ac-
crued benefit determined in a manner
that satisfies sections 411(a) and 417(e)
even if the amount of the single sum
exceeds the employee’s hypothetical
account balance. Thus, in the example
above, the plan would satisfy sections
411(a) and 417(e) if the employee
received a single sum distribution of
$59,524 (the present value of the
employee’s accrued benefit) rather than
$45,000 (the employee’s hypothetical
account balance).
B.Existing regulatory safe harbor
for cash balance plans
Section 1.401(a)(4)–8(c) of the In-
come Tax Regulations, as issued in
September 1991, provides a safe harbor
testing method for cash balance plans.
Under this method, a cash balance plan
could be tested for nondiscrimination
as though it were a defined contribu-
tion plan with actual allocations equal
to the amount of the hypothetical
allocations credited for the plan year.
In order to use the safe harbor, a cash
balance plan must satisfy certain design
requirements that relate to the accrued
benefit and valuation rules that are
unique to defined benefit plans.
Comments on the September 1991
regulations expressed concern that the
safe harbor plan design requirements
reflected an interpretation by the Serv-
ice and Treasury of the qualification
requirements that, in certain cases,
would require cash balance plans to
pay a single sum distribution in excess
of the hypothetical account balance.
Guidance was requested on the circum-
stances in which a cash balance plan
(whether or not it qualifies for safe
harbor nondiscrimination testing) is
permitted to distribute a single sum
distribution equal to the hypothetical
account balance without violating sec-
tion 411(a) or 417(e).
When revised regulations under sec-
tion 401(a)(4) were issued in Septem-
ber 1993, the safe harbor testing
method for cash balance plans was left
unchanged. The Preamble to those
regulations indicated that the safe har-
bor testing method for cash balance
plans had generated significant com-
ment and that further guidance would
be issued at a later date.
III.Analysis
A.Nonforfeiture and accrual rules
A cash balance plan is a defined
benefit plan, not a defined contribution
plan, because the benefits provided are
not based solely on actual contributions
and forfeitures allocated to an
employee’s account and the actual
investment experience and expenses of
the plan allocated to the account.
Section 411(a)(7) defines an em-
ployee’s accrued benefit differently for
defined benefit plans than for defined
contribution plans. Also, defined bene-
fit plans are subject to a number of

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statutory provisions that do not apply
to defined contribution plans. These
include the rules of section 411(b)(1)
that limit ‘‘backloading’’ of accruals;
the valuation rules of section 417(e);
and the definitely determinable benefits
requirement of section 401(a)(25).
These provisions limit the extent to
which a cash balance plan can mimic
the benefit and accrual structure of a
defined contribution plan.
Under section 411(a)(2), an em-
ployee’s accrued benefit must become
nonforfeitable in accordance with one
of the schedules specified in that
section. Under §1.411(a)–7(a)(1)(ii),
the term ‘‘accrued benefits’’ generally
refers only to pension or retirement
benefits. Under section 411(b)(1), the
accrual of the retirement benefits pay-
able at normal retirement age must
satisfy one of the rules in section
411(b)(1)(A), (B) or (C).
Under a cash balance plan, the re-
tirement benefits payable at normal
retirement age are determined by refer-
ence to the hypothetical account bal-
ance as of normal retirement age, in-
cluding benefits attributable to interest
credits to that age. Thus, benefits
attributable to interest credits must be
taken into account in determining
whether the accrual of the retirement
benefits under a cash balance plan
satisfies one of the rules in section
411(b)(1)(A), (B) or (C). Moreover,
benefits attributable to interest credits
are in the nature of accrued benefits
within the meaning of §1.411(a)–7(a),
rather than ancillary benefits, and thus,
once accrued, must become nonforfeita-
ble in accordance with a vesting
schedule that satisfies section 411(a).
Cash balance plans can be cate-
gorized based on when the benefits
attributable to interest credits accrue.
Under one type of cash balance plan
(referred to in this notice as a front-
loaded interest credit plan), future
interest credits to an employee’s hypo-
thetical account balance are not condi-
tioned upon future service. (Of course,
benefits attributable to future interest
credits may be forfeited in accordance
with the plan’s vesting provisions, to
the extent permitted under section 411.)
Thus, in the case of a frontloaded
interest credit plan, the benefits attribu-
table to future interest credits with
respect to a hypothetical allocation
accrue at the same time that the bene-
fits attributable to the hypothetical
allocation accrue. As a result, if an
employee terminates employment and
defers distribution to a later date,
interest credits will continue to be
credited to that employee’s hypothetical
account.
A second type of cash balance plan
(referred to in this notice as a back-
loaded interest credit plan) conditions
future interest credits upon further
service. In the case of a backloaded
interest credit plan, benefits attributable
to interest credits do not accrue until
the interest credits are credited to the
employee’s account. Because back-
loaded interest credit plans typically
will not satisfy any of the accrual rules
in section 411(b)(1)(A), (B) or (C), it is
anticipated that the proposed guidance
will address only frontloaded interest
credit plans.
B.Single sum distributions from
frontloaded interest credit plans
As indicated above, most cash bal-
ance plans are designed to permit a
distribution of an employee’s entire
accrued benefit, after termination of
employment, in the form of a single
sum equal to the employee’s hypotheti-
cal account balance as of the date of
the distribution. In order for a defined
benefit plan to satisfy section 417(e),
any single sum distribution payable to
an employee from the plan must not be
less than the nonforfeitable portion of
the present value of the employee’s
accrued benefit under section 411(a)(7)
(determined using the applicable inter-
est rate and mortality table under
section 417(e)).
1.Determination of the accrued
benefit
In the case of a frontloaded interest
credit plan, an employee’s accrued
benefit as of any date before attainment
of normal retirement age is based on
the employee’s hypothetical account
balance as of normal retirement age,
including future interest credits to that
age. If such a plan specifies a fixed
interest rate for use in determining
future interest credits, the employee’s
hypothetical account balance as of
normal retirement age (including future
interest credits) can be calculated pre-
cisely before normal retirement age.
However, if a frontloaded interest
credit plan specifies a variable outside
index for use in determining the
amount of interest credits, the precise
dollar amount of an employee’s hypo-
thetical account balance as of normal
retirement age (including future interest
credits to normal retirement age), and
thus the precise dollar amount of the
employee’s accrued benefit as of any
date before normal retirement age,
cannot be calculated prior to normal
retirement age.
A frontloaded interest credit plan
that specifies a variable outside index
for use in determining the amount of
interest credits must prescribe the
method for reflecting future interest
credits in the calculation of an
employee’s accrued benefit. In order to
comply with section 401(a)(25), the
method, including actuarial assump-
tions, if applicable, must preclude
employer discretion. Further, in deter-
mining the amount of an employee’s
accrued benefit, a forfeiture, within the
meaning of §1.411(a)–4T, will result if
the value of future interest credits is
projected using a rate that understates
the value of those credits or if the plan
by its terms reduces the interest rate or
rate of return used for projecting future
interest credits. A forfeiture in violation
of section 411(a) also will occur if, in
d e t e r m i n i n g t h e a m o u n t o f a n
employee’s accrued benefit, future in-
terest credits are not taken into account
(i.e., there is no projection of future
interest credits) and this has the same
effect as using a rate that understates
the value of future interest credits.
2.Calculation of the present value
of the employee’s accrued
benefit
In the case of a frontloaded interest
credit plan, a single sum distribution
optional form of benefit equal to the
hypothetical account balance will sat-
isfy section 417(e) only if the single
sum distribution is not less than the
present value of the employee’s ac-
crued benefit calculated in accordance
with the applicable interest rate and
mortality table under section 417(e)(3).
As noted above, the amount of the
employee’s accrued benefit must be
determined using a method of reflect-
ing future interest credits that satisfies
section 401(a)(25) and that does not
create a forfeiture in violation of
section 411(a).
3.Situations in which the present
value will not exceed the
hypothetical account balance
A frontloaded interest credit plan
might provide that the amount of

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interest credits is determined using a
variable interest rate or rate of return
that, by its terms, is no greater than the
applicable interest rate under section
417(e)(3). For example, a plan that has
been amended to comply with the
changes to section 417(e) made by the
Retirement Protection Act of 1994
(RPA ’94) might provide that interest
credits are determined using the lesser
of the current rate of interest on 30-
year Treasury securities or the current
yield on 1-year Treasury Constant
Maturities. Under such a plan, future
interest credits can, without violating
section 411(a), be projected to normal
retirement age using a rate that is no
greater than the applicable interest rate
under section 417(e)(3). In that case,
assuming that the annuity conversion
factor under the plan is not less than
the annuity conversion factor deter-
mined using the applicable interest rate
and mortality table under section
417(e)(3), the employee’s hypothetical
account balance will equal or exceed
the present value of the employee’s
accrued benefit determined in accord-
ance with section 417(e). Thus, a single
s u m d i s t r i b u t i o n e q u a l t o t h e
employee’s hypothetical account bal-
ance under such a plan will satisfy
sections 411(a) and 417(e).
In other cases, a single sum distribu-
tion equal to an employee’s hypotheti-
cal account balance will satisfy sections
417(e) and 411(a) if (a) the annuity
conversion factor is not less than the
annuity conversion factor determined
using the applicable interest rate and
mortality table under section 417(e)(3),
(b) under the method for reflecting
future interest credits in the calculation
of an employee’s accrued benefit, the
future interest credits are projected
using a rate that is no greater that the
applicable interest rate under section
417(e)(3), and (c) this projection does
not result in a forfeiture in violation of
section 411(a).
By contrast, if the interest rate or
rate of return under the plan used in
determining the amount of interest
credits is high relative to the section
417(e)(3) interest rate, the plan cannot
distribute a single sum equal to the
employee’s hypothetical account bal-
ance and satisfy sections 411(a) and
417(e). If such a plan provided that, in
determining an employee’s accrued
benefit, the rate used for projecting the
amount of future interest credits was no
greater than the interest rate under
section 417(e)(3), the projection would
result in a forfeiture. Alternatively, if
the plan provided for interest credits to
be projected using a rate that exceeded
the section 417(e) interest rate but then
provided for the benefit to be dis-
counted using that same higher rate, the
plan would violate section 417(e).
C.Effect of defining the accrued
benefit as the hypothetical
account balance
The requirements referred to in this
notice apply even in the case of a cash
balance plan that defines an employee’s
accrued benefit as an amount equal to
the employee’s hypothetical account
balance. Section 411(a)(7) defines the
accrued benefit in terms of benefits
payable under the plan at normal
retirement age. In a cash balance plan,
for an employee who has not attained
normal retirement age, whether the
employee’s retirement benefit payable
at normal retirement age under the plan
includes benefits attributable to future
interest credits depends on whether
those benefits have accrued.
If benefits attributable to future
interest credits have accrued, and those
benefits are disregarded when benefits
commence before normal retirement
age, the plan has effectively condi-
tioned entitlement to the benefits at-
tributable to those future interest
credits on the employee not taking a
distribution prior to normal retirement
age. Pursuant to §1.411(a)–4T, a right
that is conditioned under the plan on a
subsequent forbearance is a forfeitable
right. Accordingly, conditioning entitle-
ment to benefits on the employee not
taking a distribution violates the non-
forfeitability requirements of section
411(a).
Alternatively, if the benefits attribu-
table to future interest credits have not
accrued and will accrue only as of the
later dates when the interest credits are
included in the hypothetical account
balance, the timing of those later
accruals must be taken into account in
applying the accrual rules of section
411(b)(1). As a result, such a plan
typically will not satisfy those accrual
rules.
IV.Description of proposal
A.Variable interest rates that may
be assumed for these purposes
to be no greater than the 30-
year Treasury interest rate
It is anticipated that the regulations
will set forth a list of standard indices
and associated margins for use with
frontloaded interest credit plans that
provide interest credits equal to the
product of the balance of the hypotheti-
cal account and the current value of a
variable index. (It is anticipated that
this proposal will apply without regard
to how frequently the rate used to
determine interest credits is com-
pounded.) Under a frontloaded interest
credit plan that, for this purpose,
specifies a variable index equal to the
PBGC immediate rate or the sum of
one of the standard indices and a
margin not greater than the specified
margin associated with that standard
index, no impermissible forfeiture
would result from projecting that the
rate used to determine future interest
credits for an employee is no greater
than the applicable interest rate under
section 417(e)(3), as amended by RPA
’94. Thus, if such a plan has been
amended to comply with the changes to
section 417(e) made by RPA ’94, the
employee’s entire accrued benefit could
be distributed in the form of a single
s u m d i s t r i b u t i o n e q u a l t o t h e
employee’s hypothetical account bal-
ance without violating section 411(a) or
417(e), provided that the plan provides
the appropriate annuity conversion
factors.
The table below provides the pro-
posed list of standard indices and
associated margins. The discount rates
on Treasury bills and the yields on
Treasury Constant Maturities are the
rates reported in the Federal Reserve
Bulletin, and the Consumer Price Index
is CPI-U, as reported by the Depart-
ment of Labor. Authority would be
delegated to the Commissioner to ap-
prove other indices and associated
margins.

