Notice 97-45

Part III. Administrative, Procedural, and Miscellaneous
Highly Compensated Employee
Definition
Notice 97–45
I. PURPOSE
This notice provides guidance relating
to the definition of highly compensated
employee (“HCE”) under §414(q) of the
Internal Revenue Code (“Code”), as
amended by §1431 of the Small Business
Job Protection Act of 1996, Pub. L. 104188 (“SBJPA”). The §414(q) definition of
HCE is incorporated by certain provisions
of the Code that apply nondiscrimination
requirements to various employee benefit
plans, entities, or arrangements (“plans”).
Specifically, this notice provides:
• Guidance on making the top-paid
group election permitted by
§414(q)(1)(B)(ii), under which an
employee (other than a 5-percent
owner) with compensation in excess
of the dollar threshold is an HCE
only if the employee is among the
highest paid 20 percent of an employer’s workforce.
• A new calendar year data election
under which an employer that maintains one or more plans on a fiscal
year basis has the option to use calendar year data to simplify the determination of whether an employee is an
HCE on account of compensation
under §414(q)(1)(B).
• Transition relief from certain requirements of the top-paid group election
and the calendar year data election.
• Guidance on plan amendments to reflect the revised definition of HCE, including the application of the remedial
amendment period under § 401(b),
and certain other matters relating to
the determination of HCE status.

II. BACKGROUND
(1) Section 414(q) prior to SBJPA.
Prior to amendment by SBJPA,
§ 414(q)(1) generally provided that an
employee was an HCE if, at any time during the year or the preceding year, the employee:
(A) was a 5-percent owner,
(B) received more than $100,000 (for
1996) in annual compensation from the
employer,

1997–33 I.R.B.

(C) received more than $66,000 (for
1996) in annual compensation from the
employer and was in the top-paid group
of employees during the same year, or
(D) was an officer of the employer who
received compensation in excess of
$60,000 (for 1996).
(2) Guidance under § 414(q) prior to
SBJPA. Under §1.414(q)–1T, A–14(b) of
the temporary Income Tax Regulations,
employers were allowed to make a calendar year calculation election, under which
the preceding year’s calculations relating
to HCE determinations were made on the
basis of the calendar year ending with or
within the current year. Under section 4 of
Rev. Proc. 93–42, 1993–2 C.B. 540, as
modified by Rev. Proc. 95–34, 1995–2
C.B. 385, an employer was permitted to
use a simplified method for determining
HCEs. Rev. Proc. 95–34 also provided
model plan language for employers to use
the simplified method.
(3) SBJPA amendments to § 414(q).
Section 414(q)(1), as amended by SBJPA,
provides that the term “highly compensated employee” means any employee
who:
(A) was a 5-percent owner at any time
during the year or the preceding year, or
(B) for the preceding year had compensation from the employer in excess of
$80,000 and, if the employer so elects,
was in the top-paid group for the preceding year.
The $80,000 amount is adjusted at the
same time and in the same manner as
under § 415(d), except that the base period is the calendar quarter ending September 30, 1996.
Pursuant to § 414(q)(3), an employee is
in the top-paid group for any year if the
employee is in the group consisting of the
top 20 percent of the employees of the
employer when ranked on the basis of
compensation paid to employees during
such year. An election pursuant to §
414(q)(1)(B)(ii), under which an employee (who is not a 5-percent owner)
who has compensation in excess of
$80,000 is not an HCE if the employee is
not a member of the top-paid group, is referred to in this notice as a “top-paid
group election.”
The amendments made by § 1431 of
SBJPA generally apply to years beginning

7

after December 31, 1996.

