Rp 2007-20

Bulletin No. 2007-7
February 12, 2007

HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

INCOME TAX

T.D. 9307, page 470.

Rev. Rul. 2007–7, page 468.

Final regulations under sections 446(e) and 1016(a)(2) of the
Code provide rules for determining which changes in depreciation or amortization are, and are not, changes in method of
accounting.

Investor control and general public; taxation of variable
contracts; insurance and annuities. This ruling effectively
excludes classes of beneficial ownership from the definition of
“general public” as defined in Rev. Rul. 81–225, 1981–2 C.B.
12, for purposes of investor control analysis. Investor control
analysis is used to determine who owns (and is taxed on) income generated inside of variable contracts (e.g., variable life
insurance contracts or variable annuity contracts). Rev. Ruls.
81–225 and 2003–92 clarified and amplified.

Rev. Rul. 2007–8, page 469.
Section 357(c). Section 357(c)(1) of the Code does not apply to transactions that qualify as reorganizations described in
sections 368(a)(1)(A), (C), (D), or (G), and to which section 351
applies, provided certain requirements are satisfied. Rev. Ruls.
75–161 and 76–188 obsoleted. Rev. Rul. 78–330 modified.

T.D. 9305, page 479.
Final regulations under section 863 of the Code contain rules
governing the source of income from certain space and ocean
activities. They also contain rules governing the source of income from certain communications activities. The regulations
affect persons who derive income from activities conducted in
space or on or under water not within the jurisdiction of a foreign country, possession of the United States, or the United
States (in international water). The regulations also affect persons who derive income from transmission of communications.

T.D. 9309, page 497.
Final regulations under section 6664 of the Code provide circumstances that end the period within which a taxpayer may
file an amended return that constitutes a qualified amended return. Qualified amended returns are used to determine whether
an underpayment exists that is potentially subject to the accuracy-related penalty on underpayments.

Rev. Proc. 2007–20, page 517.
This procedure provides exceptions to the contractual protection filter, which is a reportable transaction under regulations
section 1.6011–4(b)(4). Rev. Proc. 2004–65 modified and
superseded.

EMPLOYEE PLANS
Notice 2007–14, page 501.
Permitted benefits; defined benefit plan. This notice,
which is a notice of intent to propose regulations, requests
comments regarding the types of benefits permitted to be
provided in a qualified defined benefit plan.

(Continued on the next page)

Finding Lists begin on page ii.

EXEMPT ORGANIZATIONS
Announcement 2007–13, page 519.
The IRS has revoked its determination that Hawaii Credit Counseling Service of Honolulu, HI; and Lighthouse Credit Foundation, Inc., of Largo, FL, qualify as organizations described in
sections 501(c)(3) and 170(c)(2) of the Code.

Announcement 2007–14, page 519.
A list is provided of organizations now classified as private foundations.

ADMINISTRATIVE
Notice 2007–15, page 503.
Insurance companies; closing agreements. This notice requests comments on how the Service may improve the procedures for obtaining closing agreements to correct inadvertent
failures of life insurance contracts or annuity contracts to satisfy the requirements of sections 817(h), 7702, or 7702A. The
Service is also asking for comments on the four model closing
agreements provided in this notice.

Rev. Proc. 2007–19, page 515.
Insurance companies; modified endowment contracts.
This procedure modifies Rev. Proc. 2001–42, 2001–2 C.B.
212, which provides procedures by which an issuer may
remedy an in-advertent non-egregious failure to comply with
the modified endowment contract (MEC) rules under section
7702A of the Code. The procedure updates information
regarding the indices referenced in Rev. Proc. 2001–42 and
also changes one of the indices. It allows the electronic submission of information and templates and changes the address
to which payments required under the closing agreement are
sent. Rev. Proc. 2001–42 modified and amplified.

Announcement 2007–4, page 518.
This document contains corrections to proposed regulations
(REG–208270–86, 2006–42 I.R.B. 698) regarding the determination of the items of income or loss of a taxpayer with respect to a section 987 of the Code qualified business unit as
well as the timing, amount character, and source of any section 987 gain or loss.

Announcement 2007–19, page 521.
This document cancels a public hearing on proposed regulations (REG–136806–06, 2006–47 I.R.B. 950) modifying the
standards for treating payments in lieu of taxes (PILOTs) as
generally applicable taxes for purposes of the private security
or payment test under section 141 of the Code.

February 12, 2007

2007–7 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping
them understand and meet their tax responsibilities and by

applying the tax law with integrity and fairness to all.

Introduction
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the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
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practices and procedures that affect the rights and duties of
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Revenue rulings represent the conclusions of the Service on the
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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,
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Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
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The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2007–7 I.R.B.

February 12, 2007

Place missing child here.

February 12, 2007

2007–7 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 61.—Gross Income
Defined
26 CFR 1.61–1: Gross income.
(Also § 817; § 1.817–5.)

Investor control and general public; taxation of variable contracts;
insurance and annuities. This ruling
effectively excludes classes of beneficial
ownership from the definition of “general
public” as defined in Rev. Rul. 81–225,
1981–2 C.B. 12, for purposes of investor
control analysis. Investor control analysis
is used to determine who owns (and is
taxed on) income generated inside of variable contracts (e.g., variable life insurance
contracts or variable annuity contracts).
Rev. Ruls. 81–225 and 2003–92 clarified
and amplified.

Rev. Rul. 2007–7
ISSUE
Is the holder of a variable annuity or life
insurance contract treated as the owner, for
federal income tax purposes, of an interest in a regulated investment company that
funds the variable contract solely because
interests in the same regulated investment
company are also available to investors described in § 1.817–5(f)(3) of the Income
Tax Regulations?
FACTS
A, an individual, purchases a variable
contract (within the meaning of § 817(d)
of the Internal Revenue Code) from IC, a
life insurance company subject to tax under Part 1 of Subchapter L. All assets funding the contract are held in a segregated
asset account that invests in RIC, a regulated investment company. All the beneficial interests in RIC are held by one or
more segregated asset accounts of IC, or
by investors described in § 1.817–5(f)(3).
Public access to RIC is available exclusively either through the purchase of a
variable contract, or to investors described
in § 1.817–5(f)(3).

2007–7 I.R.B.

LAW AND ANALYSIS
In Rev. Rul. 2003–92, 2003–2 C.B.
350, a taxpayer purchased a variable “annuity” contract. The segregated asset
account on which the contract was based
was divided into 10 sub-accounts, each
of which invested in a partnership. Interests in each partnership were sold in
private placement offerings to qualified
purchasers. The ruling concludes that,
because interests in the partnerships were
available for purchase by the general public, the taxpayer is considered the owner
for federal tax purposes of the interests
in the partnerships held by the sub-accounts. The same analysis applies in the
case of a variable life insurance contract.
Rev. Rul. 2003–92 clarified and amplified
Rev. Rul. 81–225, 1981–2 C.B. 12, which
concluded that the policyholder is considered the owner of mutual fund shares that
fund a variable “annuity” contract where
those shares are also available directly or
indirectly to the general public.
Section 817(h) and § 1.817–5 set forth
diversification requirements for segregated asset accounts on which variable
contracts are based. Section 817(h)(4)
and § 1.817–5(f) provide a look-through
rule for determining whether those diversification requirements are met. The
look-through rule applies to a regulated
investment company, partnership, or trust,
but only if (A) all the beneficial interests
in the investment company, partnership,
or trust are held by one or more segregated asset accounts of one or more insurance companies, and (B) public access
to the investment company, partnership
or trust is available exclusively through
the purchase of a variable contract. Under
§ 1.817–5(f)(3), the following four categories of beneficial interest are ignored
for purposes of determining whether these
two requirements are satisfied:
(1) Interests held by the general account
of a life insurance company or a corporation related to a life insurance company,
but only if the return on such interests is
computed in the same manner as the return
on an interest held by a segregated asset account is computed, there is no intent to sell
such interests to the public, and a segre-

468

gated asset account of such life insurance
company also holds or will hold a beneficial interest in the investment company,
partnership, or trust;
(2) Interests held by a manager, or a
corporation related to the manager, of the
investment company, partnership or trust,
but only if the holding of the interests is
in connection with the creation or management of the investment company, partnership or trust, the return on such interest is
computed in the same manner as the return
on an interest held by a segregated asset account is computed, and there is no intent to
sell such interests to the public;
(3) Interests held by the trustee of a
qualified pension or retirement plan; or
(4) Interests held by the public, or
treated as owned by the policyholders
pursuant to Rev. Rul. 81–225, but only
if (A) the investment company, partnership or trust was closed to the public in
accordance with Rev. Rul. 82–55, 1982–1
C.B. 12, or (B) all the assets of the segregated asset account are attributable to
premium payments made by policyholders
before September 26, 1981, to premium
payments made in connection with a qualified pension or retirement plan, or to any
combination of such premium payments.
The
investors
described
in
§ 1.817–5(f)(3) are not members of
the “general public” as that term is used in
Rev. Rul. 2003–92 and Rev. Rul. 81–225.
In the present case, all the beneficial
interests in RIC are held by one or more
segregated asset accounts of IC, or by
investors described in § 1.817–5(f)(3),
and public access to RIC is available exclusively either through the purchase of a
variable contract, or to investors described
in § 1.817–5(f)(3). Accordingly, interests
in RIC are not available to the “general
public” as that term is used in Rev. Rul.
2003–92 and Rev. Rul. 81–225, and A is
not treated as the owner of an interest in a
regulated investment company that funds
the variable contract.
HOLDING
The holder of a variable annuity or
life insurance contract is not treated as
the owner of an interest in a regulated

February 12, 2007

investment company that funds the variable contract solely because interests in
the same regulated investment company
are also available to investors described in
§ 1.817–5(f)(3).
EFFECT ON OTHER REVENUE
RULING(S)
Rev. Rul. 81–225, 1981–2 C.B. 12, and
Rev. Rul. 2003–92, 2003–2 C.B. 350, are
hereby clarified and amplified.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Chris Lieu of the Office of Chief
Counsel (Financial Institutions & Products). For further information regarding
this revenue ruling, contact Chris Lieu at
(202) 622–3970 (not a toll-free call).

Section 357.—Assumption
of Liability
26 CFR 1.357–2: Liabilities in excess of basis.

Section 357(c). Section 357(c)(1) of
the Code does not apply to transactions
that qualify as reorganizations described in
sections 368(a)(1)(A), (C), (D), or (G), and
to which section 351 applies, provided certain requirements are satisfied. Rev. Ruls.
75–161 and 76–188 obsoleted. Rev. Rul.
78–330 modified.

Rev. Rul. 2007–8
ISSUE
Does § 357(c)(1) of the Internal Revenue Code apply to transactions that
qualify as reorganizations described in
§§ 368(a)(1)(A), (C), (D) (provided the
requirements of § 354(b)(1) are satisfied), or (G) (provided the requirements
of § 354(b)(1) are satisfied) and to which
§ 351 applies?

the Y stock to A. At the time of the acquisition, the sum of the X liabilities assumed by Y exceeded X’s total adjusted
basis in the property transferred to Y. Further, the value of X’s assets transferred to
Y exceeded the amount of X’s liabilities
assumed by Y, and, immediately after the
exchange, the value of Y’s assets exceeded
the amount of Y’s liabilities. The transaction qualified as a reorganization described
in § 368(a)(1)(D) and as an exchange to
which § 351 applied.
Situation 2. A, an individual, owned
all of the stock of corporation X. B, an individual unrelated to A, owned all of the
stock of corporation Y. Y acquired all of
the assets of X in exchange for Y voting
stock and the assumption by Y of X’s liabilities. Pursuant to the plan, X liquidated
and distributed the Y voting stock to A. At
the time of the acquisition, the sum of the
X liabilities assumed by Y exceeded X’s
total adjusted basis in the property transferred to Y. Further, the value of X’s assets transferred to Y exceeded the amount
of X’s liabilities assumed by Y, and, immediately after the exchange, the value of
Y’s assets exceeded the amount of Y’s liabilities. Simultaneously, and as part of
the overall plan, B contributed property to
Y in exchange for additional Y stock so
that immediately after the transaction, B
held more than 50 percent of the vote and
of the value of all the stock of Y. The Y
stock issued to X along with the Y stock
issued to and held by B immediately after
the transaction constituted § 368(c) control
of Y. The transfer by X of all of its assets
to Y in exchange for Y voting stock and
assumption of liabilities, followed by the
liquidation of X, qualified as a reorganization described in § 368(a)(1)(C). Further,
X’s transfer of assets to Y in exchange for
Y voting stock along with B’s transfer of
property to Y in exchange for additional Y
stock was an exchange to which § 351 applied.
LAW AND ANALYSIS

FACTS
Situation 1. A, an individual, owned
all of the stock of corporation X and corporation Y. Y acquired all of the assets of
X in exchange for an amount of Y stock
constituting § 368(c) control and the assumption by Y of X’s liabilities. Pursuant
to the plan, X liquidated and distributed

February 12, 2007

Section 357(a) provides that if, as part
of the consideration in an exchange to
which § 351 or § 361 applies, a liability of
the taxpayer is assumed by another party
to the exchange then such assumption shall
not be treated as money or other property.
However, in the case of certain exchanges,
§ 357(c)(1) provides that the transferor is

469

required to recognize gain if the sum of
the amount of liabilities assumed exceeds
the total of the adjusted basis of the property transferred. Prior to the enactment of
The American Jobs Creation Act of 2004
(Public Law 108–357, 188 Stat. 1418)
(the Jobs Act), § 357(c)(1) applied in the
case of an exchange (A) to which § 351
applied, or (B) to which § 361 applied by
reason of a plan of reorganization within
the meaning of § 368(a)(1)(D). The Jobs
Act amended § 357(c)(1)(B), limiting the
application of § 357(c)(1) to exchanges to
which § 351 applies, or to which § 361
applies by reason of a plan of reorganization within the meaning of § 368(a)(1)(D)
with respect to which stock or securities
of the corporation to which the assets are
transferred are distributed in a transaction that qualifies under § 355. Thus, as
amended, § 357(c) no longer applies to an
acquisitive § 368(a)(1)(D) reorganization
– i.e., one that satisfies the requirements
of § 354(b)(1).
The legislative history to the Jobs Act
amendment to § 357(c)(1)(B) explains
Congress’s intent in removing acquisitive
§ 368(a)(1)(D) reorganizations from the
application of § 357(c)(1), as follows:
The Committee believes that . . .
the [transferee] should be permitted
to assume liabilities of the [transferor]
without application of the rule of section 357(c). This is because in an
acquisitive reorganization under section 368(a)(1)(D), the transferor must
generally transfer substantially all of
its assets to the acquiring corporation
and then go out of existence. Assumption of its liabilities by the acquiring
corporation thus does not enrich the
transferor corporation, which ceases to
exist, and whose liability was limited
to its assets in any event, by corporate
form. The Committee believes that it
was appropriate to conform the treatment of acquisitive reorganizations
under section 368(a)(1)(D) to that of
other acquisitive reorganizations.
S. Rep. No. 192, 108th Cong., 1st Sess.
185 (2003).
The Jobs Act amendment to
§ 357(c)(1)(B) excluded acquisitive
§ 368(a)(1)(D) reorganizations from the
application of § 357(c)(1), because in
such transactions the transferor ceases to
exist and cannot be enriched by the assumption of its liabilities. The Jobs Act

2007–7 I.R.B.

legislative history states that the amendment was made to conform the treatment
of § 368(a)(1)(D) acquisitive reorganizations to the treatment of other acquisitive
reorganizations. Therefore, the intent of
the Jobs Act amendment to § 357(c)(1)(B)
was to exclude reorganizations from the
application of § 357(c)(1) unless described
in § 357(c)(1)(B), regardless of whether
such reorganizations are also exchanges to
which § 351 applies.
In the transactions set forth in both Situation 1 and Situation 2, the transferor
corporation ceases to exist and, therefore,
cannot be enriched as a result of the assumption of its liabilities. In accordance
with the above reasoning, in both Situation 1 and Situation 2, § 357(c)(1) does
not apply to X’s transfer of assets to Y
in exchange for Y stock and assumption
of X’s liabilities notwithstanding the fact
that such transfers were also exchanges to
which § 351 applied.
In addition, under § 368(a)(3)(C),
if a reorganization qualifies under
§ 368(a)(1)(G) and under any other subparagraph of § 368(a)(1) or under § 332
or § 351, then, other than for purposes of
§ 357(c)(1), the transaction will be treated
as qualifying only under § 368(a)(1)(G).
However, because § 357(c)(1) is no longer
applicable to a transaction that qualifies as a reorganization described in
§ 368(a)(1)(A), (C), or (D) (provided
the requirements of § 354(b)(1) are satisfied), it is also no longer applicable to a
reorganization described in § 368(a)(1)(G)
(provided the requirements of § 354(b)(1)
are satisfied), regardless of whether § 351
applies.

tion that qualifies as a reorganization described in § 368(a)(1)(A) or (D) (that satisfies the requirements of § 354(b)(1)).

FOR
FURTHER
INFORMATION
CONTACT: Douglas H. Kim, (202)
622–3110 (not a toll-free number).

DRAFTING INFORMATION

SUPPLEMENTARY INFORMATION:

The principal author of this revenue ruling is Rebecca O. Burch of the Office of
Associate Chief Counsel (Corporate). For
further information regarding this revenue
ruling, contact Rebecca O. Burch at (202)
622–7550 (not a toll-free call).

Background

Section 446.—General Rule
for Methods of Accounting
26 CFR 1.446–1: General rule for methods of accounting.

T.D. 9307
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 1
Changes in Computing
Depreciation
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regulations.

EFFECT ON OTHER REVENUE
RULING

SUMMARY: This document contains regulations relating to a change in computing depreciation or amortization as well as
a change from a nondepreciable or nonamortizable asset to a depreciable or amortizable asset (or vice versa). Specifically,
these regulations provide guidance to any
taxpayer that makes a change in depreciation or amortization on whether such a
change is a change in method of accounting under section 446(e) of the Internal
Revenue Code and on the application of
section 1016(a)(2) in determining whether
the change is a change in method of accounting.

Rev. Rul. 75–161, 1975–1 C.B. 114,
and Rev. Rul. 76–188, 1976–1 C.B. 99,
are obsolete. Rev. Rul. 78–330, 1978–2
C.B. 147, is modified to the extent it holds
that § 357(c)(1) is applicable to a transac-

DATES: Effective Date: These regulations
are effective December 28, 2006.
Applicability Dates: For dates of
applicability,
see
§§1.167(e)–1(e),
1.446–1(e)(4), and 1.1016–3(j).

HOLDING
Section 357(c)(1) does not apply to
transactions that qualify as reorganizations
described in §§ 368(a)(1)(A), (C), (D)
(provided the requirements of § 354(b)(1)
are satisfied), or (G) (provided the requirements of § 354(b)(1) are satisfied) and to
which § 351 applies.

2007–7 I.R.B.

470

This document contains amendments
to 26 CFR part 1. On January 2, 2004,
the IRS and Treasury Department published temporary regulations (T.D. 9105,
2004–1 C.B. 419) in the Federal Register (69 FR 5) relating to the application
of section 446(e) of the Internal Revenue Code (Code) and §1.167(e)–1 to a
change in depreciation or amortization
and the application of section 1016(a)(2)
in determining whether a change in depreciation or amortization is a change in
method of accounting. On the same date,
the IRS published a notice of proposed
rulemaking (REG–126459–03, 2004–1
C.B. 437) cross-referencing the temporary
regulations in the Federal Register (69
FR 42). No public hearing was requested
or held. Several comments responding to
the notice of proposed rulemaking were
received. After consideration of all the
comments, the proposed regulations are
adopted as amended by this Treasury decision, and the corresponding temporary
regulations are removed. The revisions
are discussed here in this preamble.
Section 1400N(d), which was added
to the Code by section 101(a) of the Gulf
Opportunity Zone Act of 2005, Public
Law 109–135 (119 Stat. 2577), generally
allows a 50-percent additional first year
depreciation deduction for qualified Gulf
Opportunity Zone property. The final regulations reflect the enactment of section
1400N(d).
Explanation of Provisions
Scope
The final regulations provide the
changes in depreciation or amortization
(depreciation) for property for which
depreciation is determined under section
167, 168, 197, 1400I, 1400L(b), 1400L(c),
or 1400N(d), or former section 168, of the
Code that are, and those changes that are
not, changes in method of accounting under section 446(e). The final regulations
also clarify that the rules in §1.167(e)–1
with respect to a change in the deprecia-

February 12, 2007

tion method made without the consent of
the Commissioner apply only to property
for which depreciation is determined under section 167 (other than under section
168, 1400I, 1400L, or 1400N(d), or former section 168). Additionally, the final
regulations provide that section 1016(a)(2)
does not permanently affect a taxpayer’s
lifetime income for purposes of determining whether a change in depreciation is
a change in method of accounting under
section 446(e) and §1.446–1(e).
I. Changes in Depreciation Method under
Section 167
The final regulations retain the rules
contained in the temporary regulations
providing that the rules in §1.167(e)–1
with respect to a change in depreciation
method under §1.167(e)–1(b), (c), and (d)
made without the consent of the Commissioner apply only to property for which
depreciation is determined under section
167 (other than under section 168, 1400I,
1400L, or 1400N(d), or former section
168). No comments were received suggesting changes to these rules.
II. Changes in Depreciation That Are,
and Are Not, a Change in Method of
Accounting Under Section 446(e)
The final regulations provide rules on
the changes in depreciation that are, and
are not, a change in method of accounting
under section 446(e).
A. Changes in Depreciation That Are
Changes in Method of Accounting
The final regulations retain the rules
contained in the temporary regulations
providing the changes in depreciation
that are a change in method of accounting under section 446(e). These changes
are a change in the treatment of an asset
from nondepreciable or nonamortizable to
depreciable or amortizable, or vice versa.
Additionally, a correction to require depreciation in lieu of a deduction for the cost of
depreciable or amortizable assets that had
been consistently treated as an expense in
the year of purchase, or vice versa, is a
change in method of accounting. Further,
changes in computing depreciation generally are a change in method of accounting,
including a change in the depreciation
method, period of recovery, or convention

February 12, 2007

of a depreciable or amortizable asset, and a
change to or from claiming the additional
first year depreciation deduction provided
by section 168(k), 1400L(b), or 1400N(d)
under certain circumstances.
No comments were received suggesting
changes to these rules. However, a commentator inquired whether a calendar-year
taxpayer that has not claimed the 30-percent additional first year depreciation for
qualified property acquired after September 10, 2001, and placed in service prior
to January 1, 2002, may claim the 30-percent additional first year depreciation by
requesting a change in method of accounting. To claim the 30-percent additional
first year depreciation for this property,
Rev. Proc. 2003–50, 2003–2 C.B. 119,
provides that the taxpayer had to file an
amended return on or before December
31, 2003, or file a Form 3115, “Application for Change in Accounting Method,”
with the taxpayer’s timely filed 2003 Federal tax return. If the taxpayer did not file
this amended return or Form 3115, the taxpayer has made the deemed election not
to deduct the additional first year depreciation for the 2001 taxable year. Accordingly, the taxpayer’s change to claiming the 30-percent additional first year depreciation for qualified property placed in
service in the taxable year that included
September 11, 2001, is not a change in
method of accounting under the temporary
and final regulations. Instead, the taxpayer
must file a request for a letter ruling to revoke the election.
Another commentator questioned
whether the temporary regulations affected
the procedures for obtaining consent to
make a change in method of accounting. The regulations did not change these
procedures and, accordingly, the rules in
§1.446–1(e)(3) apply to a change in depreciation that is a change in method of
accounting. Other commentators inquired
whether a change in depreciation due to a
posting or mathematical error, or a change
in underlying facts, is a change in method
of accounting. A change in depreciation
due to a posting or mathematical error, or a
change in underlying facts, is not a change
in method of accounting because the rules
in §1.446–1(e)(2)(ii)(a) and (b) also apply
to a change in depreciation. Accordingly,
the final regulations clarify this point.

471

B. Changes in Depreciation That Are Not
Changes in Method of Accounting
The final regulations retain the rule contained in the temporary regulations that
a change in method of accounting does
not include an adjustment in the useful
life of a depreciable or amortizable asset
for which depreciation is determined under
section 167 (other than under section 168,
1400I, 1400L, or 1400N(d), or former section 168). This rule does not apply, however, if a taxpayer is changing to or from a
useful life (or recovery period or amortization period) that is specifically assigned by
the Code, the regulations under the Code,
or other guidance published in the Internal Revenue Bulletin. Several commentators questioned whether the useful life
exception from change in method of accounting treatment that was in effect before the issuance of the temporary regulations has any remaining application. Section 1.446–1(e)(2)(ii)(b), as in effect before the issuance of the temporary regulations (see §1.446–1(e) as contained in
26 CFR part 1 edition revised as of April
1, 2003), provided that a change in the
method of accounting does not include an
adjustment in the useful life of a depreciable asset. The rule still applies but is limited by the temporary and final regulations
to only a depreciable or amortizable asset
for which depreciation is determined under
section 167 (other than under section 168,
1400I, 1400L, or 1400N(d), or former section 168) and to only an adjustment in useful life that is not specifically assigned by
the Code, the regulations under the Code,
or other guidance published in the Internal
Revenue Bulletin.
The final regulations also retain the
rules contained in the temporary regulations of when an adjustment in useful life
that is not a change in method of accounting is implemented. The final regulations
clarify that these rules apply regardless
of whether the adjustment in useful life is
initiated by the IRS or a taxpayer. Furthermore, the final regulations clarify that in
implementing an adjustment in useful life
that is not a change in method of accounting, no section 481 adjustment is required
or permitted.
The final regulations retain the rule contained in the temporary regulations providing that the making of a late depreciation
election or the revocation of a timely valid

2007–7 I.R.B.

depreciation election is not a change in
method of accounting, except as otherwise
provided by the Code, the regulations under the Code, or other guidance published
in the Internal Revenue Bulletin. A commentator inquired whether a late section
179 election may be made by requesting
a change in method of accounting. Under
section 179 and the regulations under section 179, a late section 179 election generally is made by submitting a request for a
letter ruling. However, for a taxable year
beginning after 2002 and before 2010, a
taxpayer may make a section 179 election
by filing an amended return. Accordingly,
the IRS and Treasury Department have included a cross-reference to section 179(c)
and §1.179–5.
The final regulations retain the rule contained in the temporary regulations providing that any change in the placed-in-service date of a depreciable or amortizable
asset is not treated as a change in method
of accounting. The final regulations, however, clarify that this rule does not apply when the Code, the regulations under the Code, or other guidance published
in the Internal Revenue Bulletin, provide
that a change in placed-in-service date is
treated as a change in method of accounting. A commentator requested that the final regulations clarify what constitutes a
change in placed-in-service date. To illustrate the rule, the IRS and Treasury Department provided additional clarification
in the final regulations. For example, the
final regulations provide that if a taxpayer
changes the placed-in-service date of a depreciable or amortizable asset because the
taxpayer incorrectly determined the date
on which the asset was placed in service,
this change is not a change in method of
accounting. However, if a taxpayer incorrectly determines that a depreciable or
amortizable asset is nondepreciable property and later changes the treatment of the
asset to depreciable property, this change is
not a change in the placed-in-service date
of the asset but is a change from nondepreciable to depreciable property and, therefore, the change is a change in method of
accounting. The final regulations also clarify that a change in the convention of a
depreciable or amortizable asset is not a
change in the placed-in-service date of the
asset and, therefore, is a change in method
of accounting. Additionally, the final regulations provide examples illustrating what

2007–7 I.R.B.

constitutes a change in placed-in-service
date.
The final regulations retain the rules
contained in the temporary regulations as
to how and when a change in placed-in-service date that is not a change in method
of accounting is implemented. The final
regulations also clarify that these rules apply regardless of whether the change in
placed-in-service date is made by the IRS
or a taxpayer. Finally, the final regulations
provide that in implementing a change in
placed-in-service date that is not a change
in method of accounting, no section 481
adjustment is required or permitted.

temporary regulations apply to property
placed in service in a taxable year ending on or after December 30, 2003. In
accordance with this clarification, the final regulations apply only to a change
in depreciation made by a taxpayer for a
depreciable or amortizable asset placed in
service by the taxpayer in a taxable year
ending on or after December 30, 2003,
regardless of whether or not the change
in depreciation is a change in method of
accounting. Additionally, the examples in
the final regulations relating to a change in
depreciation have been revised to reflect
this effective date.

C. Item Being Changed

III. Application of Section 1016(a)(2) to a
Change in Method of Accounting

The final regulations retain the rule contained in the temporary regulations providing that for purposes of a change in depreciation, the item being changed is the
depreciation treatment of each individual
depreciable or amortizable asset or the depreciation treatment of each vintage account with respect to a depreciable asset
for which depreciation is determined under
§1.167(a)–11 (CLADR). Because general
asset accounts and mass asset accounts are
similar to vintage accounts, the final regulations clarify that the item is the depreciable treatment of each general asset account with respect to a depreciable asset
for which general asset account treatment
has been elected under section 168(i)(4)
or the item is the depreciation treatment
of each mass asset account with respect
to a depreciable asset for which mass asset account treatment has been elected under former section 168(d)(2)(A). The final regulations also retain the rule contained in the temporary regulations providing that a change in depreciation under
section 167 (other than under section 168,
1400I, 1400L, or 1400N(d), or former section 168) is permitted only with respect to
all assets in a particular account (as defined
in §1.167(a)–7) or vintage account.
D. Effective Dates
Several commentators questioned
the application of the effective date
of the temporary regulations.
In response, the IRS, in Chief Counsel Notice 2004–007 (CC–2004–007, January
28, 2004) and Chief Counsel Notice
2004–024 (CC–2004–024, July 12, 2004)
(see www.irs.gov/foia), clarified that the

472

The final regulations contain the same
rule as the temporary regulations, providing that section 1016(a)(2) does not permanently affect a taxpayer’s lifetime income for purposes of determining whether
a change in depreciation for property subject to section 167, 168, 1400I, 1400L,
or 1400N(d), or former section 168, is a
change in method of accounting under section 446(e) and the regulations under section 446(e). No comments were received
suggesting changes to this rule.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations
and, because these regulations do not impose on small entities a collection of information requirement, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to
section 7805(f) of the Code, the notice of
proposed rulemaking was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal author of these regulations is Douglas H. Kim, Office of Associate Chief Counsel (Passthroughs and

February 12, 2007

Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.167(e)–1 is amended
by revising paragraphs (a) and (e) to read
as follows:

preciation is determined under section
167 (other than under section 168, section
1400I, section 1400L(c), under section
168 prior to its amendment by the Tax
Reform Act of 1986 (100 Stat. 2121), or
under an additional first year depreciation
deduction provision (for example, section
168(k), 1400L(b), or 1400N(d))) of the
Internal Revenue Code.
*****
(e) Effective date. This section applies
on or after December 30, 2003. For the applicability of regulations before December
30, 2003, see §1.167(e)–1 in effect prior to
December 30, 2003 (§1.167(e)–1 as contained in 26 CFR part 1 edition revised as
of April 1, 2003).
§1.167(e)–1T [Removed]

§1.167(e)–1 Change in method.
(a) In general. (1) Any change in the
method of computing the depreciation
allowances with respect to a particular
account (other than a change in method
permitted or required by reason of the
operation of former section 167(j)(2) and
§1.167(j)–3(c)) is a change in method
of accounting, and such a change will
be permitted only with the consent of the
Commissioner, except that certain changes
to the straight line method of depreciation
will be permitted without consent as provided in former section 167(e)(1), (2),
and (3). Except as provided in paragraphs
(c) and (d) of this section, a change in
method of computing depreciation will
be permitted only with respect to all the
assets contained in a particular account as
defined in §1.167(a)–7. Any change in the
percentage of the current straight line rate
under the declining balance method, for
example, from 200 percent of the straight
line rate to any other percent of the straight
line rate, or any change in the interest factor used in connection with a compound
interest or sinking fund method, will constitute a change in method of depreciation.
Any request for a change in method of
depreciation shall be made in accordance
with section 446(e) and the regulations under section 446(e). For rules covering the
use of depreciation methods by acquiring
corporations in the case of certain corporate acquisitions, see section 381(c)(6) and
the regulations under section 381(c)(6).
(2) Paragraphs (b), (c), and (d) of this
section apply to property for which de-

February 12, 2007

Par. 3. Section 1.167(e)–1T is removed.
Par. 4. Section 1.168(i)–4 is amended
as follows:
1.
Paragraph (f) is amended by
removing the language “§1.446–1T
(e)(2)(ii)(d)(3)(ii)” at the end of
the paragraph and adding “§1.446–
1(e)(2)(ii)(d)(3)(ii)” in its place.
2. Paragraph (g)(2)(ii) is amended by
removing the language “as modified by
Rev. Proc. 2004–11, 2004–1 C.B. 311.”
Par. 5. Section 1.168(i)–6T is amended
as follows:
1. Paragraph (k)(2)(i) is amended
by removing the language “§1.446–1T
(e)(3)(ii)” and adding “§1.446–1(e)(3)(ii)”
in its place.
2. The last sentence in paragraph
(k)(2)(ii) is amended by removing the language “§1.446–1T(e)(3)(ii)” and adding
“§1.446–1(e)(3)(ii)” in its place.
Par. 6. Section 1.446–1 is amended
by revising paragraphs (e)(2)(ii)(a),
(e)(2)(ii)(b), (e)(2)(ii)(d), (e)(2)(iii), and
(e)(4) to read as follows:
§1.446–1 General rule for methods of
accounting.
*****
(e) * * *
(2) * * *
(ii) (a) A change in the method of accounting includes a change in the overall plan of accounting for gross income or
deductions or a change in the treatment
of any material item used in such over-

473

all plan. Although a method of accounting may exist under this definition without the necessity of a pattern of consistent treatment of an item, in most instances
a method of accounting is not established
for an item without such consistent treatment. A material item is any item that involves the proper time for the inclusion of
the item in income or the taking of a deduction. Changes in method of accounting include a change from the cash receipts and disbursement method to an accrual method, or vice versa, a change involving the method or basis used in the
valuation of inventories (see sections 471
and 472 and the regulations under sections 471 and 472), a change from the cash
or accrual method to a long-term contract
method, or vice versa (see §1.460–4), certain changes in computing depreciation or
amortization (see paragraph (e)(2)(ii)(d) of
this section), a change involving the adoption, use or discontinuance of any other
specialized method of computing taxable
income, such as the crop method, and a
change where the Internal Revenue Code
and regulations under the Internal Revenue
Code specifically require that the consent
of the Commissioner must be obtained before adopting such a change.
(b) A change in method of accounting
does not include correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in
computation of the foreign tax credit, net
operating loss, percentage depletion, or investment credit). Also, a change in method
of accounting does not include adjustment
of any item of income or deduction that
does not involve the proper time for the inclusion of the item of income or the taking
of a deduction. For example, corrections
of items that are deducted as interest or
salary, but that are in fact payments of dividends, and of items that are deducted as
business expenses, but that are in fact personal expenses, are not changes in method
of accounting. In addition, a change in the
method of accounting does not include an
adjustment with respect to the addition to
a reserve for bad debts. Although such adjustment may involve the question of the
proper time for the taking of a deduction,
such items are traditionally corrected by
adjustment in the current and future years.
For the treatment of the adjustment of the
addition to a bad debt reserve (for example, for banks under section 585 of the In-

2007–7 I.R.B.

ternal Revenue Code), see the regulations
under section 166 of the Internal Revenue
Code. A change in the method of accounting also does not include a change in treatment resulting from a change in underlying
facts. For further guidance on changes involving depreciable or amortizable assets,
see paragraph (e)(2)(ii)(d) of this section
and §1.1016–3(h).
*****
(d) Changes involving depreciable
or amortizable assets—(1) Scope. This
paragraph (e)(2)(ii)(d) applies to property subject to section 167, 168, 197,
1400I, 1400L(c), to section 168 prior to
its amendment by the Tax Reform Act
of 1986 (100 Stat. 2121) (former section 168), or to an additional first year
depreciation deduction provision of the
Internal Revenue Code (for example, section 168(k), 1400L(b), or 1400N(d)).
(2) Changes in depreciation or amortization that are a change in method of accounting. Except as provided in paragraph
(e)(2)(ii)(d)(3) of this section, a change in
the treatment of an asset from nondepreciable or nonamortizable to depreciable
or amortizable, or vice versa, is a change
in method of accounting. Additionally,
a correction to require depreciation or
amortization in lieu of a deduction for the
cost of depreciable or amortizable assets
that had been consistently treated as an
expense in the year of purchase, or vice
versa, is a change in method of accounting.
Further, except as provided in paragraph
(e)(2)(ii)(d)(3) of this section, the following changes in computing depreciation or
amortization are a change in method of
accounting:
(i) A change in the depreciation or
amortization method, period of recovery,
or convention of a depreciable or amortizable asset.
(ii) A change from not claiming to
claiming the additional first year depreciation deduction provided by, for example,
section 168(k), 1400L(b), or 1400N(d),
for, and the resulting change to the amount
otherwise allowable as a depreciation
deduction for the remaining adjusted
depreciable basis (or similar basis) of,
depreciable property that qualifies for
the additional first year depreciation deduction (for example, qualified property,
50-percent bonus depreciation property,
qualified New York Liberty Zone prop-

2007–7 I.R.B.

erty, or qualified Gulf Opportunity Zone
property), provided the taxpayer did not
make the election out of the additional
first year depreciation deduction (or did
not make a deemed election out of the
additional first year depreciation deduction; for further guidance, for example,
see Rev. Proc. 2002–33, 2002–1 C.B.
963, Rev. Proc. 2003–50, 2003–2 C.B.
119, Notice 2006–77, 2006–40 I.R.B. 590,
and §601.601(d)(2)(ii)(b) of this chapter) for the class of property in which
the depreciable property that qualifies for
the additional first year depreciation deduction (for example, qualified property,
50-percent bonus depreciation property,
qualified New York Liberty Zone property, or qualified Gulf Opportunity Zone
property) is included.
(iii) A change from claiming the 30-percent additional first year depreciation
deduction to claiming the 50-percent additional first year depreciation deduction
for depreciable property that qualifies for
the 50-percent additional first year depreciation deduction, provided the property
is not included in any class of property for
which the taxpayer elected the 30-percent,
instead of the 50-percent, additional first
year depreciation deduction (for example, 50-percent bonus depreciation property or qualified Gulf Opportunity Zone
property), or a change from claiming the
50-percent additional first year depreciation deduction to claiming the 30-percent
additional first year depreciation deduction for depreciable property that qualifies
for the 30-percent additional first year depreciation deduction, including property
that is included in a class of property for
which the taxpayer elected the 30-percent,
instead of the 50-percent, additional first
year depreciation deduction (for example,
qualified property or qualified New York
Liberty Zone property), and the resulting
change to the amount otherwise allowable as a depreciation deduction for the
property’s remaining adjusted depreciable
basis (or similar basis). This paragraph
(e)(2)(ii)(d)(2)(iii) does not apply if a taxpayer is making a late election or revoking
a timely valid election under the applicable additional first year depreciation
deduction provision of the Internal Revenue Code (for example, section 168(k),
1400L(b), or 1400N(d)) (see paragraph
(e)(2)(ii)(d)(3)(iii) of this section).