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Standard IndexAssociated
Margin
The discount rate on 3-month Treasury Bills175 basis
points
The discount rate on 6-month Treasury Bills or 12-
month Treasury Bills
150 basis
points
The yield on 1-year Treasury Constant Maturities100 basis
points
The yield on 2-year Treasury Constant Maturities or
3-year Treasury Constant Maturities
50 basis
points
The yield on 5-year Treasury Constant Maturities or
7-year Treasury Constant Maturities
25 basis
points
The yield on 10-year Treasury Constant Maturities or
any longer period Treasury Constant Maturities
0 basis points
Annual rate of change of the Consumer Price Index3 percentage
points
In developing these standard indices
and associated margins, the Service and
Treasury took into account the histor-
ical relationship between each of these
indices and the rate of interest on 30-
year Treasury securities.
Under the proposal, if a frontloaded
interest credit plan specified a variable
index for use in determining the
amount of interest credits that is equal
to the sum of a standard index (listed
in the table above) and a margin that
exceeds the specified margin associated
with that standard index, distribution of
a single sum equal to the employee’s
hypothetical account balance would not
satisfy both section 411(a) and section
417(e). If such a plan provided that the
rate used for projecting the amount of
future interest credits was no greater
than the interest rate under section
417(e)(3), the projection would result
in a forfeiture. Alternatively, if a
frontloaded interest credit plan pro-
vided for interest credits to be pro-
jected using a rate that exceeded the
section 417(e) interest rate but then
provided for the benefit to be dis-
counted using that same higher rate, the
plan would violate section 417(e).
B.Guidance will be prospective
The anticipated regulations will be
effective prospectively. In addition, for
plan years beginning before the regula-
tions are effective, a frontloaded inter-
est credit plan would not be disquali-
fied for failing to satisfy section 411(a)
or 417(e) if the amount of the distribu-
tion satisfied those sections based on a
reasonable, good-faith interpretation of
the applicable provisions of the Code,
taking into account pre-existing guid-
ance. For this purpose, plans that
comply with the guidance in this notice
are deemed to be applying a reason-
able, good faith interpretation.
V.Comments
The Service and Treasury invite
comments on the proposal described in
this notice. Comments are specifically
requested on other indices for which
guidance may be appropriate and on
guidance that would facilitate the tran-
sition to use of an approved index
(including possible guidance with re-
spect to the application of section
411(d)(6)). Any suggestion of an index
(and associated margin, if any) should
include an analysis of the historical
relationship between the index and the
rate for 30-year Treasury securities.
Comments should be submitted in writ-
ing, referencing Notice 96–7, and ad-
dressed to—
Associate Chief Counsel
(Employee Benefits and Exempt
Organizations)
CC:EBEO
ATTN: Cash Balance Guidance
Room 5214
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 20224
VI.Drafting information
The principal author of this notice is
Marjorie Hoffman of the Office of the
Associate Chief Counsel (Employee
Benefits and Exempt Organizations).
For further information, contact Ms.
Hoffman at 202-622-6030 (not a toll-
free number).
Weighted Average Interest Rate
Update
Notice 96–9
Notice 88–73 provides guidelines for
determining the weighted average inter-
est rate and the resulting permissible
range of interest rates used to calculate
current liability for the purpose of the
full funding limitation of §412(c)(7) of
the Internal Revenue Code as amended
by the Omnibus Budget Reconciliation
Act of 1987 and as further amended by
the Uruguay Round Agreements Act,
Pub. L. 103–465 (GATT).
The average yield on the 30-year
Treasury Constant Maturities for De-
cember 1995 is 6.06 percent.
The following rates were determined
for the plan years beginning in the
month shown below.

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MonthYear
Weighted
Average
90% to 108%
Permissible
Range
90% to 110%
Permissible
Range
January19967.056.35 to 7.626.35 to 7.76
Drafting Information
The principal author of this notice is
Donna Prestia of the Employee Plans
Division. For further information re-
garding this notice, call (202) 622-6076
between 2:30 and 4:00 p.m. Eastern
time (not a toll-free number). Ms.
Prestia’s number is (202) 622-7377
(also not a toll-free number).

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281996–24 I.R.B.
Part IV. Items of General Interest
Notice of Proposed Rulemaking
Disclosure of Returns and Return
Information to Procure Property or
Services for Tax Administration
Purposes
DL–1–95
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rule-
making.
SUMMARY: These proposed regula-
tions relate to the disclosure of returns
and return information in connection
with the procurement of property and
services for tax administration pur-
poses. The amendments would author-
ize the Department of Justice, including
offices of United States Attorneys, to
make such disclosures. Current dis-
closure authority within the Department
of Justice rests only with the Tax
Division. The amendments also reflect
a change to the law made by the
Omnibus Budget Reconciliation Act of
1990 regarding the type of services
about which disclosures may be made.
DATES: Comments and requests for a
public hearing must be received by
March 14, 1996.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (DL–01–95), Room
5228, Internal Revenue Service, POB
7604, Ben Franklin Station, Wash-
ington, DC 20044. In the alternative,
submissions may be hand delivered
between the hours of 8 a.m. and 5 p.m.
to: CC:DOM:CORP:R (DL–01–95),
Courier’s Desk, Internal Revenue Serv-
ice, 1111 Constitution Avenue NW.,
Washington, DC.
FOR FURTHER INFORMATION
C O N T A C T : D o n a l d S q u i r e s ,
202-622-4570 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 6103(n) of the Internal Reve-
nue Code (Code) authorizes the dis-
closure of returns and return informa-
tion, pursuant to regulations prescribed
by the Secretary of the Treasury, ‘‘to
the extent necessary in connection with
the processing, storage, transmission,
and reproduction of such returns and
return information, the programming,
maintenance, repair, testing, and pro-
curement of equipment, and the provid-
ing of other services, for purposes of
tax administration.’’
Existing regulations promulgated un-
der this section prescribe the persons
who may make such disclosures, the
situations under which such disclosures
may be made and the notification and
safeguarding procedures to be followed
when such disclosures are made.
Among the persons who may make
such disclosures are officers and
employees of the Tax Division of the
Department of Justice. The amend-
ments would authorize such disclosures
by the Department of Justice (not
solely the Tax Division) to third parties
who provide services for tax admin-
istration purposes under the conditions
and restrictions of the regulations. The
amendments would provide that, for the
purpose of this section, the ‘‘Depart-
ment of Justice’’ includes offices of
United States Attorneys.
The amendments would also conform
the regulation to the language of
section 6103(n), which was amended
by the Omnibus Budget Reconciliation
Act of 1990 to clarify that the dis-
closures authorized by this section
included those in connection with ‘‘the
providing of other services’’ (i.e. serv-
ices other than those related to the
mechanical processing of returns and
return information).
Explanation of Provisions
As currently written, 26 CFR
301.6103(n)–1 authorizes the Tax Divi-
sion of the Department of Justice,
among other entities and individuals, to
make disclosures of returns and return
information pursuant to section 6103(n)
of the Internal Revenue Code. This
authority allows the Tax Division to
disclose tax information incident to its
contracts to private parties for, among
other purposes, automated litigation
support services.
The Department of Justice has indi-
cated its intention to establish an
expanded automated tracking system
for all monetary judgments in favor of
the United States, which will be
operated by a private company under
contract with the Department. Although
the majority of tax cases are handled
by the Tax Division, there are several
United States Attorneys’ offices that
also have litigation responsibility in the
civil tax area. In addition, the Tax
Division refers some judgments in tax
cases to the United States Attorneys for
collection. Existing regulations argua-
bly would not permit these offices,
which are technically not part of the
Tax Division, to disclose tax informa-
tion incident to their inclusion of tax
judgments in the automated tracking
system.
The proposed amendment would au-
thorize the Department of Justice,
including offices of United States At-
torneys, to make disclosures to procure
property and services for tax admin-
istration purposes. Any such dis-
closures will be made under the same
conditions and restrictions already set
forth in the existing regulations. By
definition, any office within the De-
partment of Justice without tax admin-
istration duties will not have occasion
or authority pursuant to these regula-
tions to make such disclosures.
The proposed amendment would also
authorize disclosures in connection
with ‘‘the providing of other services,’’
i.e., services not related to the strict
mechanical processing or manipulation
of tax returns or return information.
This would conform the regulations to
the language of the statute, as amended
by the Omnibus Budget Reconciliation
Act of 1990 (Public Law 101–508, 104
Stat. 1388–353).
Special Analyses
It has been determined that this
notice of proposed rulemaking is not a
significant regulatory action as defined
in EO 12866. Therefore, a regulatory
assessment is not required. It has also
been determined that section 553(b) of
the Administrative Procedure Act (5
U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and,
therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, this notice of proposed rulemak-

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291996–24 I.R.B.
ing will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business.
Comments and Requests for a Public
Hearing
Before these proposed regulations
are adopted as final regulations, consid-
eration will be given to any written
comments that are submitted timely
(preferably a signed original and eight
copies) to the IRS. All comments will
be available for public inspection and
copying. A public hearing may be
scheduled if requested in writing by
any person that timely submits written
comments. If a public hearing is
scheduled, notice of the date, time, and
place for the hearing will be published
in the Federal Register.
Drafting Information
The principal author of these pro-
posed regulations is Donald Squires,
Office of the Assistant Chief Counsel
(Disclosure Litigation), IRS. However,
other personnel from the IRS, Depart-
ment of Justice and Treasury Depart-
ment participated in their development.
******
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 301 is
proposed to be amended as follows:
PART 301—PROCEDURE AND
ADMINISTRATION
Paragraph 1. The authority citation
for part 301 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Paragraph 2. Section 301.6103(n)–1
is amended as follows:
1.The first sentence of paragraph
(a) introductory text is amended by
r e m o v i n g t h e l a n g u a g e ‘ ‘ T a x
Division,’’.
2.Paragraph (a)(2) is amended by
removing the language ‘‘or to’’.
3. Paragraph (a)(2) is further
amended by adding the language ‘‘or
the providing of other services,’’ im-
mediately following the text ‘‘other
property,’’.
4.The concluding text following
paragraph (a)(2) is amended by remov-
ing the language ‘‘Tax Division,’’.
5.The second sentence of paragraph
(d) introductory text is amended by
r e m o v i n g t h e l a n g u a g e ‘ ‘ T a x
Division,’’.
6.Paragraph (d)(2) is amended by
r e m o v i n g t h e l a n g u a g e ‘ ‘ T a x
Division,’’.
7.Paragraph (e)(1) is amended by
removing the language ‘‘, and’’ at the
end of the paragraph and adding a
semicolon in its place.
8.Paragraph (e)(2) is amended by
removing the period at the end of the
paragraph and adding ‘‘; and’’ in its
place.
9.Paragraph (e)(3) is added.
10.The authority citation imme-
diately following §301.6103(n) is
removed.
The addition reads as follows:
§301.6103(n)–1 Disclosure of returns
and return information in connection
with procurement of property and
services for tax administration
purposes.
******
(e)* * *
(3)The term Department of Justice
includes offices of the United States
Attorneys.
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on
December 14, 1995, 8:45 a.m., and published
in the issue of the Federal Register for
December 15, 1995, 60 F.R. 64402)
Notice of Proposed Rulemaking and
Notice of Public Hearing
Source of Income from Sales of
Inventory and Natural Resources
Produced in One Jurisdiction and
Sold in Another Jurisdiction
INTL–3–95
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations governing the
source of income from sales of natural
resources or other inventory produced
in the United States and sold in a
foreign country or produced in a
foreign country and sold in the United
States. This document affects persons
who produce natural resources or other
inventory in the United States and sell
in a foreign country, or produce natural
resources or other inventory in a
foreign country and sell in the United
States. This document also provides
notice of a public hearing on these
proposed regulations.
DATES: Written comments and out-
lines of oral comments to be presented
at the public hearing scheduled for
April 10, 1996, at 10 a.m. must be
received by March 11, 1996.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (INTL–0003–95),
Room 5228, Internal Revenue Service,
POB 7604, Ben Franklin Station,
Washington, DC 20044. In the alterna-
tive, submissions may be hand deliv-
ered between the hours of 8 a.m. and 5
p.m. to: CC:DOM:CORP:R (INTL–
0003–95), Courier’s Desk, Internal
Revenue Service, 1111 Constitution
Avenue NW., Washington, DC. The
public hearing will be held in the IRS
Auditorium, Internal Revenue Building,
1111 Consitution Avenue, NW., Wash-
ington, DC.
FOR FURTHER INFORMATION
CONTACT: Concerning the regula-
tions, Anne Shelburne, (202) 622-3880;
concerning submissions and the hear-
ing, Ms. Christina Vasquez, (202)
622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in this notice of proposed
rulemaking has been submitted to the
Office of Management and Budget
(OMB) for review in accordance with
the Paperwork Reduction Act of 1995
(44 U.S.C. 3507).
Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk
Officer for the Department of Treasury,
Office of Information and Regulatory

