Offsets under section 6402; Arizona and Wisconsin law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Arizona or Wisconsin. Arizona and Wisconsin are community property states and, under the respective state laws, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Offsets under section 6402; California, Idaho, and Louisiana law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in California, Idaho, or Louisiana. California, Idaho, and Louisiana are community property states and, under the respective state laws, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Offsets under section 6402; Nevada, New Mexico, and Washington law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Nevada, New Mexico, and Washington. Nevada, New Mexico, and Washington are community property states and, under the respective state laws, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Offsets under section 6402; Texas law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Texas. Texas is a community property state and, under the state law, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Final regulations under section 61 of the Code amend section 1.61-8(b) of the regulations to authorize the Commissioner of Internal Revenue to provide rules allowing for the inclusion of advance rentals in gross income in a year other than the year of receipt.

2004 marginal production rates. This notice announces the applicable percentage under section 613A of the Code to be used in determining percentage depletion for marginal properties for the 2004 calendar year.

2004 enhanced oil recovery credit. The enhanced oil recovery credit for taxable years beginning in the 2004 calendar year is determined without regard to the phase-out for crude oil price increases provided in section 43(b) of the Code.

Weighted average interest rate update; corporate bond indexes; 30-year Treasury securities. The weighted average interest rate for July 2004 and the resulting permissible range of interest rates used to calculate current liability and to determine the required contribution are set forth.

A list is provided of organizations now classified as private foundations.

Final regulations, primarily under section 5891 of the Code, provide the manner and method of paying and reporting the excise tax imposed on any person who acquires structured settlement payment rights in a structured settlement factoring transaction if the transfer of the rights is not approved in advance in a qualified order.

Offsets under section 6402; Arizona and Wisconsin law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Arizona or Wisconsin. Arizona and Wisconsin are community property states and, under the respective state laws, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Offsets under section 6402; California, Idaho, and Louisiana law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in California, Idaho, or Louisiana. California, Idaho, and Louisiana are community property states and, under the respective state laws, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Offsets under section 6402; Nevada, New Mexico, and Washington law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Nevada, New Mexico, and Washington. Nevada, New Mexico, and Washington are community property states and, under the respective state laws, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

Offsets under section 6402; Texas law. This ruling provides guidance regarding the amount of an overpayment from a joint tax return that the IRS may offset against a spouse’s separate tax liability for taxpayers domiciled in Texas. Texas is a community property state and, under the state law, each spouse has an undivided 50-percent interest in all community property. Rev. Ruls. 80-7 and 85-70 amplified and clarified.

This procedure describes circumstances under which an insurance company that makes incentive payments to health care providers will be permitted to deduct those payments without regard to section 404 of the Code. The procedure also provides automatic consent procedures for a taxpayer to change its method of accounting for such payments. Rev. Proc. 2002-9 modified and amplified.

This announcement contains the annual report concerning the Pre-Filing Agreement program of the Large and Mid-Size Business Division of the Service for Calendar Year 2003.

Internal Revenue Service (IRS), Treasury.

Final regulations.

This document contains final regulations relating to the inclusion in gross income of advance rentals. The regulations authorize the Commissioner to provide rules allowing for the inclusion of advance rentals in gross income in a year other than the year of receipt. The regulations will affect taxpayers that receive advance payments for the use of certain items (such as intellectual property and computer software) to be designated by the Commissioner.

Effective Date: These regulations are effective July 8, 2004.

Applicability Date: The amendments made by these regulations apply after December 18, 2002.

Edwin B. Cleverdon, (202) 622-7900 (not a toll-free number).

Accordingly, 26 CFR part 1 is amended as follows:

The principal author of these regulations is Edwin B. Cleverdon of the Office of Associate Chief Counsel (Income Tax and Accounting). However, other personnel from the IRS and Treasury Department participated in their development.

* * * * *

Internal Revenue Service (IRS), Treasury.

Final regulations and removal of temporary regulations.

This document contains final regulations relating to the manner and method of reporting and paying the nondeductible 40 percent excise tax imposed on any person who acquires structured settlement payment rights in a structured settlement factoring transaction. The regulations provide the guidance necessary to comply with the reporting requirements of the excise tax.