474

(iv) A change from claiming to not
claiming the additional first year depreciation deduction for an asset that does
not qualify for the additional first year
depreciation deduction, including an asset
that is included in a class of property for
which the taxpayer elected not to claim
any additional first year depreciation deduction (for example, an asset that is not
qualified property, 50-percent bonus depreciation property, qualified New York
Liberty Zone property, or qualified Gulf
Opportunity Zone property), and the resulting change to the amount otherwise
allowable as a depreciation deduction for
the property’s depreciable basis.
(v) A change in salvage value to zero
for a depreciable or amortizable asset
for which the salvage value is expressly
treated as zero by the Internal Revenue
Code (for example, section 168(b)(4)), the
regulations under the Internal Revenue
Code (for example, §1.197–2(f)(1)(ii)), or
other guidance published in the Internal
Revenue Bulletin.
(vi) A change in the accounting for depreciable or amortizable assets from a single asset account to a multiple asset account (pooling), or vice versa, or from one
type of multiple asset account (pooling) to
a different type of multiple asset account
(pooling).
(vii) For depreciable or amortizable assets that are mass assets accounted for in
multiple asset accounts or pools, a change
in the method of identifying which assets have been disposed. For purposes
of this paragraph (e)(2)(ii)(d)(2)(vii), the
term mass assets means a mass or group of
individual items of depreciable or amortizable assets that are not necessarily homogeneous, each of which is minor in value
relative to the total value of the mass or
group, numerous in quantity, usually accounted for only on a total dollar or quantity basis, with respect to which separate
identification is impracticable, and placed
in service in the same taxable year.
(viii) Any other change in depreciation
or amortization as the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see
§601.601(d)(2) of this chapter).
(3) Changes in depreciation or amortization that are not a change in method of
accounting. Section 1.446–1(e)(2)(ii)(b)
applies to determine whether a change
in depreciation or amortization is not a

February 12, 2007

change in method of accounting. Further,
the following changes in depreciation or
amortization are not a change in method
of accounting:
(i) Useful life. An adjustment in the
useful life of a depreciable or amortizable
asset for which depreciation is determined
under section 167 (other than under section 168, section 1400I, section 1400L(c),
former section 168, or an additional first
year depreciation deduction provision of
the Internal Revenue Code (for example,
section 168(k), 1400L(b), or 1400N(d)))
is not a change in method of accounting. This paragraph (e)(2)(ii)(d)(3)(i) does
not apply if a taxpayer is changing to or
from a useful life (or recovery period or
amortization period) that is specifically
assigned by the Internal Revenue Code
(for example, section 167(f)(1), section
168(c), section 168(g)(2) or (3), section
197), the regulations under the Internal
Revenue Code, or other guidance published in the Internal Revenue Bulletin
and, therefore, such change is a change in
method of accounting (unless paragraph
(e)(2)(ii)(d)(3)(v) of this section applies).
See paragraph (e)(2)(ii)(d)(5)(iv) of this
section for determining the taxable year
in which to correct an adjustment in useful life that is not a change in method of
accounting.
(ii) Change in use. A change in computing depreciation or amortization allowances in the taxable year in which the
use of an asset changes in the hands of the
same taxpayer is not a change in method
of accounting.
(iii) Elections. Generally, the making
of a late depreciation or amortization election or the revocation of a timely valid
depreciation or amortization election is
not a change in method of accounting,
except as otherwise expressly provided
by the Internal Revenue Code, the regulations under the Internal Revenue Code,
or other guidance published in the Internal Revenue Bulletin. This paragraph
(e)(2)(ii)(d)(3)(iii) also applies to making
a late election or revoking a timely valid
election made under section 13261(g)(2)
or (3) of the Revenue Reconciliation Act
of 1993 (107 Stat. 312, 540) (relating to
amortizable section 197 intangibles). A
taxpayer may request consent to make a
late election or revoke a timely valid election by submitting a request for a private
letter ruling. For making or revoking an

February 12, 2007

election under section 179 of the Internal
Revenue Code, see section 179(c) and
§1.179–5.
(iv) Salvage value. Except as provided
under paragraph (e)(2)(ii)(d)(2)(v) of this
section, a change in salvage value of a depreciable or amortizable asset is not treated
as a change in method of accounting.
(v) Placed-in-service date. Except as
otherwise expressly provided by the Internal Revenue Code, the regulations under the Internal Revenue Code, or other
guidance published in the Internal Revenue Bulletin, any change in the placedin-service date of a depreciable or amortizable asset is not treated as a change in
method of accounting. For example, if
a taxpayer changes the placed-in-service
date of a depreciable or amortizable asset because the taxpayer incorrectly determined the date on which the asset was
placed in service, such a change is a change
in the placed-in-service date of the asset
and, therefore, is not a change in method
of accounting. However, if a taxpayer incorrectly determines that a depreciable or
amortizable asset is nondepreciable property and later changes the treatment of
the asset to depreciable property, such a
change is not a change in the placed-inservice date of the asset and, therefore,
is a change in method of accounting under paragraph (e)(2)(ii)(d)(2) of this section. Further, a change in the convention of a depreciable or amortizable asset is not a change in the placed-in-service
date of the asset and, therefore, is a change
in method of accounting under paragraph
(e)(2)(ii)(d)(2)(i) of this section. See paragraph (e)(2)(ii)(d)(5)(v) of this section for
determining the taxable year in which to
make a change in the placed-in-service
date of a depreciable or amortizable asset
that is not a change in method of accounting.
(vi) Any other change in depreciation or
amortization as the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see
§601.601(d)(2) of this chapter).
(4) Item being changed. For purposes
of a change in depreciation or amortization
to which this paragraph (e)(2)(ii)(d) applies, the item being changed generally is
the depreciation treatment of each individual depreciable or amortizable asset. However, the item is the depreciation treatment
of each vintage account with respect to a

475

depreciable asset for which depreciation
is determined under §1.167(a)–11 (class
life asset depreciation range (CLADR)
property). Similarly, the item is the depreciable treatment of each general asset
account with respect to a depreciable asset
for which general asset account treatment
has been elected under section 168(i)(4)
or the item is the depreciation treatment
of each mass asset account with respect to
a depreciable asset for which mass asset
account treatment has been elected under former section 168(d)(2)(A). Further,
a change in computing depreciation or
amortization under section 167 (other than
under section 168, section 1400I, section
1400L(c), former section 168, or an additional first year depreciation deduction
provision of the Internal Revenue Code
(for example, section 168(k), 1400L(b), or
1400N(d))) is permitted only with respect
to all assets in a particular account (as defined in §1.167(a)–7) or vintage account.
(5) Special rules. For purposes of a
change in depreciation or amortization
to which this paragraph (e)(2)(ii)(d) applies—
(i) Declining balance method to the
straight line method for MACRS property.
For tangible, depreciable property subject
to section 168 (MACRS property) that
is depreciated using the 200-percent or
150-percent declining balance method of
depreciation under section 168(b)(1) or
(2), a taxpayer may change without the
consent of the Commissioner from the
declining balance method of depreciation
to the straight line method of depreciation
in the first taxable year in which the use of
the straight line method with respect to the
adjusted depreciable basis of the MACRS
property as of the beginning of that year
will yield a depreciation allowance that
is greater than the depreciation allowance
yielded by the use of the declining balance
method. When the change is made, the
adjusted depreciable basis of the MACRS
property as of the beginning of the taxable
year is recovered through annual depreciation allowances over the remaining
recovery period (for further guidance, see
section 6.06 of Rev. Proc. 87–57, 1987–2
C.B. 687, and §601.601(d)(2)(ii)(b) of this
chapter).
(ii) Depreciation method changes for
section 167 property. For a depreciable or
amortizable asset for which depreciation is
determined under section 167 (other than

2007–7 I.R.B.

under section 168, section 1400I, section
1400L(c), former section 168, or an additional first year depreciation deduction
provision of the Internal Revenue Code
(for example, section 168(k), 1400L(b),
or 1400N(d))), see §1.167(e)–1(b), (c),
and (d) for the changes in depreciation method that are permitted to be
made without the consent of the Commissioner. For CLADR property, see
§1.167(a)–11(c)(1)(iii) for the changes in
depreciation method for CLADR property
that are permitted to be made without the
consent of the Commissioner. Further,
see §1.167(a)–11(b)(4)(iii)(c) for how to
correct an incorrect classification or characterization of CLADR property.
(iii) Section 481 adjustment. Except as
otherwise expressly provided by the Internal Revenue Code, the regulations under the Internal Revenue Code, or other
guidance published in the Internal Revenue Bulletin, no section 481 adjustment
is required or permitted for a change from
one permissible method of computing depreciation or amortization to another permissible method of computing depreciation or amortization for an asset because
this change is implemented by either a
cut-off method (for further guidance, for
example, see section 2.06 of Rev. Proc.
97–27, 1997–1 C.B. 680, section 2.06 of
Rev. Proc. 2002–9, 2002–1 C.B. 327, and
§601.601(d)(2)(ii)(b) of this chapter) or a
modified cut-off method (under which the
adjusted depreciable basis of the asset as of
the beginning of the year of change is recovered using the new permissible method
of accounting), as appropriate. However,
a change from an impermissible method of
computing depreciation or amortization to
a permissible method of computing depreciation or amortization for an asset results
in a section 481 adjustment. Similarly, a
change in the treatment of an asset from
nondepreciable or nonamortizable to depreciable or amortizable (or vice versa) or
a change in the treatment of an asset from
expensing to depreciating (or vice versa)
results in a section 481 adjustment.
(iv) Change in useful life. This paragraph (e)(2)(ii)(d)(5)(iv) applies to an
adjustment in the useful life of a depreciable or amortizable asset for which
depreciation is determined under section
167 (other than under section 168, section
1400I, section 1400L(c), former section
168, or an additional first year depreciation

2007–7 I.R.B.

deduction provision of the Internal Revenue Code (for example, section 168(k),
1400L(b), or 1400N(d))) and that is not
a change in method of accounting under
paragraph (e)(2)(ii)(d) of this section. For
this adjustment in useful life, no section
481 adjustment is required or permitted.
The adjustment in useful life, whether
initiated by the Internal Revenue Service
(IRS) or a taxpayer, is corrected by adjustments in the taxable year in which the
conditions known to exist at the end of
that taxable year changed thereby resulting in a redetermination of the useful life
under §1.167(a)–1(b) (or if the period of
limitation for assessment under section
6501(a) has expired for that taxable year,
in the first succeeding taxable year open
under the period of limitation for assessment), and in subsequent taxable years.
In other situations (for example, the useful life is incorrectly determined in the
placed-in-service year), the adjustment in
the useful life, whether initiated by the
IRS or a taxpayer, may be corrected by
adjustments in the earliest taxable year
open under the period of limitation for
assessment under section 6501(a) or the
earliest taxable year under examination by
the IRS but in no event earlier than the
placed-in-service year of the asset, and in
subsequent taxable years. However, if a
taxpayer initiates the correction in useful
life, in lieu of filing amended Federal tax
returns (for example, because the conditions known to exist at the end of a prior
taxable year changed thereby resulting in
a redetermination of the useful life under §1.167(a)–1(b)), the taxpayer may
correct the adjustment in useful life by
adjustments in the current and subsequent
taxable years.
(v) Change in placed-in-service date.
This paragraph (e)(2)(ii)(d)(5)(v) applies
to a change in the placed-in-service date
of a depreciable or amortizable asset that
is not a change in method of accounting
under paragraph (e)(2)(ii)(d) of this section. For this change in placed-in-service
date, no section 481 adjustment is required
or permitted. The change in placed-in-service date, whether initiated by the IRS or
a taxpayer, may be corrected by adjustments in the earliest taxable year open under the period of limitation for assessment
under section 6501(a) or the earliest taxable year under examination by the IRS but
in no event earlier than the placed-in-ser-

476

vice year of the asset, and in subsequent
taxable years. However, if a taxpayer initiates the change in placed-in-service date,
in lieu of filing amended Federal tax returns, the taxpayer may correct the placedin-service date by adjustments in the current and subsequent taxable years.
(iii) Examples. The rules of this paragraph (e) are illustrated by the following
examples:
Example 1. Although the sale of merchandise is
an income producing factor, and therefore inventories
are required, a taxpayer in the retail jewelry business
reports his income on the cash receipts and disbursements method of accounting. A change from the cash
receipts and disbursements method of accounting to
the accrual method of accounting is a change in the
overall plan of accounting and thus is a change in
method of accounting.
Example 2. A taxpayer in the wholesale dry
goods business computes its income and expenses on
the accrual method of accounting and files its Federal income tax returns on such basis except for real
estate taxes which have been reported on the cash
receipts and disbursements method of accounting.
A change in the treatment of real estate taxes from
the cash receipts and disbursements method to the
accrual method is a change in method of accounting
because such change is a change in the treatment of a
material item within his overall accounting practice.
Example 3. A taxpayer in the wholesale dry
goods business computes its income and expenses on
the accrual method of accounting and files its Federal
income tax returns on such basis. Vacation pay has
been deducted in the year in which paid because the
taxpayer did not have a completely vested vacation
pay plan, and, therefore, the liability for payment did
not accrue until that year. Subsequently, the taxpayer
adopts a completely vested vacation pay plan that
changes its year for accruing the deduction from the
year in which payment is made to the year in which
the liability to make the payment now arises. The
change for the year of deduction of the vacation pay
plan is not a change in method of accounting but
results, instead, because the underlying facts (that is,
the type of vacation pay plan) have changed.
Example 4. From 1968 through 1970, a taxpayer
has fairly allocated indirect overhead costs to the
value of inventories on a fixed percentage of direct
costs. If the ratio of indirect overhead costs to direct
costs increases in 1971, a change in the underlying
facts has occurred. Accordingly, an increase in the
percentage in 1971 to fairly reflect the increase in
the relative level of indirect overhead costs is not a
change in method of accounting but is a change in
treatment resulting from a change in the underlying
facts.
Example 5. A taxpayer values inventories at cost.
A change in the basis for valuation of inventories
from cost to the lower of cost or market is a change in
an overall practice of valuing items in inventory. The
change, therefore, is a change in method of accounting for inventories.
Example 6. A taxpayer in the manufacturing business has for many taxable years valued its inventories
at cost. However, cost has been improperly computed
since no overhead costs have been included in valu-

February 12, 2007

ing the inventories at cost. The failure to allocate an
appropriate portion of overhead to the value of inventories is contrary to the requirement of the Internal
Revenue Code and the regulations under the Internal
Revenue Code. A change requiring appropriate allocation of overhead is a change in method of accounting because it involves a change in the treatment of a
material item used in the overall practice of identifying or valuing items in inventory.
Example 7. A taxpayer has for many taxable
years valued certain inventories by a method which
provides for deducting 20 percent of the cost of the inventory items in determining the final inventory valuation. The 20 percent adjustment is taken as a “reserve for price changes.” Although this method is not
a proper method of valuing inventories under the Internal Revenue Code or the regulations under the Internal Revenue Code, it involves the treatment of a
material item used in the overall practice of valuing
inventory. A change in such practice or procedure is
a change of method of accounting for inventories.
Example 8. A taxpayer has always used a base
stock system of accounting for inventories. Under
this system a constant price is applied to an assumed
constant normal quantity of goods in stock. The base
stock system is an overall plan of accounting for inventories which is not recognized as a proper method
of accounting for inventories under the regulations.
A change in this practice is, nevertheless, a change of
method of accounting for inventories.
Example 9. In 2003, A1, a calendar year taxpayer
engaged in the trade or business of manufacturing knitted goods, purchased and placed in service
a building and its components at a total cost of
$10,000,000 for use in its manufacturing operations.
A1 classified the $10,000,000 as nonresidential real
property under section 168(e). A1 elected not to
deduct the additional first year depreciation provided
by section 168(k) on its 2003 Federal tax return. As
a result, on its 2003, 2004, and 2005 Federal tax
returns, A1 depreciated the $10,000,000 under the
general depreciation system of section 168(a), using
the straight line method of depreciation, a 39-year
recovery period, and the mid-month convention.
In 2006, A1 completes a cost segregation study
on the building and its components and identifies
items that cost a total of $1,500,000 as section 1245
property. As a result, the $1,500,000 should have
been classified in 2003 as 5-year property under
section 168(e) and depreciated on A1’s 2003, 2004,
and 2005 Federal tax returns under the general depreciation system, using the 200-percent declining
balance method of depreciation, a 5-year recovery
period, and the half-year convention. Pursuant to
paragraph (e)(2)(ii)(d)(2)(i) of this section, A1’s
change to this depreciation method, recovery period,
and convention is a change in method of accounting. This method change results in a section 481
adjustment. The useful life exception under paragraph (e)(2)(ii)(d)(3)(i) of this section does not apply
because the assets are depreciated under section 168.
Example 10. In 2003, B, a calendar year taxpayer, purchased and placed in service new equipment at a total cost of $1,000,000 for use in its plant
located outside the United States. The equipment is
15-year property under section 168(e) with a class life
of 20 years. The equipment is required to be depreciated under the alternative depreciation system of
section 168(g). However, B incorrectly depreciated

February 12, 2007

the equipment under the general depreciation system
of section 168(a), using the 150-percent declining
balance method, a 15-year recovery period, and the
half-year convention. In 2010, the IRS examines B’s
2007 Federal income tax return and changes the depreciation of the equipment to the alternative depreciation system, using the straight line method of depreciation, a 20-year recovery period, and the half-year
convention. Pursuant to paragraph (e)(2)(ii)(d)(2)(i)
of this section, this change in depreciation method
and recovery period made by the IRS is a change in
method of accounting. This method change results
in a section 481 adjustment. The useful life exception under paragraph (e)(2)(ii)(d)(3)(i) of this section
does not apply because the assets are depreciated under section 168.
Example 11. In May 2003, C, a calendar year taxpayer, purchased and placed in service equipment for
use in its trade or business. C never held this equipment for sale. However, C incorrectly treated the
equipment as inventory on its 2003 and 2004 Federal
tax returns. In 2005, C realizes that the equipment
should have been treated as a depreciable asset. Pursuant to paragraph (e)(2)(ii)(d)(2) of this section, C’s
change in the treatment of the equipment from inventory to a depreciable asset is a change in method of
accounting. This method change results in a section
481 adjustment.
Example 12. Since 2003, D, a calendar year
taxpayer, has used the distribution fee period method
to amortize distributor commissions and, under
that method, established pools to account for the
distributor commissions (for further guidance,
see Rev. Proc. 2000–38, 2000–2 C.B. 310, and
§601.601(d)(2)(ii)(b) of this chapter). A change in
the accounting of distributor commissions under
the distribution fee period method from pooling to
single asset accounting is a change in method of
accounting pursuant to paragraph (e)(2)(ii)(d)(2)(vi)
of this section. This method change results in no section 481 adjustment because the change is from one
permissible method to another permissible method.
Example 13. Since 2003, E, a calendar year taxpayer, has accounted for items of MACRS property
that are mass assets in pools. Each pool includes only
the mass assets that are placed in service by E in the
same taxable year. E is able to identify the cost basis of each asset in each pool. None of the pools are
general asset accounts under section 168(i)(4) and the
regulations under section 168(i)(4). E identified any
dispositions of these mass assets by specific identification. Because of changes in E’s recordkeeping
in 2006, it is impracticable for E to continue to identify disposed mass assets using specific identification.
As a result, E wants to change to a first-in, first-out
method under which the mass assets disposed of in
a taxable year are deemed to be from the pool with
the earliest placed-in-service year in existence as of
the beginning of the taxable year of each disposition.
Pursuant to paragraph (e)(2)(ii)(d)(2)(vii) of this section, this change is a change in method of accounting. This method change results in no section 481
adjustment because the change is from one permissible method to another permissible method.
Example 14. In August 2003, F, a calendar year
taxpayer, purchased and placed in service a copier for
use in its trade or business. F incorrectly classified
the copier as 7-year property under section 168(e). F
elected not to deduct the additional first year depreci-

477

ation provided by section 168(k) on its 2003 Federal
tax return. As a result, on its 2003 and 2004 Federal tax returns, F depreciated the copier under the
general depreciation system of section 168(a), using
the 200-percent declining balance method of depreciation, a 7-year recovery period, and the half-year
convention. In 2005, F realizes that the copier is
5-year property and should have been depreciated
on its 2003 and 2004 Federal tax returns under the
general depreciation system using a 5-year recovery
period rather than a 7-year recovery period. Pursuant to paragraph (e)(2)(ii)(d)(2)(i) of this section,
F’s change in recovery period from 7 to 5 years is a
change in method of accounting. This method change
results in a section 481 adjustment. The useful life exception under paragraph (e)(2)(ii)(d)(3)(i) of this section does not apply because the copier is depreciated
under section 168.
Example 15. In 2004, G, a calendar year taxpayer,
purchased and placed in service an intangible asset
that is not an amortizable section 197 intangible and
that is not described in section 167(f). G amortized
the cost of the intangible asset under section 167(a)
using the straight line method of depreciation and a
determinable useful life of 13 years. The safe harbor useful life of 15 or 25 years under §1.167(a)–3(b)
does not apply to the intangible asset. In 2008, because of changing conditions, G changes the remaining useful life of the intangible asset to 2 years. Pursuant to paragraph (e)(2)(ii)(d)(3)(i) of this section,
G’s change in useful life is not a change in method
of accounting because the intangible asset is depreciated under section 167 and G is not changing to or
from a useful life that is specifically assigned by the
Internal Revenue Code, the regulations under the Internal Revenue Code, or other guidance published in
the Internal Revenue Bulletin.
Example 16. In July 2003, H, a calendar year taxpayer, purchased and placed in service “off-the-shelf”
computer software and a new computer. The cost of
the new computer and computer software are separately stated. H incorrectly included the cost of this
software as part of the cost of the computer, which
is 5-year property under section 168(e). On its 2003
Federal tax return, H elected to depreciate its 5-year
property placed in service in 2003 under the alternative depreciation system of section 168(g) and H
elected not to deduct the additional first year depreciation provided by section 168(k). The class life for
a computer is 5 years. As a result, because H included the cost of the computer software as part of
the cost of the computer hardware, H depreciated the
cost of the software under the alternative depreciation system, using the straight line method of depreciation, a 5-year recovery period, and the half-year
convention. In 2005, H realizes that the cost of the
software should have been amortized under section
167(f)(1), using the straight line method of depreciation, a 36-month useful life, and a monthly convention. H’s change from 5-years to 36-months is a
change in method of accounting because H is changing to a useful life that is specifically assigned by section 167(f)(1). The change in convention from the
half-year to the monthly convention also is a change
in method of accounting. Both changes result in a
section 481 adjustment.
Example 17. On May 1, 2003, I2, a calendar year
taxpayer, purchased and placed in service new equipment at a total cost of $500,000 for use in its busi-

2007–7 I.R.B.

ness. The equipment is 5-year property under section 168(e) with a class life of 9 years and is qualified property under section 168(k)(2). I2 did not
place in service any other depreciable property in
2003. Section 168(g)(1)(A) through (D) do not apply to the equipment. I2 intended to elect the alternative depreciation system under section 168(g) for
5-year property placed in service in 2003. However,
I2 did not make the election. Instead, I2 deducted on
its 2003 Federal tax return the 30-percent additional
first year depreciation attributable to the equipment
and, on its 2003 and 2004 Federal tax returns, depreciated the remaining adjusted depreciable basis of the
equipment under the general depreciation system under 168(a), using the 200-percent declining balance
method, a 5-year recovery period, and the half-year
convention. In 2005, I2 realizes its failure to make
the alternative depreciation system election in 2003
and files a Form 3115, “Application for Change in Accounting Method,” to change its method of depreciating the remaining adjusted depreciable basis of the
2003 equipment to the alternative depreciation system. Because this equipment is not required to be depreciated under the alternative depreciation system,
I2 is attempting to make an election under section
168(g)(7). However, this election must be made in
the taxable year in which the equipment is placed in
service (2003) and, consequently, I2 is attempting to
make a late election under section 168(g)(7). Accordingly, I2’s change to the alternative depreciation system is not a change in accounting method pursuant to
paragraph (e)(2)(ii)(d)(3)(iii) of this section. Instead,
I2 must submit a request for a private letter ruling under §301.9100–3 of this chapter, requesting an extension of time to make the alternative depreciation system election on its 2003 Federal tax return.
Example 18. On December 1, 2004, J, a calendar year taxpayer, purchased and placed in service
20 previously-owned adding machines. For the 2004
taxable year, J incorrectly classified the adding machines as items in its “suspense” account for financial
and tax accounting purposes. Assets in this suspense
account are not depreciated until reclassified to a depreciable fixed asset account. In January 2006, J realizes that the cost of the adding machines is still in the
suspense account and reclassifies such cost to the appropriate depreciable fixed asset account. As a result,
on its 2004 and 2005 Federal tax returns, J did not depreciate the cost of the adding machines. Pursuant to
paragraph (e)(2)(ii)(d)(2) of this section, J’s change
in the treatment of the adding machines from nondepreciable assets to depreciable assets is a change
in method of accounting. The placed-in-service date
exception under paragraph (e)(2)(ii)(d)(3)(v) of this
section does not apply because the adding machines
were incorrectly classified in a nondepreciable suspense account. This method change results in a section 481 adjustment.
Example 19. In December 2003, K, a calendar
year taxpayer, purchased and placed in service equipment for use in its trade or business. However, K
did not receive the invoice for this equipment until
January 2004. As a result, K classified the equipment on its fixed asset records as being placed in service in January 2004. On its 2004 and 2005 Federal

2007–7 I.R.B.

tax returns, K depreciated the cost of the equipment.
In 2006, K realizes that the equipment was actually
placed in service during the 2003 taxable year and,
therefore, depreciation should have began in the 2003
taxable year instead of the 2004 taxable year. Pursuant to paragraph (e)(2)(ii)(d)(3)(v) of this section,
K’s change in the placed-in-service date of the equipment is not a change in method of accounting.

*****
(4) Effective date—(i) In general. Except as provided in paragraphs (e)(3)(iii)
and (e)(4)(ii) of this section, paragraph (e)
of this section applies on or after December 30, 2003. For the applicability of regulations before December 30, 2003, see
§1.446–1(e) in effect prior to December
30, 2003 (§1.446–1(e) as contained in 26
CFR part 1 edition revised as of April 1,
2003).
(ii) Changes involving depreciable
or amortizable assets. With respect to
paragraph (e)(2)(ii)(d) of this section,
paragraph (e)(2)(iii) Examples 9 through
19 of this section, and the language “certain changes in computing depreciation or
amortization (see paragraph (e)(2)(ii)(d)
of this section)” in the last sentence of
paragraph (e)(2)(ii)(a) of this section—
(A) For any change in depreciation or
amortization that is a change in method of
accounting, this section applies to such a
change in method of accounting made by
a taxpayer for a depreciable or amortizable
asset placed in service by the taxpayer in a
taxable year ending on or after December
30, 2003; and
(B) For any change in depreciation or
amortization that is not a change in method
of accounting, this section applies to such a
change made by a taxpayer for a depreciable or amortizable asset placed in service
by the taxpayer in a taxable year ending on
or after December 30, 2003.
§1.446–1T [Removed]
Par. 7. Section 1.446–1T is removed.
Par. 8. Section 1.1016–3 is amended
by revising paragraphs (h) and (j) to read
as follows:
§1.1016–3 Exhaustion, wear and tear,
obsolescence, amortization, and depletion
for periods since February 28, 1913.

(h) Application to a change in method of
accounting. For purposes of determining
whether a change in depreciation or amortization for property subject to section 167,
168, 197, 1400I, 1400L(c), to section 168
prior to its amendment by the Tax Reform
Act of 1986 (100 Stat. 2121) (former section 168), or to an additional first year depreciation deduction provision of the Internal Revenue Code (for example, section 168(k), 1400L(b), or 1400N(d)) is a
change in method of accounting under section 446(e) and the regulations under section 446(e), section 1016(a)(2) does not
permanently affect a taxpayer’s lifetime
income.
*****
(j) Effective date—(1) In general. Except as provided in paragraph (j)(2) of this
section, this section applies on or after December 30, 2003. For the applicability of
regulations before December 30, 2003, see
§1.1016–3 in effect prior to December 30,
2003 (§1.1016–3 as contained in 26 CFR
part 1 edition revised as of April 1, 2003).
(2) Depreciation or amortization
changes. Paragraph (h) of this section
applies to a change in depreciation or
amortization for property subject to section 167, 168, 197, 1400I, 1400L(c), to
former section 168, or to an additional first
year depreciation deduction provision of
the Internal Revenue Code (for example,
section 168(k), 1400L(b), or 1400N(d))
for taxable years ending on or after December 30, 2003.
§1.1016–3T [Removed]
Par. 9. Section 1.1016–3T is removed.
Kevin M. Brown,
Deputy Commissioner for
Services and Enforcement.
Approved December 21, 2006.
Eric Solomon,
Assistant Secretary
of the Treasury (Tax Policy).
(Filed by the Office of the Federal Register on December 22,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 28, 2006, 71 F.R. 78066)

*****

478

February 12, 2007

Section 863.—Special
Rules for Determining
Source

SUPPLEMENTARY INFORMATION:

26 CFR 1.863–8: Source of income derived from
space and ocean activity under section 863(d).

The collections of information contained in these final regulations have been
reviewed and approved by the Office of
Management and Budget (OMB) in accordance with the Paperwork Reduction Act
of 1995 (44 U.S.C. 3507(d)) under control
number 1545–1718.
The collections of information in these
final regulations are in §§1.863–8(g) and
1.863–9(k). This information is required
by the IRS to monitor compliance with
the Federal tax rules for determining the
source of income from space or ocean activities, or from transmission of communications.
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 assigned by the Office of
Management and Budget.
The estimated annual burden per respondent is 5 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,
SE:W:CAR:MP:T:T:SP, 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 a collection
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.

T.D. 9305
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Source of Income From
Certain Space and Ocean
Activities; Source of
Communications Income
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final regulations under section 863(d) governing the source of income from certain
space and ocean activities. It also contains
final regulations under section 863(a), (d),
and (e) governing the source of income
from certain communications activities.
In addition, this document contains final
regulations under section 863(a) and (b),
amending the regulations in §1.863–3 to
conform those regulations to these final
regulations. The final regulations primarily affect persons who derive income from
activities conducted in space, or on or under water not within the jurisdiction of a
foreign country, possession of the United
States, or the United States (in international water). The final regulations also
affect persons who derive income from
transmission of communications.
DATES: Effective Date: These regulations
are effective December 27, 2006.
Applicability Date: For dates of applicability, see §1.863–8(h) and §1.863–9(l).
FOR
FURTHER
INFORMATION
CONTACT: H. Michael Huynh, (202)
435–5161 (not a toll-free number).