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Affairs, Washington, DC 20503, with
copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
T:FP, Washington, DC 20224. Com-
ments on the collection of information
should be received by February 9,
1996.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number.
The collection of information re-
quirements are in proposed §§1.863–
1(b)(6) and 1.863–3(e)(2). This infor-
mation is required by the IRS to
monitor compliance with the federal
tax rules for determining the source of
income from the sale of natural re-
sources or other inventory produced in
the United States and sold in a foreign
country or produced in a foreign
country and sold in the United States.
The likely respondents are taxpayers
who produce natural resources or other
inventory in the United States and sell
in a foreign country, or who produce
natural resources or other inventory in
a foreign country and sell in the United
States. Responses to this collection of
information are required to properly
determine the source of a taxpayer’s
income from such sales.
Books or records relating to a col-
lection of information must be retained
as long as their contents may become
material in the administration of any
internal revenue law. Generally, tax
returns and tax return information are
confidential, as required by 26 U.S.C.
6103.
Estimated total annual reporting bur-
den: 1125 hours. The estimated annual
burden per respondent varies from 1
hour to 5 hours, depending on individ-
ual circumstances, with an estimated
average of 2.6 hours.
Estimated number of respondents: 425.
Estimated annual frequency of re-
sponses: One time per year.
Background
These proposed regulations contain
rules relating to the source of income
from the sale of certain natural re-
sources and other inventory. These
regulations are proposed to be effective
for taxable years beginning 30 days
after publication of final regulations.
However, taxpayers may elect to apply
these regulations for taxable years
beginning after July 11, 1995.
Explanation of provisions
I.Natural resources
A.Current regulations
Section 863 authorizes the Secretary
to promulgate regulations allocating or
apportioning to sources within or with-
out the United States all items of gross
income, expenses, losses, and deduc-
tions other than those items specified in
sections 861(a) and 862(a).
Section 1.863–1 of the existing reg-
ulations contains rules for determining
the source of income derived from the
sale of certain natural resources. Gener-
ally, under paragraph (b)(1) of those
regulations, income derived from the
ownership or operation of any farm,
mine, oil or gas well, other natural
deposit, or timber located within the
United States and from the sale by the
producer of the products within or
without the United States ordinarily
must be included in gross income from
sources within the United States. How-
ever, if a taxpayer can show to the
satisfaction of the District Director that,
due to peculiar conditions of produc-
tion and sale or for other reasons, not
all of the gross income derived there-
from should be allocated to sources
within the United States, the source of
the income generally is determined
under the 50/50 method described in
§1.863–3(b)(2) Example 2. The regula-
tions do not define ‘‘peculiar condi-
tions of production and sale.’’ In
addition, §1.863–1(b)(2) permits the
Commissioner to make an allocation or
apportionment that more clearly reflects
the proper source of a taxpayer’s
income, if the Commissioner deter-
mines that the application of paragraph
(b)(1) does not result in the proper
allocation or apportionment of income.
Similar rules apply in the case of
natural resources produced without the
United States and sold within the
United States. See §1.863–6. Thus,
income from the sale of such products
ordinarily will be allocated entirely to
foreign sources.
B.Issues under current regulations
The IRS and Treasury have reex-
amined the existing regulations under
section 863 regarding natural resources
and arrived at several conclusions.
First, certain ambiguities in existing
§1.863–1 should be clarified. For ex-
ample, the regulation does not define
the term ‘‘peculiar conditions of pro-
duction and sale,’’ and there is vir-
tually no authoritative guidance as to
the scope of that term. To the extent
that ‘‘peculiar conditions of production
and sale’’ is defined narrowly, the
regulation may lead to inappropriate
results when determining the source of
income from the sale of processed
natural resources. For example, if a
U.S. corporation harvests timber to
manufacture furniture for export, all of
its income may be from sources within
the United States. However, if another
U.S. corporation purchases cut timber
to manufacture furniture for export
from the United States, one-half of that
taxpayer’s income may be from sources
without the United States under the
50/50 method.
Second, the interaction of the exist-
ing regulations and the recently-issued
consolidated return regulations may
cause inappropriate sourcing results.
On July 11, 1995, the IRS and Treas-
ury issued final regulations under
§1.1502–13 [TD 8597 [1995–32 I.R.B.
6] (60 FR 36671)], treating members of
a U.S. consolidated group as a single
entity for purposes of determining the
source of a taxpayer’s income. The IRS
and Treasury understand that inap-
propriate results may occur when the
current section 863 regulations are
applied to certain consolidated groups
on a single entity basis. For example, a
U.S. corporation that is a member of a
consolidated group may extract oil
abroad. The oil is then transported to
the United States where it is refined by
another member of the consolidated
group. It is sold in the United States
through other members of the consoli-
dated group. Under §1.1502–13 of the
consolidated return rules, the consoli-
dated group is treated as a single
entity, and the source of income from
the sale of oil must be determined
under section 863. Because the consoli-
dated group refines the oil outside the
country of extraction, it may be that
peculiar conditions of production and
sale exist, and the exclusive sourcing
rules of paragraph (b)(1) do not apply.
Thus, the taxpayer would generally
determine the source of its income
under the 50/50 method described in
§1.863–3(b)(2) Example 2. Under this
method, 50 percent of the consolidated
group’s income would be U.S. source
income based on the place of sale.
However, this calculation may unders-
tate the appropriate amount of the

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taxpayer’s foreign source income be-
cause the value of the oil as extracted
may represent more than 50 percent of
the total value of the product that is
finally sold in the United States. The
preamble to the regulations under
§1.1502–13 indicated that the IRS and
Treasury would consider amending the
regulations under section 863 to ad-
dress these concerns.
Accordingly, the IRS and Treasury
are issuing proposed regulations under
section 863 to clarify ambiguities in the
existing regulation and to address con-
cerns created by the new §1.1502–13
regulations.
C.Proposed regulations
Section 1.863–1(b) provides special
rules for determining the source of
income from the sale of products
derived from the ownership or opera-
tion of any farm, mine, oil or gas well,
other natural deposit, or timber, within
the United States and the sale of these
products without the United States. The
proposed regulations also provide spe-
cial rules for determining the source of
income from the sale of products
derived from the ownership or opera-
tion of any farm, mine, oil or gas well,
other natural deposit, or timber, without
the United States and the sale of these
products within the United States. The
export terminal rule of paragraph (b)(1)
provides that the source of gross
receipts from the sale of such products
equal to the fair market value of the
product immediately prior to export
(referred to in the proposed regulations
as the export terminal) is determined
according to where the farm, mine, oil
or gas well, other natural deposit or
timber is located. Separate rules are
provided for determining the source of
any gross receipts in excess of the fair
market value of the product at the
export terminal. Paragraph (b)(2)
provides an exception to the approach
of paragraph (b)(1) where, prior to
export, the taxpayer engages in sub-
stantial production activities in addition
to activities related to the ownership or
operation of a farm, mine, oil or gas
well, other natural deposit, or timber.
1.Export terminal rule
Under the export terminal rule of
paragraph (b)(1), gross receipts derived
from the ownership or operation of any
farm, mine, oil or gas well, other
natural deposit, or timber, and sale of
the products derived therefrom, are
allocated between sources within and
without the United States based on the
fair market value of the product at the
export terminal. The export terminal is
the last point from which the product is
sent from the United States to a foreign
country or the last point from which
goods are sent from a foreign country
to the United States. For example, if a
U.S. corporation extracts oil in one
foreign country, sends the crude oil to
a port in a second foreign country via
pipeline, and delivers the oil to a U.S.
refinery by ship, the export terminal
would be the port in the second foreign
country where the crude oil was loaded
onto the ship.
Under the export terminal rule, the
source of gross receipts equal to the
fair market value of the product at the
export terminal is determined by the
location of the farm, mine, well,
deposit, or uncut timber. The source of
gross receipts in excess of the fair
market value of the product at the
export terminal (excess gross receipts)
is determined according to whether the
taxpayer engages in any additional
production activity following export. A
taxpayer will be treated as performing
production activities in addition to the
activities of owning or operating a
farm, mine, oil or gas well, other
natural deposit, or timber based on the
principles of §1.954–3(a)(4). However,
activities that prepare the natural re-
source itself for export, including those
that are designed to facilitate the
transportation of the natural resource to
or from the export terminal, will not be
considered additional production ac-
tivities. Thus, §1.863–1 Example 2
illustrates that liquefaction of natural
gas would not constitute additional
production activities. In addition, ac-
tivities such as delimbing and debark-
ing trees, sorting grain, and treating
and stabilizing oil would ordinarily not
constitute additional production ac-
tivities. In contrast, the transformation
of timber into furniture is not done to
prepare the natural resource itself for
export, and would constitute additional
production activity. Production ac-
tivities are defined in §1.863–1(b)(3)(i).
If no additional production occurs
following export, paragraph (b)(1)(i)
requires that the source of the excess
gross receipts be determined according
to where the farm, mine, well, deposit,
or uncut timber is located.
However, under paragraph (b)(1)(ii),
if the taxpayer engages in additional
production activities after the export
terminal and outside the country of
sale, the source of excess gross receipts
is determined under the rules of
§1.863–3. For example, if a U.S.
corporation extracts oil in a foreign
country, refines the oil in the United
States, and sells the refined product in
another foreign country, the source of
gross receipts in excess of the fair
market value of the product when it is
exported from the first foreign country
must be determined under one of the
three methods described in §1.863–3
(i.e., the 50/50 method as described in
§1.863–3(b)(1), the IFP method de-
scribed in §1.863–3(b)(2), or, if permit-
ted by the District Director, the books
and records method as described in
§1.863–3(b)(3)).
In any case not described in either
paragraph (b)(1)(i) or (ii) of the pro-
posed regulations, the source of the
excess gross receipts is determined
according to the place of sale pursuant
to paragraph (b)(1)(iii). This rule would
apply, for example, in the case where
the taxpayer engages in additional pro-
duction activities in the country of sale.
Paragraph (b)(1) addresses the con-
cerns of U.S. corporations involved in
the production of natural resources
abroad and the application of the new
§1.1502–13 consolidated return regula-
tions, by allowing them to treat the
value of the natural resources at the
point of export as income from sources
where the farm, mine, well, deposit, or
uncut timber is located. This rule has
no effect on the rules governing foreign
oil and gas extraction income under
section 907(c)(1).
On November 28, 1995, the Tenth
Circuit affirmed the Tax Court decision
in Phillips Petroleum v. Comm’r, 97
T.C. 30 (1991), which held existing
§1.863–1(b)(1) invalid to the extent it
allocates income from the sale of U.S.
natural resources solely to sources
within the United States. Phillips Pe-
troleum v. Comm’r, No. 94–9021 (10th
Cir. Nov. 28, 1995). The IRS and
Treasury will consider the implications
of this decision when finalizing these
proposed regulations.
2.Additional production prior to
export terminal
Paragraph (b)(2) provides a special
rule for determining the source of in-