III. EFFECT OF STATUTORY
CHANGES ON PRIOR GUIDANCE
(1) Prior guidance. Because of the
amendments made to § 414(q) by SBJPA,
certain portions of § 1.414(q)–1T do not
reflect current law. Except as provided in
section III(2), the calendar year calculation election under A–14(b) of §
1.414(q)–1T does not apply for years beginning after December 31, 1996. In addition, the guidance provided under section
4 of Rev. Proc. 93–42 and under Rev.
Proc. 95–34 does not apply for years beginning after December 31, 1996. The
Service intends to publish guidance in the
future that will make appropriate modifications to these items of guidance.
(2) Transition relief for 1997. For any
year beginning on or after January 1,
1997 and before January 1, 1998, employers may continue to utilize the calendar
year calculation election, taking into account the statutory amendments to §
414(q)(1)(B), and the elimination of §
414(q)(1)(C) and (D), by SBJPA.

IV. PERIODS FOR DETERMINING
HCE STATUS
(1) Determination years and look-back
years. HCE status is determined on the
basis of the applicable year (as defined
below) of the plan or other entity for
which a determination is being made
(“determination year”) and the preceding
twelve-month period (“look-back year”)
in accordance with § 414(q). Thus, under
§ 414(q), as amended by SBJPA, an employee is an HCE for a determination year
if, (a) at any time during the determination year or the look-back year, the employee was a 5-percent owner or (b) for
the look-back year, the employee had
compensation from the employer in excess of $80,000 (as adjusted) and, if the
employer so elects, was in the top-paid
group.
(2) Applicable year.
(a) Retirement plans. The applicable
year for a retirement plan is the plan year.
For purposes of this notice, a retirement
plan is a plan that is qualified under §
401(a) or 403(a) or described in § 403(b)
or 408(k).
(b) Nonretirement plans. The applica-

August 18, 1997

ble year for a nonretirement plan is the
plan year, as defined in the written plan
document or otherwise identified in the
Code and regulations. If a nonretirement
plan does not have an identified plan year,
then the employer may treat either the calendar year or the employer’s fiscal year as
the applicable year. For purposes of this
notice, a nonretirement plan is any employee benefit arrangement to which the
definition of HCE is applicable under a
provision of the Code, other than a retirement plan.

V. IMPLEMENTATION OF
ELECTIONS
(1) Top-paid group election. An employer may make a top-paid group election for a determination year. The effect
of the top-paid group election is that an
employee (who is not a 5-percent owner
at any time during the determination year
or the look-back year) with compensation
in excess of $80,000 (as adjusted) for the
look-back year is an HCE only if the employee was in the top-paid group for the
look-back year. A top-paid group election,
once made, applies for all subsequent determination years unless changed by the
employer.
(2) Calendar year data election.
(a) This notice provides a new calendar
year data election which an employer may
make for a determination year. The effect
of the calendar year data election is that
the calendar year beginning with or
within the look-back year is treated as the
employer’s look-back year for purposes
of determining whether an employee is an
HCE on account of the employee’s compensation for a look-back year under §
414(q)(1)(B). A calendar year data election, once made, applies for all subsequent determination years unless changed
by the employer.
(b) A calendar year data election made
by an employer does not apply in determining whether the employer’s employees are HCEs under § 414(q)(1)(A) on account of being 5-percent owners.
Accordingly, if an employee is a 5-percent owner in either the look-back year or
the determination year, then the employee
is an HCE, without regard to whether the
employee’s employer makes a calendar
year data election.
(c) If a plan has a calendar year as its
determination year, then the immediately

August 18, 1997

preceding calendar year is the look-back
year for the plan. This is the case whether
or not a calendar year data election is
made. Thus, a calendar year data election
would have no effect on the HCE determination for a calendar year plan.
(3) No separate notification requirement. Notification or filing with the Internal Revenue Service of a top-paid group
election or a calendar year data election is
not required in order for the election to be
valid. However, under certain circumstances, plan amendments may be required to reflect the election. See
section VII of this notice.
(4) Cross-references. Section VI of this
notice provides a consistency requirement
that applies if an employer maintains
more than one plan. Section VII of this
notice describes circumstances under
which a top-paid group election or calendar year data election, or changes to such
elections, may have to be reflected in plan
documents.