February 12, 2007

Paperwork Reduction Act

Background
Congress enacted section 863(d) and (e)
as part of the Tax Reform Act of 1986,
Pub. L. No. 99–514, 100 Stat. 2085.
Section 863(d) governs the source of income derived from space or ocean activities. Section 863(e) governs the source
of income derived from international communications activities.
The Treasury Department and the IRS
published a notice of proposed rulemaking
(REG–106030–98, 2001–1 C.B. 820) in

479

the Federal Register on January 17, 2001
(66 FR 3903), which provided proposed
regulations under section 863(a), (b), (d),
and (e) (the 2001 proposed regulations).
The Treasury Department and the IRS received numerous written comments on the
2001 proposed regulations and held a public hearing on May 23, 2001. Since that
time, the aerospace, telecommunications,
and related industries have experienced
substantial technological evolution and
significant business change and consolidation. In addition, the American Jobs
Creation Act of 2004 (AJCA), Pub. L.
No. 108–357, 118 Stat. 1418, enacted a
number of materially relevant statutory
changes that affect the treatment of space
and ocean income for purposes of the foreign tax credit and subpart F rules.
In light of the extensive written comments, industry evolution, and AJCA
changes, the Treasury Department and
the IRS felt that it was appropriate to
repropose these regulations to reflect
these changes and to provide another opportunity for comment. Consequently,
the Treasury Department and the IRS
published another notice of proposed
rulemaking in the Federal Register on
September 19, 2005 (REG–106030–98,
2005–2 C.B. 739 [70 FR 54859]), which
withdrew the 2001 proposed regulations
and provided new proposed regulations
under section 863(a), (b), (d), and (e) (the
proposed regulations). The proposed regulations provided two sets of rules: one
in §1.863–8 for determining the source
of income from space or ocean activities,
the other in §1.863–9 for determining the
source of income from communications
activities.
A public hearing on the proposed regulations was scheduled for December
15, 2005, but was ultimately cancelled
because no one requested to speak. A
few written comments, however, were
received. These comments uniformly
praised the proposed regulations as an
improvement over the 2001 proposed
regulations and generally were supportive of much of the proposed regulations.
However, commentators suggested a few
additional changes. After consideration
of these comments, the proposed regulations are adopted as final regulations,
as amended by this Treasury decision.
The revisions to regulations governing
the source of income from space or ocean

2007–7 I.R.B.

activities and the source of income from
communications activities are discussed
in section A and section B, respectively,
of this preamble.
Summary of Comments and
Explanation of Revisions
A. Space or Ocean Activity under Section
863(d)
Section 863(d) governs the source of income from certain space or ocean activities. In general, section 863(d)(1) provides that, except as provided in regulations, any income derived from a space or
ocean activity (space and ocean income)
is income from sources within the United
States (U.S. source income) if derived by
a United States person and is income from
sources without the United States (foreign
source income) if derived by a foreign person. Section 863(d)(2)(A)(i) defines space
activity to include any activity conducted
in space. Section 863(d)(2)(A)(ii) defines
ocean activity to include any activity conducted on or under water not within the
jurisdiction (as recognized by the United
States) of a foreign country, possession of
the United States, or the United States.
Section 863(d)(2)(B) excludes three types
of activities from the definition of space
or ocean activity. Space or ocean activity does not include any activity giving rise
to transportation income governed by section 863(c), international communications
income governed by section 863(e), or income with respect to mines, oil and gas
wells, or other natural deposits to the extent within the United States or any foreign
country or possession of the United States
(as defined in section 638). See Section
863(d)(2)(B).
Section 1.863–8 of the proposed regulations generally provided rules for determining the source of income derived
from space or ocean activity under section 863(d). Section 1.863–8(b)(1) of the
proposed regulations reflected the general
source rule under section 863(d)(1) that a
United States person’s space and ocean income is U.S. source income. Pursuant to
the grant of regulatory authority under section 863(d)(1), however, the proposed regulations provided an exception to this general rule. Under that exception, a United
States person’s space and ocean income is
foreign source income (and therefore not

2007–7 I.R.B.

sourced on the basis of citizenship or residency) to the extent the income, based on
all the facts and circumstances, is attributable to functions performed, resources employed, or risks assumed in a foreign country or countries.
For a foreign person, proposed
§1.863–8(b)(2) reflected the general
source rule under section 863(d)(1) that a
foreign person’s space and ocean income
is foreign source income. Pursuant to regulatory authority under section 863(d)(1),
however, the proposed regulations contained two exceptions to this general rule,
one for controlled foreign corporations
(CFCs), the other for foreign persons engaged in a U.S. trade or business. The
proposed regulations generally sourced
space and ocean income derived by a
CFC, like that of a United States person,
as U.S. source income. However, also
like the rule for a United States person, a
CFC’s space and ocean income is foreign
source income to the extent the income,
based on all the facts and circumstances,
is attributable to functions performed, resources employed, or risks assumed in a
foreign country or countries. For a foreign
person, other than a CFC, engaged in a
trade or business within the United States,
space and ocean income is U.S. source
income to the extent it is attributable to
functions performed, resources employed,
or risks assumed within the United States.
In addition to the general source rules
for United States and foreign persons,
the proposed regulations provided special
rules, applicable to both United States and
foreign persons, for income from services,
certain sales of property, and communications activities (other than international
communications activities). These special
rules, as well as modifications to the proposed regulations, are discussed below.
1. Activities performed outside space and
international water
Section 1.863–8 of the proposed regulations provided source rules only for
income from space or ocean activity.
Thus, in some cases, income derived from
a transaction must be allocated between
space and ocean income and other income.
For example, §1.863–8(b)(3)(ii)(C) of
the proposed regulations provided that
when property is produced both in space
or international water and outside space

480

and international water, gross income
allocable to production activity is allocated to production occurring in space or
international water and production occurring outside space and international water
based on where functions are performed,
resources are employed, or risks are assumed. The proposed regulations also
provided a similar analysis of functions
performed, resources employed, or risks
assumed to allocate income in the case of
performance of services. See Prop. Treas.
Reg. §1.863–8(d)(2). Under the proposed
regulations, only the amount allocated to
production or performance of a service
occurring in space or international water is
treated as space and ocean income (character rule). The source of gross income
allocated to production or performance of
a service occurring in space or international water is then determined under the
rules of proposed §1.863–8(b)(1) or (2),
as applicable (source rule).
Section 1.863–8(b)(1) of the proposed
regulations reflected the general source
rule that a United States person’s space
and ocean income is U.S. source income.
Proposed §1.863–8(b)(2) reflected the
general source rule that a foreign person’s
space and ocean income is foreign source
income. Both proposed §1.863–8(b)(1)
and (2), however, provided exceptions to
their respective general source rules. As
discussed above, under the exceptions, a
United States person’s space and ocean
income may be foreign source income
and a foreign person’s space and ocean income may be U.S. source income based on
where functions are performed, resources
are employed, or risks are assumed.
One commentator noted that in some
situations, the allocation of income derived from a transaction to determine space
and ocean income based on functions performed, resources employed, or risks assumed presumably would remove the subsequent need to further analyze functions
performed, resources employed, or risks
assumed within a country to determine the
source of the space and ocean income. In
other words, the very act of determining
the character of income seems to also determine the source of such income.
The Treasury Department and the IRS
agree with the commentator that use of the
same standard to classify the transaction
as space or ocean activity and to source
the space and ocean income may be du-

February 12, 2007

plicative in some cases. However, there
are other cases where a transaction with
some land-based activity may be classified
in its entirety as a space or ocean activity
(for example, a lease of a satellite), but the
income may be partially U.S. source and
partially foreign source under the source
rules of proposed §1.863–8(b)(1) and (2)
based on functions performed, resources
employed, or risks assumed within the
United States or a foreign country. Consequently, the character and source rules are
not always duplicative.
Thus, the extent to which the character
rules overlap with the source rules is particular to the type of transaction involved.
The Treasury Department and the IRS recognize that the overlap in the character and
source rules may produce equivalent results. But, the overlap is necessary to provide taxpayers and the IRS with workable
rules. As a result, the final regulations do
not follow this comment as a general matter.
Nonetheless, a conforming amendment
has been made to the lease transaction in
Example 1 in §1.863–8(f) of the final regulations to more clearly illustrate how the
rules work. That example illustrates that
the transaction involved is first classified
in its entirety as a space or ocean activity,
and then the resulting space and ocean income is subjected to the source rules. The
space and ocean income is sourced as foreign source income to the extent the income, based on all the facts and circumstances, is attributable to functions performed, resources employed, or risks assumed in a foreign country or countries.
2. Activities performed by another person
Section 1.863–8(a) of the proposed regulations provided that a taxpayer will not
be considered to derive income from space
or ocean activity if such activity is performed by another person. The approach
under §1.863–8(a) of the proposed regulations, providing that a taxpayer derives income from a space or ocean activity only
if it conducts such activity directly, is consistent with the approach adopted in the
§1.863–3 regulations governing the source
of income from certain sales of inventory.
See, e.g., Treas. Reg. §1.863–3(c) (“[T]he
only production activities that are taken
into account for purposes of §§1.863–1,

February 12, 2007

1.863–2, and this section are those conducted directly by the taxpayer.”).
Accordingly, commentators believed
that this provision assured that a content
provider that retains a satellite operator
to transmit programming abroad would
not derive space and ocean income based
on attribution of the satellite operator’s
activity. The Treasury Department and the
IRS agree.
One commentator noted, however, that
Examples 2 and 4 in §1.863–8(f) of the
proposed regulations seem to indicate that
this is not what was intended. In Example 2, the taxpayer, an Internet service
provider, transmits information requested
by its customer, in part using satellite capacity leased from a third party. Example
2 concludes that the service performed by
the taxpayer is considered space activity to
the extent the value of the service is attributable to functions performed, resources
employed, and risks assumed in space. In
Example 4, the taxpayer uses satellite capacity acquired from a third party to deliver programming services directly to its
customers’ televisions sets. Example 4
concludes that the taxpayer’s delivery of
programming and other services is considered space activity to the extent the value
of the delivery transaction is attributable to
performance in space. In the commentator’s view, the results reached in the examples conflict with the provision stating that
activities performed by another person are
not attributable to the taxpayer.
The Treasury Department and the IRS
do not believe that Examples 2 and 4 of
§1.863–8(f) of the proposed regulations
produce the result that the commentator
raised. In Examples 2 and 4, the taxpayer
performed the transmission or delivery activities using satellite capacity leased or
acquired from a third party. Both Examples 2 and 4 correctly conclude that the
taxpayers derived space and ocean income
from their own activities rather than from
activities of another person. Thus, the examples do not, in fact, conflict with the
text of the proposed regulations. Nevertheless, the Treasury Department and the
IRS are concerned that Examples 2 and
4 have been misinterpreted as suggesting
that activities performed by another person
may be attributable to the taxpayer in certain situations. This was not the intent of
these examples. Consequently, Examples
2 and 4 in §1.863–8(f) of the final regu-

481

lations have been modified to make clear
that the taxpayers in the examples directly
engage in a space activity by performing
the uplink (transmitting to the satellite) and
downlink functions.
These examples differ from cases in
which the taxpayer is a mere content
provider that derives income either from
the creation of content or from the creation and delivery of content, but in either
case contracts with another person to deliver the content via satellite. Pursuant
to §1.863–8(a) of the final regulations,
content providers of this type would not
derive space and ocean income because
the delivery of the content via satellite is
performed by another person. This would
be the result even though the value of the
customer contract includes a payment to
the content provider for space or ocean
activity. To clarify the distinction between
these situations and Examples 2 and 4,
a new Example 5 has been added to the
final regulations. That example involves a
content provider that does not derive space
and ocean income because the taxpayer
does not directly perform any space or
ocean activity.
3. Income characterization rules for
income from services and the de minimis
exception
Under §1.863–8(b)(4) of the proposed
regulations, to the extent a service is characterized as space or ocean activity, the
source of gross income derived from such
transaction is determined under proposed
§1.863–8(b)(1) or (2), as applicable. Section 1.863–8(d)(2)(ii)(B) of the proposed
regulations provided, however, that if the
taxpayer can demonstrate, based on all the
facts and circumstances, that the value of
the service attributable to performance in
space or international water is de minimis,
such service will not be treated as space
or ocean activity. The de minimis rule was
adopted to address taxpayers’ concerns
about potential confusion in qualifying for
the “facilitation exception” under the 2001
proposed regulations. One commentator
stated that the de minimis rule simply replaced one vague standard with another,
as neither Example 3 in §1.863–8(f) of
the proposed regulations nor the text of
the proposed regulations provides any
guidance as to when activities performed
in space or international water would be

2007–7 I.R.B.

de minimis under a facts and circumstances
approach.
The Treasury Department and the IRS
recognize that issues of interpretation may
arise in any facts and circumstances approach. Nevertheless, the Treasury Department and the IRS generally have refrained from adopting the alternative approach, to wit, adopting precise definitions and quantitative measures for a de
minimis standard. Moreover, the inclusion of a precise definition and quantitative measures for determining de minimis
value could raise equal, if not greater, concerns in terms of the quantitative threshold and other issues. Thus, the final regulations retain the de minimis standard for
determining whether a taxpayer has space
and ocean income. If the value of the service attributable to space or ocean activity
is de minimis based on the facts and circumstances, the taxpayer will not derive
space and ocean income. Nevertheless,
the Treasury Department and the IRS agree
that more guidance could be provided as
to the application of the retained de minimis rule. Accordingly, Examples 3 and 8
in §1.863–8(f) of the final regulations (Example 7 in the proposed regulations) provide clearer illustrations of when activities
performed in space or international water
would be considered de minimis for this
purpose and when those types of activities
would not be considered de minimis.
4. Source rules for income from certain
sales of property
The proposed regulations provided special rules for income from certain sales
of property, either when any production
occurs in space or international water, or
when the sale occurs in space or international water. In either case, section 863(d)
and the proposed regulations applied to
determine the source of income from the
sales of property, and the rules of sections
861(a)(6), 862(a)(6), 863(a), 863(b), and
865 apply only to the extent provided in
the proposed regulations.
a. Sales of Property Produced in the
United States and Sold in Space or
International Water
Section 1.863–8(b)(3)(ii) of the proposed regulations provided that when
the taxpayer both produces property and
sells such property, one-half of the tax-

2007–7 I.R.B.

payer’s gross income will be considered
income allocable to production activity
and one-half of such gross income will
be considered income allocable to sales
activity. Taxpayers generally must then
apply the rules of section 863(d) and the
proposed regulations to determine the
source of income allocable to production
activity and sales activity.
For production activity, the source of
gross income allocable to production occurring in space or international water
is generally based on the citizenship or
residence of the taxpayer, applying the
rules of proposed §1.863–8(b)(1) or (2),
as applicable. The source of gross income
allocable to production occurring outside
space and international water is determined under section 863(b) rather than
section 863(d). See Prop. Treas. Reg.
§1.863–8(b)(3)(ii)(B) (referencing Treas.
Reg. §1.863–3(c)(1)).
As for sales activity, when property is
sold in space or international water, the
source of gross income allocable to sales
activity is generally based on the citizenship or residence of the taxpayer, applying
the rules of proposed §1.863–8(b)(1) or
(2), as applicable. An exception to this
general rule applied in cases when the
property sold is inventory, within the
meaning of section 1221(a)(1), and is
sold in space or international water for
use, consumption, or disposition outside
space, international water, and the United
States. In that case, the source of gross
income allocable to sales activity is determined under Treas. Reg. §1.861–7(c) and
§1.863–3(c)(2). Treas. Reg. §1.861–7(c)
and §1.863–3(c)(2) generally provide for
foreign source income where the seller’s
rights, title, and interest in the property are
transferred to the buyer (the title passage
rule) outside the United States and the
property is not sold for use, consumption,
or disposition in the United States. Treas.
Reg. §1.861–7(c) and §1.863–3(c)(2) also
applied to property sold outside space and
international water. See Prop. Treas. Reg.
§1.863–8(b)(3)(ii)(D).
One commentator believed that because
certain U.S. manufacturers, such as U.S.
satellite manufacturers, produce property
that is sold in space or international water for use, consumption, or disposition
in space or international water, they are
at a disadvantage relative to U.S. manufacturers of other export property because

482

the former may have U.S. source income
with respect to income allocable to sales
activity, while the latter may have foreign
source income from sales activity.
In response to comments on the
2001 proposed regulations, proposed
§1.863–8(b)(1) was revised to provide
that space and ocean income will be foreign source income to the extent the space
and ocean income is attributable to functions performed, resources employed, or
risks assumed in a foreign country or
countries. The Treasury Department and
the IRS believe that this change may in
many cases mitigate concerns about U.S.
manufacturers potentially deriving 100
percent U.S. source income in these cases.
Moreover, the Treasury Department and
the IRS believe that the rules under the
proposed regulations for determining the
source of income allocable to sales activity
are consistent with legislative intent to assert primary tax jurisdiction over income
earned by United States persons that is not
subject to foreign tax. See S. REP. NO.
99–313, 1986–3 C.B. 357–358 (“[T]he
committee believes the United States
should assert primary tax jurisdiction over
income earned by its residents that is not
within any foreign country’s taxing jurisdiction….Moreover, when a U.S. taxpayer
conducts activities in space or international waters, foreign countries generally
do not tax the income. Thus, the foreign
tax credit limitation is inflated by income
that is not within any foreign country’s
tax jurisdiction.”). Based on the legislative history, the Treasury Department and
the IRS believe that sales of property in
space or international water — with the
exception of sales of inventory property
in space or international water for use,
consumption, or disposition outside space,
international water, and the United States
— should be considered space or ocean
activity and that the source of income
from such sales activity should be determined under section 863(d). As a result,
no changes were made in response to this
comment.
b. Purchased Versus Produced Property
Sold for Use, Consumption, or Disposition
in the United States
One commentator questioned the appropriateness of differences in determining the source of sales income depending

February 12, 2007

on whether the taxpayer produced or
purchased the property sold. Under the
proposed regulations, when property produced by the taxpayer is sold in space or
international water, the source of gross
income allocable to sales activity is generally based on the citizenship or residence
of the taxpayer, applying the rules of proposed §1.863–8(b)(1) or (2), as applicable
(and not the title passage rule) — subject
to the foregoing inventory exception for
property that will be used, consumed, or
disposed of outside space, international
water, and the United States. A slightly
different rule applied to sales of property
that had been purchased by the taxpayer.
While the proposed regulations also provided that, for purchased property, the
source of gross income allocable to sales
activity is generally based on the citizenship or residence of the taxpayer, the
inventory exception for purchased property only required that the property be
used, consumed, or disposed of outside
space and international water.
The inventory exceptions for produced
and purchased property were intended to
produce different results when inventory
property is used, consumed, or disposed
of in the United States. In such case,
the source of produced inventory property sales income is generally based on
the citizenship or residence of the taxpayer, applying the rules of proposed
§1.863–8(b)(1) or (2), because the inventory exception did not extend to produced
property sold for use, consumption, or disposition in the United States. In contrast,
the source of purchased inventory property sales income is generally based on title
passage under Treas. Reg. §1.861–7(c)
because the inventory exception did extend to purchased property even if it was
sold for use, consumption, or disposition
in the United States. The Treasury Department and the IRS believe that this
difference between the produced and purchased property rules in the space and
ocean context is consistent with the difference in the rules for sales of produced and
purchased property outside the space and
ocean context. In particular, under section
863(a) and (b) and the regulations thereunder, if property is produced in the United
States and sold for use, consumption, or
disposition in the United States, the place
of sale will be presumed to be the United
States, and income attributable to the sales

February 12, 2007

activity will be U.S. source income. See
§1.863–3(c)(2). There is, however, no
comparable rule for purchased property
under section 862(a)(6) or the regulations
thereunder. Thus, the final regulations
simply continue in the space and ocean
context the varying treatment elsewhere
for sales of purchased property and sales
of produced property.
In response to comments, however,
the produced and purchased property
rules have been modified to be similar in
structure and style, to better reflect and
highlight the differences between these
two rules.
5. Allocations
Taxpayers must allocate gross income
under paragraphs (b)(1) and (b)(2) of proposed §1.863–8 among U.S., foreign, and
space or ocean activities. Under proposed
§1.863–8(b)(3)(ii)(C), allocations are also
made between production activity occurring in space or international water and
that occurring outside space and international water. Finally, allocations are
also made under proposed §1.863–8(b)(4)
between services performed in space or
international water and services performed
outside space and international water. In
performing these allocations, the proposed regulations generally provided that
taxpayers should consider the relative
value of functions performed, resources
employed, or risks assumed in different
locations. Moreover, the preamble to the
proposed regulations provided that allocations should be based generally on section
482 principles. Commentators noted that
little guidance is given as to the mechanics
of allocation other than the statement that
the principles of section 482 should be
used. Commentators stated that allocation of gross income based on section 482
principles will result in added expense,
uncertainty, and extra burden on multinational taxpayers who are already required
to undertake and update functional analyses and satisfy substantial documentation
requirements.
While the final regulations were not
changed in response to these comments,
the Treasury Department and the IRS believe that some clarification is warranted.
In suggesting the use of section 482 principles as a guide, the Treasury Department and the IRS intend for taxpayers to

483

adopt a reasonable approach to the allocations required in this area. Taxpayers
know their businesses and will generally
be in the best position to fashion a reasonable method that most reliably reflects
the relative value of functions performed,
resources employed, and risks assumed in
different locations. In the preamble to the
proposed regulations, the Treasury Department and the IRS solicited comments on
alternative methods of allocation for particular industries and criteria that could
be used to evaluate the reasonableness of
such methods. No such comments were
received. One commentator noted, however, that the proposed regulations perhaps reflected what taxpayers in these industries have already been doing in order to determine the character and source
of their space and ocean income. Consequently, the Treasury Department and the
IRS believe that allocations of gross income based on functions performed, resources employed, and risks assumed are
appropriate in these circumstances.
6. Separation of a single transaction and
aggregation of multiple transactions
Paragraphs (d)(1)(i) and (d)(1)(ii) of
§1.863–8 of the proposed regulations provided that for purposes of determining
space or ocean activity, the Commissioner
may separate parts of a single transaction or combine separate transactions into
a single transaction. One commentator
stated that this is a “one-way” street, as
only the Commissioner has the authority
to separate or combine transactions for
purposes of the proposed regulations.
The final regulations do not change this
rule. The Treasury Department and the
IRS believe taxpayers are not inappropriately disadvantaged by this rule because
taxpayers generally have the ability to
structure their transactions in line with the
economic prospects of their businesses.
In addition, the Commissioner’s ability
to separate or combine transactions is not
unfettered. Rather, the Commissioner
may only separate or combine transactions
to better reflect the value of functions
performed, resources employed, or risks
assumed. A taxpayer can always protect itself against recharacterization by
adopting an arrangement that appropriately reflects the economic realities of a
transaction or series of transactions. The

2007–7 I.R.B.

taxpayer is clearly in the best position at
the outset to structure its arrangements in
this manner. In addition, taxpayers traditionally are not permitted to restructure
retroactively the form of their completed
transactions. Thus, the Treasury Department and the IRS believe that the limited
“one-way” rule is appropriate in this case.
7. Income derived from the leasing of
shipping cargo containers
One commentator requested that the
Treasury Department and the IRS make
clear that the final regulations under section 863(d) do not apply to income derived
from the leasing of shipping cargo containers and that such income should be treated
as rental income, sourced under sections
861 and 862. This commentator noted that
valid arguments also exist for treating income derived from the leasing of shipping
cargo containers as transportation income;
however, in the commentator’s view, the
most appropriate treatment is rental income treatment, sourced under sections
861 and 862.
The treatment of income derived from
the leasing of shipping cargo containers
is not covered by these final regulations.
Instead, the Treasury Department and the
IRS intend to address the treatment of
such income explicitly in separate guidance. That guidance may apply section
863(c), section 863(d), or other provisions
to source income derived from the leasing
of shipping cargo containers. Any such
guidance will be prospective in nature.
Until such time, the treatment of such income will be determined under existing
law.
B. Communications Activity under Section
863(a), (d), and (e)
Section 863(e) governs the source of income from international communications
activities (international communications
income). International communications
income is defined in section 863(e)(2)
as income derived from the transmission
of communications or data between the
United States and a foreign country (or
possession of the United States). Section
863(e)(1)(A) provides that any international communications income of a United
States person is sourced 50 percent in the
United States and 50 percent outside the

2007–7 I.R.B.

United States (50/50 source rule). Section 863(e)(1)(A) does not provide for
any statutory or regulatory exceptions
to this 50/50 source rule. In contrast,
section 863(e)(1)(B)(i) provides that any
international communications income of
a foreign person is sourced outside the
United States, except as provided in regulations or in section 863(e)(1)(B)(ii). The
exception under section 863(e)(1)(B)(ii)
provides that if a foreign person maintains
an office or other fixed place of business in
the United States, any international communications income attributable to such
office or other fixed place of business is
U.S. source income.
Section 1.863–9 of the proposed regulations generally provided rules for determining the source of international
communications income under section
863(e) and other communications income
under section 863(a) and (d). Proposed
§1.863–9(b)(1) reflected the rule under
section 863(e)(1)(A) that a United States
person’s international communications
income is 50 percent U.S. source income
and 50 percent foreign source income.
Proposed §1.863–9(b)(2) reflected the
general rule under section 863(e)(1)(B)
that a foreign person’s international communications income is foreign source
income.
Consistent with the statutory exception
under section 863(e)(1)(B)(ii), proposed
§1.863–9(b)(2)(iii) provided that any international communications income derived by a foreign person, other than a
CFC, that is attributable to an office or
other fixed place of business of the foreign person in the United States is U.S.
source income. International communications income is attributable to an office or
other fixed place of business to the extent
of functions performed, resources employed, or risks assumed by the office or
other fixed place of business. In addition
to the statutory exception under section
863(e)(1)(B)(ii), section 863(e)(1)(B)
provides general regulatory authority to
depart from the general 100 percent foreign source rule for foreign persons. Thus,
pursuant to this regulatory authority, the
proposed regulations contained additional
exceptions to the general rule applicable to foreign persons. In particular, the
proposed regulations provided that international communications income derived
by a CFC is 50 percent U.S. source income

484

and 50 percent foreign source income (the
same as for United States persons). The
proposed regulations also provided that
international communications income
derived by a foreign person, other than
a CFC, engaged in a trade or business
within the United States is income from
sources within the United States to the extent the income, based on all the facts and
circumstances, is attributable to functions
performed, resources employed, or risks
assumed within the United States.
In addition to the general source rules
for international communications income
of United States and foreign persons,
the proposed regulations also provided
rules, applicable to both United States
and foreign persons, for income from
U.S. communications, foreign communications, space/ocean communications,
and communications where endpoints are
indeterminate. These rules, as well as
modifications to the proposed regulations,
are discussed below.
1. Income characterization rules for
communications income
Section 1.863–9(h)(3) of the proposed
regulations provided that the type of communications activity (and thus the applicable source rule) is determined by
identifying the two points between which
the taxpayer is paid to transmit the communication. For United States and foreign
persons, U.S. communications income is
entirely U.S. source income. A taxpayer
derives U.S. communications income
when the taxpayer is paid to transmit between two points in the United States or
between the United States and a point in
space or international water. In contrast,
foreign communications income is entirely
foreign source income for United States
and foreign persons. A taxpayer derives
foreign communications income when the
taxpayer is paid to transmit between two
points in a foreign country or countries (or
a possession or possessions of the United
States), between a foreign country and
a possession of the United States, or between a foreign country (or a possession of
the United States) and a point in space or
international water. Finally, the proposed
regulations provided different source rules
for international communications income
of United States and foreign persons. See
section B.3 of this preamble for further

February 12, 2007

discussion. A taxpayer derives international communications income when the
taxpayer is paid to transmit between a
point in the United States and a point in
a foreign country (or a possession of the
United States). When a taxpayer cannot
establish the two points between which
the taxpayer is paid to transmit the communication, §1.863–9(f) of the proposed
regulation provided a default source rule
under which all the income derived by
the taxpayer from such communications
activity is U.S. source income.
Commentators stated that the treatment
of communications income as U.S. source
income when the endpoints are indeterminate is overbroad and harsh, particularly as
it relates to foreign taxpayers. Commentators also stated that taxpayers would have
to commit significant resources to develop
the technology necessary to identify the
endpoints of communications. One commentator stated that it is unclear that a reliable system can be created at any expense
to establish the endpoints of the transmission under all circumstances. Commentators suggested instead the use of any reasonable method to establish the endpoints
between which a taxpayer is paid to transmit the communications. One commentator suggested that the Treasury Department
and the IRS consider employing the Industry Issue Resolution Program or Prefiling
Agreement Program as aids in the administration of a reasonable method rule.
The Treasury Department and the IRS
solicited comments on the challenges to
identifying the endpoints of communications in specific industries or situations,
as well as suggestions for rules that are
responsive to these particular challenges.
The Treasury Department and the IRS also
solicited comments on methods to establish the endpoints of a communication that
may be reasonable for particular industries, as well as criteria that may be appropriate to evaluate the reasonableness
of such methods. In response, one commentator submitted examples of reasonable methods to establish the endpoints between which a taxpayer is paid to transmit
the communications. The examples relied
on statistical reports of data such as minutes used, areas of transmission, port locations, and transport charges. This commentator noted that current federal regulations already require telecommunications
companies to submit some of these reports

February 12, 2007

to certain governmental agencies, for example, the Federal Communications Commission.
In light of the potential complexity in
identifying the type of communications activity and in response to comments, the final regulations provide that a taxpayer may
satisfy the requirement that the taxpayer
establish the two points between which the
taxpayer is paid to transmit, and bears the
risk of transmitting, the communication by
using any consistently applied reasonable
method to establish one or both endpoints.
In doing so, the taxpayer carries the burden of proof and must establish that the
method used is reasonable (taking into account all of the facts and circumstances)
and is consistently applied. In satisfying
its burden of proof, a taxpayer will need
to maintain reasonable records of communications activities. Depending on the
facts and circumstances, methods based
on, for example, records of port or transport charges, customer billing records, a
satellite footprint, or records of termination fees made pursuant to an international
settlement agreement may be reasonable.
In addition, practices used by taxpayers to
classify or categorize certain communications activity in connection with preparation of statements and analyses for the use
of management, creditors, minority shareholders, joint ventures, or other parties or
governmental agencies in interest may be
reliable indicators of the reasonableness of
the method chosen, but need not be accorded conclusive weight by the Commissioner. Furthermore, in evaluating the reasonableness of the method chosen, consideration will be given to all the facts and
circumstances, including whether the endpoints would otherwise be identifiable absent this reasonable method provision.
Along with resultant changes made to
the text of the final regulations, several
examples have been added to §1.863–9(j)
of the final regulations that illustrate instances where the taxpayer may be able to
use reasonable methods to determine the
endpoints between which the taxpayer is
paid to transmit the communications.
2. The paid-to-do rule with respect to
foreign-originating communications
Under the proposed regulations, a taxpayer derives income from a certain type
of communications activity (for example,

485

foreign communications or international
communications) only if the taxpayer is
paid to transmit, and bears the risk of transmitting (the paid-to-do rule), the communications of such type. See Prop. Treas.
Reg. §1.863–9(h)(2) and (3). This is the
case even if the taxpayer contracts out the
transmission function.
Commentators stated that application
of the paid-to-do rule in all instances
would give rise to results that are inconsistent with Congressional intent and
may result in excessive amounts of U.S.
source income. One commentator noted
that in some cases, while it is clear that
a communication originated in a foreign
country and that a U.S. telecommunications company is paid to terminate the
foreign-originating traffic in the United
States, it is unclear exactly where the U.S.
telecommunications company picked up
the communication. This lack of clarity
often may be due to legal restrictions in
certain foreign countries on ownership of
capacity and carriage of transmissions by
non-nationals. It can also be due to the
fact that the international settlement agreements under which major international
telecommunications carriers operate often
do not specify where the traffic is picked
up or handed off, and in some cases the
hand-off point is specified by reference
to a mid-point convention, even though
the transmission signal, from a technical standpoint, travels from end-to-end
with no real points in-between. The commentator further stated that at the time
section 863(e) was enacted, U.S. carriers were generally not allowed to own
and operate facilities in foreign countries;
specifically, no U.S. carrier could carry a
foreign-to-U.S. or U.S.-to-foreign transmission end-to-end. Thus, concluded the
commentator, Congress focused on the
endpoints of the communications rather
than where the activities constituting the
transmission of communications take
place. The commentator suggested a rule
that would provide that when a taxpayer
is paid to transmit foreign-originating
communications from a point outside the
United States to a point in the United
States, the taxpayer should be deemed to
have been paid to transmit the communications from a point in the foreign country
in which the communication originated.
Upon further consideration, the Treasury Department and the IRS believe that

2007–7 I.R.B.

the paid-to-do rule may be over-inclusive in certain cases. Accordingly, the
final regulations provide that international
communications income also includes
income derived from communications
activity when the taxpayer is paid to transmit foreign-originating communications
(communications with a beginning point
in a foreign country or a possession of
the United States) from a point in space
or international water to a point in the
United States. Also, a new example has
been added to §1.863–9(j) of the final
regulations to illustrate the changes made
in the final regulations with respect to
foreign-originating communications.
The changes made in the final regulations only affect communications that originate in a foreign country (or a possession
of the United States) and does not affect
communications that originate in space, international water, or the United States. The
Treasury Department and the IRS continue
to believe that communications activity is
most appropriately characterized based on
the two points between which the taxpayer
is paid to transmit, and bears the risk of
transmitting, the communication.
3. Determining the source of
communications income based on
functions performed, resources employed,
or risks assumed in a foreign country or
countries
As discussed above, the proposed regulations provided that the source of communications income is largely dependant
on the type of communications activity
and the citizenship or residence of the
taxpayer. However, the proposed regulations provided for two instances where (in
addition to the type of communications
activity and the citizenship or residence
of the taxpayer) the source of communications income may depend on functions
performed, resources employed, or risks
assumed. First, the proposed regulations
provided that international communications income derived by a foreign person,
other than a CFC, that is attributable to
an office or other fixed place of business
of the foreign person in the United States
is U.S. source income. The proposed
regulations provided that international
communications income is attributable to
an office or other fixed place of business
to the extent of functions performed, re-

2007–7 I.R.B.

sources employed, or risks assumed by
the office or other fixed place of business.
Second, the proposed regulations provided
that international communications income
derived by a foreign person, other than
a CFC, engaged in a trade or business
within the United States is income from
sources within the United States to the extent the income, based on all the facts and
circumstances, is attributable to functions
performed, resources employed, or risks
assumed within the United States.
Commentators suggested that the final
regulations also provide for similar rules
that would source communications income
as foreign source income based on functions performed, resources employed, or
risks assumed in a foreign country or countries. For example, one commentator suggested that the source of international and
U.S. communications income derived by
any United States or foreign person (including branches, partnerships, and disregarded entities) engaged in a trade or business in a foreign country or countries is
income from sources without the United
States to the extent the income, based on
all the facts and circumstances, is attributable to functions performed, resources employed, or risks assumed in such foreign
country or countries.
While the Treasury Department and the
IRS recognize that commentators’ suggestion to provide for a source rule based on
functions performed, resources employed,
or risks assumed in a foreign country or
countries is reasonable, as explained below, the Treasury Department and the IRS
believe that the statute and legislative history preclude such an option.
a. International Communications Income
Consistent with section 863(e)(1)(A),
proposed §1.863–9(b)(1) provided that
international communications income of
a United States person is 50 percent U.S.
source income and 50 percent foreign
source income. One commentator suggested that it may be appropriate, in certain
situations, to depart from the 50/50 source
rule to provide special rules for foreign activities. According to the commentator, as
a result of local regulatory requirements,
U.S.-based international telecommunications providers often need to conduct
portions of their international business
through locally formed entities, and such

486

entities are fully subject to foreign tax on
their income. The commentator therefore
concluded that a source rule for international communications income based on
functions performed, resources employed,
or risks assumed in a foreign country or
countries is not only equitable but also
consistent with treatment accorded to foreign persons having a U.S. fixed placed
of business or engaged in a U.S. trade or
business.
The Treasury Department and the IRS
recognize that a source rule based on functions performed, resources employed, or
risks assumed may be a reasonable alternative to the 50/50 source rule. Nonetheless,
they continue to believe that the 50/50
source rule is the method that must be
used to determine the source of a United
States person’s international communications income. This is because section
863(e)(1)(A) provides for an explicit 50/50
source rule for those persons without exception. In contrast, section 863(e)(1)(B)
provides that a foreign person’s international communications income is generally sourced outside the United States,
except as provided in regulations. The
Treasury Department and the IRS believe
that the express grant of regulatory authority in the case of foreign persons and
the omission of any such authority in the
case of United States persons indicate
that Congress intended the 50/50 sourcing
rule be applied to United States persons
without regulatory modification. There is
nothing in the statute or legislative history
that clearly demonstrates a different intention. In contrast, section 863(e)(1)(B)(ii)
provides for a special source rule with respect to foreign persons with an office or
other fixed place of business in the United
States. A similar rule is not provided with
respect to a United States person’s foreign
activities. Thus, Congress chose a rule
that sourced international communications income of foreign persons in certain
instances based on the place of their activities, but expressly chose the 50/50 method
to source international communications
income of United States persons, regardless of the place of their activities.
The Treasury Department and the IRS
recognize that the statute does not require strict application of the 50/50 source
rule for CFCs. Section 863(e)(1)(B) only
provides that the international communications income of a foreign person is