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come where a taxpayer performs sub-
stantial additional production activities
before the product leaves the export
terminal. Under paragraph (b)(2), the
source of gross receipts equal to the
fair market value of the product prior
to the additional production activities is
based on the location of the farm,
mine, well, deposit, or uncut timber.
The source of gross receipts in excess
of the fair market value of the products
at the beginning of the additional
production activities is determined un-
der the rules of §1.863–3.
3.Other rules
The proposed regulation contains
rules for determining the fair market
value of relevant products. For this
purpose, fair market value depends on
all of the facts and circumstances as
they exist relative to a party in any
particular case. Thus, these rules for
determining fair market value are con-
sistent with the foreign oil and gas
rules contained in §1.907(c)–1(b)(6). In
addition, fair market value determina-
tions must be consistent with prices
charged in sales, if any, to related
parties in a transaction that is subject to
section 482. For example, if a member
of a U.S. consolidated group extracts
natural resources in a foreign country
and sells the natural resources to
another member of the same group at
the export terminal, the value of the
natural resources determined at the
export terminal should be the price
charged by the producing member to
the purchasing member for purposes of
section 482.
Under paragraph (b)(5), a taxpayer’s
gross income from sources within or
without the United States is determined
by reducing its gross receipts from
sources within or without the United
States by the cost of goods sold
properly attributable to such gross
receipts. Under paragraph (c), a tax-
payer’s taxable income from U.S. or
foreign sources must be determined
under the rules of §§1.861–8 through
1.861–14T.
Under paragraph (b)(6), taxpayers
must fully explain the methodology
used, the facts describing substantial
additional production activities (if any),
and the determination of fair market
value in a statement attached to the
taxpayer’s return. In addition, taxpayers
must provide such other information as
is required by §1.863–3(e)(2).
Taxpayers may elect to apply the
rules of these regulations for taxable
years beginning after July 11, 1995.
Otherwise, these regulations are effec-
tive for taxable years beginning 30
days after the publication of this
regulation as a final regulation.
II.Inventory other than natural
resources
A.Current regulations
Section 863 authorizes the Secretary
to promulgate regulations allocating or
apportioning to sources within or with-
out the United States all items of gross
income, expenses, losses, and deduc-
tions other than those specified in
sections 861(a) and 862(a).
Section 1.863–3 of the current reg-
ulations governs the source of income
from the sale of inventory produced (in
whole or in part) in the United States
and sold in a foreign country, or
produced (in whole or in part) in a
foreign country and sold in the United
States (Section 863 Sales). Section
1.863–3 provides three methods, set
forth in the form of three examples, to
determine the source of income from
Section 863 Sales.
§1.861–3(b)(2) Example 1 of the
current regulations illustrates how an
independent factory or production price
(IFP) applies to determine the income
attributable to production (IFP method).
An IFP generally is established if a
taxpayer regularly sells part of its
output to wholly independent distribu-
tors in such a way as to reasonably
reflect the income attributable to pro-
duction activity. If an IFP exists,
taxpayers must use the IFP method to
determine the income attributable to
production activities in both the sale
establishing the IFP and in sales of
similar products. See Phillips Pe-
troleum v. Comm’r, 97 T.C. 30 (1991),
aff’d, No. 94–9021 (10th Cir. Nov. 28,
1995); Rev. Rul. 88–73 (1988–2 C.B.
173). Gross receipts in excess of the
IFP are attributable to sales activity.
Taxpayers can otherwise establish an
IFP by showing to the satisfaction of
the District Director that an IFP exists.
Notice 89–10 (1989–1 C.B. 631) con-
tains additional rules regarding the
application of the IFP method. Section
1.863–3(b)(2) Example 1 of the current
regulations does not provide explicit
guidance as to how to determine the
source of income attributable to pro-
duction activities under the IFP
method. However, the source of income
attributable to sales activities is based
generally on where title to the inven-
tory passes to the purchaser as defined
in §1.861–7(c).
Section 1.863–3(b)(2) Example 2 of
the current regulations divides a tax-
payer’s income from Section 863 Sales
equally between production activity and
sales activity (50/50 method). The
source of income attributable to pro-
duction activity is based on the location
of the taxpayer’s property. The portion
of this production income attributable
to sources within the United States is
determined by a fraction, the numerator
of which is the taxpayer’s property
located within the United States used to
produce income from Section 863
Sales, and the denominator of which is
the taxpayer’s property both within the
United States and within a foreign
country used to produce income from
Section 863 Sales. The source of the
taxpayer’s income attributable to sales
activity is based on where title to the
inventory passes to the purchaser as
defined in §1.861–7(c).
Section 1.863–3(b)(2) Example 3 of
the current regulations allows a tax-
payer to request permission from the
District Director to use the taxpayer’s
books and records to allocate income to
sources within and without the United
States if those books reflect more
clearly than the other methods the
taxable income derived from sources
within the United States (books and
records method).
B.Issues under current regulations
On July 12, 1995, the IRS and
Treasury issued regulations under
§1.1502–13, treating members of a
consolidated group as a single entity
for purposes of determining the source
of a taxpayer’s income. The IRS and
Treasury understand that the current
section 863 regulations may raise ques-
tions when applied to certain consoli-
dated groups on a single entity basis.
The preamble to the regulations under
§1.1502–13 indicated that the IRS and
Treasury would reevaluate part of the
regulations under section 863. As part
of this process, the IRS and Treasury
also have reexamined the remainder of
the existing section 863 regulations and
have concluded that several additional
changes are necessary.
First, the existing regulations were
drafted more than 70 years ago, and

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have not been amended to reflect the
evolution of business practices. As a
result, the regulations have been the
source of controversies in recent years.
See Intel Corporation v. Comm’r, 100
T.C. 39 (1993), aff’d, No. 94–70105
(9th Cir. Oct. 16, 1995); Phillips
Petroleum v. Comm’r, 97 T.C. 30
(1991), 101 T.C. 78, 104 (1993)
(‘‘there have been no cases interpreting
[the 50/50 method] and no administra-
tive pronouncements regarding its ap-
plication since the regulation was pro-
mulgated in 1922 except for necessary
inferences to be drawn from Intel. . .’’),
aff’d, No. 94–9021 (10th Cir. Nov. 28,
1995). In part, these controversies may
be due to the structure of the current
regulations, which do not contain oper-
ative rules to describe the methods of
allocating and apportioning income, but
instead rely on examples.
Second, the existing regulations raise
important administrative concerns. For
example, the IFP method requires an
analysis of each of the taxpayer’s sales
transactions to identify an IFP. If one
or more IFPs are so identified, a
second analysis is required of each of
the taxpayer’s sales transactions to
identify which transactions are similar
to the IFP sale. In some cases, this
process may require a review of a
multitude of transactions. The IFP
method may, therefore, be difficult for
both taxpayers and the government to
apply. The existing 50/50 method also
presents administrative concerns. For
example, the 50/50 method may require
the taxpayer to determine the fair
market value of each of its assets at the
end of every tax year. Taxpayers have
often commented to the IRS about the
difficulties of determining the fair
market value of their assets.
Third, the existing regulations result
in disparate treatment of similarly
situated taxpayers. Although an IFP
must be used under current rules if one
exists, the mandate applies only to
taxpayers selling inventory to certain
independent distributors. Taxpayers
selling exclusively to related parties are
not required to use the IFP method
since the IRS may not establish an IFP
based on such sales. Instead, these
taxpayers use the 50/50 method to
source their income from export sales.
Thus, taxpayers selling inventory ex-
clusively to related parties may be
deemed to generate far more foreign
source income than taxpayers selling a
portion of their inventory to independ-
ent distributors, even though the two
taxpayers may perform the same func-
tions. The IRS and Treasury believe
that this differing treatment of similarly
situated taxpayers is not justified.
Fourth, the existing 50/50 method
can result in apportionment of income
that is inconsistent with the common
understanding of that method. The
50/50 method is generally characterized
as a method that would source export
sales income one-half in the United
States and one-half in a foreign coun-
try. For example, in 1984 the Treasury
Department stated: ‘‘Generally, [in-
come derived from manufacture and
sale of property] is allocated one-half
on the basis of the place of manufac-
ture and half on the basis of the place
of sale .. . ’’ Treasury Department, Tax
Reform for Fairness, Simplicity, and
Economic Growth, Nov. 1984 at 364.
In addition, Congress understands the
50/50 method to operate in this fashion.
In 1986, the House, Senate and Con-
ference Committees each stated: ‘‘[Un-
der the existing 50/50 method], half of
such income generally is sourced in the
country of manufacture, and half of the
income is sourced on the basis of the
place of sale’’. House Rep. No. 426,
99th Cong. 1st Sess. 359 (1985); S.
Rep. No. 313, 99th Cong. 2d Sess. 329
(1986); H.R. Conf. Rep. No. 841, 99th
Cong. 2d Sess. II–595 (1986). The staff
of the Joint Committee on Taxation has
referred to the 50/50 method as the
‘‘production/marketing split’’ and
stated that under this method ‘‘50
percent of such income generally is
attributed to the place of production
. . .’’ Staff of the Joint Comm. on
Taxation, Factors Affecting Interna-
tional Competitiveness of the United
States 148 (1991).
The existing regulations may, how-
ever, allow taxpayers to use the 50/50
method to obtain results that are
inconsistent with this common under-
standing. Under the existing regula-
tions, 50 percent of the income is
treated as sales income and sourced on
the basis of title passage. The remain-
ing 50 percent is treated as production
income and sourced based on the
location of assets. This half of the
formula is not necessarily, however,
limited to production assets. For exam-
ple, goodwill and accounts receivables
are counted as assets in allocating
production income. The inclusion of
sales assets in the formula allocating
production income results in additional
income being allocated to sales ac-
tivities. The contribution of the sales
assets to sales income should be re-
flected only in the 50 percent of the
income that is allocated to sales and
sourced under title passage. Thus, the
production income formula should only
take into account assets directly in-
volved in the production of inventory.
B.Proposed Regulations
1.Overview
Section 1.863–3 provides rules for
allocating and apportioning income
from Section 863 Sales. Generally,
§1.863–3(b) provides three methods for
determining the amount of gross in-
come attributable to production activity
and the amount of gross income
attributable to sales activity. The source
of gross income attributable to each
activity is then determined under the
rules of paragraph (c). Paragraph (d)
provides rules to determine the source
of taxable income. Reporting and elec-
tion rules are set forth under paragraph
(e) of the proposed regulations. The
proposed regulations reserve on para-
graph (f) (prior paragraph (c)), dealing
with income partly from sources within
a possession of the United States. The
IRS and Treasury solicit comments
from taxpayers regarding changes that
should be made to new paragraph (f)
(if any) to conform to the other
changes in §1.863–3.
The proposed regulations generally
apply an aggregate approach in taking
into account a taxpayer’s interest in a
partnership. The IRS and Treasury
solicit comments on the appropriate
treatment of partnerships, including
whether there should be special rules
for limited partnerships, de minimis
interests in partnerships, and tiered
partnerships.
2.Methods to determine gross
income attributable to production
activity and sales activity
Section 1.863–3 generally retains the
three methods of the current regulations
for splitting income between production
and sales activity, with several
modifications.
a.50/50 method
The proposed regulations do not
change the allocation of half of the

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taxpayer’s income from Section 863
Sales to production activity and half to
sales activity. As described below, the
proposed regulations modify and clarify
the determination of the location of
assets. In addition, paragraph (b)(1) of
the proposed regulations makes the
50/50 method the general rule to
determine the amount of income at-
tributable to production and sales ac-
tivities. The taxpayer, however, may
elect to apply the IFP method, de-
scribed in paragraph (b)(2), or, with the
consent of the District Director, the
books and records method, described in
paragraph (b)(3).
b.IFP method
By making the IFP method elective,
the proposed regulations significantly
reduce administrative burdens related to
its application and eliminate any bias
against taxpayers choosing to export
through independent distributors.
Under the proposed regulations, the
taxpayer may elect to apply the IFP
method if it is able to establish an IFP.
As in the current regulations, an IFP is
fairly established by actual sales of the
taxpayer if the taxpayer regularly sells
part of its output to wholly independent
distributors or other selling concerns in
such a way as to reasonably reflect the
income attributable to production ac-
tivity. Once the IFP is established, it
can be used to determine the amount of
income attributable to production ac-
tivity in other Section 863 Sales if the
inventory sold in the other sales is
substantially similar in physical charac-
teristics and function, and is sold at a
similar level of distribution as the
inventory sold in a sale establishing an
IFP. A sale will not be considered to
establish an IFP if sales activity for the
relevant product is significant in rela-
tion to all of the activities for that
product. The IRS and Treasury intend
to supersede Notice 89–10 upon pub-
lication of final regulations.
The proposed regulations would also
eliminate the existing rule permitting
taxpayers to otherwise establish an IFP
by showing to the satisfaction of the
District Director that a sale reasonably
reflecting the income attributable to
production exists. This ‘‘otherwise
established’’ IFP is rarely, if ever,
used. American Law Institute, Interna-
tional Aspects of United States Income
Taxation 31 (1987). The IRS and
Treasury solicit comments from tax-
payers on the continued utility of the
otherwise established IFP.
The proposed regulations omit the
reference in the existing regulation to a
sales branch. A taxpayer may elect to
use the IFP method even if it does not
maintain a sales branch in a foreign
country.
c.Books and records method
The proposed regulations retain the
books and records method of the
existing regulations, permitting tax-
payers to request permission from the
District Director to use their books and
records to determine the income at-
tributable to production and sales ac-
tivities. The District Director will
consider a taxpayer’s request if the
taxpayer maintains a detailed allocation
of receipts and expenditures, clearly
reflecting the amount of income from
production and sales activities.
The books and records method is
rarely, if ever, used. American Law
Institute, International Aspects of
United States Income Taxation, 31
(1987). The IRS and Treasury solicit
comments from taxpayers on the con-
tinued utility of the books and records
method, or whether the books and
records method should be replaced by
another method of economic sourcing.
3.Determination of source of gross
income
Unlike the current regulations which
provide specific rules for determining
the source of income attributable to
production activity and sales activity
only for purposes of the 50/50 method,
the proposed regulations adopt rules
applicable to each of the three methods.
Under the proposed regulations, once
gross income attributable to production
activity and sales activity has been
determined under one of the methods
described in paragraph (b), the source
of the income is determined separately
for each type of income under para-
graph (c). The source of gross income
attributable to production activity is
determined under paragraph (c)(1),
based on the location of production
assets, and the source of gross income
attributable to sales activity is deter-
mined under paragraph (c)(2) based on
the location of the sale.
a.Source of gross income attributable
to production activity
The proposed regulations generally
adopt the approach set forth in the
current regulations under the 50/50
method, but with modifications and
clarifications.
Under §1.863–3(c)(1), the source of
income attributable to production ac-
tivity is determined based on the
location of the taxpayer’s production
assets. Thus, if a taxpayer manufactures
inventory exclusively in the United
States, all of its income attributable to
production activity will be considered
from sources within the United States.
The rules described below are intended
to apply only to taxpayers that produce
inventory both within and without the
United States.
Under the proposed regulations, the
source of a taxpayer’s income from
production activities is determined by
reference to the taxpayer’s production
assets, instead of all of its assets that
produce income from Section 863
Sales. The IRS and Treasury believe
that this change is appropriate to ensure
that the source of production income
corresponds to the location of produc-
tion activity. Production assets are
defined to include tangible and intang-
ible property owned by the taxpayer
that are used to produce inventory sold
in Section 863 Sales. Any property not
directly used to produce inventory is
excluded. Thus, accounts receivable
and marketing intangibles are excluded
because they are sales assets and not
production assets. Other assets ex-
cluded because they do not directly
produce inventory are transportation
assets, warehouses, inventory, work-in-
process, raw materials, cash, invest-
ment assets, and stock of a subsidiary.
Working capital is excluded to avoid
uncertainty arising from determinations
of the appropriate amount of working
capital. In addition, working capital
would generally be apportioned pro
rata in accordance with a taxpayer’s
production assets. As under the current
regulations, leased assets are excluded;
only assets owned by the taxpayer are
included.
The proposed regulations also pro-
vide specific rules for determining
where a production asset is located.
Tangible assets are located where the
assets are used by the taxpayer. Intang-
ible assets are located where the
tangible production assets to which
they relate are located.
Where production takes place both
within the United States and within a