VI. CONSISTENCY REQUIREMENT
FOR ELECTIONS
(1) Consistency requirement — in general. Except as provided in section VI(3)
and (4), in order to be effective, a top-paid
group election made by an employer must
apply consistently to the determination
years of all plans of the employer that
begin with or within the same calendar
year. Similarly, except as provided in section VI(3) and (4), in order to be effective,
a calendar year data election made by an
employer must apply consistently to the
determination years of all plans of the employer, other than a plan with a calendar
year determination year, that begin within
the same calendar year.
(2) Interaction of top-paid group election and calendar year data election. The
top-paid group election and the calendar
year data election are independent of each
other. Thus, an employer making one of
the elections is not required also to make
the other election. However, if both elections are made, the look-back year in determining the top-paid group must be the
calendar year beginning with or within
the look-back year, in accordance with
section V of this notice.
(3) Multiemployer plans. Satisfaction of
the consistency requirement is determined
without regard to any multiemployer plans
in which the employer participates.

8

(4) Transition relief for years prior to
2000.
(a) Transition relief for 1997. The consistency requirement will not apply to determination years beginning with or
within the 1997 calendar year. Thus, an
employer may make a top-paid group
election or a calendar year data election
for a plan for a determination year beginning with or within 1997, without regard
to whether the employer makes that election for any other plan.
(b) Transition relief for 1998 and 1999.
For determination years beginning on or
after January 1, 1998, and before January
1, 2000, (i) nonretirement plans are not
subject to the consistency requirement,
and (ii) satisfaction of the consistency requirement with respect to retirement plans
is determined without regard to any plans
of the employer that are nonretirement
plans.

VII. QUALIFIED RETIREMENT
PLAN AMENDMENTS FOR HCE
DEFINITION
(1) Qualified plans that must be
amended. If a retirement plan qualified
under § 401(a) or 403(a) contains the definition of HCE under § 414(q), as in effect before SBJPA, the plan must be
amended to reflect the definition of HCE
under § 414(q), as amended by SBJPA. If
an employer makes either a top-paid
group or calendar year data election for a
determination year, a plan that contains
the definition of HCE must reflect the
election. If the employer changes either a
top-paid group or calendar year data election, the plan must be amended to reflect
the change. However, a plan is not required to add a definition of HCE merely
to reflect a top-paid group or calendar
year data election.
(2) Amendment date. Rev. Proc. 97–41,
1997–33 IRB, provides that qualified retirement plans have a remedial amendment period under § 401(b) so that certain
plan amendments for SBJPA are not required to be adopted before the last day of
the first plan year beginning on or after
January 1, 1999 (with a later date for governmental plans). Pursuant to Rev. Proc.
97–41, a plan provision reflecting the definition of HCE is a disqualifying provision and thus any plan amendments to reflect the definition of HCE in § 414(q), as
amended by SBJPA, and to reflect any

1997–33 I.R.B.

choices regarding the top-paid group or
calendar year data elections, are not required to be made until the end of this remedial amendment period. However,
plans must be operated in accordance
with the SBJPA changes to the HCE definition in § 414(q) as of the statutory effective date, and plans required to be
amended to reflect those changes must be
so amended retroactively effective as of
that date. In addition, under Rev. Proc.
97–41, any retroactive amendments must
reflect the choices made in the operation
of the plan for each determination year,
including choices made with respect to
the top-paid group election and the calendar year data election (and any changes to
those elections), and the first date that the
plan operated in accordance with those
choices (and any such changes).