February 12, 2007

foreign source income, except as provided
in regulations. Consistent with and in light
of this regulatory authority, however, the
Treasury Department and the IRS believe
that the 50/50 source rule is the most appropriate method to determine the source
of a CFC’s international communications
income. This approach addresses the concern of the Treasury Department and the
IRS that United States persons may use
CFCs to obtain benefits that are inconsistent with the purposes of section 863(e).
Consequently, the rules for determining
the source of international communications income derived by a CFC should be
the same as the rules for determining the
source of such income if it is derived by
a United States person. In addition, the
Treasury Department and the IRS believe
that the 50/50 source rule for CFCs, as opposed to the 100 percent U.S. source rule
that was originally proposed as part of the
2001 proposed regulations, should limit
the potential for multiple levels of taxation
that commentators raised with respect to
those prior proposed regulations.
b. U.S. Communications Income
Section 1.863–9(c) of the proposed
regulations provided that income derived
by a United States or foreign person from
U.S. communications activity is entirely
from sources within the United States.
One commentator noted that a foreign
person deriving income from the transmission of communications between a point
in the United States and another point in
the United States or between a point in the
United States and a point in space or international water has 100 percent U.S. source
income, even if much or all of the activity
involved is outside the United States. In
contrast, under the space and ocean rules,
a foreign person has U.S. source income
only to the extent the income is attributable to functions performed, resources
employed, or risks assumed within the
United States. Commentators therefore
suggested modification of the 100 percent
U.S. source rule for U.S. communications
income derived by United States and foreign persons to take into account foreign
activities.
The Treasury Department and the IRS
recognize that a source rule based on functions performed, resources employed, or
risks assumed may be a reasonable alter-

February 12, 2007

native to the 100 percent U.S. source rule
for U.S. communications. Nonetheless,
the Treasury Department and the IRS believe that Congress did not intend such an
option. The legislative history indicates
that if a communication is between two
points within the United States, the “income attributable thereto is to be sourced
entirely as U.S. source income.” S. REP.
NO. 99–313, 1986–3 C.B. 359 (emphasis added). Congress intended such a result “even if the communication is routed
through a satellite located in space, regardless of the satellite’s location.” Id. Thus,
the legislative history clearly provides that
Congress intended that U.S. communications income be sourced entirely as U.S.
source income.
4. International communications income
derived by a foreign person (other than
a CFC)
Proposed §1.863–9(b)(2) reflected the
general rule under section 863(e)(1)(B)
that a foreign person’s international communications income is foreign source
income. Consistent with the statutory
exception under section 863(e)(1)(B)(ii),
proposed §1.863–9(b)(2)(iii) provided that
any international communications income
derived by a foreign person, other than
a CFC, that is attributable to an office or
other fixed place of business of the foreign person in the United States is U.S.
source income. International communications income is attributable to an office
or other fixed place of business to the
extent of functions performed, resources
employed, or risks assumed by the office
or other fixed place of business. Pursuant
to the grant of regulatory authority under section 863(e)(1)(B), the proposed
regulations provided other exceptions to
the general rule for foreign persons. The
first exception is the 50/50 source rule
for CFCs under §1.863–9(b)(2)(ii) of the
proposed regulations, as discussed above.
The second exception was provided in
§1.863–9(b)(2)(iv) of the proposed regulations and applied to foreign persons other
than CFCs. Section 1.863–9(b)(2)(iv) of
the proposed regulations provided that
international communications income
derived by a foreign person, other than
a CFC, engaged in a trade or business
within the United States, that is attributable to functions performed, resources

487

employed, or risks assumed within the
United States is U.S. source income. One
commentator noted that it is unclear why
a separate rule is needed for a fixed place
of business in the United States and a U.S.
trade or business because international
communications income attributable to
a fixed place of business in the United
States should also be attributable to functions performed, resources employed and
risks assumed within the United States.
As indicated, the office or other
fixed place of business rule under
§1.863–9(b)(2)(iii) of the proposed regulations was derived from the statutory language of section 863(e), while the trade or
business rule under §1.863–9(b)(2)(iv) of
the proposed regulations was derived from
the express grant of regulatory authority
to source international communications
income of foreign persons as other than
foreign source. The Treasury Department
and the IRS recognize that in most situations, the latter trade or business rule
would indeed subsume the former fixed
place of business rule, but still believe that
the later rule serves an important function.
The trade or business rule addresses the
concern of the Treasury Department and
the IRS that a foreign person could avoid a
U.S. fixed place of business under section
863(e)(1)(B)(ii), yet engage in significant
communications activity in the United
States. The Treasury Department and the
IRS believe that Congress intended that
a foreign person engaged in substantial
business in the United States be subject to
U.S. tax on that communications activity.
5. Allocations
Section 1.863–9(h)(1)(ii) of the proposed regulations provided that to the extent that a taxpayer’s transaction consists
in part of non-de minimis communications
activity and in part of non-de minimis
non-communications activity, each part
of the transaction must be treated as a
separate transaction. Gross income is
then allocated to each communications
activity transaction and each non-communications activity transaction to the extent
the income, based on all the facts and
circumstances, is attributable to functions
performed, resources employed, or risks
assumed in each such activity. Moreover,
the Treasury Department and the IRS suggested in the preamble to the proposed

2007–7 I.R.B.

regulations that allocations of gross income should be based generally on section
482 principles. One commentator stated
that the complexities inherent in allocating
income, based on section 482 principles,
between the separated transactions are
significant.
While the final regulations were not
changed in response to this comment, as in
the case of allocations for space and ocean
income, the Treasury Department and the
IRS believe that some clarification is warranted. In suggesting the use of section
482 principles as a guide, the Treasury Department and the IRS intend for taxpayers to adopt a reasonable approach to the
allocations required in this area. Taxpayers know their businesses and will generally be in the best position to fashion a reasonable method that most reliably reflects
the relative value of functions performed,
resources employed, and risks assumed in
different locations. In the preamble to the
proposed regulations, the Treasury Department and the IRS solicited comments on
alternative methods of allocation for particular industries and criteria that could
be used to evaluate the reasonableness of
such methods. No such comments were received. One commentator noted, however,
that the proposed regulations perhaps reflected what taxpayers in these industries
have already been doing in order to determine the character and source of their communications income. Consequently, as in
the case of space and ocean income, the
Treasury Department and the IRS believe
that allocations of gross income based on
functions performed, resources employed,
and risks assumed are appropriate in these
circumstances.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment pursuant to that Order is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations. Pursuant to the
Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that the collection of information in these regulations
will not have a significant economic impact on a substantial number of small en-

2007–7 I.R.B.

tities. This certification is based on the
fact that the rules provided in these regulations principally affect large multinational corporations that pay foreign taxes
on income derived from substantial foreign operations and that use these and any
other applicable source rules in determining their foreign tax credit. Accordingly,
a Regulatory Flexibility Act assessment is
not required. Pursuant to section 7805(f)
of the Internal Revenue Code, the NPRM
preceding these regulations were submitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal author of these regulations is H. Michael Huynh of the Office
of the Associate Chief Counsel (International). However, other personnel from the
Treasury Department and the IRS participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are 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, in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.863–8 also issued under
26 U.S.C. 863(a), (b) and (d). * * *
Section 1.863–9 also issued under
26 U.S.C. 863(a), (d) and (e). * * *
Par. 2. Section 1.863–3 is amended by:
1. Adding a sentence after the first sentence in paragraph (a)(1).
2. Adding a sentence at the end of paragraph (c)(1)(i)(A).
3. Adding a sentence after the first sentence in paragraph (c)(2).
The additions read as follows:
§1.863–3 Allocation and apportionment
of income from certain sales of inventory.
(a) * * * (1) * * * To determine the
source of income from sales of property
produced by the taxpayer, when the property is either produced in whole or in part

488

in space or on or under water not within the
jurisdiction (as recognized by the United
States) of a foreign country, possession of
the United States, or the United States (in
international water), or is sold in space or
international water, the rules of §1.863–8
apply, and the rules of this section do not
apply except to the extent provided in
§1.863–8. * * *
*****
(c) * * * (1) * * * (i) * * * (A) * * * For
rules regarding the source of income when
production takes place, in whole or in part,
in space or international water, the rules
of §1.863–8 apply, and the rules of this
section do not apply except to the extent
provided in §1.863–8.
*****
(2) * * * Notwithstanding any other
provision, for rules regarding the source
of income when a sale takes place in
space or international water, the rules
of §1.863–8 apply, and the rules of this
section do not apply except to the extent
provided in §1.863–8. * * *
*****
Par. 3. Sections 1.863–8 and 1.863–9
are added to read as follows:
§1.863–8 Source of income derived from
space and ocean activity under section
863(d).
(a) In general. Income of a United
States or a foreign person derived from
space and ocean activity (space and ocean
income) is sourced under the rules of this
section, notwithstanding any other provision, including sections 861, 862, 863, and
865. A taxpayer will not be considered
to derive income from space or ocean activity, as defined in paragraph (d) of this
section, if such activity is performed by
another person, subject to the rules for
the treatment of consolidated groups in
§1.1502–13.
(b) Source of gross income from space
and ocean activity—(1) Space and ocean
income derived by a United States person. Space and ocean income derived by
a United States person is income from
sources within the United States. However, space and ocean income derived by
a United States person is income from
sources without the United States to the
extent the income, based on all the facts

February 12, 2007

and circumstances, is attributable to functions performed, resources employed, or
risks assumed in a foreign country or
countries.
(2) Space and ocean income derived by
a foreign person—(i) In general. Space
and ocean income derived by a person
other than a United States person is income
from sources without the United States, except as otherwise provided in this paragraph (b)(2).
(ii) Space and ocean income derived by
a controlled foreign corporation. Space
and ocean income derived by a controlled
foreign corporation within the meaning of
section 957 (CFC) is income from sources
within the United States. However, space
and ocean income derived by a CFC is
income from sources without the United
States to the extent the income, based on
all the facts and circumstances, is attributable to functions performed, resources employed, or risks assumed in a foreign country or countries.
(iii) Space and ocean income derived
by foreign persons engaged in a trade or
business within the United States. Space
and ocean income derived by a foreign
person (other than a CFC) engaged in a
trade or business within the United States
is income from sources within the United
States to the extent the income, based on
all the facts and circumstances, is attributable to functions performed, resources employed, or risks assumed within the United
States.
(3) Source rules for income from certain
sales of property—(i) Sales of purchased
property. When a taxpayer sells purchased
property in space or international water,
the source of gross income from the sale
generally will be determined under paragraph (b)(1) or (2) of this section, as applicable. However, if such property is inventory property within the meaning of section 1221(a)(1) (inventory property) and is
sold for use, consumption, or disposition
outside space and international water, the
source of income from the sale will be determined under §1.861–7(c).
(ii) Sales of property produced by the
taxpayer—(A) General. If the taxpayer
both produces property and sells such
property, the taxpayer must allocate gross
income from such sales between production activity and sales activity under the
50/50 method. Under the 50/50 method,
one-half of the taxpayer’s gross income

February 12, 2007

will be considered income allocable to
production activity, and the source of that
income will be determined under paragraph (b)(3)(ii)(B) or (C) of this section.
The remaining one-half of such gross income will be considered income allocable
to sales activity, and the source of that income will be determined under paragraph
(b)(3)(ii)(D) of this section.
(B) Production only in space or international water, or only outside space
and international water. When production occurs only in space or international
water, income allocable to production activity is sourced under paragraph (b)(1) or
(2) of this section, as applicable. When
production occurs only outside space
and international water, income allocable
to production activity is sourced under
§1.863–3(c)(1).
(C) Production both in space or international water and outside space and international water. When property is produced both in space or international water
and outside space and international water,
gross income allocable to production activity must be allocated to production occurring in space or international water and
production occurring outside space and international water. Such gross income is
allocated to production activity occurring
in space or international water to the extent the income, based on all the facts and
circumstances, is attributable to functions
performed, resources employed, or risks
assumed in space or international water.
The balance of such gross income is allocated to production activity occurring outside space and international water. The
source of gross income allocable to production activity in space or international
water is determined under paragraph (b)(1)
or (2) of this section, as applicable. The
source of gross income allocated to production activity occurring outside space
and international water is determined under §1.863–3(c)(1).
(D) Source of income allocable to
sales activity. When property produced
by the taxpayer is sold outside space and
international water, the source of gross
income allocable to sales activity will
be determined under §§1.861–7(c) and
1.863–3(c)(2). When property produced
by the taxpayer is sold in space or international water, the source of gross income
allocable to sales activity generally will be
determined under paragraph (b)(1) or (2)

489

of this section, as applicable. However, if
such property is inventory property within
the meaning of section 1221(a)(1) and is
sold in space or international water for
use, consumption, or disposition outside
space, international water, and the United
States, the source of gross income allocable to sales activity will be determined
under §§1.861–7(c) and 1.863–3(c)(2).
(4) Special rule for determining the
source of gross income from services. To
the extent a transaction characterized as
the performance of a service constitutes a
space or ocean activity, as determined under paragraph (d)(2)(ii) of this section, the
source of gross income derived from such
transaction is determined under paragraph
(b)(1) or (2) of this section.
(5) Special rule for determining source
of income from communications activity
(other than income from international
communications activity).
Space and
ocean activity, as defined in paragraph (d)
of this section, includes activity that occurs
in space or international water that is characterized as a communications activity as
defined in §1.863–9(h)(1) (other than international communications activity). The
source of space and ocean income that is
also communications income as defined
in §1.863–9(h)(2) (but not space/ocean
communications income as defined in
§1.863–9(h)(3)(v)) is determined under
the rules of §1.863–9(c), (d), and (f), as
applicable, rather than under paragraph
(b) of this section. The source of space
and ocean income that is also space/ocean
communications income as defined in
§1.863–9(h)(3)(v) is determined under the
rules of paragraph (b) of this section. See
§1.863–9(e).
(c) Taxable income. When a taxpayer
allocates gross income under paragraph
(b)(1), (b)(2), (b)(3)(ii)(C), or (b)(4) of
this section, the taxpayer must allocate expenses, losses, and other deductions as prescribed in §§1.861–8 through 1.861–14T
to the class or classes of gross income that
include the income so allocated in each
case. A taxpayer must then apply the rules
of §§1.861–8 through 1.861–14T to apportion properly amounts of expenses, losses,
and other deductions so allocated to such
gross income between gross income from
sources within the United States and gross
income from sources without the United
States.

2007–7 I.R.B.

(d) Space and ocean activity—(1) Definition—(i) Space activity. In general,
space activity is any activity conducted in
space. For purposes of this section, space
means any area not within the jurisdiction
(as recognized by the United States) of a
foreign country, possession of the United
States, or the United States, and not in
international water. For purposes of determining space activity, the Commissioner
may separate parts of a single transaction into separate transactions or combine
separate transactions as part of a single
transaction. Paragraph (d)(3) of this section lists specific exceptions to the general
definition of space activity. Activities that
constitute space activity include but are
not limited to—
(A) Performance and provision of services in space, as defined in paragraph
(d)(2)(ii) of this section;
(B) Leasing of equipment located in
space, including spacecraft (for example,
satellites) or transponders located in space;
(C) Licensing of technology or other
intangibles for use in space;
(D) Production, processing, or creation
of property in space, as defined in paragraph (d)(2)(i) of this section;
(E) Activity occurring in space that is
characterized as communications activity
(other than international communications
activity) under §1.863–9(h)(1);
(F) Underwriting income from the insurance of risks on activities that produce
space income; and
(G) Sales of property in space (see
§1.861–7(c)).
(ii) Ocean activity. In general, ocean
activity is any activity conducted on or
under water not within the jurisdiction
(as recognized by the United States) of a
foreign country, possession of the United
States, or the United States (collectively,
in international water). For purposes
of determining ocean activity, the Commissioner may separate parts of a single
transaction into separate transactions or
combine separate transactions as part of a
single transaction. Paragraph (d)(3) of this
section lists specific exceptions to the general definition of ocean activity. Activities
that constitute ocean activity include but
are not limited to—
(A) Performance and provision of services in international water, as defined in
paragraph (d)(2)(ii) of this section;

2007–7 I.R.B.

(B) Leasing of equipment located in
international water, including underwater
cables;
(C) Licensing of technology or other
intangibles for use in international water;
(D) Production, processing, or creation
of property in international water, as defined in paragraph (d)(2)(i) of this section;
(E) Activity occurring in international
water that is characterized as communications activity (other than international communications activity) under
§1.863–9(h)(1);
(F) Underwriting income from the insurance of risks on activities that produce
ocean income;
(G) Sales of property in international
water (see §1.861–7(c));
(H) Any activity performed in Antarctica;
(I) The leasing of a vessel that does not
transport cargo or persons for hire between
ports-of-call (for example, the leasing of
a vessel to engage in research activities in
international water); and
(J) The leasing of drilling rigs, extraction of minerals, and performance and provision of services related thereto, except as
provided in paragraph (d)(3)(ii) of this section.
(2) Determining a space or ocean activity—(i) Production of property in space
or international water. For purposes of
this section, production activity means an
activity that creates, fabricates, manufactures, extracts, processes, cures, or ages
property within the meaning of section
864(a) and §1.864–1.
(ii) Special rule for performance of services—(A) General. Except as provided in
paragraph (d)(2)(ii)(B) of this section, if a
transaction is characterized as the performance of a service, then such service will
be treated as a space or ocean activity in
its entirety when any part of the service is
performed in space or international water.
Services are performed in space or international water if functions are performed, resources are employed, or risks are assumed
in space or international water, regardless
of whether performed by personnel, equipment, or otherwise.
(B) Exception to the general rule. If
the taxpayer can demonstrate the value of
the service attributable to performance occurring in space or international water, and
the value of the service attributable to performance occurring outside space and in-

490

ternational water, then such service will
be treated as space or ocean activity only
to the extent of the activity performed in
space or international water. The value of
the service is attributable to performance
occurring in space or international water
to the extent the performance of the service, based on all the facts and circumstances, is attributable to functions performed, resources employed, or risks assumed in space or international water. In
addition, if the taxpayer can demonstrate,
based on all the facts and circumstances,
that the value of the service attributable
to performance in space and international
water is de minimis, such service will not
be treated as space or ocean activity.
(3) Exceptions to space or ocean activity. Space or ocean activity does not include the following types of activities:
(i) Any activity giving rise to transportation income as defined in section
863(c).
(ii) Any activity with respect to mines,
oil and gas wells, or other natural deposits,
to the extent the mines, wells, or natural
deposits are located within the jurisdiction
(as recognized by the United States) of any
country, including the United States and its
possessions.
(iii) Any activity giving rise to international communications income as defined
in §1.863–9(h)(3)(ii).
(e) Treatment of partnerships. This section is applied at the partner level.
(f) Examples. The following examples
illustrate the rules of this section:
Example 1. Space activity—activity occurring on
land and in space—(i) Facts. S, a United States person, owns satellites in orbit. S leases one of its satellites to A. S, as lessor, will not operate the satellite.
Part of S’s performance as lessor in this transaction
occurs on land. Assume that the combination of S’s
activities is characterized as the lease of equipment.
(ii) Analysis. Because the leased equipment is located in space, the transaction is defined in its entirety as space activity under paragraph (d)(1)(i) of
this section. Income derived from the lease will be
sourced under paragraph (b)(1) of this section. Under paragraph (b)(1) of this section, S’s space income
is sourced outside the United States to the extent the
income, based on all the facts and circumstances,
is attributable to functions performed, resources employed, or risks assumed in a foreign country or countries.
Example 2. Space activity—(i) Facts. X is an Internet service provider. X offers a service that permits
a customer (C) to connect to the Internet via a telephone call, initiated by the modem of C’s personal
computer, to a control center. X transmits information requested by C to C’s personal computer, in part
using satellite capacity leased by X from S. X per-

February 12, 2007

forms the uplink and downlink functions. X charges
its customers a flat monthly fee. Assume that neither X nor S derive international communications income within the meaning of §1.863–9(h)(3)(ii). In
addition, assume that X is able to demonstrate, pursuant to paragraph (d)(2)(ii)(B) of this section, the extent to which the value of the service is attributable to
functions performed, resources employed, and risks
assumed in space.
(ii) Analysis. Under paragraph (d)(2)(ii) of this
section, the service performed by X constitutes space
activity to the extent the value of the service is attributable to functions performed, resources employed,
and risks assumed in space. To the extent the service
performed by X constitutes space activity, the source
of X’s income from the service transaction is determined under paragraph (b) of this section. To the
extent the service performed by X does not constitute space or ocean activity, the source of X’s income
from the service is determined under sections 861,
862, and 863, as applicable. To the extent that X derives space and ocean income that is also communications income within the meaning of §1.863–9(h)(2),
the source of X’s income is determined under paragraph (b) of this section and §1.863–9(c), (d), and
(f), as applicable, as provided in paragraph (b)(5) of
this section. S derives space and ocean income that
is also communications income within the meaning
of §1.863–9(h)(2), and the source of S’s income is
therefore determined under paragraph (b) of this section and §1.863–9(c), (d), and (f), as applicable, as
provided in paragraph (b)(5) of this section.
Example 3. Services as space activity—de minimis value attributable to performance occurring in
space—(i) Facts. R owns a retail outlet in the United
States. R engages S to provide a security system for
R’s premises. S operates its security system by transmitting images from R’s premises directly to a satellite, and from the satellite to a group of S employees located in Country B, who monitor the premises
by viewing the transmitted images. The satellite is
used as a medium of delivery and not as a method of
surveillance. O provides S with transponder capacity
on O’s satellite, which S uses to transmit those images. Assume that S’s transaction with R is characterized as the performance of a service. Assume that O’s
provision of transponder capacity is also viewed as
the provision of a service. Assume also that S is able
to demonstrate, pursuant to §1.863–9(h)(1), that the
value of the transaction with R attributable to communications activities is de minimis.
(ii) Analysis. S derives income from providing
monitoring services. S can demonstrate, pursuant to
paragraph (d)(2)(ii) of this section, that based on all
the facts and circumstances, the value of S’s service
transaction attributable to performance in space is de
minimis. Thus, S is not treated as engaged in a space
activity, and none of S’s income from the service
transaction is space income. In addition, because S
demonstrates that the value of the transaction with
R attributable to communications activities is de
minimis, S is not required under §1.863–9(h)(1)(ii)
to treat the transaction as separate communications
and non-communications transactions, and none
of S’s gross income from the transaction is treated
as communications income within the meaning of
§1.863–9(h)(2). O’s provision of transponder capacity is viewed as the provision of a service. Based on
all the facts and circumstances, the value of O’s ser-

February 12, 2007

vice transaction attributable to performance in space
is not de minimis. Thus, O’s activity will be considered space activity, pursuant to paragraph (d)(2)(ii)
of this section, to the extent the value of the services
transaction is attributable to performance in space
(unless O’s activity in space is international communications activity). To the extent that O derives
communications income, the source of such income
is determined under paragraph (b) of this section
and §1.863–9(b), (c), (d), and (f), as applicable, as
provided in paragraph (b)(5) of this section. R does
not derive any income from space activity.
Example 4. Space activity—(i) Facts. L, a domestic corporation, offers programming and certain
other services to customers located both in the United
States and in foreign countries. Assume that L’s provision of programming and other services in this Example 4 is characterized as the provision of a service,
and that no part of the service transaction occurs in
space or international water. Assume that the delivery
of the programming constitutes a separate transaction
also characterized as the performance of a service.
L uses satellite capacity acquired from S to deliver
the programming service directly to customers’ television sets. L performs the uplink and downlink functions, so that part of the value of the delivery transaction derives from functions performed and resources
employed in space. Assume that these contributions
to the value of the delivery transaction occurring in
space are not considered de minimis under paragraph
(d)(2)(ii)(B) of this section. Customer C pays L to
provide and deliver programming to C’s residence in
the United States. Assume S’s provision of satellite
capacity in this Example 4 is viewed as the provision
of a service, and also that S does not derive international communications income within the meaning of
§1.863–9(h)(3)(ii).
(ii) Analysis. S’s activity will be considered
space activity. To the extent that S derives space and
ocean income that is also communications income
under §1.863–9(h)(2), the source of S’s income is
determined under paragraph (b) of this section and
§1.863–9(c), (d), and (f), as applicable, as provided
in paragraph (b)(5) of this section. On these facts,
L’s activities are treated as two separate service
transactions: the provision of programming (and
other services), and the delivery of programming.
L’s income derived from provision of programming
and other services is not income derived from space
activity. L’s delivery of programming and other
services is considered space activity, pursuant to
paragraph (d)(2)(ii) of this section, to the extent the
value of the delivery transaction is attributable to performance in space. To the extent that the delivery of
programming is treated as a space activity, the source
of L’s income derived from the delivery transaction
is determined under paragraph (b)(1) of this section,
as provided in paragraph (b)(4) of this section. To
the extent that L derives space and ocean income that
is also communications income within the meaning
of §1.863–9(h)(2), the source of such income is
determined under paragraph (b) of this section and
§1.863–9(b), (c), (d), (e), and (f), as applicable, as
provided in paragraph (b)(5) of this section.
Example 5. Space activity—(i) Facts. The facts
are the same as in Example 4, except that L does
not deliver the programming service directly but instead engages R, a domestic corporation specializing
in content delivery, to deliver by transmission its pro-

491

gramming. For all portions of a transmission which
require satellite capacity, R, in turn, contracts out
such functions to S. S performs the uplink and downlink functions, so that part of the value of the delivery
transaction derives from functions performed and resources employed in space.
(ii) Analysis. L’s activity will not be considered
space activity because none of L’s activity occurs in
space. Thus, L does not derive any space and ocean
income. L does, however, derive communications
income within the meaning of §1.863–9(h)(2). This
is the case even though L does not perform the
transmission function because L is paid by Customer
C to transmit, and bears the risk of transmitting,
the communications or data. To the extent that L’s
activity consists in part of non-de minimis communications and non-de minimis non-communications
activity, each part of the transaction must be treated
as a separate transaction and gross income is allocated accordingly under §1.863–9(h)(1)(ii). In
addition, L must also allocate expenses, losses, and
other deductions, for example, payments to R, to
the class or classes of gross income that include
the income so allocated. R’s activity will not be
considered space activity. Since R contracts out all
of the functions involving satellite capacity to S, no
part of R’s activity occurs in space. Thus, R does
not derive any space and ocean income. R does,
however, derive communications income within the
meaning of §1.863–9(h)(2). This is the case even
though R does not perform the transmission function
because R is paid by L to transmit, and bears the
risk of transmitting, the communications or data. S’s
activity will be considered space activity. To the
extent that S derives space and ocean income that
is also communications income within the meaning
of §1.863–9(h)(2), the source of such income is
determined under paragraph (b) of this section and
§1.863–9(b), (c), (d), (e), and (f), as applicable, as
provided in paragraph (b)(5) of this section.
Example 6. Space activity—treatment of land activity—(i) Facts. S, a United States person, offers remote imaging products and services to its customers.
In year 1, S uses its satellite’s remote sensors to gather
data on certain geographical terrain. In year 3, C, a
construction development company, contracts with S
to obtain a satellite image of an area for site development work. S pulls data from its archives and transfers to C the images gathered in year 1, in a transaction that is characterized as a sale of the data. S’s
rights, title, and interest in the data pass to C in the
United States. Before transferring the images to C,
S uses computer software in its land-based office to
enhance the images so that the images can be used.
(ii) Analysis. The collection of data and creation
of images in space is characterized as the creation of
property in space. Because S both produces and sells
the data, S must allocate gross income from the sale of
the data between production activity and sales activity under the 50/50 method of paragraph (b)(3)(ii)(A).
The source of S’s income allocable to production activity is determined under paragraph (b)(3)(ii)(C) of
this section because production activities occur both
in space and on land. The source of S’s income attributable to sales activity is determined under paragraph (b)(3)(ii)(D) of this section (by reference to
§1.863–3(c)(2)) as U.S. source income because S’s
rights, title, and interest in the data pass to C in the
United States.

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Example 7.
Use of intangible property in
space—(i) Facts. X acquires a license to use a
particular satellite slot or orbit, which X sublicenses
to C. C pays X a royalty.
(ii) Analysis. Because the royalty is paid for the
right to use intangible property in space, the source
of the royalty paid by C to X is determined under
paragraph (b) of this section.
Example 8. Performance of services—(i) Facts.
E, a domestic corporation, operates satellites with
sensing equipment that can determine how much heat
and light particular plants emit and reflect. Based on
the data, E will provide F, a U.S. farmer, a report analyzing the data, which F will use in growing crops.
E analyzes the data from offices located in the United
States. Assume that E’s combined activities are characterized as the performance of services.
(ii) Analysis. Based on all the facts and circumstances, the value of E’s service transaction attributable to performance in space is not de minimis. Thus,
E’s activities will be considered space activities, pursuant to paragraph (d)(2)(ii) of this section, to the extent the value of E’s service transaction is attributable
to performance in space. To the extent E’s service
transaction constitutes a space activity, the source of
E’s income derived from the service transaction will
be determined under paragraph (b)(4) of this section,
by reference to paragraph (b)(1) of this section. To the
extent that E’s service transaction does not constitute
a space or ocean activity, the source of E’s income derived from the service transaction is determined under
sections 861, 862, and 863, as applicable.
Example 9. Separate transactions—(i) Facts.
The same facts as Example 8, except that E provides
the raw data to F in a transaction characterized as a
sale of a copyrighted article. In addition, E provides
an analysis in the form of a report to F. The price F
pays E for the raw data is separately stated.
(ii) Analysis. To the extent that the provision of
raw data and the analysis of the data are each treated
as separate transactions, the source of income from
the production and sale of data is determined under
paragraph (b)(3)(ii) of this section. The provision of
services would be analyzed in the same manner as in
Example 8.
Example 10. Sale of property in international water—(i) Facts. T purchased and owns transatlantic
cable that lies in international water. T sells the cable
to B, with T’s rights, title, and interest in the cable
passing to B in international water. Assume that the
transatlantic cable is not inventory property within
the meaning of section 1221(a)(1).
(ii) Analysis. Because T’s rights, title, and interest in the property pass to B in international water, the sale takes place in international water under
§1.861–7(c), and the sale transaction is ocean activity under paragraph (d)(1)(ii) of this section. The
source of T’s sales income is determined under paragraph (b)(3)(i) of this section, by reference to paragraph (b)(1) or (2) of this section.
Example 11. Sale of property in space—(i) Facts.
S, a United States person, manufactures a satellite in
the United States and sells it to a customer who is not
a United States person. S’s rights, title, and interest
in the satellite pass to the customer in space.
(ii) Analysis. Because S’s rights, title, and interest
in the satellite pass to the customer in space, the sale
takes place in space under §1.861–7(c), and the sale
transaction is space activity under paragraph (d)(1)(i)

2007–7 I.R.B.

of this section. The source of income derived from
the sale of the satellite in space is determined under
paragraph (b)(3)(ii) of this section, with the source
of income allocable to production activity determined
under paragraphs (b)(3)(ii)(A) and (B) of this section,
and the source of income allocable to sales activity
determined under paragraphs (b)(3)(ii)(A) and (D) of
this section. Under paragraph (b)(1) of this section,
S’s space income is sourced outside the United States
to the extent the income, based on all the facts and
circumstances, is attributable to functions performed,
resources employed, or risks assumed in a foreign
country or countries.
Example 12. Sale of property in space—(i) Facts.
S has a right to operate from a particular position
(satellite slot or orbit) in space. S sells the right to operate from that position to P. Assume that the sale of
the satellite slot is characterized as a sale of property
and that S’s rights, title, and interest in the satellite
slot pass to P in space.
(ii) Analysis. The sale of the satellite slot takes
place in space under §1.861–7(c) because S’s rights,
title, and interest in the satellite slot pass to P in space.
The sale of the satellite slot is space activity under
paragraph (d)(1)(i) of this section, and income or gain
from the sale is sourced under paragraph (b)(3)(i) of
this section, by reference to paragraph (b)(1) or (2) of
this section.
Example 13. Source of income of a foreign person—(i) Facts. FP, a foreign corporation that is not
a CFC, derives income from the operation of satellites. FP operates ground stations in the United States
and in foreign Country FC. Assume that FP is considered engaged in a trade or business within the United
States based on FP’s operation of the ground station
in the United States.
(ii) Analysis. Under paragraph (b)(2)(iii) of this
section, FP’s space income is sourced in the United
States to the extent the income, based on all the facts
and circumstances, is attributable to functions performed, resources employed, or risks assumed within
the United States.
Example 14. Source of income of a foreign person—(i) Facts. FP, a foreign corporation that is not
a CFC, operates remote sensing satellites in space to
collect data and images for its customers. FP uses
an independent agent, A, in the United States who
provides marketing, order-taking, and other customer
service functions. Assume that FP is considered engaged in a trade or business within the United States
based on A’s activities on FP’s behalf in the United
States.
(ii) Analysis. Under paragraph (b)(2)(iii) of this
section, FP’s space income is sourced in the United
States to the extent the income, based on all the facts
and circumstances, is attributable to functions performed, resources employed, or risks assumed within
the United States.

(g) Reporting and documentation requirements—(1) In general. A taxpayer
making an allocation of gross income under paragraph (b)(1), (b)(2), (b)(3)(ii)(C),
or (b)(4) of this section must satisfy the requirements in paragraphs (g)(2), (3), and
(4) of this section.
(2) Required documentation. In all
cases, a taxpayer must prepare and main-

492

tain documentation in existence when its
return is filed regarding the allocation of
gross income and allocation and apportionment of expenses, losses, and other
deductions, the methodologies used, and
the circumstances justifying use of those
methodologies. The taxpayer must make
available such documentation within 30
days upon request.
(3) Access to software. If the taxpayer
or any third party used any computer
software, within the meaning of section
7612(d), to allocate gross income, or to
allocate or apportion expenses, losses, and
other deductions, the taxpayer must make
available upon request—
(i) Any computer software executable
code, within the meaning of section
7612(d), used for such purposes, including
an executable copy of the version of the
software used in the preparation of the
taxpayer’s return (including any plug-ins,
supplements, etc.) and a copy of all related
electronic data files. Thus, if software subsequently is upgraded or supplemented,
a separate executable copy of the version
used in preparing the taxpayer’s return
must be retained;
(ii) Any related computer software
source code, within the meaning of section 7612(d), acquired or developed by the
taxpayer or a related person, or primarily
for internal use by the taxpayer or such
person rather than for commercial distribution; and
(iii) In the case of any spreadsheet software or similar software, any formulae or
links to supporting worksheets.
(4) Use of allocation methodology. In
general, when a taxpayer allocates gross
income under paragraph (b)(1), (b)(2),
(b)(3)(ii)(C), or (b)(4) of this section, it
does so by making the allocation on a
timely filed original return (including extensions). However, a taxpayer will be
permitted to make changes to such allocations made on its original return with
respect to any taxable year for which the
statute of limitations has not closed as
follows:
(i) In the case of a taxpayer that has
made a change to such allocations prior
to the opening conference for the audit of
the taxable year to which the allocation relates or who makes such a change within
90 days of such opening conference, if the
IRS issues a written information document
request asking the taxpayer to provide the

February 12, 2007

documents and such other information described in paragraphs (g)(2) and (3) of this
section with respect to the changed allocations and the taxpayer complies with such
request within 30 days of the request, then
the IRS will complete its examination, if
any, with respect to the allocations for that
year as part of the current examination cycle. If the taxpayer does not provide the
documents and information described in
paragraphs (g)(2) and (3) of this section
within 30 days of the request, then the procedures described in paragraph (g)(4)(ii)
of this section shall apply.
(ii) If the taxpayer changes such allocations more than 90 days after the opening conference for the audit of the taxable year to which the allocations relate
or the taxpayer does not provide the documents and information with respect to the
changed allocations as requested in accordance with paragraphs (g)(2) and (3) of
this section, then the IRS will, in a separate cycle, determine whether an examination of the taxpayer’s allocations is warranted and complete any such examination. The separate cycle will be worked as
resources are available and may not have
the same estimated completion date as the
other issues under examination for the taxable year. The IRS may ask the taxpayer to
extend the statute of limitations on assessment and collection for the taxable year
to permit examination of the taxpayer’s
method of allocation, including an extension limited, where appropriate, to the taxpayer’s method of allocation.
(h) Effective date. This section applies
to taxable years beginning on or after December 27, 2006.
§1.863–9 Source of income derived from
communications activity under section
863(a), (d), and (e).
(a) In general. Income of a United
States or a foreign person derived from
each type of communications activity, as
defined in paragraph (h)(3) of this section, is sourced under the rules of this
section, notwithstanding any other provision including sections 861, 862, 863, and
865. Notwithstanding that a communications activity would qualify as space or
ocean activity under section 863(d) and the
regulations thereunder, the source of income derived from such communications
activity is determined under this section,

February 12, 2007

and not under section 863(d) and the regulations thereunder, except to the extent
provided in §1.863–8(b)(5).
(b) Source of international communications income—(1) International communications income derived by a United States
person. Income derived from international
communications activity (international
communications income) by a United
States person is one-half from sources
within the United States and one-half from
sources without the United States.
(2) International communications income derived by foreign persons—(i) In
general. International communications
income derived by a person other than a
United States person is, except as otherwise provided in this paragraph (b)(2),
wholly from sources without the United
States.
(ii) International communications income derived by a controlled foreign corporation. International communications
income derived by a controlled foreign
corporation within the meaning of section 957 (CFC) is one-half from sources
within the United States and one-half from
sources without the United States.
(iii) International communications income derived by foreign persons with a
fixed place of business in the United States.
International communications income derived by a foreign person, other than a
CFC, that is attributable to an office or
other fixed place of business of the foreign person in the United States is from
sources within the United States. The principles of section 864(c)(5) apply in determining whether a foreign person has an
office or fixed place of business in the
United States. See §1.864–7. International
communications income is attributable to
an office or other fixed place of business
to the extent of functions performed, resources employed, or risks assumed by the
office or other fixed place of business.
(iv) International communications income derived by foreign persons engaged
in a trade or business within the United
States. International communications income derived by a foreign person (other
than a CFC) engaged in a trade or business
within the United States is income from
sources within the United States to the extent the income, based on all the facts and
circumstances, is attributable to functions
performed, resources employed, or risks
assumed within the United States.