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foreign country, the regulations apply a
property fraction to apportion produc-
tion income between U.S. and foreign
sources. The taxpayer’s foreign source
gross production income is determined
by multiplying its gross production
income by a fraction, the numerator of
which is the taxpayer’s production
assets located within a foreign country,
and the denominator of which is the
taxpayer’s production assets located
both within the United States and
within a foreign country.
The current regulations generally
include assets in the property formula
at fair market value. The proposed
regulations modify this rule to provide
that an asset must be included in the
property formula at its average adjusted
basis (see section 1011). The IRS and
Treasury believe that this change to
adjusted basis will significantly sim-
plify the application of this formula for
both taxpayers and the IRS.
The proposed regulations also con-
tain more detailed guidance than the
current regulations for determining the
amounts to be included in the property
fraction. For example, the proposed
regulations would require that if the
asset is used to produce inventory sold
in Section 863 Sales and is also used to
produce other property, the basis of the
asset must be prorated to account for
such other uses.
The purpose of the property formula
is to attribute the source of the
taxpayer’s production income to the
location of its production activity. The
IRS and Treasury are concerned that
taxpayers may be able to affect the
location of assets without changing the
situs of economic activity. Accordingly,
comments are solicited about whether
there should be rules to prevent manip-
ulation of this formula in a manner
inconsistent with the purpose of the
regulation.
b.Source of gross income
attributable to sales activity
The source of gross income that is
attributable to sales activity is deter-
mined under paragraph (c)(2). As under
the current regulations, the source of
this income is generally based on
where a sale takes place. See §1.861–
7(c). Accordingly, if a U.S. producer
sells its goods in a foreign country, the
income attributable to sales activity is
generally foreign source income.
The proposed regulation would retain
the language of the existing regulation,
which only applies to sales that occur
within a foreign country. The IRS and
Treasury solicit comments as to
whether the regulations should be
expanded to apply to sales made in
international waters or in space. The
IRS and Treasury are concerned, how-
ever, that if such a change were made,
a U.S. seller may try to use the 50/50
method by selling inventory in interna-
tional waters to U.S. purchasers, even
when the goods were destined for the
United States. In view of these con-
cerns, the IRS and Treasury also solicit
comments as to whether the regulations
should provide an exception to the title
passage rule in the case of sales of
goods produced in the United States
and destined for use in the United
States.
4.Determination of source of taxable
income
Once the amount and source of gross
income are determined under paragraph
(c), taxpayers then determine the
source of their taxable income. Under
proposed paragraph (d), taxpayers must
allocate or apportion under §§1.861–8
through 1.861–14T the amounts of
expenses, losses and other deductions
to its gross income determined under
each method described in paragraph
(b). In the case of amounts of ex-
penses, losses and other deductions
allocated or apportioned to gross in-
come determined under the IFP method
or the books and records method, the
taxpayer must apply the rules of
§§1.861–8 through 1.861–14T to allo-
cate or apportion these amounts be-
tween gross income from sources
within and without the United States.
For amounts of expenses, losses and
other deductions allocated or appor-
tioned to gross income determined
under the 50/50 method, taxpayers
must apportion expenses and other
deductions pro rata based on the
relative amounts of U.S. and foreign
source gross income. These rules are
consistent with existing regulations.
5.Election and reporting rules
Under paragraph (e) of the proposed
regulations, a taxpayer must use the
50/50 method unless the taxpayer elects
to use the IFP method, or elects the
Books and Records method. The tax-
payer makes the election by using the
method on its tax return. Once the tax
return is filed, the election is not
revokable for that year. In addition,
that method must be used in later
taxable years unless the Commissioner
or her delegate consents to a change.
Permission to change methods in later
years will not be withheld unless the
change would result in a substantial
distortion of the source of income.
A taxpayer must fully explain the
methodology used in paragraph (b), and
the amount of income allocated or
apportioned to U.S. and foreign sources
in a statement attached to its tax return.
6.Conforming changes
The proposed regulations make con-
forming changes to §1.863–2 of the
regulations. Under §1.863–2, the tax-
payer may elect to apply the 50/50
method to its net taxable income,
instead of its gross income as specified
in §1.863–3. The proposed regulations
clarify that income derived from the
purchase of personal property within a
possession of the United States and its
sale within the United States is subject
to these regulations only to the extent it
is not excluded by §1.936–6(a)(5),
Q&A 7. Other changes to §1.863–2
were intended to conform the language
of the regulation to the changes in
§1.863–3.
Finally, the IRS and Treasury will
reconsider the existing regulations
issued under section 863 regarding
transportation services and cable and
telegraph services in light of the Tax
Reform Act of 1986. Accordingly, the
transportation rules contained in
§1.863–4 will only apply to services
that are not described in section 863(c)
and the telegraph and cable rules
contained in §1.863–5 are deleted. No
inference is intended as to whether
portions of the existing regulations
continued to apply after the Tax
Reform Act of 1986.
7.Proposed effective dates
These regulations are effective for
taxable years beginning 30 days after
publication of final regulations. How-
ever, taxpayers may apply these regula-
tions for taxable years beginning after
July 11, 1995, and before 30 days after
publication of these regulations as final
regulations.

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Special Analyses
It has been determined that this
notice of proposed rulemaking is not a
significant regulatory action as defined
in EO 12866. Therefore, a regulatory
assessment is not required. It is hereby
certified that these regulations will not
have a significant economic impact on
a substantial number of small entities.
Accordingly, a regulatory flexibility
analysis is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, this notice of proposed rulemak-
ing will be submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business.
Comments and Public Hearing
Before these proposed regulations
are adopted as final regulations, consid-
eration will be given to any written
comments (a signed original and eight
(8) copies) that are submitted timely to
the IRS. All comments will be avail-
able for public inspection and copying.
A public hearing has been scheduled
for April 10, 1996, at 10 a.m. in the
IRS Auditorium. Because of access
restrictions, visitors will not be admit-
ted beyond the Internal Revenue Build-
ing 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
comments at the hearing must submit
written comments and an outline of
topics to be discussed and the time to
be devoted to each topic (signed
original and eight (8) copies) by March
11, 1996.
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 regula-
tions is Anne Shelburne, Office of
Associate Chief Counsel (Interna-
tional). However, other personnel from
the IRS and Treasury Department
participated 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 entries
in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.863–1 also issued under 26
U.S.C. 863.
Section 1.863–2 also issued under 26
U.S.C. 863.
Section 1.863–3 also issued under 26
U.S.C. 863.
Section 1.863–4 also issued under 26
U.S.C. 863.
Section 1.863–6 also issued under 26
U.S.C. 863. * * *
Par. 2. Sections 1.863–0 is added to
read as follows:
§1.863–0 Table of contents.
This section lists captions contained
in §§1.863–1, 1.863–2, and 1.863–3.
§1.863–1 Allocation of gross income.
(a)In general.
(b)Natural resources.
(1)In general.
(2)Additional production prior to
export terminal.
(3)Definitions.
(i)Production activity.
(ii)A d d i t i o n a l p r o d u c t i o n
activities.
(iii)Export terminal.
(4)Determination of fair market
value.
(5)Determination of gross income.
(6)Tax return disclosure.
(7)Examples.
(c)D e t e r m i n a t i o n o f t a x a b l e
income.
(d)Effective dates.
§1.863–2 Allocation and
apportionment of taxable income.
(a)D e t e r m i n a t i o n o f t a x a b l e
income.
(b)Determination of source of tax-
able income.
(c)Effective dates.
§1.863–3 Allocation and
apportionment of income from certain
sales of inventory.
(a)In general.
(b)Methods to determine income
attributable to production ac-
tivity and sales activity.
(1)50/50 method.
(i)Determination of gross income.
(ii)Example.
(2)IFP method.
(i)Establishing an IFP.
(ii)Applying the IFP method.
(iii)Determination of gross income.
(iv)Examples.
(3)Books and records method.
(c)Determination of the source of
gross income from production
activity and sales activity.
(1)Income attributable to produc-
tion activity.
(i)Production only within the
United States or only within
foreign countries.
(A)Source of income.
(B)Definition of production assets.
(C)Location of production assets.
(ii)Production both within the
United States and within for-
eign countries.
(A)Source of income.
(B)Adjusted basis of production
assets.
(iii)Examples.
(2)Income attributable to sales
activity.
(d)Determination of source of tax-
able income.
(e)Election and reporting rules.
(1)Elections under paragraph (b)
of this section.
(2)Disclosure on tax return.
(f)Income partly from sources
within a possession of the
United States. [Reserved]
(g)Effective dates.
Par. 3. Sections 1.863–1, 1.863–2,
and 1.863–3 are revised to read as
follows:
§1.863–1 Allocation of gross income.
(a)In general. Items of gross in-
come other than those specified in
section 861(a) and section 862(a) will
generally be separately allocated to
sources within or without the United