VIII. OTHER ISSUES RELATING
TO DETERMINATION OF HCE
STATUS
(1) Determining HCE status for 1997.
As noted earlier, the amendments made
by § 1431 of the SBJPA generally apply
to years beginning after December 31,
1996. However, § 1431(d)(1) provides
that, in determining whether an employee
is an HCE for years beginning in 1997,
the amendments to § 414(q) are treated as
having been in effect for years beginning
in 1996. Accordingly, in determining
whether an employee is an HCE for the
determination year beginning with or
within the 1997 calendar year, an employer must consider whether the employee was a 5-percent owner or had
compensation in excess of $80,000 for the
look-back year that began with or within
the 1996 calendar year. An employer also
may make the calendar year data election
and/or the top-paid group election with
respect to determination years beginning
with or within the 1997 calendar year, in
accordance with the guidance in this notice. The SBJPA amendments to § 414(q)
are not applicable in determining the employer’s HCEs for determination years
beginning prior to January 1, 1997.
(2) Highly compensated former employees. For purposes of determining status as a highly compensated former employee under § 1.414(q)–1T, A–4,
whether an employee was a highly compensated active employee for a determination year that ended on or after the em-

1997–33 I.R.B.

ployee’s 55th birthday, or that was a separation year, is based on the rules applicable to determining HCE status as in effect
for that determination year.
(3) Determining 5-percent ownership
by attribution of ownership interest to
family members. The definition of 5-percent owner in § 414(q)(2) refers to §
416(i)(1), which in turn refers to the attribution rules of § 318. Under the rules of
§318, an individual is considered to own
any stock owned directly or indirectly by
the individual’s spouse, children, grandchildren or parents. Consequently, an employee who is the spouse, child, parent or
grandparent (“family member”) of an individual who has a 5-percent interest in
the employer at any time during the lookback year or the determination year is
treated as an HCE under § 414(q)(1)(A),
regardless of the family member’s compensation level. These statutory provisions relating to the definition of 5-percent owner under § 414(q)(2) are different
from the family aggregation rules under
former § 414(q)(6) and are unaffected by
the repeal of those rules under §
1431(b)(1) of SBJPA.

IX. EXAMPLES
The following examples illustrate the
rules in this notice:
Example 1: (a) Employer A has maintained a defined benefit plan qualified
under § 401(a) (Plan M) since 1996 with a
plan year beginning April 1 and ending
March 31. Employer A has never had a 5percent owner. For Plan M’s determination year beginning April 1, 2000 and
ending March 31, 2001, Employer A does
not make a calendar year data election or
a top-paid group election.
(b) Under § 414(q)(1)(B), Employer A
determines HCEs for Plan M’s determination year beginning April 1, 2000, based
upon the compensation of Employer A’s
employees in Plan M’s look-back year.
Thus, the HCEs are those employees who
had compensation over $80,000 (as adjusted) during the period beginning April
1, 1999 and ending March 31, 2000.
Example 2: (a) Assume the same facts
as in Example 1, except that Employer A
hires a new employee, Employee X, on
March 1, 2000 at an annual salary of
$240,000. Employee X is not a 5-percent
owner during the determination year beginning April 1, 2000 or the look-back

9

year beginning April 1, 1999. During the
month of March, 2000, Employee X’s
compensation was $20,000.
(b) Because Employee X’s compensation during Plan M’s look-back year beginning April 1, 1999 was less than
$80,000 (as adjusted), Employee X is not
an HCE for Plan M’s determination year
beginning April 1, 2000.
Example 3: (a) Employer B has maintained a qualified defined benefit plan
(Plan N) since 1996 that has a calendar
plan year. Employer B makes a top-paid
group election for Plan N’s 1998 determination year, which is the 1998 calendar
year. Employer B had 15 employees in
the 1997 calendar year and has never had
a 5-percent owner. These employees,
along with their compensation for the
1997 calendar year, are listed below.
Employees
1
2
3
4
5-15