493

(c) Source of U.S. communications income. Income derived by a United States
or foreign person from U.S. communications activity is from sources within the
United States.
(d) Source of foreign communications
income. Income derived by a United States
or foreign person from foreign communications activity is from sources without the
United States.
(e) Source of space/ocean communications income. The source of income derived by a United States or foreign person
from space/ocean communications activity is determined under section 863(d) and
the regulations thereunder.
(f) Source of communications income
when taxpayer cannot establish the two
points between which the taxpayer is paid
to transmit the communication. Income
derived by a United States or foreign person from communications activity, when
the taxpayer cannot establish the two
points between which the taxpayer is paid
to transmit the communication as required
in paragraph (h)(3)(i) of this section, is
from sources within the United States.
(g) Taxable income. When a taxpayer
allocates gross income under paragraph
(b)(2)(iii), (b)(2)(iv), or (h)(1)(ii) of this
section, the taxpayer must allocate expenses, losses, and other deductions as prescribed in §§1.861–8 through 1.861–14T
to the class or classes of gross income that
include the income so allocated in each
case. A taxpayer must then apply the rules
of §§1.861–8 through 1.861–14T properly
to apportion amounts of expenses, losses,
and other deductions so allocated to such
gross income between gross income from
sources within the United States and gross
income from sources without the United
States. For amounts of expenses, losses,
and other deductions allocated to gross
income derived from international communications activity, when the source of
income is determined under the 50/50
method of paragraph (b)(1) or (b)(2)(ii)
of this section, taxpayers generally must
apportion expenses, losses, and other
deductions between sources within the
United States and sources without the
United States pro rata based on the relative amounts of gross income from sources
within the United States and gross income
from sources without the United States.
However, the preceding sentence shall
not apply to research and experimental

2007–7 I.R.B.

expenditures qualifying under §1.861–17,
which are to be allocated and apportioned
under the rules of that section.
(h) Communications activity and income derived from communications activity—(1) Communications activity—(i)
General rule. For purposes of this part,
communications activity consists solely
of the delivery by transmission of communications or data (communications).
Delivery of communications other than
by transmission (for example, by delivery of physical packages and letters) is
not communications activity within the
meaning of this section. Communications activity also includes the provision
of capacity to transmit communications.
Provision of content or any other additional service provided along with, or in
connection with, a non-de minimis communications activity must be treated as a
separate non-communications activity unless de minimis. Communications activity
or non-communications activity will be
treated as de minimis to the extent, based
on the facts and circumstances, the value
attributable to such activity is de minimis.
(ii) Separate transaction. To the extent
that a taxpayer’s transaction consists in
part of non-de minimis communications
activity and in part of non-de minimis
non-communications activity, each such
part of the transaction must be treated as
a separate transaction. Gross income is
allocated to each such communications
activity transaction and non-communications activity transaction to the extent
the income, based on all the facts and
circumstances, is attributable to functions
performed, resources employed, or risks
assumed in each such activity.
(2) Income derived from communications activity. Income derived from communications activity (communications income) is income derived from the delivery by transmission of communications,
including income derived from the provision of capacity to transmit communications. Income may be considered derived from a communications activity even
if the taxpayer itself does not perform the
transmission function, but in all cases, the
taxpayer derives communications income
only if the taxpayer is paid to transmit, and
bears the risk of transmitting, the communications.
(3) Determining the type of communications activity—(i) In general. Whether

2007–7 I.R.B.

income is derived from international communications activity, U.S. communications activity, foreign communications
activity, or space/ocean communications
activity is determined by identifying the
two points between which the taxpayer is
paid to transmit the communication. The
taxpayer must establish the two points between which the taxpayer is paid to transmit, and bears the risk of transmitting, the
communication. Whether the taxpayer
contracts out part or all of the transmission
function is not relevant. A taxpayer may
satisfy the requirement that the taxpayer
establish the two points between which the
taxpayer is paid to transmit, and bears the
risk of transmitting, the communication by
using any consistently applied reasonable
method to establish one or both endpoints.
In evaluating the reasonableness of such
method, consideration will be given to
all the facts and circumstances, including
whether the endpoints would otherwise be
identifiable absent this reasonable method
provision and the reliability of the data.
Depending on the facts and circumstances,
methods based on, for example, records of
port or transport charges, customer billing
records, a satellite footprint, or records
of termination fees made pursuant to an
international settlement agreement may be
reasonable. In addition, practices used by
taxpayers to classify or categorize certain
communications activity in connection
with preparation of statements and analyses for the use of management, creditors,
minority shareholders, joint ventures, or
other parties or governmental agencies in
interest may be reliable indicators of the
reasonableness of the method chosen, but
need not be accorded conclusive weight by
the Commissioner. In all cases, the method
chosen to establish the two points between
which the taxpayer is paid to transmit, and
bears the risk of transmitting, the communication must be supported by sufficient
documentation to permit verification by
the Commissioner.
(ii) Income derived from international
communications activity. Income derived
by a taxpayer from international communications activity (international communications income) is income derived from communications activity, as defined in paragraph (h)(2) of this section, when the taxpayer is paid to transmit—

494

(A) Between a point in the United States
and a point in a foreign country (or a possession of the United States); or
(B) Foreign-originating communications (communications with a beginning
point in a foreign country or a possession
of the United States) from a point in space
or international water to a point in the
United States.
(iii) Income derived from U.S. communications activity. Income derived by a
taxpayer from U.S. communications activity (U.S. communications income) is income derived from communications activity, as defined in paragraph (h)(2) of this
section, when the taxpayer is paid to transmit—
(A) Between two points in the United
States; or
(B) Between the United States and a
point in space or international water, except as provided in paragraph (h)(3)(ii)(B)
of this section.
(iv) Income derived from foreign communications activity. Income derived by a
taxpayer from foreign communications activity (foreign communications income) is
income derived from communications activity, as defined in paragraph (h)(2) of this
section, when the taxpayer is paid to transmit—
(A) Between two points in a foreign
country or countries (or a possession or
possessions of the United States);
(B) Between a foreign country and a
possession of the United States; or
(C) Between a foreign country (or a
possession of the United States) and a
point in space or international water.
(v) Income derived from space/ocean
communications activity. Income derived
by a taxpayer from space/ocean communications activity (space/ocean communications income) is income derived from communications activity, as defined in paragraph (h)(2) of this section, when the taxpayer is paid to transmit between a point
in space or international water and another
point in space or international water.
(i) Treatment of partnerships. This section is applied at the partner level.
(j) Examples. The following examples
illustrate the rules of this section:
Example 1. Income derived from non-communications activity—remote data base access—(i) Facts.
D provides its customers in various foreign countries
with access to its data base, which contains information on certain individuals’ health care insurance coverage. Customer C obtains access to D’s data base by

February 12, 2007

placing a call to D’s telephone number. Assume that
C’s telephone service, used to access D’s data base,
is provided by a third party, and that D assumes no
responsibility for the transmission of the information
via telephone.
(ii) Analysis. D is not paid to transmit communications and does not derive income from communications activity within the meaning of paragraph (h)(2)
of this section. Rather, D derives income from provision of content or provision of services to its customers. Therefore, the rules of this section do not apply to determine the source of D’s income.
Example 2. Income derived from U.S. communications activity—U.S. portion of international communication—(i) Facts. TC, a local telephone company, receives an access fee from an international carrier for picking up a call from a local telephone customer and delivering the call to a U.S. point of presence (POP) of the international carrier. The international carrier picks up the call from its U.S. POP and
delivers the call to a foreign country.
(ii) Analysis. TC is not paid to carry the transmission between the United States and a foreign country.
TC is paid to transmit a communication between two
points in the United States. TC derives U.S. communications income as defined in paragraph (h)(3)(iii)
of this section, which is sourced under paragraph (c)
of this section as U.S. source income.
Example 3. Income derived from international
communications activity—underwater cable—(i)
Facts. TC, a domestic corporation, owns an underwater fiber optic cable. Pursuant to contracts, TC
makes available to its customers capacity to transmit
communications via the cable. TC’s customers then
solicit telephone customers and arrange to transmit
the telephone customers’ calls. The cable runs in part
through U.S. waters, in part through international
waters, and in part through foreign country waters.
(ii) Analysis. TC derives international communications income as defined in paragraph (h)(3)(ii)
of this section because TC is paid to make available capacity to transmit communications between
the United States and a foreign country. Because TC
is a United States person, TC’s international communications income is sourced under paragraph (b)(1)
of this section as one-half from sources within the
United States and one-half from sources without the
United States.
Example 4. Income derived from international
communications activity—satellite—(i) Facts. S, a
United States person, owns satellites in orbit and uplink facilities in Country X, a foreign country. B, a
resident of Country X, pays S to deliver B’s programming from S’s uplink facility, located in Country X,
to a downlink facility in the United States owned by
C, a customer of B.
(ii) Analysis. S derives international communications income under paragraph (h)(3)(ii) of this section
because S is paid to transmit the communications between a beginning point in a foreign country and an
endpoint in the United States. Because S is a United
States person, the source of S’s international communications income is determined under paragraph
(b)(1) of this section as one-half from sources within
the United States and one-half from sources without
the United States.
Example 5. The paid-to-do rule—foreign communications via domestic route—(i) Facts. TC is paid
to transmit communications from Toronto, Canada,

February 12, 2007

to Paris, France. TC transmits the communications
from Toronto to New York. TC pays another communications company, IC, to transmit the communications from New York to Paris.
(ii) Analysis. Under the paid-to-do rule of paragraph (h)(3)(i) of this section, TC derives foreign
communications income under paragraph (h)(3)(iv)
of this section because TC is paid to transmit communications between two points in foreign countries,
Toronto and Paris. Under paragraph (h)(3)(i) of this
section, the character of TC’s communications activity is determined without regard to the fact that TC
pays IC to transmit the communications for some portion of the delivery path. IC has international communications income under paragraph (h)(3)(ii) of this
section because IC is paid to transmit the communications between a point in the United States and a point
in a foreign country.
Example 6. The paid-to-do rule—domestic communication via foreign route—(i) Facts. TC is paid
to transmit a call between two points in the United
States, but routes the call through Canada.
(ii) Analysis. Under paragraph (h)(3)(i) of this
section, the character of income derived from communications activity is determined by the two points
between which the taxpayer is paid to transmit, and
bears the risk of transmitting, the communications,
without regard to the path of the transmission between those two points. Thus, under paragraph
(h)(3)(iii) of this section, TC derives income from
U.S. communications activity because it is paid
to transmit the communications between two U.S.
points.
Example 7. The paid-to-do rule—foreign-originating communications—(i) Facts.
Under an
international settlement agreement, G, a Country X
international carrier, pays T to receive all calls originating in Country X that are bound for the United
States and to terminate such calls in the United
States. Due to Country X legal restrictions, the international settlement agreement specifies that G carries
the transmission to a point outside the territory of
Country X and that T carries the foreign-originating
transmission from such point to the destined point
in the United States. T, in turn, contracts out with
another communications company, S, to transmit the
U.S. portion of the communications. Tracing and
identifying the endpoints of each transmission is not
possible or practical. T does, however, keep records
of termination fees received from G for terminating
the foreign-originating calls.
(ii) Analysis. T derives communications income
as defined in paragraph (h)(2) of this section. Based
on all the facts and circumstances, T can establish that
T is paid to transmit, and bears the risk of transmitting, foreign-originating calls from a point in space
or international water to a point in the United States
using a reasonable method to establish the endpoints,
assuming that this method is consistently applied. In
this case, T can reasonably establish that T is paid to
receive foreign-originating calls and terminate such
calls in the United States based on the records of
termination fees pursuant to an international settlement agreement. Under paragraph (h)(3)(ii)(B) of
this section, a taxpayer derives income from international communications activity when the taxpayer is
paid to transmit foreign-originating communications
from space or international water to the United States.
Thus, under paragraph (h)(3)(ii)(B) of this section, T

495

derives income from international communications.
If, based on all the facts and circumstances, T could
reasonably trace and identify the endpoints, then T
would have to directly establish that each call originated in a foreign country. Assuming T is able to do
so, the rest of the analysis in this Example 7 remains
the same. Under paragraph (h)(3)(iii) of this section,
S derives income from U.S. communications activity
because S is paid to transmit the communications between two U.S. points.
Example 8. Indeterminate endpoints—prepaid
telephone calling cards—(i) Facts. S purchases
capacity from TC to transmit telephone calls. S sells
prepaid telephone calling cards that give customers
access to TC’s telephone lines for a certain number
of minutes. Assume that S cannot establish the endpoints of its customers’ telephone calls, even under
the reasonable method rule of paragraph (h)(3) of
this section.
(ii) Analysis. S derives communications income
as defined in paragraph (h)(2) of this section because
S makes capacity to transmit communications available to its customers. In this case, S cannot establish the two points between which the communications are transmitted. Therefore, S’s communications
income is U.S. source income, as provided by paragraph (f) of this section.
Example 9. Reasonable methods—minutes of use
data on long distance calling plans—(i) Facts. B provides both domestic and international long distance
services in a calling plan for a limited number of minutes for a set amount each month. Tracing and identifying the endpoints of each transmission is not possible or practical. B is, however, able to establish
that the calling plan generated $10,000 of revenue for
25,000 minutes based on reports derived from customer billing records. Based on minutes of use data
in these reports, B is able to establish that of the total
25,000 minutes, 60 percent or 15,000 minutes were
for U.S. long distance calls and 40 percent or 10,000
minutes were for international calls.
(ii) Analysis. B derives communications income
as defined in paragraph (h)(2) of this section. Based
on all the facts and circumstances, B can establish the
two points between which B is paid to transmit, and
bears the risk of transmitting, the communications using a reasonable method to establish the endpoints,
assuming that this method is consistently applied. In
this case, B can reasonably establish that 60 percent
of the income derived from the long distance calling
plan is U.S. communications income and 40 percent
is international communications income based on the
minutes of use data derived from customer billing
records to establish the endpoints of the communications. If, based on all the facts and circumstances,
B could reasonably trace and identify the endpoints,
then B would have to directly identify the endpoints
between which B is paid to transmit the communications.
Example 10. Reasonable methods—system design—(i) Facts. D operates satellites which are
designed to transmit signals through two separate
ranges of signal frequencies (bands). Due to technological limitations, requirements, and practicalities,
one band is designed to only transmit signals within
the United States. The other band is designed to
transmit signals between foreign countries and the
United States. D cannot trace and identify the endpoints of each individual transmission. D does,

2007–7 I.R.B.

however, track the total transmission through each
band and the total income derived from transmitting
signals through each band.
(ii) Analysis. D derives communications income
as defined in paragraph (h)(2) of this section. Based
on all the facts and circumstances, D can establish
the two points between which D is paid to transmit, and bears the risk of transmitting, the communications using a reasonable method to establish endpoints, assuming that this method is consistently applied. In this case, D can reasonably establish that
income derived from transmissions through the first
band is U.S. communications income and income derived from transmissions through the second band is
international communications income based on the
design of the bands to establish the endpoints of the
communications.
Example 11. Reasonable methods—port locations—(i) Facts. X provides its customer, C, with a
virtual private network (VPN) so that C’s U.S. headquarter office can connect and communicate with offices in the United States, Country X, Country Y, and
Country Z. Assume that the VPN is only for communications with the U.S. headquarter office. X cannot
trace and identify the endpoints of each transmission.
C pays X a set amount each month for the entire service, regardless of the magnitude of the usage or the
geographic points between which C uses the service.
(ii) Analysis. X derives communications income
as defined in paragraph (h)(2) of this section. Based
on the facts and circumstances, X can establish the
two points between which X is paid to transmit, and
bears the risk of transmitting, the communications using a reasonable method to establish endpoints, assuming that this method is consistently applied. In
this case, X can reasonably establish that one-fourth
of the income derived from the VPN service is U.S.
communications income and three-fourths is international communications income based on the location
of the VPN ports to establish the endpoints of the
communications.
Example 12. Indeterminate endpoints—Internet
access—(i) Facts. B, a domestic corporation, is an
Internet service provider. B charges its customer, C,
a monthly lump sum for Internet access. C accesses
the Internet via a telephone call, initiated by the modem of C’s personal computer, to one of B’s control
centers, which serves as C’s portal to the Internet. B
transmits data sent by C from B’s control center in
France to a recipient in England, over the Internet.
B does not maintain records as to the beginning and
endpoints of the transmission.
(ii) Analysis. B derives communications income
as defined in paragraph (h)(2) of this section. The
source of B’s communications income is determined
under paragraph (f) of this section as income from
sources within the United States because B cannot
establish the two points between which it is paid to
transmit the communications.
Example 13. De minimis non-communications
activity—(i) Facts. The same facts as in Example 12.
Assume in addition that B replicates frequently requested sites on B’s own servers, solely to speed up
response time. Assume that B’s replication of frequently requested sites would be considered a de minimis non-communications activity under this section.
(ii) Analysis. On these facts, because B’s replication of frequently requested sites would be considered a de minimis non-communications activity, B is

2007–7 I.R.B.

not required to treat the replication activity as a separate non-communications activity transaction under
paragraph (h)(1) of this section. B derives communications income under paragraph (h)(2) of this section.
The character and source of B’s communications income are determined by demonstrating the points between which B is paid to transmit the communications, under paragraph (h)(3)(i) of this section.
Example 14. Income derived from communications and non-communications activity—bundled
services—(i) Facts. A, a domestic corporation, offers customers local and long distance phone service,
video, and Internet services. Customers pay a flat
monthly fee plus 10 cents a minute for all long-distance calls, including international calls.
(ii) Analysis. Under paragraph (h)(1)(ii) of this
section, to the extent that A’s transaction with its customer consists in part of non-de minimis communications activity and in part of non-de minimis non-communications activity, each such part of the transaction
must be treated as a separate transaction. A’s gross income from the transaction is allocated to each such
communications activity transaction and non-communications activity transaction in accordance with
paragraph (h)(1)(ii) of this section. To the extent A
can establish that it derives international communications income as defined in paragraph (h)(3)(ii) of
this section, A would determine the source of such
income under paragraph (b)(1) of this section. If A
cannot establish the points between which it is paid to
transmit communications, as required by paragraph
(h)(3)(i) of this section, A’s communications income
is from sources within the United States, as provided
by paragraph (f) of this section.
Example 15. Income derived from communications and non-communications activity—(i) Facts. B,
a domestic corporation, is paid by D, a cable system operator in Foreign Country, to provide television
programs and to transmit the television programs to
Foreign Country. Using its own satellite transponder,
B transmits the television programs from the United
States to downlink facilities owned by D in Foreign
Country. D receives the transmission, unscrambles
the signals, and distributes the broadcast to D’s customers in Foreign Country. Assume that B’s provision of television programs is a non-de minimis
non-communications activity, and that B’s transmission of television programs is a non-de minimis communications activity.
(ii) Analysis. Under paragraph (h)(1)(ii) of
this section, B must treat its communications and
non-communications activities as separate transactions. B’s gross income is allocated to each such
separate communications and non-communications
activity transaction in accordance with paragraph
(h)(1)(ii) of this section. Income derived by B
from the transmission of television programs to D’s
Foreign Country downlink facility is international
communications income as defined in paragraph
(h)(3)(ii) of this section because B is paid to transmit
communications from the United States to a foreign
country.
Example 16. Income derived from foreign communications activity—(i) Facts. S provides satellite
capacity to B, a broadcaster located in Australia. B
beams programming from Australia to the satellite.
S’s satellite picks the communications up in space
and beams the programming over a footprint covering Southeast Asia.

496

(ii) Analysis. S derives communications income
as defined in paragraph (h)(2) of this section. S’s income is characterized as foreign communications income under paragraph (h)(3)(iv) of this section because S picks up the communication in space, and
beams it to a footprint entirely covering a foreign
area. Under paragraph (d) of this section, S’s foreign
communications income is from sources without the
United States. If S were beaming the programming
over a satellite footprint that covered area both in the
United States and outside the United States, S would
be required to allocate the income derived from the
different types of communications activity.

(k) Reporting and documentation requirements—(1) In general. A taxpayer
making an allocation of gross income
under paragraph (b)(2)(iii), (b)(2)(iv), or
(h)(1)(ii) of this section must satisfy the
requirements in paragraphs (k)(2), (3), and
(4) of this section.
(2) Required documentation. In all
cases, a taxpayer must prepare and maintain documentation in existence when its
return is filed regarding the allocation of
gross income, and allocation and apportionment of expenses, losses, and other
deductions, the methodologies used, and
the circumstances justifying use of those
methodologies. The taxpayer must make
available such documentation within 30
days upon request.
(3) Access to software. If the taxpayer
or any third party used any computer
software, within the meaning of section
7612(d), to allocate gross income, or to
allocate or apportion expenses, losses, and
other deductions, the taxpayer must make
available upon request—
(i) Any computer software executable
code, within the meaning of section
7612(d), used for such purposes, including
an executable copy of the version of the
software used in the preparation of the
taxpayer’s return (including any plug-ins,
supplements, etc.) and a copy of all related
electronic data files. Thus, if software subsequently is upgraded or supplemented,
a separate executable copy of the version
used in preparing the taxpayer’s return
must be retained;
(ii) Any related computer software
source code, within the meaning of section 7612(d), acquired or developed by the
taxpayer or a related person, or primarily
for internal use by the taxpayer or such
person rather than for commercial distribution; and
(iii) In the case of any spreadsheet software or similar software, any formulae or
links to supporting worksheets.

February 12, 2007

(4) Use of allocation methodology.
In general, when a taxpayer allocates
gross income under paragraph (b)(2)(iii),
(b)(2)(iv), or (h)(1)(ii) of this section, it
does so by making the allocation on a
timely filed original return (including extensions). However, a taxpayer will be
permitted to make changes to such allocations made on its original return with
respect to any taxable year for which the
statute of limitations has not closed as
follows:
(i) In the case of a taxpayer that has
made a change to such allocations prior
to the opening conference for the audit of
the taxable year to which the allocation relates or who makes such a change within
90 days of such opening conference, if the
IRS issues a written information document
request asking the taxpayer to provide the
documents and such other information described in paragraphs (k)(2) and (3) of this
section with respect to the changed allocations and the taxpayer complies with such
request within 30 days of the request, then
the IRS will complete its examination, if

any, with respect to the allocations for that
year as part of the current examination cycle. If the taxpayer does not provide the
documents and information described in
paragraphs (k)(2) and (3) of this section
within 30 days of the request, then the procedures described in paragraph (k)(4)(ii)
of this section shall apply.
(ii) If the taxpayer changes such allocations more than 90 days after the opening conference for the audit of the taxable year to which the allocations relate
or the taxpayer does not provide the documents and information with respect to the
changed allocations as requested in accordance with paragraphs (k)(2) and (3) of
this section, then the IRS will, in a separate cycle, determine whether an examination of the taxpayer’s allocations is warranted and complete any such examination. The separate cycle will be worked as
resources are available and may not have
the same estimated completion date as the
other issues under examination for the taxable year. The IRS may ask the taxpayer to
extend the statute of limitations on assess-

ment and collection for the taxable year
to permit examination of the taxpayer’s
method of allocation, including an extension limited, where appropriate, to the taxpayer’s method of allocation.
(l) Effective date. This section applies
to taxable years beginning on or after December 27, 2006.
PART 602—OMB CONTROL
NUMBERS UNDER THE PAPERWORK
REDUCTION ACT
Par. 4. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 5. In §602.101 paragraph (b) is
amended by adding an entry to the table in
numerical order, §§1.863–8 and 1.863–9,
to read as follows:
§602.101 OMB Control numbers.
*****
(b) * * *

CFR part or section where
identified and described

Current OMB
control No.

*****
1.863–8
1.863–9

...........................................................
...........................................................

1545–1718
1545–1718

*****
Kevin M. Brown,
Acting Deputy Commissioner for
Services and Enforcement.
Approved December 21, 2006.
Eric Solomon,
Acting Secretary
of the Treasury (Tax Policy).
(Filed by the Office of the Federal Register on December 26,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 27, 2006, 71 F.R. 77594)

Section 6664.—Definitions
and Special Rules
26 CFR 1.6664–1: Accuracy-related and fraud
penalties; definitions, effective date and special
rules.

T.D. 9309
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 1
Qualified Amended Returns
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.

February 12, 2007

497

SUMMARY: This document contains final regulations that state the rules relating
to qualified amended returns by providing
circumstances that end the period within
which a taxpayer may file an amended return that constitutes a qualified amended
return. The IRS uses qualified amended
returns to determine whether an underpayment exists that is potentially subject to
the accuracy-related penalty on underpayments. Among other things, these final
regulations provide that the period for filing a qualified amended return is terminated once the IRS has served a John Doe
summons on a third party with respect to
the taxpayer’s tax liability. In addition,
for taxpayers who have claimed tax benefits from undisclosed listed transactions,
the regulations provide that the period for
filing a qualified amended return is terminated once the IRS requests information
related to the transaction that is required

2007–7 I.R.B.

to be included on a list under section 6112
from any person who made a tax statement
to or for the benefit of the taxpayer, or any
person who gave material aid, assistance,
or advice to the taxpayer. The regulations
also provide that the date on which published guidance is issued announcing a settlement initiative for a listed transaction in
which penalties, in whole or in part, are
compromised or waived is an additional
date by which a taxpayer must file a qualified amended return.
DATES: Effective Date: These regulations
are effective January 9, 2007.
Applicability Dates: For dates of applicability, see §1.6664–1(b)(3).
FOR
FURTHER
INFORMATION
CONTACT:
Laura
Urich
Daly,
202–622–4940 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains Final Regulations under 26 CFR part 1 relating to
qualified amended returns. Temporary
regulations (T.D. 9186, 2005–1 C.B. 790)
relating to qualified amended returns were
published in the Federal Register (70 FR
10037) on March 2, 2005. A notice of
proposed rulemaking (REG–122847–04,
2005–1 C.B. 804) cross-referencing the
temporary regulations was published in
the Federal Register (70 FR 10062) for
the same day. A correction (70 FR 36345)
and a correcting amendment (published
as Announcement 2005–53, 2005–2 C.B.
258 [70 FR 36344]) to the regulations
were published in the Federal Register
on June 23, 2005, and a correction to the
correction was published in the Federal
Register (70 FR 43635) on July 28, 2005.
No written or electronic comments were
received from the public in response to
the notice of proposed rulemaking and
no public hearing was requested or held.
The proposed regulations are adopted as
amended by this Treasury decision, and
the corresponding temporary regulations
are removed. The revisions are discussed
below.

2007–7 I.R.B.

Explanation of Revisions
The final regulations clarify the applicability date of the regulations. Under
the Special Rules section, the sentence in
the proposed and temporary regulations regarding disclosure pursuant to §1.6011–4
was removed in these final regulations because it could be incorrectly interpreted
to provide relief from the section 6707A
penalty. These final regulations are not intended to have any effect upon the applicability of the section 6707A penalty. In
addition, examples one, four, five, six, and
seven in the proposed and temporary regulations were further clarified. Finally, example eight in the proposed and temporary
regulations was removed as unnecessary.
No other substantive revisions were
made to the proposed and temporary regulations or the corrections to those regulations. These final regulations do, however,
include revisions to the table of contents
to the regulations under section 6664.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It has also been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations, and because
the regulation does not impose a collection
of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f)
of the Internal Revenue Code, the notice of
proposed rulemaking preceding this regulation was submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its impact on
small businesses.
Drafting Information
The principal author of this regulation is
Laura Urich Daly, Office of the Associate
Chief Counsel (Procedure & Administration), Administrative Provisions and Judicial Practice Division.
*****

498

Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.6664–0 is amended by
adding entries for §§1.6664–1(b)(3) and
1.6664–2(c)(3)(i), (ii) and (5), and revising
the entry for §1.6664–2(c)(4) to read as
follows:
§1.6664–0 Table of contents.
*****
§1.6664–1 Accuracy-related and fraud
penalties; definitions, effective date and
special rules.
*****
(b) * * *
(3) Qualified amended returns.
§1.6664–2 Underpayment.
*****
(c) * * *
(3) * * *
(i) General rule.
(ii) Undisclosed listed transactions.
(4) Special rules.
(5) Examples.
*****
Par. 3. Section 1.6664–1 is amended
by:
1. Revising the section heading.
2. Adding paragraph (b)(3).
The revision and addition read as follows:
§1.6664–1 Accuracy-related and fraud
penalties; definitions, effective date and
special rules.
*****
(b) * * *
(3) Qualified amended returns. Sections 1.6664–2(c)(1), (c)(2), (c)(3)(i)(A),
(c)(3)(i)(B), (c)(3)(i)(C), (c)(3)(i)(D)(2),
(c)(3)(i)(E), and (c)(4) are applicable for
amended returns and requests for administrative adjustment filed on or after March
2, 2005. Sections 1.6664–2(c)(3)(i)(D)(1)
and (c)(3)(ii)(B) and (C) are applicable

February 12, 2007

for amended returns and requests for
administrative adjustment filed on or after April 30, 2004. The applicability
date for §1.6664–2(c)(3)(ii)(A) varies
depending upon which event occurs under §1.6664–2(c)(3)(i). For purposes of
§1.6664–2(c)(3)(ii)(A), the date described
in §1.6664–2(c)(3)(i)(D)(1) is applicable for amended returns and requests
for administrative adjustment filed on
or after April 30, 2004. For purposes
of §1.6664–2(c)(3)(ii)(A), the dates described in §1.6664–2(c)(3)(i)(A), (B), (C),
(D)(2), and (E) are applicable for amended
returns and requests for administrative adjustment filed on or after March 2, 2005.
Section 1.6664–2(c)(1) through (c)(3),
as contained in 26 CFR part 1 revised
as of April 1, 2004 and as modified by
Notice 2004–38, 2004–1 C.B. 949, applies with respect to returns and requests
for administrative adjustment filed on or
after April 30, 2004 and before March 2,
2005. Section 1.6664–2(c)(1) through (3),
as contained in 26 CFR part 1 revised as
of April 30, 2004, applies with respect
to returns and requests for administrative
adjustment filed before April 30, 2004.
§1.6664–1T [Removed]
Par. 4. Section 1.6664–1T is removed.
Par. 5. Section 1.6664–2(c) is revised
to read as follows:
§1.6664–2 Underpayment.
*****
(c) Amount shown as the tax by the taxpayer on his return—(1) Defined. For purposes of paragraph (a) of this section, the
amount shown as the tax by the taxpayer
on his return is the tax liability shown
by the taxpayer on his return, determined
without regard to the items listed in paragraphs (b)(1), (2), and (3) of this section,
except that it is reduced by the excess of—
(i) The amounts shown by the taxpayer
on his return as credits for tax withheld under section 31 (relating to tax withheld on
wages) and section 33 (relating to tax withheld at source on nonresident aliens and
foreign corporations), as payments of estimated tax, or as any other payments made
by the taxpayer with respect to a taxable
year before filing the return for such taxable year, over
(ii) The amounts actually withheld, actually paid as estimated tax, or actually

February 12, 2007

paid with respect to a taxable year before
the return is filed for such taxable year.
(2) Effect of qualified amended return.
The amount shown as the tax by the taxpayer on his return includes an amount
shown as additional tax on a qualified
amended return (as defined in paragraph
(c)(3) of this section), except that such
amount is not included if it relates to a
fraudulent position on the original return.
(3) Qualified amended return defined—(i) General rule.
A qualified
amended return is an amended return,
or a timely request for an administrative
adjustment under section 6227, filed after
the due date of the return for the taxable
year (determined with regard to extensions
of time to file) and before the earliest of—
(A) The date the taxpayer is first contacted by the Internal Revenue Service
(IRS) concerning any examination (including a criminal investigation) with
respect to the return;
(B) The date any person is first contacted by the IRS concerning an examination of that person under section 6700 (relating to the penalty for promoting abusive
tax shelters) for an activity with respect to
which the taxpayer claimed any tax benefit
on the return directly or indirectly through
the entity, plan or arrangement described
in section 6700(a)(1)(A);
(C) In the case of a pass-through item
(as defined in §1.6662–4(f)(5)), the date
the pass-through entity (as defined in
§1.6662–4(f)(5)) is first contacted by the
IRS in connection with an examination of
the return to which the pass-through item
relates;
(D)(1) The date on which the IRS serves
a summons described in section 7609(f)
relating to the tax liability of a person,
group, or class that includes the taxpayer
(or pass-through entity of which the taxpayer is a partner, shareholder, beneficiary,
or holder of a residual interest in a REMIC)
with respect to an activity for which the
taxpayer claimed any tax benefit on the return directly or indirectly.
(2) The rule in paragraph (c)(3)(i)(D)(1)
of this section applies to any return on
which the taxpayer claimed a direct or indirect tax benefit from the type of activity
that is the subject of the summons, regardless of whether the summons seeks the production of information for the taxable period covered by such return; and

499

(E) The date on which the Commissioner announces by revenue ruling, revenue procedure, notice, or announcement,
to be published in the Internal Revenue
Bulletin (see §601.601(d)(2) of this chapter), a settlement initiative to compromise
or waive penalties, in whole or in part, with
respect to a listed transaction. This rule applies only to a taxpayer who participated
in the listed transaction and for the taxable year(s) in which the taxpayer claimed
any direct or indirect tax benefits from the
listed transaction. The Commissioner may
waive the requirements of this paragraph
or identify a later date by which a taxpayer
who participated in the listed transaction
must file a qualified amended return in the
published guidance announcing the listed
transaction settlement initiative.
(ii) Undisclosed listed transactions. An
undisclosed listed transaction is a transaction that is the same as, or substantially
similar to, a listed transaction within the
meaning of §1.6011–4(b)(2) (regardless
of whether §1.6011–4 requires the taxpayer to disclose the transaction) and was
neither previously disclosed by the taxpayer within the meaning of §1.6011–4
or §1.6011–4T, nor disclosed under Announcement 2002–2, 2002–1 C.B. 304,
(see §601.601(d)(2)(ii) of this chapter)
by the deadline therein. In the case of an
undisclosed listed transaction for which
a taxpayer claims any direct or indirect
tax benefits on its return (regardless of
whether the transaction was a listed transaction at the time the return was filed), an
amended return or request for administrative adjustment under section 6227 will
not be a qualified amended return if filed
on or after the earliest of–
(A) The dates described in paragraph(c)(3)(i) of this section;
(B) The date on which the IRS first
contacts any person regarding an examination of that person’s liability under section
6707(a) with respect to the undisclosed
listed transaction of the taxpayer; or
(C) The date on which the IRS requests,
from any person who made a tax statement to or for the benefit of the taxpayer
or from any person who gave the taxpayer
material aid, assistance, or advice as described in section 6111(b)(1)(A)(i) with respect to the taxpayer, the information required to be included on a list under section 6112 relating to a transaction that was
the same as, or substantially similar to, the