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States. See §1.863–2 for alternate
methods to determine the income from
sources within or without the United
States in the case of items specified in
§1.863–2(a). See also sections 865(b)
and 865(e)(2).
(b)Natural resources—(1) In gen-
eral. Except to the extent provided in
paragraph (b)(2) of this section, gross
receipts from the sale outside the
United States of products derived from
the ownership or operation of any farm,
mine, oil or gas well, other natural
deposit, or timber within the United
States, are allocated between sources
within or without the United States
based on the fair market value of the
product at the export terminal (as
defined in paragraph (b)(3)(iii) of this
section). Except to the extent provided
in paragraph (b)(2) of this section,
gross receipts from the sale within the
United States of products derived from
the ownership or operation of any farm,
mine, oil or gas well, other natural
deposit, or timber outside the United
States are also allocated between
sources within or without the United
States based on the fair market value of
the product at the export terminal. The
source of gross receipts equal to the
fair market value of the product at the
export terminal will be from sources
where the farm, mine, well, deposit, or
uncut timber is located. The source of
gross receipts from the sale of the
product in excess of its fair market
value at the export terminal (excess
gross receipts) will be determined as
follows—
(i)If the taxpayer does not engage
in additional production activities (as
defined in paragraph (b)(3)(ii) of this
section), excess gross receipts will be
from sources where the farm, mine,
well, deposit, or uncut timber is
located;
(ii)If the taxpayer engages in addi-
tional production activities subsequent
to shipment from the export terminal
and outside the country of sale, the
source of excess gross receipts must be
determined under §1.863–3. For pur-
poses of applying §1.863–3, only pro-
duction assets used in additional pro-
duction activity subsequent to the
export terminal are taken into account;
or
(iii)In all other cases, excess gross
receipts will be from sources within the
country of sale, as described in §1.861–
7(c). This paragraph (b)(1)(iii) applies,
for example, to a taxpayer that engages
in additional production activities in the
country of sale.
(2)Additional production prior to
export terminal. Notwithstanding any
other provision of this section, gross
receipts from the sale of products
derived by a taxpayer who performs
additional production activities as de-
fined in paragraph (b)(3)(ii) of this
section before the relevant product is
shipped from the export terminal are
allocated between sources within and
without the United States based on the
fair market value of the product imme-
diately prior to the additional produc-
tion activities. The source of gross
receipts equal to the fair market value
of the product immediately prior to the
additional production activities will be
from sources where the farm, mine,
well, deposit, or uncut timber is lo-
cated. The source of gross receipts
from the sale of the product in excess
of the fair market value immediately
prior to the additional production ac-
tivities must be determined under
§1.863–3. For purposes of applying
§1.863–3, only production assets used
in the additional production activities
are taken into account.
(3)Definitions—(i) Production ac-
tivity. For purposes of this section,
production activity means an activity
that creates, fabricates, manufactures,
extracts, processes, cures, or ages in-
ventory. See §1.864–1.
(ii)Additional production activities.
For purposes of this section, additional
production activities are substantial
production activities performed by the
taxpayer in addition to activities from
the ownership or operation of any farm,
mine, oil or gas well, other natural
deposit, or timber. Whether a taxpayer
performs such additional production
activities will be determined under the
principles of §1.954–3(a)(4). However,
in no case will activities that prepare
the natural resource itself for export,
including those that are designed to
facilitate the transportation of the natu-
ral resource to or from the export
terminal, be considered additional pro-
duction activities for purposes of this
section.
(iii)Export terminal. Where the
farm, mine, well, deposit, or uncut
timber is located without the United
States, the export terminal will be the
final point in a foreign country from
which goods are shipped from a foreign
country to the United States. Where the
farm, mine, well, deposit, or uncut
timber is located within the United
States, the export terminal will be the
final point in the United States from
which goods are shipped from the
United States to a foreign country. The
export terminal is determined without
regard to any contractual terms agreed
to by the taxpayer and without regard
to whether there is an actual sale of the
products at the export terminal.
(4)Determination of fair market
value. For purposes of this section, fair
market value depends on all of the
facts and circumstances as they exist
relative to a party in any particular
case. Where the products are sold to a
related party in a transaction subject to
section 482, the determination of fair
market value under this section must be
consistent with the arm’s length price
determined under section 482.
(5)Determination of gross income.
To determine the amount of a tax-
payer’s gross income from sources
within or without the United States, the
taxpayer’s gross receipts from sources
within or without the United States
determined under this paragraph (b)
must be reduced by the cost of goods
sold properly attributable to gross
receipts from sources within or without
the United States.
(6)Tax return disclosure. A tax-
payer that determines the source of its
income under this paragraph (b) shall
attach a statement to its return explain-
ing the methodology used to determine
fair market value under paragraph
(b)(4) of this section, and explaining
any additional production activities (as
defined in paragraph (b)(3)(ii) of this
section) performed by the taxpayer. In
addition, the taxpayer must provide
such other information as is required
by §1.863–3.
(7)Examples. The following exam-
ples illustrate the rules of this para-
graph (b):
Example 1. No additional production. US
Mines, a U.S. corporation, extracts coal in the
United States and, without substantial additional
production, sells the coal in a foreign country.
Under §1.863–1(b) and (b)(1)(i), all of US
Mines’ income will be from sources within the
United States.
Example 2. Scope of additional production. US
Gas, a U.S. corporation, extracts natural gas
within the United States, and transports the
natural gas to a U.S. port where it is liquified in
preparation for shipment. The liquified natural
gas is then transported via freighter and sold
without additional production activities in a
foreign country. Liquefaction of natural gas is
not an additional production activity because
liquefaction prepares the natural gas for transpor-

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tation from the export terminal. Therefore, under
§1.863–1(b) and (b)(1)(i), all of US Gas’ income
will be from sources within the United States.
Example 3. Sale in third country. US Gold, a
U.S. corporation, mines gold in country X,
produces gold jewelry in the United States, and
sells the jewelry in country Y. Assume that the
fair market value of the gold at the export
terminal in country X is $40, and that US Gold
ultimately sells the gold jewelry in country Y for
$100. Under §1.863–1(b), $40 of US Gold’s
gross receipts will be allocated to sources
without the United States. Under §1.863–
1(b)(1)(ii), the source of the remaining $60 of
gross receipts will be determined under §1.863–
3. If US Gold applies the 50/50 method
described in §1.863–3, $20 of cost of goods sold
is properly attributable to activities subsequent to
the export terminal, and all of US Gold’s
production assets subsequent to the export
terminal are located in the United States, then
$20 of gross income will be allocated to sources
within the United States and $20 of gross income
will be allocated to sources without the United
States.
Example 4. Production in country of sale. US
Oil, a U.S. corporation, extracts oil in country X,
transports the oil via pipeline to the export
terminal in country Y, refines the oil in the
United States, and sells the refined product in the
United States to unrelated persons. Assume that
the fair market value of the oil at the export
terminal in country Y is $80, and that US Oil
ultimately sells the refined product for $100.
Under §1.863–1(b)(1), $80 of US Oil’s gross
receipts will be allocated to sources without the
United States, and under §1.863–1(b)(1)(iii) the
remaining $20 of gross receipts will be allocated
to sources within the United States.
Example 5. Additional production prior to
export. US Furniture, a U.S. corporation, cuts
trees in the United States, converts the trees into
lumber, uses the lumber to manufacture furniture
in the United States, and sells the furniture in
another country. Assume that the fair market
value of the trees when the conversion into
lumber begins is $40, and that US Furniture
ultimately sells the furniture for $100. Because
the conversion of the trees into lumber is an
additional production activity within the United
States within the meaning of §1.863–1(b)(3)(ii),
the source of US Furniture’s income will be
determined under §1.863–1(b)(2). Thus, $40 of
US Furniture’s gross receipts will be allocated to
sources within the United States. The source of
the remaining $60 of gross receipts will be
determined under §1.863–3. If US Furniture
applies the 50/50 method described in §1.863–
3(b)(1), $20 of cost of goods sold is properly
attributable to the additional production activity,
and all of US Furniture’s production assets used
in the additional production activity are located
in the United States, then $20 of gross income
will be allocated to sources within the United
States and $20 of gross income will be allocated
to sources without the United States.
(c)Determination of taxable income.
The taxpayer’s taxable income from
sources within or without the United
States will be determined under the
rules of §§1.861–8 through 1.861–14T
for determining taxable income from
sources within the United States.
(d)Effective dates. The rules of this
section will apply to taxable years
beginning 30 days after publication of
these regulations as final regulations.
However, taxpayers may apply the
rules of this section for taxable years
beginning after July 11, 1995, and
before 30 days after publication of
these regulations as final regulations.
For years beginning before 30 days
after publication of these regulations as
final regulations, see §1.863–1 (as
contained in 26 CFR part 1 revised as
of April 1, 1995).
§1.863–2 Allocation and
apportionment of taxable income.
(a)Determination of taxable income.
Section 863(b) provides an alternate
method for determining taxable income
from sources within the United States
in the case of gross income derived
from sources partly within and partly
without the United States. Under this
method, taxable income is determined
by deducting from such gross income
the expenses, losses, or other deduc-
tions properly apportioned or allocated
thereto and a ratable part of any other
expenses, losses, or deductions that
cannot definitely be allocated to some
item or class of gross income. The
income to which this section applies
(and that is treated as derived partly
from sources within and partly from
sources without the United States) will
consist of gains, profits, and income—
(1)From certain transportation or
other services rendered partly within
and partly without the United States to
the extent not within the scope of
section 863(c) or other specific provi-
sions of this title;
(2)From the sale of inventory prop-
erty (within the meaning of section
865(i)) produced (in whole or in part)
by the taxpayer in the United States
and sold in a foreign country or
produced (in whole or in part) by the
taxpayer in a foreign country and sold
in the United States; or
(3)Derived from the purchase of
personal property within a possession
of the United States and its sale within
the United States, to the extent not
excluded from the scope of these regu-
lations under §1.936–6(a)(5), Q&A 7.
(b)Determination of source of tax-
able income. Income treated as derived
from sources partly within and partly
without the United States under para-
graph (a) of this section may be
allocated to sources within and without
the United States pursuant to §1.863–1
or apportioned to such sources in
accordance with the methods described
in other regulations under section 863.
To determine the source of certain
types of income described in paragraph
(a)(1) of this section, see §1.863–4. To
determine the source of gross income
described in paragraph (a)(2) of this
section, see §1.863–3. However, the
principles of §1.863–3(b)(1) and (c)
may be applied to determine the source
of taxable income from sales of inven-
tory property. To determine the source
of income described in paragraph (a)(3)
of this section, see §1.863–3(f).
(c)Effective dates. This section will
apply to taxable years beginning 30
days after publication of these regula-
tions as final regulations. However,
taxpayers may apply the rules of this
section for taxable years beginning
after July 11, 1995, and before 30 days
after publication of these regulations as
final regulations. For years beginning
before 30 days after publication of
these regulations as final regulations,
see §1.863–2 (as contained in 26 CFR
part 1 revised as of April 1, 1995).
§1.863–3 Allocation and
apportionment of income from certain
sales of inventory.
(a)In general. This section applies
to determine the source of income
derived from the sale of inventory
property (inventory) produced (in
whole or in part) by a taxpayer within
the United States and sold within a
foreign country, or produced (in whole
or in part) by a taxpayer in one or
more foreign countries and sold within
the United States (Section 863 Sales).
For purposes of this section, a tax-
payer’s production activity includes
production activities conducted by
members of the same affiliated group
as defined under section 1504(a). A
taxpayer’s production activity also in-
cludes production activities conducted
through a partnership of which the
taxpayer is a partner either directly or
through one or more partnerships. A
taxpayer subject to this section must
divide gross income from Section 863
Sales between production activity and
sales activity using one of the methods
described in paragraph (b) of this
section. The source of gross income
from production activity and from sales
activity must then be determined under
paragraph (c) of this section. Taxable
income from Section 863 Sales is

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determined under paragraph (d) of this
section. Paragraph (e) of this section
describes the rules for electing the
methods described in paragraph (b) of
this section and the information that a
taxpayer must disclose on a tax return.
Paragraph (f) of this section applies to
determine the source of certain income
derived from a possession of the
United States. Paragraph (g) of this
section provides effective dates for the
rules in this section. Once a taxpayer
has elected a method described in
paragraph (b) of this section, the
taxpayer must separately apply that
method to Section 863 Sales in the
United States and to Section 863 Sales
in foreign countries. In addition, the
taxpayer must apply the rules of
paragraphs (c) and (d) of this section
by aggregating all Section 863 Sales to
which a method described in paragraph
(b) of this section applies. See section
865(i)(1) for the definition of inventory
property; §1.861–7(c) for the time and
place of sale. See also section
865(e)(2).
(b)Methods to determine income
attributable to production activity and
sales activity—(1) 50/50 method—(i)
Determination of gross income. Gener-
ally, gross income from Section 863
Sales will be apportioned between
production activity and sales activity
under the 50/50 method as described in
this paragraph (b)(1). Under the 50/50
method, one-half of the taxpayer’s
gross income will be considered in-
come attributable to production activity
and the source of that income will be
determined under the rules of para-
graph (c)(1) of this section. The re-
maining one-half of such gross income
will be considered income attributable
to sales activity and the source of that
income will be determined under the
rules of paragraph (c)(2) of this sec-
tion. In lieu of the 50/50 method, the
taxpayer may elect to determine the
source of income from Section 863
Sales under the IFP method described
in paragraph (b)(2) of this section or,
with the consent of the District Direc-
tor, the books and records method
described in paragraph (b)(3) of this
section.
(ii)Example. The following example
illustrates the rules of this paragraph
(b)(1):
Example. 50/50 method. (i) P, a U.S. corpora-
tion, produces widgets in the United States. P
sells the widgets for $100 to D, an unrelated
foreign distributor, in another country. P’s cost
of goods sold is $40. Thus, P’s gross income is
$60.
(ii)Pursuant to the 50/50 method, one-half of
P’s gross income, or $30, is considered income
attributable to production activity, and one-half
of P’s gross income, or $30, is considered
income attributable to sales activity.
(2)IFP method—(i) Establishing an
IFP. A taxpayer may elect to allocate
gross income earned from production
activity and sales activity using the
independent factory price (IFP) method
described in this paragraph (b)(2) if an
IFP is fairly established. An IFP is
fairly established based on a sale by
the taxpayer only if the taxpayer
regularly sells part of its output to
wholly independent distributors or
other selling concerns in such a way as
to reasonably reflect the income earned
from production activity. A sale will
not be considered to fairly establish an
IFP if sales activity by the taxpayer
with respect to that sale is significant
in relation to all of the activities with
respect to that product.
(ii)Applying the IFP method. If the
taxpayer elects to use the IFP method,
the amount of the gross sales price
equal to the IFP will be treated as
attributable to production activity, and
the excess of the gross sales price over
the IFP will be treated as attributable to
sales activity. If a taxpayer elects to
use the IFP method, the IFP must be
applied to all Section 863 Sales of
inventory that are substantially similar
in physical characteristics and function,
and are sold at a similar level of
distribution as the inventory sold in the
sale fairly establishing an IFP. The IFP
will only be applied to sales that are
reasonably contemporaneous with the
sale fairly establishing the IFP. An IFP
cannot be applied to sales in other
geographic markets if the markets are
substantially different. The rules of this
paragraph will also apply to determine
the division of gross receipts between
production activity and sales activity in
a Section 863 Sale that itself fairly
establishes an IFP. If the taxpayer
elects to apply the IFP method, the IFP
method must be applied to all sales for
which an IFP may be fairly established
for that taxable year and each subse-
quent taxable year. The taxpayer will
apply either the 50/50 method de-
scribed in paragraph (b)(1) of this
section or the books and records
method described in paragraph (b)(3)
of this section to any other Section 863
Sale for which an IFP cannot be estab-
lished or applied for each taxable year.
(iii)Determination of gross income.
The amount of a taxpayer’s gross in-
come from production activity is deter-
mined by reducing the amount of gross
receipts from production activity by the
cost of goods sold properly attributable
to production activity. The amount of a
taxpayer’s gross income from sales
activity is determined by reducing the
amount of gross receipts from sales
activity by the cost of goods sold (if
any) properly attributable to sales ac-
tivity. The source of gross income from
production activity is determined under
the rules of paragraph (c)(1) of this
section, and the source of gross income
from sales activity will be determined
under the rules of paragraph (c)(2) of
this section.
(iv)Examples. The following exam-
ples illustrate the rules of this para-
graph (b)(2):
Example 1. IFP method. (i) P, a U.S. producer,
purchases cotton and produces cloth in the
United States. P sells cloth in country X to D, a
unrelated foreign clothing manufacturer, for
$100. Cost of goods sold for cloth is $80,
entirely attributable to production activity. P does
not engage in significant sales activity in relation
to its other activities in the sales to D. Under
these facts, the sale to D fairly establishes an IFP
of $100. Assume that P elects to use the IFP
method. Accordingly, $100 of the gross sales
price is treated as attributable to production
activity, and no amount of income from this sale
is attributable to sales activity. After reducing the
gross sales price by cost of goods sold, $20 of
the gross income is treated as attributable to
production activity ($100-$80).
(ii)P also sells cloth in country X to A, a
unrelated foreign retail outlet, for $110. Because
P elected the IFP method and the cloth is
substantially similar to the cloth sold to D, the
IFP fairly established in the sales to D must be
used to determine the amount attributable to
production activity in the sale to A. Accordingly,
$100 of the gross sales price is treated as
attributable to production activity and $10
($110-$100) is attributable to sales activity. After
reducing the gross sales price by cost of goods
sold, $20 of the gross income is treated as
attributable to production activity ($100-$80) and
$10 is attributable to sales activity.
Example 2. Scope of IFP Method. (i) USCo
manufactures three dissimilar products. USCo
elects to apply the IFP method. In year 1, an IFP
can be established for sales of product X, but not
for products Y and Z. In year 2, an IFP cannot
be established for any of USCo’s products. In
year 3, an IFP can be established for products X
and Y, but not for product Z.
(ii)In year 1, USCo must apply the IFP
method to sales of product X. In year 2, although
USCo’s IFP election remains in effect, USCo is
not required to apply the IFP election to any
products. In year 3, USCo is required to apply
the IFP method to sales of products X and Y.
(3)Books and records method. A
taxpayer may elect to determine the