Effective Date: These regulations are effective July 8, 2004.

Applicability Dates: For dates of applicability, see §157.5891-1(e).

Shareen S. Pflanz of the Office of Associate Chief Counsel (Income Tax and Accounting) at 202-622-4920 (not a toll-free call).

Accordingly, title 26 CFR parts 157 and 602 are amended as follows:

Paragraph 1. Part 157 is revised to read as follows:

The principal author of these final regulations is Shareen S. Pflanz, Office of Associate Chief Counsel (Income Tax and Accounting). However, other personnel from the IRS and Treasury Department participated in their development.

* * * * *

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in Arizona or Wisconsin?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in Arizona or Wisconsin. Because these states have similar community property laws, Arizona and Wisconsin are addressed in one ruling. This ruling makes assumptions about the operation of state community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in California, Idaho, or Louisiana should refer to Rev. Rul. 2004-72; taxpayers domiciled in Nevada, New Mexico or Washington should refer to Rev. Rul. 2004-73; and taxpayers domiciled in Texas should refer to Rev. Rul. 2004-74.

Situation 1, Arizona. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Arizona at all relevant times. The tax liability incurred by Liable Spouse for Year 1 is a separate debt under Arizona law. Applying Rev. Rul. 80-7, 1980-1 C.B. 296, the Service determines that $750 of the overpayment is attributable to income taxes withheld from Liable Spouse’s wages, and $250 of the overpayment is attributable to income taxes withheld from Non-Liable Spouse’s wages.

Arizona law provides that community property is all property acquired during marriage, except for property acquired by a spouse by gift, devise, or descent. See Ariz. Rev. Stat. section 25-211 (2003). There is a rebuttable presumption under Arizona law that all property acquired during marriage is community property. See Mitchell v. Mitchell, 732 P.2d 208, 212 (Ariz. 1987) (en banc). Arizona law defines separate property as property owned by a spouse before marriage and property acquired during marriage by a spouse by gift, devise, or descent. See Ariz. Rev. Stat. section 25-213 (2003). In addition, separate property includes any profits or income derived from separate property during marriage. See Ariz. Rev. Stat. section 25-213 (2003).

Arizona law provides that a creditor may reach all of the liable spouse’s separate property and all of the community property to satisfy a community debt. See Ariz. Rev. Stat. section 25-215(D) (2003). In addition, a creditor may reach all community property that would have been the liable spouse’s separate property but for marriage and all of the liable spouse’s separate property to satisfy a separate debt. See Ariz. Rev. Stat. section 25-215(B) (2003). Further, the Service may reach the liable spouse’s interest in any community property that would have been the non-liable spouse’s separate property but for marriage to satisfy a separate debt of the liable spouse. In re Ackerman, 424 F.2d 1148 (9^th Cir. 1970). However, a creditor may not reach any of the non-liable spouse’s separate property to satisfy the liable spouse’s separate debt. See Ariz. Rev. Stat. section 25-215(A) (2003).

Under Arizona law, community debts are debts incurred during marriage for the benefit of the community. See Ariz. Rev. Stat. section 25-215(D) (2003); Johnson v. Johnson, 638 P.2d 705, 711-712 (Ariz. 1981). Arizona law presumes that a debt incurred by a spouse during marriage is a community debt. See In re Marriage of Hrudka, 919 P.2d 179, 186-187 (Ariz. Ct. App. 1995). If a debt is not a community debt, then it is a separate debt. See id. at 187.

Situation 2, Wisconsin. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Wisconsin at all relevant times. The tax liability incurred by Liable Spouse for Year 1 is a liability incurred before marriage that is attributable to action or inaction before marriage under Wisconsin law. Applying Rev. Rul. 80-7, 1980-1 C.B. 296, the Service determines that $750 of the overpayment is attributable to income taxes withheld from Liable Spouse’s wages, and $250 of the overpayment is attributable to income taxes withheld from Non-Liable Spouse’s wages.