2007–7 I.R.B.

undisclosed listed transaction, regardless
of whether the taxpayer’s information is
required to be included on that list.
(4) Special rules.
(i) A qualified
amended return includes an amended
return that is filed to disclose information
pursuant to §1.6662–3(c) or §1.6662–4(e)
and (f) even though it does not report any
additional tax liability. See §1.6662–3(c),
§1.6662–4(f), and §1.6664–4(c) for rules
relating to adequate disclosure.
(ii) The Commissioner may by revenue
procedure prescribe the manner in which
the rules of paragraph (c) of this section
regarding qualified amended returns apply
to particular classes of taxpayers.
(5) Examples. The following examples illustrate the provisions of paragraphs
(c)(3) and (c)(4) of this section:
Example 1. T, an individual taxpayer, claimed
tax benefits on its 2002 Federal income tax return
from a transaction that is substantially similar to the
transaction identified as a listed transaction in Notice 2002–65, 2002–2 C.B. 690 (Partnership Entity
Straddle Tax Shelter). T did not disclose his participation in this transaction on a Form 8886, “Reportable Transaction Disclosure Statement,” as required by §1.6011–4. On June 30, 2004, the IRS requested from P, T’s material advisor, an investor list
required to be maintained under section 6112. The
section 6112 request, however, related to the type
of transaction described in Notice 2003–81, 2003–2
C.B. 1223 (Tax Avoidance Using Offsetting Foreign
Currency Option Contracts). T did not participate in
(within the meaning of §1.6011–4(c)) a transaction
described in Notice 2003–81. T may file a qualified
amended return relating to the transaction described
in Notice 2002–65 because T did not claim a tax benefit with respect to the listed transaction described in
Notice 2003–81, which is the subject of the section
6112 request.
Example 2. The facts are the same as in Example
1, except that T’s 2002 Federal income tax return reflected T’s participation in the transaction described
in Notice 2003–81. As of June 30, 2004, T may not
file a qualified amended return for the 2002 tax year.
Example 3. (i) Corporation X claimed tax benefits from a transaction on its 2002 Federal income tax
return. In October 2004, the IRS and Treasury De-

2007–7 I.R.B.

partment identified the transaction as a listed transaction. In December 2004, the IRS contacted P concerning an examination of P’s liability under section
6707(a) (as in effect prior to the amendment to section
6707 by section 816 of the American Jobs Creation
Act of 2004 (the Jobs Act), Public Law 108–357 (118
Stat. 1418)). P is the organizer of a section 6111 tax
shelter (as in effect prior to the amendment to section
6111 by section 815 of the Jobs Act) who provided
representations to X regarding tax benefits from the
transaction, and the IRS has contacted P about the
failure to register that transaction. Three days later,
X filed an amended return.
(ii) X’s amended return is not a qualified amended
return, because X did not disclose the transaction before the IRS contacted P. X’s amended return would
have been a qualified amended return if it was submitted prior to the date on which the IRS contacted P.
Example 4. The facts are the same as in Example 3 except that, instead of contacting P concerning
an examination under section 6707(a), in December
2004, the IRS served P with a John Doe summons
described in section 7609(f) relating to the tax liability of participants in the type of transaction for which
X claimed tax benefits on its return. X cannot file
a qualified amended return after the John Doe summons has been served regardless of when, or whether,
the transaction becomes a listed transaction.
Example 5. On November 30, 2003, the IRS
served a John Doe summons described in section
7609(f) on Corporation Y, a credit card company.
The summons requested the identity of, and information concerning, United States taxpayers who, during
the taxable years 2001 and 2002, had signature
authority over Corporation Y’s credit cards issued
by, through, or on behalf of certain offshore financial institutions. Corporation Y complied with the
summons, and identified, among others, Taxpayer
B. On May 31, 2004, before the IRS first contacted
Taxpayer B concerning an examination of Taxpayer
B’s Federal income tax return for the taxable year
2002, Taxpayer B filed an amended return for that
taxable year, that showed an increase in Taxpayer
B’s Federal income tax liability. Under paragraph
(c)(3)(i)(D) of this section, the amended return is
not a qualified amended return because it was not
filed before the John Doe summons was served on
Corporation Y.
Example 6. The facts are the same as in Example 5. Taxpayer B continued to maintain the offshore
credit card account through 2003 and filed an original
tax return for the 2003 taxable year claiming tax benefits attributable to the existence of the account. On

500

March 21, 2005, Taxpayer B filed an amended return
for the taxable year 2003, that showed an increase
in Taxpayer B’s Federal income tax liability. Under
paragraph (c)(3)(i)(D) of this section, the amended return is not a qualified amended return because it was
not filed before the John Doe summons for 2001 and
2002 was served on Corporation Y, and the return reflects benefits from the type of activity that is the subject of the John Doe summons.
Example 7. (i) On November 30, 2003, the IRS
served a John Doe summons described in section
7609(f) on Corporation Y, a credit card company. The
summons requested the identity of, and information
concerning, United States taxpayers who, during the
taxable years 2001 and 2002, had signature authority
over Corporation Y’s credit cards issued by, through,
or on behalf of certain offshore financial institutions.
Taxpayer C did not have signature authority over any
of Corporation Y’s credit cards during either 2001
or 2002 and, therefore, was not a person described in
the John Doe summons.
(ii) In 2003, Taxpayer C first acquired signature
authority over a Corporation Y credit card issued by
an offshore financial institution. Because Taxpayer C
did not have signature authority during 2001 or 2002
over a Corporation Y credit card issued by an offshore
financial institution, and was therefore not covered
by the John Doe summons served on November 30,
2003, Taxpayer C’s ability to file a qualified amended
return for the 2003 taxable year is not limited by paragraph (c)(3)(i)(D) of this section.

*****
§1.6664–2T [Removed]
Par. 6. Section 1.6664–2T is removed.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 21, 2006.
Eric Solomon,
Assistant Secretary of the
Treasury (Tax Policy).
(Filed by the Office of the Federal Register on January 8,
2007, 8:45 a.m., and published in the issue of the Federal
Register for January 9, 2007, 72 F.R. 902)

February 12, 2007

Part III. Administrative, Procedural, and Miscellaneous
Description of Benefits
Permitted to be Provided
in Qualified Defined Benefit
Plans
Notice 2007–14
I. PURPOSE
The Treasury Department and the Internal Revenue Service are considering guidance under §§ 401(a) and 411 of the Internal Revenue Code to provide clarification
regarding the types of benefits that are permitted to be provided in a qualified defined
benefit plan. The guidance under consideration would initially be issued in the form
of proposed regulations. This notice describes the guidance under consideration
and requests comments on the issues raised
in Part III of this notice.
II. BACKGROUND
Section 401(a) provides rules for
qualified pension plans, profit-sharing
plans, and stock bonus plans. Section
1.401–1(a)(2) of the Income Tax Regulations provides that a qualified pension plan
(i.e., a qualified defined benefit plan or
money purchase pension plan) is a definite
written program and arrangement which
is communicated to the employees and
which is established and maintained by
an employer to provide for the livelihood
of the employees or their beneficiaries
after the retirement of such employees
through the payment of benefits. Under
§ 1.401–1(b)(1)(i), a qualified pension
plan must be established and maintained
by an employer primarily to provide systematically for the payment of definitely
determinable benefits for employees over
a period of years, usually for life, after
retirement.1
Retirement benefits in a qualified defined benefit plan usually are measured by,
and based on, factors such as years of service and compensation. A qualified defined benefit plan (or other qualified pension plan) also may provide certain non-retirement benefits, such as disability ben1

efits and incidental death benefits. Under § 1.401–1(b)(1)(i), a qualified pension
plan is not permitted to provide for the payment of benefits not customarily included
in a pension plan, such as layoff benefits.2
Section 411(d)(6)(A) generally provides that a plan is treated as not satisfying the requirements of § 411 if the
accrued benefit of a participant is decreased by a plan amendment. Section
411(d)(6)(B) provides that a plan amendment that has the effect of eliminating or
reducing an early retirement benefit or a
retirement-type subsidy, or eliminating an
optional form of benefit, with respect to
benefits attributable to service before the
amendment is treated as impermissibly
reducing accrued benefits. For a retirement-type subsidy, this protection applies
only with respect to an employee who
satisfies the preamendment conditions
for the subsidy (either before or after the
amendment).
Not all types of benefits permitted to
be provided in a qualified defined benefit
plan are protected from cutback under
§ 411(d)(6). In this respect, the 1984 Senate Finance Committee Report regarding
section 301(a) of the Retirement Equity
Act of 1984, Public Law 98–397 (98 Stat.
1426) (REA), which extended § 411(d)(6)
anti-cutback protection to optional forms
of benefit, early retirement benefits, and
retirement-type subsidies, provides, in
part:
The bill provides that the term “retirement-type subsidy” is to be defined by
Treasury regulations. The committee
intends that under these regulations,
a subsidy that continues after retirement is generally to be considered a
retirement-type subsidy. The committee expects, however, that a qualified
disability benefit, a medical benefit,
a social security supplement, a death
benefit (including life insurance), or
a plant shutdown benefit (that does
not continue after retirement age) will
not be considered a retirement-type
subsidy. The committee expects that
Treasury regulations will prevent the
recharacterization of retirement-type

benefits as benefits that are not protected by the provision.
S. Rep. No. 98–575, at 30.
Sections 1.411(d)–3 and 1.411(d)–4,
which were amended on August 12,
2005 (T.D. 9219, 2005–2 C.B. 538 [70
FR 47109]), provide rules relating to
§ 411(d)(6) protected benefits.
Section 1.411(d)–4, Q&A–1(d), specifies
that certain benefits, including ancillary
benefits, are not protected from reduction or elimination under § 411(d)(6)(B).
Section 1.411(d)–3 also includes rules
relating to ancillary benefits.
Section 1.411(d)–3(b)(3)(i) provides that
§ 411(d)(6) does not provide protection
for benefits that are ancillary benefits,
other rights and features, or any other benefits that are not described in § 411(d)(6).
Section 1.411(d)–3(g)(2) defines the
term “ancillary benefit” as:
(1) a social security supplement under a
defined benefit plan (other than a QSUPP
as defined in § 1.401(a)(4)–12));
(2) a benefit payable under a defined
benefit plan in the event of disability (to
the extent that the benefit exceeds the
benefit otherwise payable), but only if
the total benefit payable in the event of
disability does not exceed the maximum
qualified disability benefit, as defined in
§ 411(a)(9);
(3) a life insurance benefit;
(4) a medical benefit described in
§ 401(h);
(5) a death benefit under a defined benefit plan other than a death benefit which
is part of an optional form of benefit; or
(6) a plant shutdown benefit or other
similar benefit in a defined benefit plan
that does not continue past retirement age
and does not affect the payment of the accrued benefit, but only to the extent that
such plant shutdown benefit or other similar benefit is permitted in a qualified pension plan.
Section 1.411(d)–3(g) defines other
key terms relating to the anti-cutback
rules, including “retirement-type subsidy”
and “retirement-type benefit.” Section
1.411(d)–3(g)(6)(iv) defines the term “retirement-type subsidy” as the excess, if

The regulations under § 401(a) provide separate rules for profit-sharing plans and stock bonus plans. See § 1.401–1(a)(2) and (b)(1)(ii) and (iii).

2

Section 1.401–1(b)(1)(i) specifies that other benefits not customarily included in a pension plan include benefits for sickness, accident, hospitalization, or medical expenses (except medical
benefits described in § 401(h) as defined in § 1.401–14(a)).

February 12, 2007

501

2007–7 I.R.B.

any, of the actuarial present value of a
retirement-type benefit, over the actuarial present value of the accrued benefit
commencing at normal retirement age or
at actual commencement date, if later,
with both such actuarial present values
determined as of the date the retirement-type benefit commences. Section
1.411(d)–3(g)(6)(iii) defines the term “retirement-type benefit” as the payment
of a distribution alternative with respect
to an accrued benefit or the payment of
any other benefit under a defined benefit
plan (including a QSUPP as defined in
§ 1.401(a)(4)–12) that is permitted to be
in a qualified pension plan, continues after
retirement, and is not an ancillary benefit.
Under § 1.411(d)–4, Q&A–6, a plan
may limit the availability of § 411(d)(6)
protected benefits to employees who meet
objective conditions that are ascertainable, specifically set forth in the plan,
and not subject to employer discretion.3
Q&A–6 provides examples of permissible
objective conditions. Section 1.411(d)–4,
Q&A–7 generally provides that a plan
is not permitted to be amended to add
objective conditions with respect to a
§ 411(d)(6) protected benefit that has
already accrued. However, a plan amendment does not violate § 411(d)(6) to the
extent that it applies to benefits that accrue after the amendment. Therefore, an
amendment adding objective conditions
to a § 411(d)(6) protected benefit is permitted with respect to benefits that accrue
after the applicable amendment date.4
Section 411(a) provides that a qualified
plan must provide that an employee’s right
to his normal retirement benefit is nonforfeitable upon the attainment of normal retirement age, and also provides vesting requirements with respect to an employee’s
accrued benefit. Under § 411(a)(9), the
term “normal retirement benefit” is defined as the greater of the early retirement
benefit under the plan or the benefit under
the plan commencing at normal retirement
age. Section 411(b)(1) provides anti-backloading rules governing the accrual of benefits under a defined benefit plan, to ensure
that the minimum vesting rules of § 411(a)

are not circumvented through a plan formula under which accruals are inappropriately deferred.
Section 905(b) of the Pension Protection Act of 2006 (“PPA ’06), enacted on
August 17, 2006, added § 401(a)(36),
which provides that, for plan years beginning after December 31, 2006, a pension
plan will not fail to qualify under § 401(a)
solely because the plan provides that a
distribution may be made to an employee
who has attained age 62 and who is not
separated from employment at the time of
the distribution.
III. GUIDANCE UNDER
CONSIDERATION
Treasury and the Service have become
concerned that certain qualified defined
benefit plans may include nontraditional
benefits that are not subject to the protections of § 411 and other qualification rules
of § 401(a). Examples of the types of benefits for which this concern arises include:
(1) benefits that are payable only upon the
involuntary termination of an employee or
in other limited circumstances that are unrelated to retirement; and (2) benefits that
could exceed the amount of the accrued
benefit payable under the plan. If these
benefits are contingent on future events
that are not reasonably and reliably predictable on an actuarial basis, it is difficult
to determine compliance with the incidental benefit requirements.5 Moreover,
there may be a risk that, in effect, if the
contingent event on which the benefit is
conditioned occurs, such a benefit could
become a substantial or even the primary
benefit that plan participants expect to
receive. Such benefits also may not be the
types of benefits that have been customarily included in qualified pension plans.
Benefits payable only upon an employee’s
involuntary separation from service also
raise questions regarding whether the
availability of the benefits is based on
conditions that are within the employer’s
control, and whether such benefits circumvent the vesting and anti-backloading
protections of § 411, as well as the defi-

nitely determinable benefits requirement
of § 401(a). In addition, such benefits may
not be among the type of benefits that are
intended to receive the tax benefits generally applicable to qualified plan benefits.
Treasury and the Service believe that
guidance to clarify the application of the
requirements of §§ 401(a) and 411 to these
types of benefits may be appropriate in
light of the regulations under § 411(d)(6)
that were issued in 2005. The § 1.411(d)–3
definitions of an ancillary benefit, a retirement-type benefit, and a retirement-type
subsidy depend, in part, on whether a benefit is permitted to be provided in a qualified
defined benefit plan. However, current
guidance does not directly address whether
certain benefits, such as benefits which
are similar to plant shutdown benefits that
do not continue after retirement or benefits payable solely upon involuntary separation, are permitted to be provided in a
qualified pension plan. Thus, Treasury and
the Service are considering whether to propose guidance that would clarify the types
of benefits that are permitted to be provided in qualified defined benefit plans.
The guidance under consideration may
include the following:
A. Permitted benefits. The guidance
might provide that, in addition to the
payment of retirement-type benefits (including retirement-type subsidies), the
only benefit payments that are permitted
to be provided under a qualified defined
benefit plan are the payment of the ancillary benefits specifically identified in
§ 1.411(d)–3(g)(2).
B. Plant shutdown benefits and similar ancillary benefits. With respect to
a plant shutdown benefit, the guidance
might require that the benefit be payable
as a result of an objectively defined plant
shutdown event, such as an event that
requires notice under the Worker Adjustment and Retraining Notification Act of
1988 (WARN), 29 U.S.C. section 2102.
For benefits that are similar to plant shutdown benefits and that do not continue
past retirement age, the guidance might
set forth the extent to which there are any
such “similar benefits,” as described in

3

A plan provision that permits an employer to deny a participant a § 411(d)(6) protected benefit for which the participant is otherwise eligible through the exercise of discretion violates the
requirements of § 411(d)(6). See § 1.411(d)–4, Q&A–4. Similarly, pursuant to § 1.411(d)–4, Q&A–6(b), a plan cannot condition the availability of § 411(d)(6) protected benefits on objective
conditions that are within the employer’s discretion.

4

The term applicable amendment date means the later of the effective date of a plan amendment or the date the amendment is adopted. See § 1.411(d)–3(g)(4).

5

In the case of benefits which are contingent on events that are reasonably and reliably predictable on an actuarial basis (e.g., death), the probability that those contingencies will occur is
taken into account in determining whether retirement benefits are the primary benefit under the plan (i.e., whether nonretirement benefits provided under the plan are merely incidental).

2007–7 I.R.B.

502

February 12, 2007

§ 1.411(d)–3(g)(2)(vi), that are permitted
to be provided in a qualified defined benefit plan.
The guidance also might clarify that an
ancillary plant shutdown benefit, as described in § 1.411(d)–3(g)(2)(vi), is permitted to be provided in a qualified defined
benefit plan only if the amount payable in
any year prior to retirement does not exceed the amount payable annually under
the participant’s accrued benefit expressed
as an annual benefit commencing at normal retirement age and that the benefit may
not be paid in a shorter or longer alternative form of payment. Under such a rule,
for example, if a plan participant who is
below the plan’s normal retirement age of
65 had an accrued benefit payable as a life
annuity at age 65 of $1,000 a month, the
plan would be permitted to provide an ancillary plant shutdown benefit payable as
a temporary annuity in an amount up to
$1,000 a month. In such a case, the ancillary plant shutdown benefit would be paid
to the plan participant up until the annuity starting date for payment of the participant’s accrued benefit under the plan (e.g.,
age 65 or some earlier age when the participant commences payment of the participant’s accrued benefit in the form of
a qualified joint and survivor annuity or
elects an alternative optional form). This
illustration of an ancillary plant shutdown
benefit is different from a subsidized early
retirement benefit payable on the occurrence of a plant shutdown.6
C. Contingent accruals and early retirement benefits. The guidance might also
provide that, except for the payment of
the accrued benefit in an optional form, a
retirement-type benefit (and thus a retirement-type subsidy) is permitted to be provided in a qualified defined benefit plan
only if the amount of the benefit is no
greater than the unreduced accrued benefit provided under the plan. The guidance
might also clarify the extent to which additional accruals are permitted, taking into
account the backloading and vesting rules
under § 411, if those accruals arise by reason of an event other than attainment of a
specified age, performance of service, receipt or derivation of compensation, or the
occurrence of death or disability (e.g., if
those additional accruals arise upon invol-

untary termination of employment). The
guidance also might clarify the extent to
which early retirement benefits (i.e., benefits payable before normal retirement age,
but after severance from employment, that
are not ancillary benefits) payable as a result of a plant shutdown event, an involuntary termination of employment, or another event similarly under the control of
the employer are permitted to be provided
in a qualified defined benefit plan.
IV. EFFECTIVE DATE
It is anticipated that the guidance under consideration in this notice would be
prospective. No implication is intended
that the consideration of these issues affects the application of current law.

ernment Entities) and Kathleen Herrmann
of the Employee Plans, Tax Exempt and
Government Entities Division. For further information regarding this notice, contact Ms. Kinard at (202) 622–6060 or
Mr. Rutledge at (202) 622–6090 (not tollfree numbers).

Closing Agreements for
Certain Life Insurance and
Annuity Contracts that Fail
to Meet the Requirements
of Section 817(h), 7702 or
7702A (As Applicable)
Notice 2007–15
SECTION 1. PURPOSE

V. COMMENTS REQUESTED
Comments regarding the guidance under consideration described in Part III of
this notice are requested. Of particular interest to Treasury and the Service are comments regarding the extent to which qualified defined benefit plans currently offer
the types of benefits described in Part III
of this notice, and comments regarding any
appropriate transition rules that should be
included in the guidance.
Written comments should be submitted
by May 13, 2007. Send submissions to
CC:PA:LPD:PR, (Notice 2007–14), Room
5203, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washington, D.C. 20044. Comments may also
be hand delivered Monday through Friday between the hours of 8:30 a.m. and
4:00 p.m. to: Internal Revenue Service, CC:PA:LPD:PR, (Notice 2007–14),
Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W.,
Washington, DC. Alternatively, comments may be submitted via the Internet
at [email protected]
(Notice 2007–14). All comments will be
available for public inspection.
DRAFTING INFORMATION
The principal authors of this notice are
Pamela R. Kinard and Preston Rutledge of
the Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and Gov-

This notice requests comments on how
the Internal Revenue Service (the Service)
might improve the procedures for obtaining closing agreements to correct inadvertent failures of life insurance or annuity contracts to satisfy the requirements of
§§ 817(h), 7702 or 7702A of the Internal
Revenue Code (Code), as applicable. This
notice also provides four draft model closing agreements for comment.
SECTION 2. BACKGROUND
.01 Qualification as a life insurance
contract under § 7702. (1) Section 7702
defines the term “life insurance contract”
for all purposes of the Code. Section
7702(a) provides that a “life insurance
contract” is any contract that is a life insurance contract under the applicable law, but
only if such contract either (1) meets the
cash value accumulation test of § 7702(b),
or (2) meets the guideline premium requirements of § 7702(c) and falls within
the cash value corridor of § 7702(d). (For
flexible premium life insurance contracts
issued before January 1, 1985, § 101(f)(1)
provides that any amount paid by reason
of death of the insured under a flexible
premium life insurance contract issued
before January 1, 1985, is excluded from
gross income only if, under the contract,
the sum of the premiums does not exceed
the guideline premium limitation as of
such time.)

6

An example of a subsidized early retirement benefit is the unreduced early retirement benefit described in Bellas v. CBS, Inc., 221 F.3d 517 (3d. Cir. 2000), cert. denied, 531 U.S. 1104
(2001) (holding that an early retirement benefit that is more valuable than an actuarially reduced normal retirement benefit and that is payable on occurrence of an unpredictable contingent
event is a retirement-type subsidy, and therefore is protected under § 204(g) of the Employee Retirement Income Security Act of 1974).

February 12, 2007

503

2007–7 I.R.B.

(2) Charges for benefits that are qualified additional benefits (QABs) within the
meaning of § 7702(f)(5) are subject to the
expense charge rule of § 7702(C)(3)(B)(ii)
for purposes of determining whether a
contract satisfies the cash value accumulation test or the guideline premium
requirements, as applicable.
Section
7702(b)(2)(B); Rev. Rul. 2005–6, 2005–1
C.B. 471.
(3) Section 7702(f)(8) provides that if
a taxpayer establishes to the satisfaction
of the Secretary that the requirements of
§ 7702(a) were not met due to reasonable
error, and reasonable steps are being taken
to remedy that error, the Secretary may
waive such failure.
(4) Section 7702(g)(1)(A) provides that
if at any time a contract that is a life insurance contract under the applicable law
does not meet the definition of a life insurance contract under § 7702(a), the income on the contract for any taxable year
of the policyholder shall be treated as ordinary income received or accrued by the
policyholder during such year. Further,
§ 7702(g)(1)(C) provides that if, during
any taxable year of the policyholder, a contract that is a life insurance contract under the applicable law ceases to meet the
definition of life insurance contract under
§ 7702(a), the income on the contract for
all prior taxable years is treated as received
or accrued during the taxable year in which
such cessation occurs.
.02 Diversification requirement for
variable contracts. (1) Section 817(d)
defines the term “variable contract” to
mean a contract that (1) provides for the
allocation of all or part of the amounts
received under the contract to an account
that, pursuant to state law or regulation,
is segregated from the general asset accounts of the company, and (2) provides
for the payment of annuities, or is a life
insurance contract, or provides for funding
of insurance on retired lives. In the case
of an annuity contract or a contract that
provides funding of insurance on retired
lives, the amounts paid in or the amounts
paid out are required to reflect the investment return and the market value of the
segregated asset account. In the case of a
life insurance contract, the amount of the
death benefit (or the period of coverage)
must be adjusted on the basis of the investment return and the market value of
the segregated asset account.

2007–7 I.R.B.

(2) Section 817(h) provides that for purposes of §§ 72 and 7702(a), a variable contract (other than a pension plan contract)
that is otherwise described in § 817, and
that is based on a segregated asset account,
is not treated as an annuity, endowment, or
life insurance contract for any period (and
any subsequent period) for which the investments made by such account are not
adequately diversified.
(3) Section 1.817–5(a)(2) of the Income
Tax Regulations provides that the investments of a segregated asset account are
treated as satisfying the diversification requirements of § 1.817–5(b) for one or more
periods if (1) the issuer or holder of a variable contract based on the account shows
that the failure to satisfy the diversification requirements was inadvertent; (2) the
investments of the account satisfy the diversification requirements within a reasonable time after discovery of the failure; and
(3) the issuer or holder agrees to make such
adjustments or pay such amounts as the
Commissioner may require.
.03 Treatment of Modified Endowment
Contracts. (1) Section 7702A defines a
modified endowment contract (MEC) as
a contract that meets the requirement of
§ 7702 but fails to meet the 7-pay test
of § 7702A(b), or that is received in exchange for a contract that is a MEC. Under § 7702A(b), a contract fails to meet
the 7-pay test if the accumulated amount
paid under the contract at any time during
the first seven contract years exceeds the
sum of the net level premiums that would
have been paid on or before that time if the
contract provided for paid-up future benefits after the payment of seven level annual
premiums.
(2) Section 7702A(c)(1) provides
that determinations under the 7-pay
test are made by applying the rules of
§§ 7702(b)(2) and 7702(e), with modifications. Under this provision, charges for
QABs are accounted for under the expense
charge rule of § 7702(c)(3)(B)(ii).
(3) Section 72(e)(10) provides that
a MEC is subject to the rules of
§ 72(e)(2)(B) (which taxes non-annuity
distributions on an income-out-first basis)
and § 72(e)(4)(A) (which generally treats
loans, assignments, or pledges of any portion of the value of a MEC as non-annuity
distributions). Further, under § 72(v), an
amount received under a MEC may be
subject to a 10% additional tax.

504

.04 Authority to enter into closing
agreements. Under the authority of § 7121,
the Service may enter into a closing agreement with a taxpayer in respect of any
internal revenue tax for any taxable period.
SECTION 3. EXISTING CORRECTION
PROCEDURES
To remedy the significant unforeseen
tax consequences for holders of contracts
that fail these provisions, the Service provides procedures for issuers of these failed
contracts to enter into closing agreements
with the Service.
(1) In Rev. Rul. 91–17, 1991–1 C.B.
190, amplified by Rev. Proc. 92–25,
1992–1 C.B. 741, an insurance company
issued contracts that qualified as life insurance, endowment, and annuity contracts
under the applicable law, but otherwise
failed to meet the definition of life insurance contracts under § 7702(a) or the
diversification requirements of § 817(h).
The ruling concludes that the income on
the contracts is a non-periodic distribution
for which the insurance company is subject
to certain recordkeeping, reporting, withholding and deposit obligations. In addition, if the company’s failure to meet
those obligations was not due to reasonable cause, the company could be subject
to various penalties under the Code. Rev.
Rul. 91–17 provides that the Service will
waive civil penalties for failure to satisfy
the reporting, withholding, and deposit requirements for income deemed received
under § 7702(g) if (a) the insurance company requests and receives a waiver of the
failure to meet the definition of a life insurance contract pursuant to § 7702(f)(8); (b)
the insurance company satisfies the conditions of § 1.817–5(a)(2)(i)-(iii) of the regulations; or (c) the insurance company requests and, in a timely manner, executes a
closing agreement under which the company agrees to pay an amount based on the
amount of tax that would have been owed
by the policyholders if they were treated as
receiving the income on the contracts, and
any interest with regard to such tax. Notice
99–48, 1999–2 C.B. 429, provides the tax
rates to be used to compute the amount of
tax that would have been owed by the policyholders if they were treated as receiving
the income on the contracts.

February 12, 2007

(2) Rev. Proc. 92–25, 1992–1 C.B. 741,
provides a procedure by which an issuer
of a variable contract seeking relief under § 1.817–5(a)(2) of the regulations may
request to enter into a closing agreement
with the Service. Under the procedure, an
issuer of the failed contracts may remedy
the failure by paying an amount based on
the tax and interest that the policyholder
would be required to pay. A model closing agreement was provided.
(3) Rev. Proc. 2001–42, 2001–2 C.B.
212, modified and amplified by Rev. Proc.
2007–19, page 515, this Bulletin, provides
the procedure by which an issuer may
remedy an inadvertent non-egregious failure to comply with the MEC rules under
§ 7702A. Under this procedure, an issuer
may remedy such a failure by paying an
amount based on the overages on the unintended MECs and the tax and interest
that the policyholder would be required
to pay on those overages, based on proxy
earnings and tax rates. A model closing agreement was provided. Rev. Proc.
2007–19 simplified Rev. Proc. 2001–42
by making it easier for issuers to locate
indices used to compute proxy earnings
rates, and by permitting electronic filing
of templates that are required under the
procedure.
(4) Rev. Rul. 2005–6, 2005–1 C.B.
471, provides that for purposes of determining whether a contract qualifies as a
life insurance contract under § 7702 or as
a MEC under § 7702A, charges for QABs
are taken into account under the expense
charge rule of § 7702(c)(3)(B)(ii). The
revenue ruling provides three alternatives
for issuers of life insurance contracts that
do not account for QABs under the expense charge rule. Alternative C, which
applies after February 7, 2006, provides
that an issuer whose compliance system
does not properly account for charges for
QABs may request a closing agreement
under certain terms. Under this alternative,
the amount required to be paid is based on
the number of contracts for which relief is
requested.
SECTION 4. DRAFT MODEL
CLOSING AGREEMENTS
Four draft model closing agreements
are set forth in Exhibits A through D. Exhibit A would correct inadvertent failures
to satisfy the guideline premium require-

February 12, 2007

ments of § 7702. Exhibit B would correct failures to satisfy the requirements of
§ 7702 or the requirements of § 7702A
due to improper accounting for charges for
QABs. See Rev. Rul. 2005–6, Alternative C. Exhibits C and D would update the
model closing agreements previously provided in Rev. Proc. 2001–42 (for inadvertent MECs) and Rev. Proc. 92–25 (for inadvertent failures to satisfy the diversification requirements of § 817(h)).
SECTION 5. REQUEST FOR
COMMENTS
.01 In general. Because additional
changes to the existing procedures may be
warranted, the Service invites comments
on how the various correction procedures
in general may be simplified.
.02 Draft model closing agreements.
The Service requests comments on the
model closing agreements that are included in this notice as Exhibits A, B, C,
and D. The Service will consider all comments before issuing final model closing
agreements.
.03 Other matters. In addition to the
general matters described in section 5.01
and 5.02, the Service requests comments
in the following specific areas:
(a) Under what circumstances, if any,
should the Service retain the discretion to
negotiate different terms and conditions
for failures that otherwise would be covered by the final model closing agreement?
(b) Would additional model closing
agreements be useful to remedy other failures involving life insurance or annuity
contracts, such as the failure of a life insurance contract to satisfy the cash value
accumulation test of § 7702(b), or the
failure of an annuity contract to contain
the distribution provisions required under
§ 72(s)? If so, please describe the specific
failures.
(c) Could the process for obtaining
a waiver of reasonable errors under
§ 7702(f)(8) be simplified? If so, please
describe.
(d) Do the three alternatives set forth
in Rev. Rul. 2005–6 provide an appropriate model for remedies of other errors
under § 7702 that would have been considered reasonable within the meaning of
§ 7702(f)(8) before, but not after, the Service published guidance on the underlying
legal issue?

505

(e) Could the amounts that are required
to be paid under the model closing agreements be determined more simply, without
altering the incentives already in place for
complying with §§ 72, 817(h), 7702 and
7702A and for coming forward voluntarily
once errors are discovered? For example,
do the existing procedures require issuers
to produce information not otherwise generated in the normal course of administering the contracts? Are there circumstances
in which the amount paid under the model
closing agreements would more appropriately be determined based on factors other
than total income on the contract?
(f) Do the amounts required to be paid
under the model closing agreements strike
an appropriate balance between making
the government whole for the tax that
otherwise would be due, and encouraging
voluntary compliance with the underlying
provisions once an error is discovered?
If lesser amounts might be appropriate in
some circumstances, what are those circumstances and how should those amounts
be limited?
(g) Should each model closing agreement contain language to the effect the
agreement is null and void if the taxpayer
does not remit the required payment and
undertake the required corrective actions
within the time frames set forth in the
agreement? Do the time frames in the draft
model closing agreements allow taxpayers
enough time to satisfy their obligations under those agreements?
.04 Address for submitting comments. Written comments on the issues
addressed in this notice may be submitted to the Office of the Associate
Chief Counsel (Financial Institutions
and Products), Attention: Melissa S.
Luxner (Notice 2007–15), room 3552,
CC:FIP:4, Internal Revenue Service, 1111
Constitution Avenue, NW, Washington,
DC 20224.
Alternatively, taxpayers
may submit comments electronically to
[email protected].
The Service requests any comments by
June 12, 2007.
SECTION 6. PENDING REQUESTS
FOR CLOSING AGREEMENTS
The Service will continue to process
closing agreements under §§ 72, 817(h),
7702 and 7702A under existing procedures until those procedures are modified

2007–7 I.R.B.

by publication in the Internal Revenue
Bulletin.

DRAFTING INFORMATION
The principal author of this notice
is Melissa S. Luxner of the Office of
Associate Chief Counsel (Financial In-

stitutions & Products). For further information regarding this notice, contact
Melissa S. Luxner at (202) 622–3970 (not
a toll-free call).