1997 Compensation
$200,000
110,000
101,000
90,000
50,000 or less

(b) In determining Employer B’s HCEs
for the calendar year 1998 under the toppaid group election, Plan N’s relevant
look-back year is the 1997 calendar year.
Employer B must determine whether any
employee had compensation above
$80,000, and was in the group consisting
of the top 20 percent of the employees of
Employer B in the 1997 calendar year,
when ranked on the basis of compensation from Employer B during the 1997
calendar year.
(c) Employees 1, 2 and 3 comprise the
top 20 percent of Employer B’s 15 employees for the 1997 calendar year based
on compensation from Employer B during the 1997 calendar year. Although Employee 4 had compensation over $80,000
in the 1997 calendar year, Employee 4
was not in the top-paid group for the 1997
calendar year and is therefore not an HCE
for Plan N’s 1998 determination year.
This will be the case regardless of
whether Employees 1, 2 and 3 continue to
be employed in the 1998 calendar year.
Example 4: (a) Employer C has a qualified profit sharing plan (Plan O) with a
calendar plan year. Employer C also has a
qualified defined benefit plan (Plan P)
with a plan year beginning April 1 and
ending March 31. Employer C makes the

August 18, 1997

top-paid group election for Plan O for the
calendar year 2000.
(b) Pursuant to the consistency rule requiring that the employer make the same
election for all determination years of all
plans of the employer that begin with or
within the same calendar year, Employer
C must also make the top-paid group election for Plan P’s determination year beginning April 1, 2000 and ending March
31, 2001.
(c) The look-back year for purposes of
determining whether any of Employer C’s
employees is an HCE under Employer C’s
top-paid group election for Plan O is the
1999 calendar year and for Plan P is the
April 1, 1999 to March 31, 2000 year. The
group of Employer C’s employees that are
HCEs for Plan O’s 2000 determination
year are those employees who had compensation above $80,000 (as adjusted)
and who were in the top 20 percent of employees based on compensation for the
1999 calendar year, while the group of
Employer C’s employees that are HCEs
for Plan P’s determination year beginning
April 1, 2000 are those employees who
had compensation above $80,000 (as adjusted) and who were in the top 20 percent of employees based upon compensation for Plan P’s look-back year beginning
April 1, 1999.
Example 5: (a) Since 1998, Employer
D has maintained a qualified cash or deferred arrangement under § 401(k) (Plan
Q). Plan Q has a calendar plan year. Employer D has never made a calendar year
data election or a top-paid group election
for Plan Q and has never had a 5-percent
owner. Under § 401(k)(3)(A)(ii), as
amended by the SBJPA, unless an employer elects to use current year data for
all eligible employees, the actual deferral
percentage (ADP) test for the plan year is
applied by comparing the ADP for all eligible HCEs for the plan year to the ADP
for all other eligible employees (nonHCEs) for the preceding plan year. Employer D has not elected to use current
year data for the nonHCEs for the 2000
calendar year.
(b) In conducting the ADP test for the
2000 calendar year, Employer D compares the ADP for the 2000 calendar year
for the group of employees who had compensation above $80,000 (as adjusted) for
the 1999 calendar year, and who are eligible under the plan for the 2000 calendar

August 18, 1997

year, with the ADP for the 1999 calendar
year for the group of employees who were
nonHCEs for the 1999 calendar year and
who were eligible under the plan for the
1999 calendar year. Employer D would
have previously determined who the
HCEs were for the 1999 calendar year,
that is, the employees of Employer D who
had compensation above $80,000 (as adjusted) for the 1998 calendar year. The
nonHCEs for the 1999 calendar year are
those employees who were employees in
the 1999 calendar year and who were not
determined to be HCEs for the 1999 calendar year.
Example 6: (a) Employer E has maintained a qualified profit sharing plan (Plan
R) since 1996 with an April 1 to March 31
plan year. Employer E has also maintained a defined benefit plan (Plan S)
since 1996 with an October 1 to September 30 plan year. Employer E decides to
make the calendar year data election for
determination years of Plan R and Plan S
beginning in the 2000 calendar year.
Thus, Employer E makes the election for
Plan R’s determination year beginning
April 1, 2000 and ending March 31, 2001,
and Plan S’s determination year beginning October 1, 2000 and ending September 30, 2001.
(b) The 2000 calendar year begins
within Plan R’s look-back year beginning
April 1, 1999 and ending March 31, 2000,
and Plan S’s look-back year beginning
October 1, 1999 and ending September
30, 2000 and is treated as Employer E’s
look-back year for both Plans R and S for
purposes of determining Employer E’s
HCEs on the basis of compensation.
Thus, in determining HCE status under §
414(q)(1)(B) Employer E determines
whether an employee has compensation
for the look-back year in excess of
$80,000 (as adjusted), and if applicable,
the composition of the top-paid group, on
the basis of compensation for the 2000
calendar year.
Example 7: (a) Assume the same facts
as in Example 6, except that Employer E
also maintains Plan T, a qualified defined
benefit plan with a calendar plan year.
Employer E fails to make the calendar
year data election for Plan T.
(b) Because the consistency requirement for the calendar year data election is
applied without regard to calendar year
plans, the consistency requirement is sat-