Wisconsin law classifies property owned by a spouse as either marital property or individual property. See Wis. Stat. section 766.31 (2002). Marital property is a form of community property, and each spouse has a 50 percent interest in the marital property. See Wis. Stat. section 766.31(3) (2002); Rev. Rul. 87-13, 1987-1 C.B. 20. Marital property includes all property that is not individual property and that was acquired after the determination date. See Wis. Stat. section 766.31 (2002). The determination date is the latest of either: (1) the date of marriage; (2) the date both spouses are domiciled in Wisconsin; or (3) January 1, 1986. See Wis. Stat. section 766.01(5) (2002). Wisconsin law presumes that all property owned by a spouse is marital property. See Wis. Stat. section 766.31(2) (2002). This presumption may be rebutted. See Lloyd v. Lloyd, 487 N.W.2d 647, 652 (Wis. Ct. App. 1992).

Wisconsin law defines individual property as property owned by a spouse before the determination date. See Wis. Stat. section 766.31(9) (2002). In addition, individual property includes property acquired during marriage and after the determination date if the property is: (1) received by gift, bequest, or devise to one spouse; (2) income paid to one spouse from a trust, unless the trust provides otherwise; (3) received in exchange for or obtained with the proceeds of other individual property; (4) designated as individual property by decree, marital property agreement, or reclassification pursuant to Wis. Stat. section 766.31(10); or (5) recovered for personal injury. See Wis. Stat. section 766.31(7) (2002).

Wisconsin law classifies debts incurred by a spouse into three separate categories: (1) debts incurred before or during marriage that are attributable to action or inaction before marriage; (2) debts incurred during marriage for the benefit of the marriage or family; and (3) debts incurred during marriage that are not for the benefit of marriage or family. See Wis. Stat. section 766.55 (2002). Wisconsin law presumes that a debt incurred during marriage is for the benefit of the marriage or the family. See Wis. Stat. section 766.55(1) (2002). If a spouse before marriage or during marriage incurs a debt that is attributable to action or inaction before marriage, Wisconsin law allows that spouse’s creditor to reach all marital property that would have been that spouse’s individual property but for the marriage and all individual property of that spouse. See Wis. Stat. section 766.55(2)(c)(1) (2002). Further, Wisconsin law allows the Service to reach the liable spouse’s interest in any marital property that would have been the non-liable spouse’s individual property but for marriage. Vorhies v. Z. Management, Civil No. 86-C695-S (W.D. Wis. 1987). If a spouse incurs a debt for the benefit of the marriage or the family, Wisconsin law allows a creditor to reach all marital property and all individual property of that spouse. See Wis. Stat. section 766.55(2)(b) (2002); Sokaogon Gaming Ent. v. Curda-Derickson, 668 N.W.2d 736 (Wis. Ct. App. 2003). If a debt incurred by a spouse was not for the benefit of the marriage or the family, Wisconsin law allows a creditor to reach that spouse’s individual property and interest in marital property. See Wis. Stat. section 766.55(2)(d) (2002).

Situation 3, Wisconsin. Liable Spouse and Non-Liable Spouse are domiciled in Wisconsin at all relevant times. In Year 1, Liable Spouse and Non-Liable spouse are single and have no outstanding tax liabilities. In Year 2, Liable Spouse and Non-Liable Spouse marry. For Year 2, Liable Spouse incurs a tax liability, that, under Wisconsin law, is a liability incurred during marriage but is not for the benefit of marriage or family. Non-Liable Spouse is not liable for this tax liability under Wisconsin law.

In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment resulted from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Applying Rev. Rul. 80-7, the Service determines that $750 of the overpayment is attributable to income taxes withheld from Liable Spouse’s wages, and $250 of the overpayment is attributable to income taxes withheld from Non-Liable Spouse’s wages. Wisconsin community property laws are the same as in Situation 2.

Situation 4, Wisconsin. Same as Situation 3, except that under Wisconsin law, Liable Spouse’s Year 2 tax liability is a liability for the benefit of marriage or family.