EXHIBIT A
Effective as of date executed by Internal
Revenue Service
CLOSING AGREEMENT AS TO FINAL DETERMINATION
COVERING SPECIFIC MATTERS
UNDER SECTION 7702
THIS CLOSING AGREEMENT (“Agreement”) is made pursuant to § 7121 of the Internal Revenue Code (the “Code”) by and
between [Insert Taxpayer Name, Address and EIN] (“Taxpayer”) and the Commissioner of Internal Revenue (the “Service”).
WHEREAS,
A. Taxpayer is the issuer of one or more contracts that were intended to qualify as life insurance contracts under § 7702.
B. Pursuant to Rev. Rul. 91–17, 1991–1 C.B. 190, amplified by Rev. Proc. 92–25, 1992–1 C.B. 741, as supplemented by Notice
99–48, 1999–2 C.B. 429, the Service under certain circumstances will waive civil penalties for failure of a taxpayer to satisfy the
reporting, withholding and deposit requirements for income received or deemed received under § 7702(g).
C. By letter dated [Insert date] Taxpayer submitted to the Service, pursuant to Rev. Proc. 2006–1, 2006–1 I.R.B. 1 [or successor
Rev. Proc., if applicable], a request for this Agreement covering [Insert number] of Taxpayer’s life insurance contracts identified
on Exhibit A attached to this Agreement (the “Contracts”).
D. Taxpayer intended that each of the Contracts meet the definition of life insurance contract under § 7702. For each Contract,
however, Taxpayer accepted and retained premiums that exceeded the Contract’s guideline premium limitations under § 7702(c)(2)
[or § 101(f), if applicable]. As a result, each of the Contracts identified on Exhibit A failed to satisfy the requirements of § 7702.
E. The Service has determined that the errors described in C above which caused the Contracts to fail to satisfy the requirements
of § 7702 were not reasonable errors within the meaning of § 7702(f)(8) [or § 101(f)(3)(H), if applicable], but are eligible for relief
under Rev. Rul. 91–17.
F. Taxpayer represents to the Service that:
(1) With respect to Contracts under which the “death benefit,” within the meaning of Notice 99–48, 1999–2 C.B. 429, is
less than $50,000, the aggregate “income on the contract,” within the meaning of § 7702(g)(1), through [Insert date], is
$[insert amount]. The aggregate “income on the contract” for each year of failure is:
Year

Amount

Total
(2) With respect to Contracts under which the “death benefit,” within the meaning of Notice 99–48, is equal to or exceeds
$50,000 but is less than $180,000, the aggregate “income on the contract,” within the meaning of § 7702(g)(1), through
[Insert date], is $ [insert amount]. The aggregate “income on the contract” for each year of failure is:
Year

Amount

Total

2007–7 I.R.B.

506

February 12, 2007

(3) With respect to Contracts under which the “death benefit,” within the meaning of Notice 99–48, is equal to or exceeds
$180,000, the aggregate income on the contract,” within the meaning of § 7702(g)(1), through [Insert date], is $ [insert
amount]. The aggregate “income on the contract” for each year of failure is:
Year

Amount

Total
G. With respect to Contracts under which the death benefit is less than $50,000, the tax (determined at a tax rate of 15 percent)
that would have been owed by the Contract holders if they were treated as receiving the income on the Contracts set forth in E(1)
above is $ [insert amount]. With respect to Contracts under which the death benefit is equal to or exceeds $50,000 but is less than
$180,000, the tax (determined at a rate of 28 percent) that would have been owed by the Contract holders if they were treated as
receiving the income on the Contracts set forth in E(2) above is $ [insert amount]. With respect to Contracts under which the death
benefit is equal to or exceeds $180,000, the tax (determined at a tax rate of 36 percent) that would have been owed by the Contract
holders if they were treated as receiving the income on the Contracts set forth in E(3) above is $ [insert amount].
The total tax that would have been owed by the Contract holders if they were treated as receiving the income on the Contracts
is $ [insert amount]. Interest on the total tax through [Insert date] is $ [insert amount]. The two amounts total $ [insert amount].
H. To ensure that the Contracts qualify as life insurance contracts under § 7702(a), Taxpayer and the Service have entered into
this Agreement.
NOW THEREFORE IT IS HEREBY FURTHER DETERMINED AND AGREED BETWEEN TAXPAYER AND THE SERVICE AS FOLLOWS:
1. In consideration for the agreement of the Service as set forth in Section 2 below, Taxpayer agrees as follows:
(A) Taxpayer will pay the Service the amount of $ [insert amount] at the time and in the manner described in Section 3 below.
(B) The amount paid pursuant to Section 1(A) above is not deductible, nor is such amount refundable, subject to credit or
offset, or otherwise recoverable from the Service.
(C) For purposes of Taxpayer’s complying with its reporting and withholding obligations under the Code,
(i)

neither the investment in the contract for purposes of § 72, nor the premiums paid for purposes of § 7702 [or
§ 101(f), if applicable], on any Contract can be increased by any portion of the amount set forth in Section 1(A)
above. If any such increases are made, they are entitled to no effect.

(ii)

neither the investment in the contract for purposes of § 72, nor the premiums paid, for purposes of § 7702 [or
§101(f), if applicable], on any Contract can be increased by any portion of the amount which Taxpayer represents
to be the income on the contract for all of the Contracts in the aggregate. If any such increases are made, they
are entitled to no effect.

(D) With respect to each Contract that is in force on the effective date of this Agreement, to the extent necessary in order to
bring such Contract into compliance with § 7702 [or §101(f), if applicable]:
(i)

(ii)

If the sum of the premiums paid as of the effective date of this Agreement exceeds the guideline premium
limitation as of such date, Taxpayer will take the following corrective action:
(a)

Increase the death benefit to not less than an amount that will ensure compliance with § 7702 [or §101(f),
if applicable], or

(b)

Refund to the Contract holder the amount of such excess, with interest at the Contract’s interest crediting
rate; or

If the sum of the premiums paid as of the effective date of this Agreement does not exceed the guideline premium
limitation as of such date, Taxpayer will take no corrective action.

(E) With respect to any Contract which terminated by reason of the death of the insured and (i) prior to the date this
Agreement is executed by the Service and Taxpayer and (ii) at a time when the premiums paid exceeded the guideline
premium limitation for the Contract, Taxpayer will pay the Contract holder or the Contract holder’s estate such excess,
with interest at the Contract’s interest crediting rate.

February 12, 2007

507

2007–7 I.R.B.

2. In consideration of the agreement of Taxpayer set forth in Section 1 above, the Service agrees as follows:
(A) To treat each Contract that is still in force as of the effective date of this Agreement as having satisfied the requirements of
§ 7702 [or § 101(f), if applicable] during the period from the date of issuance of the Contract through and including
the later of (i) the date of the execution of this Agreement by the Service; or (ii) the date of any corrective action
described in Section 1(D) above;
(B) To treat each Contract that terminated prior to the effective date of this Agreement as having satisfied the requirements
of § 7702 [or 101(f), if applicable] during the period from date of issuance of the Contract through and including the
date of the Contract’s termination;
(C) To treat the failures described above, and any corrective action described in Section 1(D) or 1(E) above, as having no
effect on the date the Contract was issued or entered into;
(D) To treat any amount paid prior to the effective date of this Agreement to any beneficiary under a Contract by reason of
the death of the insured as paid under a life insurance contract for purposes of the exclusion from gross income under
§ 101(a)(1);
(E) To waive civil penalties for failure of Taxpayer to satisfy the reporting, withholding, or deposit requirements for income
deemed received by Contract holders under § 7702; and
(F) To treat no portion of the amount described in Section 1(A) above as income to the Contract holders.
3. Any action required of Taxpayer in Section 1(D) or 1(E) above shall be taken by Taxpayer no later than ninety (90) days
after the date of execution of this Agreement by the Service. Payment of the amount described in Section 1(A) above shall be
made within thirty (30) days after the date of execution of this Agreement by the Service by check payable to the “United States
Treasury,” delivered together with a copy of this executed Agreement to Internal Revenue Service, Receipt and Control Stop 31,
201 W. Rivercenter Blvd., Covington, KY 41011.
4. This Agreement is, and shall be construed as being, for the benefit of Taxpayer. Contract holders covered by this Agreement
are intended beneficiaries of this Agreement. This Agreement shall not be construed as creating any liability of Taxpayer to the
Contract holders.
5. Neither the Service nor Taxpayer shall endeavor by litigation or other means to attack the validity of this Agreement.
6. This Agreement may not be cited or relied upon as precedent in the disposition of any other matter.
NOW THIS CLOSING AGREEMENT FURTHER WITNESSETH, that the Service and Taxpayer mutually agree that the matters so determined shall be final and conclusive, except as follows:
1. The matter to which this Agreement relates may be reopened in the event of fraud, malfeasance, or misrepresentation of
material facts set forth herein.
2. This Agreement is subject to sections of the Code that expressly provide that effect be given to their provisions notwithstanding any other law or rule of law except § 7122.
3. This Agreement is subject to any legislation enacted subsequent to the date of execution hereof if the legislation provides that
it is effective with respect to closing agreements.
IN WITNESS WHEREOF, the parties have subscribed their names to these presents in triplicate.
[Insert Taxpayer name]
Date Signed:

By:
Title:
COMMISSIONER OF INTERNAL REVENUE

Date Signed:

By:
Title:

2007–7 I.R.B.

508

February 12, 2007

EXHIBIT B
Effective as of date executed by Internal
Revenue Service
CLOSING AGREEMENT AS TO FINAL DETERMINATION
COVERING SPECIFIC MATTERS
UNDER REV. RUL. 2005–6
THIS CLOSING AGREEMENT (“Agreement”) is made pursuant to § 7121 of the Internal Revenue Code (the “Code”) by and
between [Insert Taxpayer Name, Address and EIN] (“Taxpayer”) and the Commissioner of Internal Revenue (the “Service”).
WHEREAS,
A. Taxpayer is the issuer of one or more contracts that were intended to qualify as life insurance contracts under § 7702 and that
provided qualified additional benefits (QABs) within the meaning of § 7702(f)(5).
B. Pursuant to Rev. Rul. 2005–6, 2005–1 C.B. 471, the Service under certain circumstances will waive civil penalties for
failure of a taxpayer to satisfy the reporting, withholding and deposit requirements for income received or deemed received under
§ 7702(g).
C. By letter dated [Insert date] Taxpayer submitted to the Service, pursuant to Rev. Proc. 2006–1, 2006–1 I.R.B. 1 [or successor
Rev. Proc., if applicable], a request for this Agreement covering [Insert number] of Taxpayer’s life insurance contracts identified
on Exhibit A attached to this Agreement (the “Contracts”).
D. Taxpayer intended that each of the Contracts meet the definition of a life insurance contract under § 7702 and not be a modified endowment contract (MEC) within the meaning of § 7702A. Taxpayer, however, maintained a compliance system for the
contracts that did not account properly for charges for qualified additional benefits (QABs) under § 7702(c)(3)(B)(ii). As a result,
the Contracts identified in Exhibit A failed to satisfy the requirements of § 7702 or § 7702A, as applicable.
E. The Service has determined that the errors described in C above qualify the issuer for the remedy described in Rev. Rul.
2005–6.
F. To ensure that the Contracts qualify as life insurance contracts under § 7702(a), Taxpayer and the Service have entered into
this Agreement.
NOW THEREFORE IT IS HEREBY FURTHER DETERMINED AND AGREED BETWEEN TAXPAYER AND THE SERVICE AS FOLLOWS:
1.

In consideration for the agreement of the Service as set forth in Section 2 below, Taxpayer agrees as follows:

(A) To pay the Service the amount of $ [insert amount] at the time and in the manner described in Section 3 below.
(B) The amount paid pursuant to Section 1(A) above is not deductible, nor is such amount refundable, subject to credit or
offset, or otherwise recoverable from the Service.
(C) For purposes of Taxpayer’s complying with its reporting and withholding obligations under the Code,
(i)

neither the investment in the contract for purposes of § 72, nor the premiums paid for purposes of § 7702, on any
Contract can be increased by any portion of the amount set forth in Section 1(A) above. If any such increases
are made, they are entitled to no effect.

(ii)

neither the investment in the contract for purposes of § 72, nor the premiums paid, for purposes of § 7702, on
any Contract can be increased by any portion of the amount which Taxpayer represents to be the income on the
contract for all of the Contracts in the aggregate. If any such increases are made, they are entitled to no effect.

(D) With respect to each Contract that is in force on the effective date of this Agreement, to the extent necessary in order to
bring such Contract into compliance with § 7702:
(i)

If the sum of the premiums paid as of the effective date of this Agreement exceeds the amount necessary to keep
the contracts in compliance with the requirements of § 7702, Taxpayer will take the following corrective action:
(a)

Increase the death benefit to not less than an amount that will ensure compliance with § 7702, or

(b)

Refund to the Contract holder the amount of such excess, with interest at the Contract’s interest crediting
rate; or

February 12, 2007

509

2007–7 I.R.B.

(ii)

If the sum of the premiums paid as of the effective date of this Agreement does not exceed the amount necessary
to keep the contracts in compliance with the requirements of § 7702, Taxpayer will take no corrective action.

(E) With respect to any Contract which terminated by reason of the death of the insured and (i) prior to the date this
Agreement is executed by the Service and Taxpayer and (ii) at a time when the premiums paid exceeded the guideline
premium limitation for the Contract, Taxpayer will pay the Contract holder or the Contract holder’s estate such excess,
with interest at the Contract’s interest crediting rate.
2. In consideration of the agreement of Taxpayer set forth in Section 1 above, the Service agrees as follows:
(A) To treat each Contract that is still in force as of the effective date of this Agreement as having satisfied the requirements of
§ 7702 [and § 7702A, if applicable], during the period from the date of issuance of the Contract through and including
the later of (i) the date of the execution of this Agreement by the Service, or (ii) the date of any corrective action
described in Section 1(D) above;
(B) To treat each Contract that terminated prior to the effective date of this Agreement as having satisfied the requirements of
§ 7702 [and § 7702A, if applicable] during the period from date of issuance of the Contract through and including the
date of the Contract’s termination;
(C) To treat the failures described above, and any corrective action described in Section 1(D) or 1(E) above, as having no
effect on the date the Contract was issued or entered into;
(D) To treat any amount paid prior to the effective date of this Agreement to any beneficiary under a Contract by reason of
the death of the insured as paid under a life insurance contract for purposes of the exclusion from gross income under
§ 101(a)(1);
(E) To waive civil penalties for failure of Taxpayer to satisfy the reporting, withholding, or deposit requirements for income
deemed received by Contract holders under § 7702 [and § 7702A, if applicable]; and
(F) To treat no portion of the amount described in Section 1(A) above as income to the Contract holders.
3. Any action required of Taxpayer in Section 1(D) or 1(E) above shall be taken by Taxpayer no later than ninety (90) days
after the date of execution of this Agreement by the Service. Payment of the amount described in Section 1(A) above shall be
made within thirty (30) days after the date of execution of this Agreement by the Service by check payable to the “United States
Treasury” delivered together with a copy of this executed Agreement, to Internal Revenue Service, Receipt and Control Stop 31,
201 W. Rivercenter Blvd., Covington, KY 41011.
4. This Agreement is, and shall be construed as being, for the benefit of Taxpayer. Contract holders covered by this Agreement
are intended beneficiaries of this Agreement. This Agreement shall not be construed as creating any liability of Taxpayer to the
Contract holders.
5. Neither the Service nor Taxpayer shall endeavor by litigation or other means to attack the validity of this Agreement.
6. This Agreement may not be cited or relied upon as precedent in the disposition of any other matter.
NOW THIS CLOSING AGREEMENT FURTHER WITNESSETH, that the Service and Taxpayer mutually agree that the matters so determined shall be final and conclusive, except as follows:
1. The matter to which this Agreement relates may be reopened in the event of fraud, malfeasance, or misrepresentation of
material facts set forth herein.
2. This Agreement is subject to sections of the Code that expressly provide that effect be given to their provisions notwithstanding any other law or rule of law except § 7122.
3. This Agreement is subject to any legislation enacted subsequent to the date of execution hereof if the legislation provides that
it is effective with respect to closing agreements.
IN WITNESS WHEREOF, the parties have subscribed their names to these presents in triplicate.
[Insert Taxpayer name]
Date Signed:

By:
Title:

2007–7 I.R.B.

510

February 12, 2007

COMMISSIONER OF INTERNAL REVENUE
Date Signed:

By:
Title:

EXHIBIT C
Effective as of date executed by Internal
Revenue Service
CLOSING AGREEMENT AS TO FINAL DETERMINATION
COVERING SPECIFIC MATTERS
UNDER SECTION 7702A
THIS CLOSING AGREEMENT (“Agreement”) is made pursuant to § 7121 of the Internal Revenue Code (the “Code”) by and
between [Insert Taxpayer name, address, and EIN] (“Taxpayer”) and the Commissioner of Internal Revenue (the “Service”).
WHEREAS,
A. Taxpayer is the issuer of one or more life insurance contracts under § 7702;
B. Pursuant to Rev. Proc. 2001–42, 2001–2 C.B. 212, an issuer under certain circumstances may remedy an inadvertent nonegregious failure to comply with the modified endowment contract rules under § 7702A.
C. By letter dated [Insert date], Taxpayer submitted to the Service, pursuant to Rev. Proc. 2006–1, 2006–1 I.R.B. 1 [or successor
Rev. Proc., if applicable], a request for this Agreement covering [Insert number] modified endowment contracts identified on
Exhibit A attached to this Agreement (the “Contracts”).
D. Taxpayer intended that each of the Contracts not be a modified endowment contract (MEC) under § 7702A. Taxpayer represents that the Contract[s] is [are] not described in Sec. 4.02 of Rev. Proc. 2001–42.
E. The Service has determined that the contracts identified on Exhibit A are eligible for relief under Rev. Proc. 2001–42.
F. Taxpayer represents that the cumulative “overage earnings,” within the meaning of Sec. 3.06 of Rev. Proc. 2001–42, for the
Contract[s] equal $ [Insert amount].
G. Taxpayer represents that the total of the amounts determined under Sec. 5.03(1)(a), (b), and (c) of Rev. Proc. 2001–42, after
taking the special rule in Sec. 5.03(2) of that revenue procedure into account, with regard to the Contract[s] are $ [Insert amount],
$ [Insert amount], and $ [Insert amount], respectively.
H. To ensure that the Contract[s] is/are not treated as [a] modified endowment contract[s], Taxpayer and the Service have entered
into this Agreement.
NOW THEREFORE, IT IS HEREBY FURTHER DETERMINED AND AGREED BETWEEN TAXPAYER AND THE SERVICE AS FOLLOWS:
1. In consideration for the agreement of the Service as set forth in Section 2 below, Taxpayer agrees as follows:
(A) Taxpayer will pay to the Service the amount of $ [Insert amount] at the time and in the manner described in Section 3
below.
(B) The amount paid pursuant to Section 1(A) above is not deductible by Taxpayer, nor is such amount refundable, subject to
credit or offset, or otherwise recoverable by Taxpayer from the Service.
(C) For purposes of Taxpayer’s complying with its reporting and withholding obligations under the Code,
(i)

neither the investment in the contract for purposes of § 72, nor the premiums paid for purposes of § 7702, on any
Contract can be increased by any portion of the amount set forth in Section 1(A) above. If any such increases
are made, they are entitled to no effect.

February 12, 2007

511

2007–7 I.R.B.

(ii)

neither the investment in the contract for purposes of § 72, nor the premiums paid, for purposes of § 7702, on
any Contract can be increased by any portion of the amount which Taxpayer represents to be the income on the
contract for all of the Contracts in the aggregate. If any such increases are made, they are entitled to no effect.

(D) To bring Contract[s] for which the testing period (as defined in Sec. 3.01 of Revenue Procedure 2001–42) will not have
expired on or before the date 90 days after the execution of this Agreement into compliance with § 7702A, either by an
increase in death benefit[s] or the return of the excess premiums and earnings thereon to the contract holder[s].
2. In consideration of the agreement of Taxpayer set forth in Section 1 above, the Service agrees as follows:
(A) To treat each Contract as having satisfied the requirements of § 7702A during the period from the date of issuance of the
Contract through and including the later of—
(i)

date of the execution of this Agreement, and

(ii)

the date of the corrective actions described in Section 1(D) above;

(B) To treat the corrective action described in 1(D) above as having no effect on the date the Contract was issued or
entered into;
(C) To waive civil penalties for failure of Taxpayer to satisfy the reporting, withholding, and/or deposit requirements for
income subject to tax under § 72(e)(10) that was received or deemed received by a contract holder under a Contract in
a calendar year ending prior to the date of execution of this Agreement; and
(D) To treat no portion of the sum described in Section 1(A) above as income to the Contract holders.
3. The actions required of Taxpayer in Section 1(D) above shall be taken by Taxpayer no later than ninety (90) days after the date
of execution of this Agreement by the Service. Payment of the amount described in Section 1(A) above shall be made within thirty
(30) days of the date of execution of this Agreement by the Service by check payable to the “United States Treasury,” delivered
together with a copy of this executed Agreement to Internal Revenue Service, Receipt & Control Stop 31, 201 W. Rivercenter Blvd.,
Covington, KY 41011.
4. This Agreement is, and shall be construed as being, for the benefit of Taxpayer. The Contract holders covered by this Agreement are intended beneficiaries of this Agreement. This Agreement shall not be construed as creating any liability of an issuer to
the Contract holders.
5. Neither the Service nor Taxpayer shall endeavor by litigation or other means to attack the validity of this Agreement.
6. This Agreement may not be cited or relied upon as precedent in the disposition of any other matter.
NOW THIS CLOSING AGREEMENT FURTHER WITNESSETH, that Taxpayer and the Service mutually agree that the matters so determined shall be final and conclusive, except as follows:
1. The matter to which this Agreement relates may be reopened in the event of fraud, malfeasance, or misrepresentation of
material facts set forth herein.
2. This Agreement is subject to sections of the Code that expressly provide that effect be given to their provisions notwithstanding any other law or rule of law except § 7122.
3. This Agreement is subject to any legislation enacted subsequent to the date of execution hereof if the legislation provides that
it is effective with respect to closing agreements.
IN WITNESS WHEREOF, the parties have subscribed their names to these presents in triplicate.
[Insert Taxpayer name]
Date Signed:

By:
Title:

2007–7 I.R.B.

512

February 12, 2007

COMMISSIONER OF INTERNAL REVENUE
Date Signed:

By:
Title:

EXHIBIT D
Effective as of date executed by Internal
Revenue Service
CLOSING AGREEMENT AS TO FINAL DETERMINATION
COVERING SPECIFIC MATTERS
UNDER SECTION 817(h)
THIS CLOSING AGREEMENT (“Agreement”), is made pursuant to § 7121 of the Internal Revenue Code (the “Code”) by and
between [Insert Taxpayer, Name, Address and EIN] (Taxpayer”) and the Commissioner of Internal Revenue (the “Service”).
WHEREAS,
A. Taxpayer is the issuer of one or more variable contracts, as defined in § 817(d) (without regard to § 817(h)), which are based,
in whole or in part, on a segregated asset account (the “Account”) and that provide for the allocation of amounts received under the
variable contracts to the Account.
B. Pursuant to Rev. Proc. 92–25, 1992–1 C.B. 741, the Service may treat the investments of a segregated asset account on
which a variable contract is based as satisfying the diversification requirements of § 817(h) and § 1.817–5(b) of the Income Tax
Regulations for periods during which there was an inadvertent failure to diversify.
C. By letter dated [Insert date,] Taxpayer submitted to the Service, pursuant to Rev. Proc. 2006–1, 2006–1 I.R.B. 1 [or successor
Rev. Proc., if applicable], a request for this Agreement that the [Insert account name] be treated as adequately diversified under
§ 817(h) for the period [Insert period of nondiversification] (“the period of nondiversification”).
D. Taxpayer intended that Account be adequately diversified within the meaning of § 817 and § 1.817–5(b). The failure of the
investments of the Account to satisfy the requirements of § 1.817–5(b) for the period of nondiversification was inadvertent.
E. The Service has determined that the failure of Account to satisfy the requirements of § 817(h) is eligible for relief under Rev.
Proc. 92–25.
F. Taxpayer represents that the failure of the investments of the Account to satisfy the requirements of § 1.817–5(b) was discovered on [Insert date], and the investments came into compliance with those requirements on [Insert date].
G. The “income on the contract,” within the meaning of § 1.817–5(a)(2) and § 7702(g)(l)(B) (without regard to § 7701(g)(l)(C)),
for all contracts based on the Account during the period of non-diversification in the aggregate totals $[Insert amount] for the
[Insert account name].
H. The sum of the amounts computed in sections 4.02(1)(A) and (B) and 4.02(2)(A) of Rev. Proc. 92–25 is $ [Insert amount].
The sum of the interest amounts computed in sections 4.02(1)(C) and 4.02(2)(A) of Rev. Proc. 92–25 is $ [Insert amount].
I. To ensure that variable contracts that provide for the allocation of amounts received thereunder to the Account are treated as
annuity, endowment, or life insurance contracts, as applicable, Taxpayer and the Service have entered into this Agreement.
NOW THEREFORE, IT IS HEREBY FURTHER DETERMINED AND AGREEED BETWEEN TAXPAYER AND THE SERVICE AS FOLLOWS:
1. In consideration for the agreement of the Service as set forth in Section 2 below, Taxpayer agrees as follows:
(A) Taxpayer will pay the Service the amount of $ [Insert amount] at the time and in the manner described in Section 3 below.
(B) The amount paid pursuant to Section 1(A) above is not deductible, nor is such amount refundable, subject to credit or
offset, or otherwise recoverable from the Service;
(C) For purposes of Taxpayer’s complying with its reporting and withholding obligations under the Code,

February 12, 2007

513

2007–7 I.R.B.

(i)

neither the investment in the contract for purposes of § 72, nor the premiums paid for purposes of § 7702 [or
§ 101(f), if applicable], on any Contract can be increased by any portion of the amount set forth in Section 1(A)
above. If any such increases are made, they are entitled to no effect.

(ii)

neither the investment in the contract for purposes of § 72, nor the premiums paid, for purposes of § 7702 [or
§101(f), if applicable], on any Contract can be increased by any portion of the amount which Taxpayer represents
to be the income on the contract for all of the Contracts in the aggregate. If any such increases are made, they
are entitled to no effect.

2. In consideration of the agreement of Taxpayer set forth in Section 1 above, the Service agrees as follows:
(A) To treat the investments of the Account as adequately diversified for purposes of § 817(h) during the period of
nondiversification; and
(B) To treat no portion of the amounts described in Section 1(A) above as income to the Contract holders.
3. Payment of the sum described in section 1(A) above shall be made within thirty (30) days of the date of execution of this
Agreement by the Service. This payment must be made by check payable to the “United States Treasury,” delivered, together with
a copy of this executed Agreement, to Internal Revenue Service Center, Receipt and Control Stop 31, 201 W. Rivercenter Blvd.,
Covington, KY 41011.
4. This Agreement is, and shall be construed as being, for the benefit of Taxpayer. Holders of contracts based on the Account
are intended beneficiaries of this Agreement. This Agreement shall not be construed as creating any liability of Taxpayer to the
holders of the contracts based on the Account.
5. Neither the Service nor Taxpayer shall endeavor by litigation or other means to attack the validity of this Agreement.
6. This Agreement may not be cited or relied upon as precedent in the disposition of any other matter.
NOW THIS CLOSING AGREEMENT FURTHER WITNESSETH, that the Service and Taxpayer mutually agree that the matters so determined shall be final and conclusive, except as follows:
1. The matter to which this Agreement relates may be reopened in the event of fraud, malfeasance, or misrepresentation of
material facts set forth herein.
2. This Agreement is subject to sections of the Code that expressly provide that effect be given to their provisions notwithstanding any other law or rule of law except § 7122.
3. This Agreement is subject to any legislation enacted subsequent to the date of execution hereof if the legislation provides that
it is effective with respect to closing agreements.
IN WITNESS WHEREOF, the parties have subscribed their names to these presents in triplicate.
[Insert Taxpayer name]
Date Signed:

By:
Title:
COMMISSIONER OF INTERNAL REVENUE

Date Signed:

By:
Title:

2007–7 I.R.B.

514

February 12, 2007

26 CFR § 301.7121: Closing agreements.
(Also Part I, section 7702A.)

Rev. Proc. 2007–19
SECTION 1. PURPOSE
This revenue procedure modifies the
procedure by which an issuer of a life insurance contract may remedy an inadvertent non-egregious failure to comply with
the modified endowment contract rules under § 7702A of the Internal Revenue Code.
Rev. Proc. 2001–42, 2001–2 C.B. 212, is
modified and amplified.
SECTION 2. BACKGROUND
.01 Definition of a modified endowment
contract
(1) Section 7702A(a) provides that
a life insurance contract is a modified
endowment contract (“MEC”) if the contract—
(a) is entered into on or after June 21,
1988, and fails to meet the “7-pay test” of
§ 7702A(b), or
(b) is received in exchange for a contract described in paragraph (a) of this section 2.01(1).
(2) A contract fails to meet the 7-pay
test if the accumulated amount paid under
the contract at any time during the first 7
contract years exceeds the sum of the net
level premiums which would have to be
paid on or before such time if the contract
were to provide for paid-up “future benefits” (as defined in §§ 7702A(c)(3) and
7702(f)(4)) after the payment of 7 level annual premiums.
.02 Tax treatment of amounts received
under a MEC. Section 72(e)(10) provides that a MEC is subject to the rules
of § 72(e)(2)(B), which tax non-annuity
distributions on an income-out-first basis,
and the rules of § 72(e)(4)(A) (as modified
by §§ 72(e)(10)(A)(ii) and 72(e)(10)(B)),
which generally deem loans and assign-

February 12, 2007

ments or pledges of any portion of the
value of a MEC to be non-annuity distributions. Moreover, under § 72(v), the
portion of any annuity or non-annuity distribution received under a MEC that is
includible in gross income is subject to a
10% additional tax unless the distribution
is made on or after the date on which the
taxpayer attains age 591/2, is attributable to
the taxpayer’s becoming disabled (within
the meaning of § 72(m)(7)), or is part of a
series of substantially equal periodic payments (not less frequently than annually)
made for the life (or life expectancy) of
the taxpayer or the joint lives (or joint life
expectancies) of such taxpayer and the
taxpayer’s beneficiary.
.03 Rev. Proc. 2001–42. The Internal
Revenue Service (“Service”) is aware of
situations in which, as a result of inadvertent non-egregious failures to comply
with the MEC rules, life insurance premiums are collected which exceed the 7-pay
limit provided by § 7702A(b). This can
produce significant unforeseen tax consequences for the contract holders. To
allow issuers to remedy such situations,
Rev. Proc. 2001–42 sets forth the circumstances under which the Service will
enter into closing agreements which provide that contracts identified in the closing
agreements will not be treated as MECs.
Under Rev. Proc. 2001–42, an issuer must
provide information about the contracts
that are subject to the closing agreement,
including a template for each contract
setting forth the cumulative amounts paid
under the contract, the contract’s cumulative 7-pay premium, the overage, if any,
for each contract year, the earnings rate
applicable for each contract year, and the
overage earnings for each contract year.
In addition, the issuer must agree to pay
under the closing agreement an amount
based on the contract’s overage, overage
earnings, and tax and interest thereon.
.04 Need for changes to Rev. Proc.
2001–42. During the 5 years it has admin-

515

istered Rev. Proc. 2001–42, the Service
has become aware of a number of changes
that would make it easier for issuers to use
that procedure to seek relief. The Service
has determined that the General Account
Total Return would be more accessible to
taxpayers if based on Moody’s Seasoned
Corporate Aaa and Baa Bond Yields,
rather than on the indices provided in Rev.
Proc. 2001–42; similarly, the Bond Fund
Total Return would be more accessible if
the Merrill Lynch Corporate Bond Master
Bond Index, Total Return, were instead
identified as the Merrill Lynch U.S. Corporate Master Index (C0A0); the Service
has the capacity to process electronic
exhibits in connection with requests for
closing agreements involving life insurance contracts (see, e.g., Notice 2005–35,
2005–1 C.B. 1087); and, the Service has
changed the address to which payments
under Rev. Proc. 2001–42 must be sent.
SECTION 3. CHANGES TO EXISTING
PROCEDURE
.01 General Account Total Return. Rev.
Proc. 2001–42, section 3.07(2), is modified to provide that the General Account
Total Return is the arithmetic average
(weighted on a 50–50 basis) of the following two rates: (1) Moody’s Seasoned
Corporate Aaa Bond Yield, frequency
annual; and (2) Moody’s Seasoned Corporate Baa Bond Yield, frequency annual.
Both rates are published by Moody’s
Investors Service, Inc., or any successor thereto, and are publicly available
at www.federalreserve.gov. Under this
methodology, the General Account Total
Return for 2005 would be (5.23 + 6.06)/2
= 5.645. Section 3.07(2) is further modified to include the following tables setting
forth the General Account Total Return as
so determined for the years 1988 through
2005:

2007–7 I.R.B.

Year

General Account
Total Return

Year

1988
1989
1990
1991
1992
1993
1994
1995
1996

10.2%
9.7%
9.8%
9.2%
8.6%
7.5%
8.3%
7.8%
7.7%

1997
1998
1999
2000
2001
2002
2003
2004
2005

.02 Variable Contracts Earnings Rate
Table. Rev. Proc. 2001–42, section
3.07(3), is modified by substituting the
following earnings rate table for that

7.6%
6.9%
7.4%
8.0%
7.5%
7.2%
6.2%
6.1%
5.6%

which appears in section 3.07. This table
supplements the existing table by providing earnings rates for the years 2001
through 2005:

Year

Variable contracts
Earnings rate

Year

Variable contracts
Earnings rate

1988
1989
1990
1991
1992
1993
1994
1995
1996

13.5%
17.4%
1.4%
25.4%
5.9%
13.9%
-1.0%
23.0%
14.3%

1997
1998
1999
2000
2001
2002
2003
2004
2005

17.8%
19.7%
12.8%
-5.5%
-7.1%
-14.1%
19.6%
6.9%
2.1%

.03 Bond Fund Total Return. Rev.
Proc. 2001–42, section 3.07(6), is modified to provide that the Bond Fund Total
Return is (a) the “calendar year percentage
return” (as defined in section 3.07(7) of
Rev. Proc. 2001–42) represented by the
end-of-year values of the Merrill Lynch
U.S. Corporate Master Index (C0A0), as
published by Merrill Lynch & Company,
Inc., or any successor thereto, less (b) 1.0
percentage point. The Merrill Lynch U.S.
Corporate Master Index (C0A0) is publicly available at www.mlindex.ml.com.
Under this methodology, the Bond
Fund Total Return for 2005 would be
((1546.511 1516.602)/1516.602) .01 =
0.9721 percent.
.04 Address for Payment. The address
set forth in Rev. Proc. 2001–42, section
5.04, for payment of the amount required
under a closing agreement concerning inadvertent MECs is modified to read as follows: Internal Revenue Service, Receipt &
Control Stop 31, 201 W. Rivercenter Blvd.,
Covington, KY 41011.

2007–7 I.R.B.

General Account
Total Return

.05 Electronic Submissions. A new section 5.06 is added to Rev. Proc. 2001–42
to read as follows:
“.06 Electronic submissions. The information required under this revenue procedure may be submitted to the Service
electronically, in read-only format, on
a CD-ROM. Adobe Portable Document
format is a suitable format. Other formats may be arranged on a case-by-case
basis. The issuer must provide a total of
3 CD-ROMs, one for each of the three
(3) copies of the closing agreement.”
.06 Additional changes to Rev. Proc.
2001–42. The Service is aware that additional changes to Rev. Proc. 2001–42
may be warranted. Notice 2007–15, page
503, this Bulletin, requests comments on
a variety of issues affecting closing agreements for life insurance products, including inadvertent MECs. The Service will
continue to process closing agreements under the provisions of Rev. Proc. 2001–42,
as modified by this revenue procedure, until Rev. Proc. 2001–42 is replaced or further modified by publication in the Internal
Revenue Bulletin.

516

SECTION 4. PAPERWORK
REDUCTION ACT
The collections of information in Rev.
Proc. 2001–42 have been previously
reviewed and approved by the Office
of Management and Budget in accordance with the Paperwork Reduction Act
(44 U.S.C. 3507) under control number
1545–1752. This revenue procedure does
not make substantive changes to those
collections of information.
SECTION 5. EFFECTIVE DATE
This revenue procedure is effective for
submissions received after January 26,
2007, the date this revenue procedure was
made available to the public.
SECTION 6. EFFECT ON OTHER
DOCUMENTS
Rev. Proc. 2001–42 is modified and
amplified.

February 12, 2007

DRAFTING INFORMATION
The principal author of this revenue
procedure is Katherine A. Hossofsky of
the Office of the Associate Chief Counsel
(Financial Institutions & Products). For
further information regarding this revenue
procedure, please contact Ms. Hossofsky
at (202) 622–8435 (not a toll-free call).

26 CFR 601.105: Examination of returns and claims
for refund, credit or abatement; determination of
correct tax liability.
(Also: Part I, §§ 6011, 6111, 6112; 1.6011–4,
301.6112–1.)