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amount of its gross income from Sec-
tion 863 Sales that is attributable to
production and sales activities for the
taxable year based upon its books of
account if it has received in advance
the permission of the District Director
having audit responsibility over its tax
return. The taxpayer must establish to
the satisfaction of the District Director
that the taxpayer, in good faith and
unaffected by considerations of tax
liability, will regularly employ in its
books of account a detailed allocation
of receipts and expenditures which
clearly reflects the amount of the
taxpayer’s income from production and
sales activities. If a taxpayer receives
permission to apply the books and
records method, but does not comply
with a material condition set forth by
the District Director, the District Direc-
tor may, in its discretion, revoke
permission to use the books and
records method. The source of gross
income treated as attributable to pro-
duction activity under this method may
be determined under the rules of
paragraph (c)(1) of this section, and the
source of gross income attributable to
sales activity will be determined under
the rules of paragraph (c)(2) of this
section.
(c)Determination of the source of
gross income from production activity
and sales activity—(1) Income attribu-
table to production activity—(i) Pro-
duction only within the United States
or only within foreign countries—(A)
Source of income. Where the taxpayer’s
production assets are located only with-
in the United States or only within a
foreign country, the income attributable
to production activity is sourced where
the taxpayer’s production assets are
located. For rules regarding the source
of income when production assets are
located both within the United States
and within one or more foreign coun-
tries, see paragraph (c)(1)(ii) of this
section. For purposes of this section,
production activity means an activity
that creates, fabricates, manufactures,
extracts, processes, cures, or ages in-
ventory. See §1.864–1.
(B)Definition of production assets.
For purposes of this section, production
assets include only tangible and intang-
ible assets owned by the taxpayer that
are directly used by the taxpayer to
produce inventory described in para-
graph (a) of this section. Production
assets do not include assets that are not
directly used to produce inventory
described in paragraph (a) of this
section. Thus, production assets do not
include such assets as accounts receiv-
ables, intangibles not related to produc-
tion of inventory (e.g., marketing intan-
gibles, including trademarks and
customer lists), transportation assets,
warehouses, the inventory itself, raw
materials, or work-in-process. In addi-
tion, production assets do not include
cash or other liquid assets (including
working capital), investment assets,
prepaid expenses, or stock of a subsidi-
ary. A partner will be treated as
owning its proportionate share of the
partnership’s production assets, deter-
mined by reference to the partner’s
distributive share of partnership income
for the year attributable to such produc-
tion assets.
(C)Location of production assets.
For purposes of this section, a tangible
production asset will be considered
located where the asset is physically
located. An intangible production asset
will be considered located where the
tangible production assets owned by
the taxpayer to which it relates are
located.
(ii)Production both within the
United States and within foreign
countries—(A) Source of income.
Where the taxpayer’s production assets
are located both within the United
States and within one or more foreign
countries, income from sources without
the United States will be determined by
multiplying the income attributable to
production activity by a fraction, the
numerator of which is the average
adjusted basis of production assets that
are located in one or more foreign
countries and the denominator of which
is the average adjusted basis of all
production assets in foreign countries
and in the United States. The remaining
income is treated as from sources
within the United States.
(B)Adjusted basis of production
assets. For purposes of paragraph
(c)(1)(ii)(A) of this section, the ad-
justed basis of an asset is determined
under section 1011. The average ad-
justed basis is computed by averaging
the adjusted basis of the asset at the
beginning and end of the taxable year,
unless by reason of material changes
during the taxable year such average
does not fairly represent the average
for such year. In this event, the average
adjusted basis will be determined upon
a more appropriate basis. If production
assets are used to produce inventory
sold in Section 863 Sales and are also
used to produce other property during
the taxable year, the portion of its
adjusted basis that is included in the
f r a c t i o n d e s c r i b e d i n p a r a g r a p h
(c)(1)(ii)(A) of this section will be
determined under any method that
reasonably reflects the portion of the
assets that produces inventory sold in
Section 863 Sales. For example, the
portion of such an asset that is included
in the formula may be determined by
multiplying the asset’s average adjusted
basis by a fraction, the numerator of
which is the gross receipts from sales
of inventory from Section 863 Sales
produced by the asset, and the de-
nominator of which is the gross re-
ceipts from all property produced by
that asset. For purposes of this section,
a taxpayer’s basis in production assets
held through a partnership shall be
determined by reference to the part-
nership’s adjusted basis in its assets
(including a partner’s special basis
adjustment, if any, under section 743).
(iii)Examples. The following exam-
ples illustrate the rules of this para-
graph (c)(1):
Example 1. Source of production income. (i)
A, a U.S. corporation, produces widgets that are
sold both within the United States and within a
foreign country. The initial manufacture of all
widgets occurs in the United States. The second
stage of production of widgets that are sold
within a foreign country is completed within the
country of sale. A’s U.S. plant and machinery
which is involved in the initial manufacture of
the widgets has an average adjusted basis of
$200. A also owns warehouses used to store
work-in-process. A owns foreign equipment with
an average adjusted basis of $25. A’s gross
receipts from all sales of widgets is $100, and its
gross receipts from export sales of widgets is
$25. Assume that apportioning average adjusted
basis using gross receipts is reasonable. Assume
A’s cost of goods sold from the sale of widgets
in the foreign countries is $13 and thus, its gross
income from widgets sold in foreign countries is
$12. A uses the 50/50 method to divide its gross
income between production activity and sales
activity.
(ii)A determines its production gross income
from sources without the United States by
multiplying one-half of A’s $12 of gross income
from sales of widgets in foreign countries, or $6,
by a fraction, the numerator of which is all
relevant foreign production assets, or $25, and
the denominator of which is all relevant produc-
tion assets, or $75 ($25 foreign assets + ($200
U.S. assets 3 $25 gross receipts from export
sales/$100 gross receipts from all sales)). There-
fore, A’s gross production income from sources
without the United States is $2 ($6 3 ($25/$75)).
Example 2. Location of intangible property.
Assume the same facts as Example 1, except that
A employs a patented process that applies only
to the initial production of widgets. In computing
the formula used to determine the source of

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income from production activity, A’s patent, if it
has an average adjusted basis, would be located
in the United States.
(2)Income attributable to sales ac-
tivity. The source of the taxpayer’s
income that is attributable to sales
activity will be determined under the
provisions of §1.861–7(c).
(d)Determination of source of tax-
able income. Once the source of gross
income has been determined under
paragraph (c) of this section, the
taxpayer must properly allocate and
apportion separately under §§1.861–8
through 1.861–14T the amounts of its
expenses, losses, and other deductions
to its respective amounts of gross
income from Section 863 Sales deter-
mined separately under each method
described in paragraph (b) of this
section. In addition, if the taxpayer
deducts expenses for research and
development under section 174 that
may be attributed to its Section 863
Sales under §1.861–8(e)(3), the tax-
payer must separately allocate or ap-
portion expenses, losses, and other
deductions to its respective amounts of
gross income from each relevant prod-
uct category that the taxpayer uses in
applying the rules of §1.861–8(e)(3)-
(i)(A). In the case of gross income
from Section 863 Sales determined
under the IFP method or the books and
records method, the rules of §§1.861–8
through 1.861–14T must apply to prop-
erly allocate or apportion amounts of
expenses, losses and other deductions
allocated and apportioned to such gross
income between gross income from
sources within and without the United
States. In the case of gross income
from Section 863 Sales determined
under the 50/50 method, the amounts
of expenses, losses, and other deduc-
tions allocated and apportioned to such
gross income must be apportioned
between sources within and without the
United States pro rata based on the
relative amounts of gross income from
sources within and without the United
States determined under the 50/50
method.
(e)Election and reporting rules—(1)
Elections under paragraph (b) of this
section. If a taxpayer does not elect a
method specified in paragraph (b)(2) or
(3) of this section, the taxpayer must
apply the method specified in para-
graph (b)(1) of this section. The
taxpayer may elect to apply the method
specified in paragraph (b)(2) of this
section by using the method on a
timely filed original return (including
extensions). A taxpayer may elect to
apply the method specified in para-
graph (b)(3) of this section by using
the method on a timely filed original
return (including extensions), but only
if the taxpayer has received permission
from the District Director to apply that
method. Once a method under para-
graph (b) of this section has been used,
that method must be used in later
taxable years unless the Commissioner
consents to a change. See e.g., para-
graph (b)(2)(ii) Example 2 of this
section. However, if a taxpayer elects
to change to or from the method
specified in paragraph (b)(3) of this
section, the taxpayer must obtain per-
mission from the District Director
instead of the Commissioner. Permis-
sion to change methods from one year
to another year will not be withheld
unless the change would result in a
substantial distortion of the source of
the taxpayer’s income.
(2)Disclosure on tax return. A tax-
payer who uses one of the methods
described in paragraph (b) of this
section must fully explain the meth-
odology used, the circumstances justi-
fying use of that method, the extent
that sales are aggregated, and the
amount of income so allocated.
(f)Income partly from sources
within a possession of the United
States. [Reserved]
(g)Effective dates. The rules of
paragraphs (a) through (e) of this
section will apply to taxable years
beginning 30 days after publication of
final regulations. However, taxpayers
may apply these regulations for taxable
years beginning after July 11, 1995,
and before 30 days after publication of
these regulations as final regulations.
For years beginning before 30 days
after the publication of these regula-
tions as final regulations, see §1.863–3
(as contained in 26 CFR part 1 revised
as of April 1, 1995).
Par. 4. Section 1.863–4 is amended
by revising the section heading and
paragraph (a) to read as follows:
§1.863–4 Certain transportation
services.
(a)General. A taxpayer carrying on
the business of transportation service
(other than an activity giving rise to
transportation income described in sec-
tion 863(c) or to income subject to
other specific provisions of this title)
between points in the United States and
points outside the United States derives
income partly from sources within and
partly from sources without the United
States.
******
§1.863–5 [Removed]
Par. 5. Section 1.863–5 is removed
30 days after publication of this regula-
tion as a final regulation.
Margaret Milner Richardson,
Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on
December 7, 1995, 2:00 p.m., and published in
the issue of the Federal Register for December
11, 1995, 60 F.R. 63478)