Section 6402(a) of the Internal Revenue Code provides that, in the case of any overpayment, the Service may credit the amount of the overpayment, including interest, against any internal revenue tax liability on the part of the person who made the overpayment and shall refund the balance to the person.

Revenue Ruling 74-611, 1974-2 C.B. 399, holds that if a husband and wife file a joint return, each spouse has a separate interest in the jointly reported income and a separate interest in any overpayment. However, filing a joint return does not create a new property interest for the husband or the wife. Id.

Revenue Ruling 80-7, 1980-1 C.B. 296, holds that if a husband and wife file a joint return showing an overpayment, the Service may credit one spouse’s interest in the overpayment against that spouse’s separate tax liability. The amount of the spouse’s interest in the overpayment is calculated by subtracting the spouse’s share of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

Revenue Ruling 85-70, 1985-1 C.B. 361, provides a two-step process to determine the amount of a joint overpayment that the Service may offset against one spouse’s separate tax liability if the spouses are domiciled in a community property state. First, if the joint overpayment is from wages that are community property income, then each spouse is considered to be the recipient of one-half of the aggregated wages regardless of whether the spouses may have earned different amounts of wages (the one-half rule). Accordingly, each spouse has a one-half interest in the overpayment, and the Service may offset the liable spouse’s one-half interest in the overpayment against the liable spouse’s separate federal tax liability regardless of whether state law provides that creditors may reach community property to satisfy the separate debts of a spouse. Id. Rev. Rul. 85-70 does not specifically address what portion of each spouse’s actual wages is treated as having been offset as a result of applying the one-half rule. Under the facts of Rev. Rul. 85-70, and specifically the assumed state laws, that analysis was not necessary. However, applying the second step of Rev. Rul. 85-70 in other cases may require a determination of the amount of each spouse’s actual wages that were offset after applying the one-half rule. For that purpose, each spouse under the first step of Rev. Rul. 85-70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

Second, Rev. Rul. 85-70 provides that state law may enable the Service to offset an additional portion of the joint overpayment from community property sources to satisfy a spouse’s separate federal tax liability. This additional right of offset is available if state law provides that creditors may reach community property to satisfy the separate debts of a spouse. (The amount potentially available to be offset under the second step of Rev. Rul. 85-70 is the amount remaining after application of the first step of that revenue ruling.) However, if state law provides that community property may not be reached to satisfy the premarital or other separate debts of either spouse, then the Service may not offset any portion of the non-liable spouse’s share of the overpayment from community property sources against the liable spouse’s separate tax liability. Id.

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse.

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

The first step is to identify the underlying source of the overpayment. The Service looks to the tax payments made by the spouses, including income tax withholding and estimated tax payments and other credits, such as the earned income tax credit, that gave rise to the overpayment. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87-52, 1987-1 C.B. 347, for guidance.

The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be characterized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

The third step is to offset the liable spouse’s share of the overpayment from a community property source against the liable spouse’s separate tax liability. Under Rev. Rul. 85-70, the Service may offset the liable spouse’s 50-percent interest in the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach the non-liable spouse’s share of the overpayment from a community property source. See Rev. Rul. 85-70.

The fifth step is to determine whether the Service may, under state law, reach a portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

Apply the five-step process to each situation.

(1) Step 1.

In Situation 1, Situation 2, Situation 3, and Situation 4, the overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2.

Arizona and Wisconsin law presume that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, Situation 3, and Situation 4, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because state law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, Situation 3, and Situation 4 is assumed to be from a community property source.

(3) Step 3.

Under Arizona and Wisconsin law, each spouse has a present and equal interest in all community property. In Situation 1, Situation 2, Situation 3, and Situation 4, $750 of the overpayment is from income tax withholding from Liable Spouse’s wages, and $250 of the overpayment is from income tax withholding from Non-Liable Spouse’s Year 3 wages. Applying Rev. Rul. 85-70, the Service may offset $375 of the income tax withholding attributable to Liable Spouse’s wages and $125 of the income tax withholding attributable to Non-Liable Spouse’s wages. Therefore, in Situation 1, Situation 2, Situation 3, and Situation 4, the Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

(4) Step 4.