10

isfied regardless of whether Employer E
makes a calendar year data election for
Plan T.
Example 8: Assume the same facts as
in Example 6. For Plan R, in determining
whether any of Employer E’s employees
is an HCE on account of being a 5-percent
owner, the employee’s ownership in Employer E is examined for Plan R’s 2000
and 2001 plan years (April 1, 1999 to
March 31, 2000, and April 1, 2000 to
March 31, 2001). For Plan S, in determining whether any of Employer E’s employees is an HCE on account of being a 5percent owner, the employee’s ownership
in Employer E is examined for Plan S’s
2000 and 2001 plan years (October 1,
1999 to September 30, 2000, and October
1, 2000 to September 30, 2001). This is
because the calendar year data election
does not apply in determining whether an
employee is a 5-percent owner.
Example 9: (a) Employer F maintains
Plan U, a defined benefit plan with a calendar year plan year. Employee Y was
employed by Employer F since 1990.
Employee Y retired at age 65 from employment with Employer F in 1998. Employee Y was an HCE in 1992 under the
rules applicable in 1992 to determine
HCE status, but was not an HCE in any
other year, including 1998.
(b) Because Employee Y was an HCE
for a determination year (1992) ending on
or after Employee Y’s 55th birthday, Employee Y is a highly compensated former
employee for determination years beginning after Employee Y’s retirement.

X. PAPERWORK REDUCTION
ACT
The collection of information contained in this notice has been reviewed
and approved by the Office of Management and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C.
3507) under control number 1545–1550.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
control number.
The collection of information in this
notice is in Section VII. This requirement
to amend plan documents is necessary to
update plan documents to reflect the
amended definition of HCE under §
414(q). This information will be used to

1997–33 I.R.B.

determine which employees are HCEs for
purposes of determining contributions,
benefits, or the availability of other rights
or features under the plan. The collection
of information is required to obtain a benefit. The likely respondents are businesses
or other for-profit institutions, nonprofit
institutions, and small businesses or organizations.
The estimated total annual recordkeeping burden is 65,605 hours.
The estimated annual burden per
recordkeeper varies from 10 minutes to
30 minutes, depending on individual circumstances, with an estimated average of
18 minutes. The estimated number of
recordkeepers is 218,683.
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.

XI. COMMENTS
This notice does not address all of the
procedural requirements that may be necessary to implement the top-paid group
election or the calendar year data election
for future years. However, any additional
requirements would be applied prospectively only. The Treasury and the Service
invite comments and suggestions regarding procedural issues and the other matters discussed in this notice.
Comments can be addressed to
CC:DOM:CORP:R (Notice 97–45), room
5228, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, comments
may be hand delivered between the hours
of 8 a.m. and 5 p.m. to CC:DOM:CORP:R
(Notice 97–45), Courier’s Desk, Internal
Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively,
taxpayers may transmit comments electronically via the IRS Internet site at
http://www.irs.ustreas.gov/prod/tax_regs/
comments.html.

phone service at (202) 622-6074 or (202)
622-6075, between the hours of 1:30 p.m.
and 3:30 p.m. Eastern Time, Monday
through Thursday, or Ms. Grinde at (202)
622-6214, or Patricia McDermott of the
Office of the Associate Chief Counsel
(Employee Benefits and Exempt Organizations) at (202) 622-6030. These are not
toll-free numbers.