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

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43
NameAddressDesignationEffective Date
Muraskin, DavidNew York, NYAttorneyNovember 6, 1995
Kelsey, PatrickPoolesville, MDCPANovember 13, 1995
Announcement of the Expedited Suspension of Attorneys, Certified Public
Accountants, Enrolled Agents, and Enrolled Actuaries From Practice Before the
Internal Revenue Service
Under title 31 of the Code of Federal
Regulations, section 10.76, the Director
of Practice is authorized to immediately
suspend from practice before the Inter-
nal Revenue Service any practitioner
who, within five years, from the date
the expedited proceeding is instituted,
(1) has had a license to practice as an
attorney, certified public accountant, or
actuary suspended or revoked for
cause; or (2) has been convicted of any
crime under title 26 of the United
States Code or, of a felony under title
18 of the United States Code involving
dishonesty or breach of trust.
Attorneys, certified public account-
ants, enrolled agents, and enrolled ac-
tuaries are prohibited in any Internal
Revenue Service matter from directly
or indirectly employing, accepting as-
sistance from, being employed by, or
sharing fees with, any practitioner
disbarred or suspended from practice
before the Internal Revenue Service.
To enable attorneys, certified public
accountants, enrolled agents, and en-
rolled actuaries to identify practitioners
under expedited suspension from prac-
tice before the Internal Revenue Serv-
ice, the Director of Practice will an-
nounce in the Internal Revenue Bulletin
the names and addresses of practition-
ers who have been suspended from such
practice, their designation as attorney,
certified public accountant, enrolled
agent, or enrolled actuary, and date or
period of suspension. This announce-
ment will appear in the weekly Bulletin
at the earliest practicable date after
such action and will continue to appear
in the weekly Bulletins for five succes-
sive weeks or for as many weeks as is
practicable for each attorney, certified
public accountant, enrolled agent, or
enrolled actuary so suspended and will
be consolidated and published in the
Cumulative Bulletin.
The following individuals have been
placed under suspension from practice
before the Internal Revenue Service by
virtue of the expedited proceeding
provisions of the applicable regulations:
NameAddressDesignationDate of Suspension
Trebatch, Henry T.Great Neck, NYCPAIndefinite from November 6, 1995
Roomberg, AlanMinersville, PACPAIndefinite from November 10, 1995
Elfenbein, Emanuel B.Miami, FLEnrolled
Agent
Indefinite from November 27, 1995
Cerullo, Louis, J.Boca Raton, FLCPAIndefinite from November 27, 1995
Fogel, HaroldSt. Paul, MNCPAIndefinite from December 13, 1995
Glover, Paul L.Downers Grove, ILAttorneyIndefinite from December 13, 1995
Miller, John R.Akron, OHAttorneyIndefinite from December 13, 1995
Pofahl, CharlesDallas, TXAttorneyIndefinite from December 18, 1995
Walburg, DouglasMahtomedi, MNCPAIndefinite from December 18, 1995
Hibler, Thomas M.Plymouth, MICPA/
Attorney
Indefinite from December 18, 1995
Oringer, RonaldFlanders, NJCPAIndefinite from December 29, 1995
Butcher, FrederickStillwater, NJCPAIndefinite from December 29, 1995
Tokars, FredericAtlanta, GAAttorneyIndefinite from December 29, 1995
Atkins, Sanford I.Moreland Hills, OHAttorneyIndefinite from December 29, 1995

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44
Definition of Terms
Revenue rulings and revenue proce-
dures (hereinafter referred to as ‘‘rul-
ings’’) that have an effect on previous
rulings use the following defined terms
to describe the effect:
Amplified describes a situation where
no change is being made in a prior
published position, but the prior posi-
tion is being extended to apply to a
variation of the fact situation set forth
therein. Thus, if an earlier ruling held
that a principle applied to A, and the
new ruling holds that the same princi-
ple also applies to B, the earlier ruling
is amplified. (Compare with modified,
below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in
a prior ruling is being changed.
Distinguished describes a situation
where a ruling mentions a previously
published ruling and points out an
essential difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but
not to B, and the new ruling holds that
it applies to both A and B, the prior
ruling is modified because it corrects a
published position. (Compare with am-
plified and clarified, above).
Obsoleted describes a previously
published ruling that is not considered
determinative with respect to future
transactions. This term is most com-
monly used in a ruling that lists
previously published rulings that are
obsoleted because of changes in law or
regulations. A ruling may also be
obsoleted because the substance has
been included in regulations subse-
quently adopted.
Revoked describes situations where
the position in the previously published
ruling is not correct and the correct
position is being stated in the new
ruling.
Superseded describes a situation
where the new ruling does nothing
more than restate the substance and
situation of a previously published
ruling (or rulings). Thus, the term is
used to republish under the 1986 Code
and regulations the same position pub-
lished under the 1939 Code and regula-
tions. The term is also used when it is
desired to republish in a single ruling a
series of situations, names, etc., that
were previously published over a
period of time in separate rulings. If
If the new ruling does more than
restate the substance of a prior ruling, a
combination of terms is used. For
example, modified and superseded de-
scribes a situation where the substance
of a previously published ruling is
being changed in part and is continued
without change in part and it is desired
to restate the valid portion of the
previously published ruling in a new
ruling that is self contained. In this
case the previously published ruling is
first modified and then, as modified, is
superseded.
Supplemented is used in situations in
which a list, such as a list of the names
of countries, is published in a ruling
and that list is expanded by adding
further names in subsequent rulings.
After the original ruling has been
supplemented several times, a new
ruling may be published that includes
the list in the original ruling and the
additions, and supersedes all prior
rulings in the series.
Suspended is used in rare situations
to show that the previous published
rulings will not be applied pending
some future action such as the issuance
of new or amended regulations, the
outcome of cases in litigation, or the
outcome of a Service study.
Abbreviations
The following abbreviations in current use and
formerly used will appear in material published
in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.

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Numerical Finding List
1
Bulletins 1996–1 through 1996–5
Announcements:
96–1, 1996–2 I.R.B. 57
96–2, 1996–2 I.R.B. 57
96–3, 1996–2 I.R.B. 57
96–4, 1996–3 I.R.B. 50
96–5, 1996–4 I.R.B. 99
96–6, 1996–5 I.R.B. 43
96–7, 1996–5 I.R.B. 44
Notices:
96–2, 1996–2 I.R.B. 15
96–1, 1996–3 I.R.B. 30
96–4, 1996–4 I.R.B. 69
96–6, 1996–5 I.R.B. 27
Proposed Regulations:
EE–20–95, 1996–5 I.R.B. 15
EE–34–95, 1996–3 I.R.B. 49
EE–35–95, 1996–5 I.R.B. 19
EE–53–95, 1996–5 I.R.B. 23
IA–33–95, 1996–4 I.R.B. 99
INTL–9–95, 1996–5 I.R.B. 24
Revenue Procedures:
96–1, 1996–1 I.R.B. 8
96–2, 1996–1 I.R.B. 60
96–3, 1996–1 I.R.B. 82
96–4, 1996–1 I.R.B. 94
96–5, 1996–1 I.R.B. 129
96–6, 1996–1 I.R.B. 151
96–7, 1996–1 I.R.B. 185
96–8, 1996–1 I.R.B. 187
96–9, 1996–2 I.R.B. 15
96–10, 1996–2 I.R.B. 17
96–11, 1996–2 I.R.B. 18
96–12, 1996–3 I.R.B. 30
96–13, 1996–3 I.R.B. 31
96–14, 1996–3 I.R.B. 41
96–15, 1996–3 I.R.B. 41
96–16, 1996–3 I.R.B. 45
96–17, 1996–4 I.R.B. 69
96–18, 1996–4 I.R.B. 73
96–19, 1996–4 I.R.B. 80
96–20, 1996–4 I.R.B. 88
96–21, 1996–4 I.R.B. 96
96–22, 1996–5 I.R.B. 27
96–23, 1996–5 I.R.B. 27
96–24, 1996–5 I.R.B. 28
Revenue Rulings:
96–1, 1996–1 I.R.B. 7
96–2, 1996–2 I.R.B. 5
96–3, 1996–2 I.R.B. 14
1
A cumulative list of all Revenue Rulings,
Revenue Procedures, Treasury Decisions, etc.,
published in Internal Revenue Bulletins 1995–27
through 1995–52 will be found in Internal
Revenue Bulletin 1996–1, dated January 2, 1996.
Revenue Rulings—Continued
96–6, 1996–2 I.R.B. 8
96–4, 1996–3 I.R.B. 16
96–5, 1996–3 I.R.B. 29
96–7, 1996–3 I.R.B. 12
96–8, 1996–4 I.R.B. 62
96–9, 1996–4 I.R.B. 5
96–10, 1996–4 I.R.B. 27
96–11, 1996–4 I.R.B. 28
Treasury Decisions:
8630, 1996–3 I.R.B. 19
8631, 1996–3 I.R.B. 7
8632, 1996–4 I.R.B. 6
8633, 1996–4 I.R.B. 20
8634, 1996–3 I.R.B. 17
8635, 1996–3 I.R.B. 5
8636, 1996–4 I.R.B. 64
8637, 1996–4 I.R.B. 29
8638, 1996–5 I.R.B. 5
8639, 1996–5 I.R.B. 12
8640, 1996–2 I.R.B. 10

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Finding List of Current Action on
Previously Published Items
1
Bulletins 1996–1 through 1996–5
*Denotes entry since last publication
Revenue Procedures:
65–17
Modified by
96–14, 1996–3 I.R.B. 41
66–49
Modified by
96–15, 1996–3 I.R.B. 41
88–32
Obsoleted by
96–15, 1996–3 I.R.B. 41
88–33
Obsoleted by
96–15, 1996–3 I.R.B. 41
89–19
Superseded by
96–17, 1996–4 I.R.B. 69
89–48
Superseded in part by
96–17, 1996–4 I.R.B. 69
91–22
Modified by
96–1, 1996–1 I.R.B. 8
91–22
Amplified by
96–13, 1996–3 I.R.B. 31
91–23
Superseded by
96–13, 1996–3 I.R.B. 31
91–24
Superseded by
96–14, 1996–3 I.R.B. 41
91–26
Superseded by
96–13, 1996–3 I.R.B. 31
92–20
Modified by
96–1, 1996–1 I.R.B. 8
92–85
Modified by
96–1, 1996–1 I.R.B. 8
93–16
Superseded by
96–11, 1996–2 I.R.B. 18
93–46
Superseded in part by
96–17, 1996–4 I.R.B. 69
1
A cumulative finding list for previously
published items mentioned in Internal Revenue
Bulletins 1995–27 through 1995–52 will be
found in Internal Revenue Bulletin 1996–1, dated
January 2, 1996.
Revenue Procedures—Continued
Superseded by
96–18, 1996–4 I.R.B. 73
94–18
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
94–59
Superseded in part by
96–17, 1996–4 I.R.B. 69
Superseded by
96–18, 1996–4 I.R.B. 73
95–1
Superseded by
96–1, 1996–1 I.R.B. 8
95–2
Superseded by
96–2, 1996–1 I.R.B. 60
95–3
Superseded by
96–3, 1996–1 I.R.B. 82
95–4
Superseded by
96–4, 1996–1 I.R.B. 94
95–5
Superseded by
96–5, 1996–1 I.R.B. 129
95–6
Superseded by
96–6, 1996–1 I.R.B. 151
95–7
Superseded by
96–7, 1996–1 I.R.B. 185
95–8
Superseded by
96–8, 1996–1 I.R.B. 187
95–13
Superseded by
96–20, 1996–4 I.R.B. 88
95–20
Superseded by
96–24, 1996–5 I.R.B. 28
95–50
Superseded by
96–3, 1996–1 I.R.B. 82
96–3
Amplified by
96–12, 1996–3 I.R.B. 30
Revenue Rulings:
66–307
Obsoleted by
96–3, 1996–2 I.R.B. 14
72–437
Modified by
96–13, 1996–3 I.R.B. 31
80–80
Obsoleted by
96–3, 1996–2 I.R.B. 14
82–80
Modified by
96–14, 1996–3 I.R.B. 41
92–19
Supplemented in part
96–2, 1996–2 I.R.B. 5
92–75
Clarified by
96–13, 1996–3 I.R.B. 31
95–10
Supplemented and superseded by
96–4, 1996–3 I.R.B. 16
95–11
Supplemented and superseded by
96–5, 1996–3 I.R.B. 29