Under Arizona and Wisconsin law, the amount of community property that a creditor may reach depends on the character of the debt.

In Situation 1, Liable Spouse’s Year 1 tax liability is a separate debt under Arizona law. To satisfy a separate debt, Arizona law provides that a creditor may reach all community property that would have been Liable Spouse’s separate property but for marriage. Under Arizona law, Liable Spouse’s wages and income tax withholdings would have been Liable Spouse’s separate property had Liable Spouse and Non-Liable Spouse not married. Therefore, a creditor may reach all of Liable Spouse’s wages and income tax withholdings to satisfy Liable Spouse’s separate debt. Applying Arizona law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $375 of the overpayment that is attributable to Liable Spouse’s wages and income tax withholdings.

In Situation 2, Liable Spouse’s Year 1 federal tax liability is a liability incurred before marriage that is attributable to action or inaction before marriage under Wisconsin law. In this situation, Wisconsin law provides that a creditor may reach all marital property that would have been Liable Spouse’s individual property but for marriage. Under Wisconsin law, Liable Spouse’s wages and income tax withholding would have been Liable Spouse’s separate property had Liable Spouse and Non-Liable Spouse not married. Therefore, a creditor may reach all of Liable Spouse’s wages and income tax withholding to satisfy Liable Spouse’s Year 1 tax liability. Applying Wisconsin law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $375 of the overpayment that is attributable to Liable Spouse’s wages and income tax withholdings.

In Situation 3, Liable Spouse’s Year 2 tax liability is a liability that was incurred during marriage but was not for the benefit of the marriage or the family under Wisconsin law. In this situation, Wisconsin law provides that a creditor may reach Liable Spouse’s interest in marital property. However, because the debt was not for the benefit of the marriage or family, applying Wisconsin law in this Step 4, the Service may reach only Liable Spouse’s individual property and interest in marital property, and therefore may not offset any amount of the overpayment in addition to the amount offset in Step 3, from a community property source. Accordingly, the additional amount the Service may offset under Step 4 is zero.

In Situation 4, Liable Spouse’s Year 2 tax liability is a liability that was incurred during marriage and was for the benefit of the marriage or the family under Wisconsin law. In this situation, Wisconsin law provides that a creditor may reach all marital property. Accordingly, the Service may offset the remaining $500 of the overpayment against Liable Spouse’s Year 2 tax liability.

(5) Step 5.

Under both Arizona and Wisconsin law, a creditor may reach 100 percent of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, Situation 3, and Situation 4, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

Situation 1. The Service may offset $875 of the overpayment against Liable Spouse’s separate Year 1 tax liability.

Situation 2. The Service may offset $875 of the overpayment against Liable Spouse’s separate Year 1 tax liability.

Situation 3. The Service may offset $500 of the overpayment against Liable Spouse’s separate Year 2 tax liability.

Situation 4. The Service may offset $1,000 of the overpayment against Liable Spouse’s separate Year 2 tax liability.

Revenue Ruling 80-7 and Rev. Rul. 85-70 are amplified and clarified.

The principal author of this revenue ruling is Michael A. Skeen of the Office of the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact Michael A. Skeen at (202) 622-4910 (not a toll-free call).

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in California, Idaho, or Louisiana?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in California, Idaho, or Louisiana. Because these states have similar community property laws, California, Idaho, and Louisiana are addressed in one ruling. This ruling makes assumptions about the operation of state community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in Arizona or Wisconsin should refer to Rev. Rul. 2004-71; taxpayers domiciled in Nevada, New Mexico or Washington should refer to Rev. Rul. 2004-73; and taxpayers domiciled in Texas should refer to Rev. Rul. 2004-74.

Situation 1, California. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in California at all relevant times.

Except as otherwise provided by statute, California law provides that all property, either real or personal, that is acquired during marriage is community property, and each spouse has a 50 percent interest in the community property. See Cal. Fam. Code sections 760, 751 (2003). There is a rebuttable presumption under California law that all property acquired by a spouse during marriage is community property. See In re Marriage of Haines, 39 Cal. Rptr. 2d 673, 681 (1995).