Rev. Proc. 2007–20

reportable transaction, or will be excluded
from any individual category of reportable
transaction, if the Commissioner makes a
determination by published guidance that
the transaction is not subject to the reporting requirements of § 1.6011–4.
SECTION 3. SCOPE
This revenue procedure applies to taxpayers that may be required to disclose reportable transactions under § 6011, material advisors that may be required to disclose reportable transactions under § 6111,
and material advisors that may be required
to maintain lists under § 6112. This revenue procedure also applies for purposes
of § 4965.

(6) Transactions in which the refundable or contingent fee is related to the empowerment zone employment credit under
§ 1396(a).
(7) Transactions in which the refundable or contingent fee is related to the renewal community employment credit under § 1400H.
(8) Transactions in which the refundable or contingent fee is related to the employee retention credit under § 1400R(a),
(b), or (c).
SECTION 5. EFFECT ON OTHER
DOCUMENTS
This document modifies and supersedes
Rev. Proc. 2004–65, 2004–2 C.B. 965.

SECTION 1. PURPOSE

SECTION 4. APPLICATION

SECTION 6. EFFECTIVE DATE

This revenue procedure provides that
certain transactions with contractual protection are not reportable transactions
for purposes of the disclosure rules under § 1.6011–4(b)(4) of the Income Tax
Regulations. However, these transactions may be reportable transactions for
purposes of the disclosure rules under
§ 1.6011–4(b)(2), (b)(3), (b)(5), (b)(6), or
(b)(7).

.01 In general.
The definition of
a transaction with contractual protection includes references to “tax consequences” and “tax benefits.” For purposes
of § 1.6011–4, “tax” is defined as “Federal
income tax.” § 1.6011–4(c)(5). Accordingly, § 1.6011–4(b)(4) does not apply
to transactions in which the refundable or
contingent fees are based on the taxpayer’s
liability for taxes other than federal income
taxes.
.02 Exceptions. The following transactions are not taken into account in determining whether a transaction is a transaction with contractual protection under
§ 1.6011–4(b)(4):
(1) Transactions in which the refundable or contingent fee is related to the work
opportunity credit under § 51 of the Internal Revenue Code.
(2) Transactions in which the refundable or contingent fee is related to the welfare-to-work credit under § 51A.
(3) Transactions in which the refundable or contingent fee is related to the Indian employment credit under § 45A(a).
(4) Transactions in which the refundable or contingent fee is related to the
low-income housing credit under § 42(a).
(5) Transactions in which the refundable or contingent fee is related to the new
markets tax credit under § 45D(a).

This revenue procedure is effective January 26, 2007, the date this revenue procedure was released to the public. The exceptions under section 4.02(1) through (3)
apply to transactions that are entered into
on or after January 1, 2003. The exceptions under section 4.02(4) through (8) apply to all transactions, regardless of when
the transaction was entered into, that otherwise would have to have been disclosed
under § 1.6011–4(b)(4) on or after January
1, 2006.

SECTION 2. BACKGROUND
.01 Section 1.6011–4 requires a taxpayer that participates in a reportable
transaction to disclose the transaction in
accordance with the procedures provided
in § 1.6011–4. Under § 1.6011–4(b), one
category of reportable transaction is a
transaction with contractual protection. A
transaction with contractual protection is
defined in § 1.6011–4(b)(4). Generally,
a transaction with contractual protection
is a transaction involving a fee that is
refundable if all or part of the intended
tax consequences from the transaction are
not sustained or a transaction involving
a fee that is contingent on the taxpayer’s
realization of the tax benefits from the
transaction.
.02 Section 1.6011–4(b)(8)(i) provides
that a transaction will not be considered a

February 12, 2007

517

SECTION 7. DRAFTING
INFORMATION
The principal author of this revenue
procedure is Charles Wien of the Office
of Associate Chief Counsel (Passthroughs
& Special Industries). For further information regarding this revenue procedure,
contact Mr. Wien at (202) 622–3070 (not
a toll-free call).

2007–7 I.R.B.

Part IV. Items of General Interest
Income and Currency Gain
or Loss With Respect to a
Section 987 QBU; Correction
Announcement 2007–4
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to notice of proposed rulemaking.
SUMMARY: This document contains corrections to a notice of proposed rulemaking (REG–208270–86, 2006–42 I.R.B.
698) that was published in the Federal
Register on Thursday, September 7, 2006
(71 FR 52876), regarding the determination of the items of income or loss of
a taxpayer with respect to a section 987
qualified business unit as well as the timing, amount character and source of any
section 987 gain or loss.
FOR
FURTHER
INFORMATION
CONTACT: Sheila Ramaswamy, (202)
622–3870 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The notice of proposed rulemaking
(REG–208270–86) that is the subject of
these corrections is under section 987 of
the Internal Revenue Code.
Need for Correction
As published, the notice of proposed
rulemaking (REG–208270–86) contains
errors that may prove to be misleading and
are in need of clarification.
Correction of Publication
Accordingly, the notice of proposed
rulemaking (REG–208270–86), that was
the subject of FR Doc. 06–7250, is corrected as follows:
1. On page 52879, second column, in
the preamble under the paragraph heading “E. Concerns Regarding the 1991 Proposed Regulations: Notice 2000–20,” the
sixteenth line following the formula, the

2007–7 I.R.B.

language “DE. The DE conducts mineral”
is corrected to read “DE. The DE conducts
mineral extraction in Country X”.
2. On page 52886, first column, in
the preamble under the paragraph heading
“C. Section 1.987–3 Determination of the
Items of Section 987 Taxable Income or
Loss of an Owner of a Section 987 QBU,”
the eighth line, the language “under other
provisions are not taken” is corrected to
read “under other provisions of the Code
or regulations are not taken”.
3. On page 52886, second column,
under the paragraph heading “C. Section
1.987–3 Determination of the Items of
Section 987 Taxable Income or Loss of
an Owner of a Section 987 QBU,” first
full paragraph, ninth line from the bottom
of the paragraph, the language “rates for
amount realized and adjusted” is corrected
to read “rates for the amount realized and
adjusted”.
4. On page 52886, second column,
under the paragraph heading “C. Section
1.987–3 Determination of the Items of Section 987 Taxable Income or Loss of an
Owner of a Section 987 QBU,” second full
paragraph, fifth line, the language “Generally the amount realized and” is corrected
to read “Generally, the amount realized
and adjusted”.
§ 1.987–1 [Corrected]
5. On page 52895, second column,
§ 1.987–1(b)(7), paragraph (ii)(B) of Example 1, fifth line from the bottom of the
paragraph, the language “neither the activities of DE1 or DE2 are” is corrected to
read “the activities of DE1 are not”.
§ 1.987–2 [Corrected]
6.
On page 52899, first column,
§ 1.987–2(c)(9), lines 2 and 3, the language “illustrate the principles of this
paragraph (c). For purposes of these” is
corrected to read “illustrate the principles
of paragraph (b) of this section and this
paragraph (c). For purposes of these”.
7. On page 52899, second column,
§ 1.987–2(c)(9), paragraph (ii)(B) of Example 1, last line, the language “section
988 to X as a result of the loan.” is corrected to read “section 988 to X as a result
of the disregarded loan.”

518

8. On page 52899, third column,
§ 1.987–2(c)(9), paragraph (ii)(A) of Example 3, line 3, the language “Federal tax
purposes and therefore is a” is corrected
to read “Federal income tax purposes and
therefore is a”.
9.
On page 52900, first column,
§ 1.987–2(c)(9), paragraph (ii)(C) of Example 4, line 3, the language “regarded for
U.S. Federal tax purposes. As a” is corrected to read “regarded for U.S. Federal
income tax purposes. As a”.
10. On page 52900, second column,
§ 1.987–2(c)(9), paragraph (ii)(A) of Example 7, line 1, the language “(ii) Analysis.
(A) For Federal tax purposes” is corrected
to read “(ii) Analysis. (A) For Federal income tax purposes”.
11. On page 52901, third column,
§ 1.987–2(d)(2), line 3, the language “described in section 988(c)(1)(i) and (ii)”
is corrected to read “described in section
988(c)(1)(B)(i) and (ii)”.
§ 1.987–3 [Corrected]
12. On page 52902, third column,
§ 1.987–3(e)(2), line 5, the language “described in section 988(c)(1)(A)(i) and”
is corrected to read “described in section
988(c)(1)(B)(i) and”.
13. On page 52904, first column,
§ 1.987–3(f) Example 3., the fourth line
from the bottom of the paragraph, the language “section and § 1.987–1(c)(3) €8,000
x $1=” is corrected to read “section and
§ 1.987–1(c)(3) (€8,000 x $1=”.
§ 1.987–6 [Corrected]
14. On page 52911, first column,
§ 1.987–6(c) Example, lines 5 through
10 from the bottom of the column,
the language “of this section, Sf7,500
(Sf750,000/Sf1,000,000 x Sf10,000) of
the section 987 gain will be treated as
foreign source general limitation income
which is not subpart F income and Sf2,500
(Sf250,000/Sf1,000,000 x Sf10,000)
will” is corrected to read “of this section, Sf7,500 ((Sf750,000/Sf1,000,000) x
Sf10,000) of the section 987 gain will be
treated as foreign source general limitation income which is not subpart F income
and Sf2,500 ((Sf250,000/Sf1,000,000) x
Sf10,000) will”.

February 12, 2007

Cynthia E. Grigsby,
Senior Federal Register Liaison Officer,
Publications and Regulations Branch,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on December 26,
2006, 8:45 a.m., and published in the issue of the Federal
Register for December 27, 2006, 71 F.R. 77654)

Deletions From Cumulative
List of Organizations
Contributions to Which
are Deductible Under Section
170 of the Code
Announcement 2007–13
The names of organizations that no
longer qualify as organizations described
in section 170(c)(2) of the Internal Revenue Code of 1986 are listed below.
Generally, the Service will not disallow
deductions for contributions made to a
listed organization on or before the date
of announcement in the Internal Revenue
Bulletin that an organization no longer
qualifies. However, the Service is not
precluded from disallowing a deduction
for any contributions made after an organization ceases to qualify under section
170(c)(2) if the organization has not timely
filed a suit for declaratory judgment under
section 7428 and if the contributor (1) had
knowledge of the revocation of the ruling
or determination letter, (2) was aware that
such revocation was imminent, or (3) was
in part responsible for or was aware of the
activities or omissions of the organization
that brought about this revocation.
If on the other hand a suit for declaratory judgment has been timely filed, contributions from individuals and organizations described in section 170(c)(2) that
are otherwise allowable will continue to
be deductible. Protection under section
7428(c) would begin on February 12,
2007, and would end on the date the court
first determines that the organization is
not described in section 170(c)(2) as more
particularly set forth in section 7428(c)(1).
For individual contributors, the maximum
deduction protected is $1,000, with a husband and wife treated as one contributor.
This benefit is not extended to any individual, in whole or in part, for the acts or

February 12, 2007

omissions of the organization that were
the basis for revocation.
Hawaii Credit Counseling Service
Honolulu, HI
Lighthouse Credit Foundation, Inc.
Largo, FL

Foundations Status of Certain
Organizations
Announcement 2007–14
The following organizations have failed
to establish or have been unable to maintain their status as public charities or as operating foundations. Accordingly, grantors
and contributors may not, after this date,
rely on previous rulings or designations
in the Cumulative List of Organizations
(Publication 78), or on the presumption
arising from the filing of notices under section 508(b) of the Code. This listing does
not indicate that the organizations have lost
their status as organizations described in
section 501(c)(3), eligible to receive deductible contributions.
Former Public Charities. The following organizations (which have been treated
as organizations that are not private foundations described in section 509(a) of the
Code) are now classified as private foundations:
3TO, Sunnyvale, CA
According to His Riches Corporation,
Washington, DC
ActiVote America, Inc., Carmel, IN
Africa Tent Evangelism, Inc.,
Lubbock, TX
African Aids Prevention and Medical
Assistance Foundation, Charlotte, NC
All Faith Youth Outreach Program, Inc.,
Montgomery, AL
Alliance Preparatory High School,
Rancho Cucamonga, CA
AMOR, Inc., Queens, NY
Animal Resource Center, Inc., Slinger, WI
Answer Evangelistic Ministries, Inc.,
San Antonio, TX
Arch Angel Arts Center, Rochelle, VA
Aventis Behring Foundation for Research
and Advancement of Patient Health,
King of Prussia, PA
Bamboo Village Hawaii, Inc.,
Kurtistown, HI

519

Begin Again Ministries, Inc.,
Springfield, MO
Bethel Ministries, Inc., Huachuca City, AZ
Better Days Ahead, Inc., Houston, TX
B.F. Walker & Associates, Inc.,
Atlanta, GA
BHPS PTO, Inc., Tallahassee, FL
Blessed Through You, Inc., Odenton, MD
Breaking the Cycle, Inc., Smyrna, GA
Bucklin Community Better Life
Foundation, Bucklin, KS
Building Doorways, Andover, MN
Bullock Foundation, Inc., Charlotte, NC
Butte Ski Club, Butte, MT
Called to Serve, Troy, MI
Cardiology P.C. Research Foundation,
Birmingham, AL
Casa Del Sol Mobile Home Corporation,
Davis, CA
CECN Foundation, Nacogdoches, TX
Center for Civil War Living History, Inc.,
Roanoke, VA
Center for Regional Economic Strategies,
Dayton, OH
Central Washington Community Wellness
Foundation, Ellensburg, WA
Changed Lives Seminars and Ministry,
Memphis, TN
Chillicothe 757 Colts Baseball,
Chillicothe, OH
Christian Life School Foundation,
Kenosha, WI
Christian Rationalism Redeemer Center
Correspondent, Inc., Waterbury, CT
Clarence & Lynn Wolfe Foundation,
Searcy, AR
Columbus Georgia Wheelchair Athletic
Association, Columbus, GA
Community Finance Corporation,
Tucson, AZ
Community Healing Arts Center, Inc.,
Florence, MA
Community Health Resource, Inc.,
Hogansville, GA
Community Transportation Agency, Inc.,
Wilmington, DE
Conrad Charitable Foundation,
Northville, MI
Consciousness, Inc., Milwaukee, WI
Coptic Legal Foundation, Glendale, CA
Council for Educational Improvement,
Santa Fe, NM
Cri-Du-Chat Research Foundation,
Cumming, GA
Danielle Dawn Smalley Foundation, Inc.,
Crandall, TX
Danish American Language Foundation,
St. Charles, IL

2007–7 I.R.B.

Danita Corbitt Memorial Scholarship,
Inc., Rossville, GA
Developmental Education & Research,
Inc., Chandler, AZ
Diamonds in the Rough, New Orleans, LA
Disabled First, Oceanside, CA
Disabled Traveler, Lapeer, MI
Do2Learn Foundation, Inc., Raleigh, NC
Doctor William H. Huger Home
Charitable Trust, Charleston, SC
Dragon Fly After School Program,
Cambridge, MA
Duxbury Recreation Foundation, Inc.,
Duxbury, MA
Eagle Feather Publishing and Research
Institute, Austin, TX
El Leon Literary Arts, Inc., Berkeley, CA
Enchantment House Community Services,
Incorporated, Missouri City, TX
Energy Farm, Jackson, MS
Energy for the Future,
Rancho Cordova, CA
Engineers Rod & Gun Club Charities,
Ottawa, IL
Eucalyptus View, Inc., Escondido, CA
Faithful Servant Ministries, Alvord, TX
Family Images, Inc., New York, NY
Family Unity World Wide, Rockmart, GA
First Baptist Faith Foundation,
Hilton Head, SC
For the Love of Homeless Pets, Inc.,
Hialeah Gardens, FL
Foundation for Consumers Construction
Assistance, Inc., Bethany, OK
Foundation for in Home Care,
Incorporated, Chattanooga, TN
Foundation for Integrative Therapies,
Washington, DC
Foundation for Professional Excellence in
the Community College, Austin, TX
Foundation for the Re-Entry of
Ex-Offenders, Inc., (Free), Clinton, OH
Freedom Watch, Inc., Miami, FL
Gente Ayudando Gente S A, Houston, TX
Georgia Advocate Health Partners, Inc.,
Atlanta, GA
Grace Baptist Chapel Community
Development Corporation, Bronx, NY
Grace Community Development
Corporation, Memphis, TN
Grapevine Center for Communication
Arts, Inc., Bloomfield, CT
Hair Angels Foundation, Inc., Carmel, IN
Healing the Environment, Inc.,
Thayne, WI
Hearts of Peace Foundation, Boulder, CO
Hope Foundation, Incorporated,
Gaithersburg, MD

2007–7 I.R.B.

Housing & Community Synergy, Inc.,
Anaheim, CA
Howard Family Foundation, Inc.,
Los Angeles, CA
Human Services Projects, Inc.,
Park Forest, IL
Idaho Clean Air Foundation, Inc.,
Sandpoint, ID
Imani Support Services, Inc.,
Birmingham, AL
In His Rest Ministries, Anacortes, WA
Inner City Youth Computer Network,
Philadelphia, PA
Inspirational Family Enrichment
Association, Inc., Inkster, MI
Institute for the Advancement of
Contemporary Chinese Architecture,
Ltd., Oyster Bay, NY
Institute of Media Research, Inc.,
Cambridge, MA
Institute United for the Study and Defense
Against Racism Toward Chinese
People, Inc., Flushing, NY
Interdisciplinary Artists Aggregation,
Inc., Santa Cruz, CA
International Justice Center, Inc.,
Suwanee, GA
International Latino Womens Congress,
Philadelphia, PA
Isbell Home, Inc., Gadsden, AL
Jack and Elizabeth Gellman Torah
Foundation, Inc., Amherst, NY
Jewishlinks, Inc., San Mateo, CA
Jo Saltkill Ministries, Inc., Ft. Worth, TX
John J. Barcklow Foundation, Inc.,
Springfield, VA
Kathedral Community Development, Inc.,
Tampa, FL
Kinderhudson Corporation, Nyack, NY
Ladwin Corp., San German, PR
Lafontaine Christian Church Scholarship
Fund, Omaha, NE
Land Conservancy, Inc., Fairfield, NJ
Lark Second Chance, Harvey, IL
Laws of Life Expression Contest, Inc.,
Greensboro, NC
L D P Memorial Fund, Inc., Elizabeth, NJ
Linda Parham Ministries, Inc.,
Worcester, MA
Long March Foundation, Inc.,
New York, NY
Love for Life Foundation of Philippine
American Physicians in America,
Ledyard, CT
Lyceum Corporation, Dallas, TX
Making a Difference Foundation,
Los Angeles, CA

520

Mapua Alumni Foundation, Inc.,
Yorba Linda, CA
Maridon Museum, Butler, PA
Marion Regional Healthcare Foundation,
Mullins, SC
Mauldin Scholarship Charitable Trust,
North Little Rock, AR
Metropolitan Community Housing and
Development Organization, Inc.,
Baton Rouge, LA
Mirandette Martial Arts Center, Inc.,
Kentwood, MI
Moscow Directors’ Art Theatre Studio of
New York, New York, NY
Mount Pleasant Outreach Ministries, Inc.,
Atlanta, GA
Movement is Life, Inc., Detroit, MI
Moving Transit Through LA,
Los Angeles, CA
NBCAR Historic District, Dothan, AL
Neurotherapy Research Association, Inc.,
Chevy Chase, MD
New Beginning Home Preparing for the
Future, Winston Salem, NC
New Dimension Theatre Studio, Inc.,
Edgewater, NJ
New Vision Generational Learning
Center, Kalamazoo, MI
Nickel of Hope, Cedar Hill, TX
Nile Vintage Group, Inc., Brooklyn, NY
Non Profit Secretarial Service NPSS, Inc.,
Houston, TX
North Coast Alliance, Cambria, CA
North Florida Housing, Inc., Newberry, FL
Note Worthy Outreach, Inc., Mission, KS
Notoriety, Inc., Irvine, CA
N.P.R.S.C., Inc., New Port Richey, FL
Nutritional Biomedicine Research
Institute, Inc., Aspen, CO
Officeplease Foundation, Glen Ellen, CA
On Target of North Carolina, Inc.,
Kernersville, NC
Osseo Community Foundation,
Osseo, MN
Our Father’s House, Inc.,
Goose Creek, SC
Oxford Muse, Pearland, TX
Particle Economics Research Institute,
Eastsound, WA
Partnership for Health, Healing &
Community, Saco, ME
Perpetual Help Unlimited, Chicago, IL
Pineland Farms, Inc., New Gloucester, ME
Place of Hope Dog Rescue Foundation,
Valentine, AZ
Pokagon Fund, Inc., New Buffalo, MI
Preventive Care for Productive Lives,
Inc., Potomac, MD

February 12, 2007

Professionals Network of Florida, Inc.,
Jupiter, FL
Project Jakana, Ukiah, CA
Radar, Inc., Reno, NV
Rational Living Foundation, Inc.,
Tampa, FL
Real Estate Education Foundation,
Albuquerque, NM
Rhonda Joy Edwards Vansant Foundation,
Inc., Portland, OR
Rock Springs Community Center,
Mullin, TX
Rockville Striders Youth Track Club, Inc.,
Rockville, MD
Rozie Wilson White Agency, Inc.,
Cedar Hill, TX
Ruthmere Foundation, Inc., Elkhart, IN
Sea Life Studies, Inc., Morro Bay, CA
Seeds of Hope, Corralitos, CA
Senior Citizens Foundation, Inc.,
Deming, NM
Serv Behavioral Health Systems, Inc.,
West Trenton, NJ
Share the Warmth, Inc., Evansville, IN
Sharing the Journey, Toledo, OH
Sharon Sockwell-Clark Mission
Foundation, Inc., Bergheim, TX
Shield of Faith Out Reach Ministries, Inc.,
Atlanta, GA
Shirley A. Cunningham Jr. Family
Foundation, Inc., Georgetown, KY
Show Low Housing Coalition, Inc.,
Show Low, AZ
Sibley House, Nuevo, CA
Silence the Violence, Inc., Brooklyn, NY
Snow Cloud Farm, Inc., Asheville, NC
Solutions Community Outreach, Inc.,
Houston, TX
South Central Urban Ministries, Inc.,
Nashville, TN
Southwest Psychoanalytic Foundation,
Tucson, AZ
Spirit Investigations, Inc., Nashville, TN
Spotlight Fashion Group, Spartanburg, SC
SRDS, Sartell, MN
SS&W Enterprise, Inc., Philadelphia, PA
St. Augustine Foundation, Ltd.,
Yonkers, NY
St. Claude Community Family Center,
River Ridge, LA
Stewart W. and Willma C. Hoyt
Foundation, Binghamton, NY

February 12, 2007

Stratford Festival Theater, Inc.,
Fairfield, CT
Sundance Farm, Inc., Inman, KS
Supporting Parents Educational Dreams,
Inc., Portland, OR
Tallship Michigan, Franklin, MI
Talons & Tails, Inc., Bunnell, FL
Tarlow Family Foundation, Inc.,
St. Louis, MO
Temple Broadcasting Communication,
Inc., Simpsonville, SC
Texas Panhandle Film Commission,
Amarillo, TX
Thomasville Initiative, Thomasville, NC
Titusville Friends of the Arts,
Hydetown, PA
To God be the Glory Ministries,
St. Louis, MO
Tony J. Ferry Ministries, Rehoboth, MA
Trail Corps Academy, Silverthorne, CO
United Charities of America,
San Angelo, TX
Upward Bound Youth Foundation, Inc.,
Clearwater, FL
Veneto Org, Washington, DC
Virtuous Women Under Construction,
Los Angeles, CA
VNA Foundation, Inc., Syracuse, NY
Walk-Ons, Inc., Salt Lake City, UT
Well Ministries, Inc., Wings Mills, MD
West Piedmont Workforce Investment
Board, Martinsville, VA
Wishing Well Foundation of America,
Inc., Palmetto Bay, FL
Women and Wisdom Foundation, Inc.,
Greensboro, NC
Women of Faith Ministries and Gods
Associates, Indianapolis, IN
Women of Light Foundation, Inc.,
Potomac, MD
Workers Housing Corporation,
San Juan, PR
WOW Community Outreach, Inc.,
Birmingham, AL
W.W.O.C.B. — “We Want Our Children
Back” Community Organization of
Athens, Athens, AL
Xristos Association, Inc.,
South Holland, IL
Yonkers Partnership Housing
Development Fund Corporation,
Yonkers, NY

521

Youth Determined to Succeed Y.D.T.S.,
Inc., Pittsburgh, PA
Youth Excelling Socially, Inc.,
Little Rock, AR
Youth of Promise, Irvine, CA
If an organization listed above submits
information that warrants the renewal of
its classification as a public charity or as
a private operating foundation, the Internal Revenue Service will issue a ruling or
determination letter with the revised classification as to foundation status. Grantors
and contributors may thereafter rely upon
such ruling or determination letter as provided in section 1.509(a)–7 of the Income
Tax Regulations. It is not the practice of
the Service to announce such revised classification of foundation status in the Internal Revenue Bulletin.

Treatment of Payments in Lieu
of Taxes Under Section 141
Announcement 2007–19
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Cancellation of notice of public
hearing on proposed rulemaking.
SUMMARY: This document cancels a
public hearing on proposed regulations
(REG–136806–06, 2006–47 I.R.B. 950)
modifying the standards for treating payments in lieu of taxes (PILOTs) as generally applicable taxes for purposes of
the private security or payment test under
section 141.
DATES: The public hearing, originally
scheduled for February 13, 2007 at
10 a.m. is cancelled.
FOR
FURTHER
INFORMATION
CONTACT: Kelly Banks of the Publications and Regulations Branch, Legal
Processing Division, Associate Chief
Counsel (Procedure and Administration)
at (202) 622–0392 (not a toll-free number).

2007–7 I.R.B.

SUPPLEMENTARY INFORMATION:
A notice of proposed rulemaking and notice of public hearing that appeared in
the Federal Register on Thursday, October 19, 2006 (71 FR 61693), announced
that a public hearing was scheduled for
February 13, 2007, at 10 a.m. in the
IRS Auditorium, New Carrollton Federal Building, 5000 Ellin Road, Lanham,
MD 20706. Subsequently, a notice of
change of location of public hearing was
published in the Federal Register on
Tuesday, December 26, 2006, (published
as Announcement 2007–6, 2007–4 I.R.B.
376 [71 FR 77352]) changing the location
to the IRS Auditorium, Internal Revenue
Building, 1111 Constitution Avenue, NW,
Washington, DC. The subject of the public
hearing is under section 141 of the Internal
Revenue Code.
The public comment period for these
regulations expired on January 16, 2007.

2007–7 I.R.B.

The notice of proposed rulemaking and notice of public hearing instructed those interested in testifying at the public hearing
to submit a request to speak and an outline of the topics to be addressed. As of
Tuesday, January 23, 2007, no one has requested to speak. Therefore, the public
hearing scheduled for February 13, 2007,
is cancelled.
LaNita Van Dyke,
Branch Chief,
Publications and Regulations Branch,
Legal Processing Division,
Associate Chief Counsel
(Procedure and Administration).
(Filed by the Office of the Federal Register on January 29,
2007, 8:45 a.m., and published in the issue of the Federal
Register for January 30, 2007, 72 F.R. 4220)

522

February 12, 2007

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the effect:
Amplified describes a situation where
no change is being made in a prior published position, but the prior position is being extended to apply to a variation of the
fact situation set forth therein. Thus, if
an earlier ruling held that a principle applied to A, and the new ruling holds that the
same principle also applies to B, the earlier
ruling is amplified. (Compare with modified, below).
Clarified is used in those instances
where the language in a prior ruling is being made clear because the language has
caused, or may cause, some confusion.
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 amplified and clarified, above).
Obsoleted describes a previously published ruling that is not considered determinative with respect to future transactions. This term is most commonly used in
a ruling that lists previously published rulings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.
Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a new ruling.
Superseded describes a situation where
the new ruling does nothing more than restate the substance and situation of a previously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same position published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single ruling a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new ruling does more than restate the substance

of a prior ruling, a combination of terms
is used. For example, modified and superseded describes a situation where the
substance of a previously 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.

ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.

PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D. —Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z —Corporation.

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.

February 12, 2007

i

2007–7 I.R.B.

Numerical Finding List1

Revenue Procedures— Continued:

Bulletins 2007–1 through 2007–7

2007-13, 2007-3 I.R.B. 295
2007-14, 2007-4 I.R.B. 357

Announcements:
2007-1, 2007-1 I.R.B. 243
2007-2, 2007-2 I.R.B. 263
2007-3, 2007-4 I.R.B. 376
2007-4, 2007-7 I.R.B. 518
2007-5, 2007-4 I.R.B. 376
2007-6, 2007-4 I.R.B. 376

2007-15, 2007-3 I.R.B. 300
2007-16, 2007-4 I.R.B. 358
2007-17, 2007-4 I.R.B. 368
2007-18, 2007-5 I.R.B. 413
2007-19, 2007-7 I.R.B. 515
2007-20, 2007-7 I.R.B. 517

Revenue Rulings:

2007-7, 2007-4 I.R.B. 377
2007-8, 2007-5 I.R.B. 416

2007-1, 2007-3 I.R.B. 265

2007-9, 2007-5 I.R.B. 417

2007-2, 2007-3 I.R.B. 266

2007-10, 2007-6 I.R.B. 464

2007-3, 2007-4 I.R.B. 350

2007-11, 2007-6 I.R.B. 464

2007-4, 2007-4 I.R.B. 351

2007-12, 2007-6 I.R.B. 465

2007-5, 2007-5 I.R.B. 378

2007-13, 2007-7 I.R.B. 519

2007-6, 2007-5 I.R.B. 393

2007-14, 2007-7 I.R.B. 519

2007-7, 2007-7 I.R.B. 468

2007-19, 2007-7 I.R.B. 521

2007-8, 2007-7 I.R.B. 469
2007-9, 2007-6 I.R.B. 422

Notices:
Treasury Decisions:
2007-1, 2007-2 I.R.B. 254
2007-2, 2007-2 I.R.B. 254

9298, 2007-6 I.R.B. 434

2007-3, 2007-2 I.R.B. 255

9299, 2007-6 I.R.B. 460

2007-4, 2007-2 I.R.B. 260

9300, 2007-2 I.R.B. 246

2007-5, 2007-3 I.R.B. 269

9301, 2007-2 I.R.B. 244

2007-6, 2007-3 I.R.B. 272

9302, 2007-5 I.R.B. 382

2007-7, 2007-5 I.R.B. 395

9303, 2007-5 I.R.B. 379

2007-8, 2007-3 I.R.B. 276

9304, 2007-6 I.R.B. 423

2007-9, 2007-5 I.R.B. 401

9305, 2007-7 I.R.B. 479

2007-10, 2007-4 I.R.B. 354

9306, 2007-6 I.R.B. 420

2007-11, 2007-5 I.R.B. 405

9307, 2007-7 I.R.B. 470

2007-12, 2007-5 I.R.B. 409

9309, 2007-7 I.R.B. 497

2007-13, 2007-5 I.R.B. 410
2007-14, 2007-7 I.R.B. 501
2007-15, 2007-7 I.R.B. 503

Proposed Regulations:
REG-152043-05, 2007-2 I.R.B. 263
REG-161919-05, 2007-6 I.R.B. 463
REG-125632-06, 2007-5 I.R.B. 415

Revenue Procedures:
2007-1, 2007-1 I.R.B. 1
2007-2, 2007-1 I.R.B. 88
2007-3, 2007-1 I.R.B. 108
2007-4, 2007-1 I.R.B. 118
2007-5, 2007-1 I.R.B. 161
2007-6, 2007-1 I.R.B. 189
2007-7, 2007-1 I.R.B. 227
2007-8, 2007-1 I.R.B. 230
2007-9, 2007-3 I.R.B. 278
2007-10, 2007-3 I.R.B. 289
2007-11, 2007-2 I.R.B. 261
2007-12, 2007-4 I.R.B. 354

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin
2006–52, dated December 26, 2006.

2007–7 I.R.B.

ii

February 12, 2007

Finding List of Current Actions on
Previously Published Items1
Bulletins 2007–1 through 2007–7
Notices:

Revenue Procedures— Continued:

Revenue Rulings— Continued:

2004-11

2003-43

Superseded by

Modified by

Rev. Proc. 2007-16, 2007-4 I.R.B. 358

Notice 2007-2, 2007-2 I.R.B. 254

2004-65

2003-92

2005-29

Modified and superseded by

Clarified and amplified by

Modified and superseded by

Rev. Proc. 2007-20, 2007-7 I.R.B. 517

Rev. Rul. 2007-7, 2007-7 I.R.B. 468

Notice 2007-4, 2007-2 I.R.B. 260

2005-12

2005-76

2006-2

Superseded by

Supplemented and superseded by

Modified and superseded by

Rev. Proc. 2007-17, 2007-4 I.R.B. 368

Rev. Rul. 2007-4, 2007-4 I.R.B. 351

Notice 2007-4, 2007-2 I.R.B. 260

2005-69

Treasury Decisions:

2006-50

Superseded by

Amplified, clarified, and modified by

Rev. Proc. 2007-15, 2007-3 I.R.B. 300

Notice 2007-11, 2007-5 I.R.B. 405

2006-1

Proposed Regulations:

Superseded by

Corrected by
Ann. 2007-9, 2007-5 I.R.B. 417
Ann. 2007-10, 2007-6 I.R.B. 464

Rev. Proc. 2007-1, 2007-1 I.R.B. 1
REG-208270-86
Corrected by
Ann. 2007-4, 2007-7 I.R.B. 518
REG-141901-05
Corrected by
Ann. 2007-7, 2007-4 I.R.B. 377
REG-142270-05
Corrected by
Ann. 2007-2, 2007-2 I.R.B. 263
REG-127819-06
Corrected by
Ann. 2007-5, 2007-4 I.R.B. 376
REG-136806-06
Corrected by
Ann. 2007-6, 2007-4 I.R.B. 376
Hearing cancelled by
Ann. 2007-19, 2007-7 I.R.B. 521

Revenue Procedures:

9278

9286

2006-2

Corrected by

Superseded by

Ann. 2007-8, 2007-5 I.R.B. 416

Rev. Proc. 2007-2, 2007-1 I.R.B. 88
2006-3
Superseded by
Rev. Proc. 2007-3, 2007-1 I.R.B. 108
2006-4
Superseded by
Rev. Proc. 2007-4, 2007-1 I.R.B. 118
2006-5
Superseded by
Rev. Proc. 2007-5, 2007-1 I.R.B. 161
2006-6
Superseded by
Rev. Proc. 2007-6, 2007-1 I.R.B. 189
2006-7
Superseded by
Rev. Proc. 2007-7, 2007-1 I.R.B. 227

98-20

2006-8

Superseded by

Superseded by

Rev. Proc. 2007-12, 2007-4 I.R.B. 354

Rev. Proc. 2007-8, 2007-1 I.R.B. 230

2000-38

Revenue Rulings:

Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B. 358
2000-50
Modified by
Rev. Proc. 2007-16, 2007-4 I.R.B. 358
2001-42
Modified and amplified by
Rev. Proc. 2007-19, 2007-7 I.R.B. 515
2002-9
Modified and amplified by

75-161
Obsoleted by
Rev. Rul. 2007-8, 2007-7 I.R.B. 469
76-188
Obsoleted by
Rev. Rul. 2007-8, 2007-7 I.R.B. 469
78-330
Modified by
Rev. Rul. 2007-8, 2007-7 I.R.B. 469

Rev. Proc. 2007-14, 2007-4 I.R.B. 357
Modified by

81-225

Rev. Proc. 2007-16, 2007-4 I.R.B. 358

Rev. Rul. 2007-7, 2007-7 I.R.B. 468

Clarified and amplified by

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2006–27 through 2006–52 is in Internal Revenue Bulletin 2006–52, dated December 26,
2006.

February 12, 2007

iii

2007–7 I.R.B.

INTERNAL REVENUE BULLETIN
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