26 CFR 601.204: Changes in accounting periods
and in methods of accounting.
(Also Part I, §§ 165, 167, 263, 263A, 446, 481;
1.165-2, 1.167(a)-3, 1.263(a)-2, 1.263A-2, 1.446-1,
1.481-4.)

Rev. Proc. 97-35
SECTION 1. PURPOSE
.01 This revenue procedure describes
three alternative methods of accounting
for package design costs: (1) the capitalization method (see section 5.01 of this
revenue procedure), (2) the design-by-design capitalization and 60-month amortization method (see section 5.02 of this
revenue procedure), and (3) the pool-ofcost capitalization and 48-month amortization method (see section 5.03 of this
revenue procedure). A taxpayer may
change to or adopt any one of these three
methods. The procedures for a taxpayer
to change to one of these three methods
are provided in Rev. Proc. 97–37, page
18, which provides simplified and uniform procedures to obtain automatic consent to make this and other changes in
methods of accounting. This revenue procedure modifies and supersedes Rev.
Proc. 90–63, 1990–2 C.B. 664.
.02 The three methods of accounting
for package design costs described in this
revenue procedure are the same methods
of accounting that were described in Rev.
Proc. 90–63. Accordingly, a taxpayer that
properly changed to or adopted one of
these methods pursuant to Rev. Proc.
90–63 is not required to change its
method of accounting to comply with this
revenue procedure.
SECTION 2. DEFINITIONS

DRAFTING INFORMATION
The principal author of this notice is Ingrid Grinde of the Employee Plans Division. For further information regarding
this notice, please contact the Employee
Plans Division’s taxpayer assistance tele-

1997–33 I.R.B.

For purposes of this revenue procedure,
the terms “package design” and “package
design cost” have the meanings provided
in Rev. Rul. 89–23, 1989–1 C.B. 85. If
the taxpayer develops the package design,
the term includes the cost of materials,

11

labor, and overhead associated with the
design, including all design exploration
and study (for example, the development
of any related design which, although
abandoned, advances the development of
the design selected), refinement of the
basic design selected, testing, and preparation of the final master comprehensive
design. If an independent contractor performs the work, the term includes all
billings related to the development of the
particular package, including all design
exploration and study (for example, the
development of any related design which,
although abandoned, advances the development of the design selected), refinement of the basic design selected, testing,
and preparation of the final master comprehensive design. If the taxpayer purchases the package, the term includes the
purchase price. The costs associated with
coupon inserts, refund offers, and other
short-lived promotion-related changes are
specifically excepted from the definition
of “package design cost.”
SECTION 3. BACKGROUND
.01 Section 263(a) of the Internal Revenue Code provides that no deduction is
allowed for any amount paid for new
buildings or for permanent improvements
or betterments made to increase the value
of any property or estate. Section
1.263(a)–2 of the Income Tax Regulations
includes in its examples of capital expenditures the costs of acquiring property
having a useful life substantially beyond
the tax year.
.02 An expenditure generally must be
capitalized under § 263 if the expenditure
creates, enhances, or is part of the cost of
acquiring a tangible or intangible asset
having a useful life that extends substantially beyond the end of the tax year in
which the expenditure is incurred. See
INDOPCO, Inc. v. Commissioner, 503
U.S. 79 (1992); Commissioner v. Lincoln
Savings and Loan Association, 403 U.S.
345 (1971), 1971-2 C.B. 116; Central
Texas Savings and Loan Association v.
United States, 731 F.2d 1181 (5th Cir.
1984); Ellis Banking Corp. v. Commissioner, 688 F.2d 1376 (11th Cir. 1982),
cert. denied, 463 U.S. 1207 (1983); and
Cleveland Electric Illuminating Company
v. United States, 7 Cl. Ct. 220 (1985).
Generally, taxpayers must capitalize
package design costs incurred prior to

August 18, 1997