California law defines separate property as all property owned by a spouse prior to marriage, and all property acquired by a spouse by gift, bequest, devise, or descent. See Cal. Fam. Code section 770(a)(1), (a)(2) (2003). In addition, California law provides that all rents, issues, and profits from separate property are separate property. See Cal. Fam. Code section 770(a)(3) (2003).

California law provides that a creditor may reach all of the community property to satisfy a debt incurred by a spouse before or during marriage. See Cal. Fam. Code section 910(a) (2003). A creditor may also reach all of the liable spouse’s separate property to satisfy a debt incurred by the liable spouse; however, a creditor may not reach any of the non-liable spouse’s separate property. See Cal. Fam. Code section 913 (2003).

Situation 2, Idaho. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Idaho at all relevant times.

Idaho law defines separate property as all property owned by a spouse before marriage, and all property acquired by a spouse during marriage by gift, bequest, devise or descent, or property acquired with the proceeds of his or her separate property. See Idaho Code section 32-903 (2003). Idaho law defines community property as all other property acquired by either spouse during marriage. See Idaho Code section 32-906(1) (2003). Idaho law provides a rebuttable presumption that property acquired during marriage is community property, and the burden of proof is on the party asserting that the property is separate property. See Worzala v. Worzala, 913 P.2d 1178, 1182 (Idaho 1996).

Idaho law provides that income generated during marriage from any property, regardless of whether the property is separate or community property, is generally community property, unless: (1) the conveyance by which the property is acquired specifically identifies this property as the separate property of one spouse; or (2) both spouses agree in writing that the property, and any income related to this property, is the separate property of one spouse. See Idaho Code section 32-906(1) (2003).

Idaho law provides that a creditor may reach all of the community property; both real and personal, to satisfy a spouse’s separate debt. Bliss v. Bliss, 898 P.2d 1081, 1084 (Idaho 1995). If the husband incurs a debt, a creditor may not reach the wife’s separate property to satisfy this debt. See Idaho Code section 32-911 (2003). Further, if the wife incurs a debt before marriage, a creditor may not reach the husband’s separate property to satisfy this debt. See Idaho Code section 32-910 (2003).

Situation 3, Louisiana. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Louisiana at all relevant times, and Liable Spouse’s tax liability is a separate obligation as defined by Louisiana law.

Louisiana law defines separate property as including property acquired by a spouse prior to marriage, property acquired with that spouse’s separate property, property acquired by a spouse through inheritance or donation to that spouse individually, damages awarded to a spouse in connection with the management of that spouse’s separate property, and property acquired by a spouse from a voluntary partition of the community during marriage. See La. Civ. Code Ann. art. 2341 (2003). Louisiana law defines community property as property acquired by a spouse during marriage that is not separate property. See La. Civ. Code Ann. art. 2338 (2003). Louisiana law provides a rebuttable presumption that all property in the possession of either spouse is community property. See La. Civ. Code Ann. art. 2340 (2003). Each spouse has a 50 percent interest in community property. See La. Civ. Code Ann. art. 2336 (2003).

Louisiana law provides that a creditor may reach all of the community property to satisfy separate and community obligations. See La. Civ. Code Ann. art. 2345 (2003). In addition, a creditor may reach all of the liable spouse’s separate property to satisfy separate and community obligations. See Id.

Under Louisiana law, obligations incurred by a spouse are either community obligations or separate obligations. See La. Civ. Code Ann. art. 2359 (2003). A community obligation is defined as an obligation incurred during marriage for either the common interest of both spouses or for the interest of the other spouse. See La. Civ. Code Ann. art. 2360 (2003). A separate obligation is defined as an obligation that was incurred before marriage, after marriage has terminated, or during marriage, though not for the benefit of the community. See La. Civ. Code Ann. art. 2363 (2003). Louisiana law provides a rebuttable presumption that all obligations incurred during marriage are community obligations. See La. Civ. Code Ann. art. 2361 (2003).

Section 6402(a) of the Internal Revenue Code provides that, in the case of any overpayment, the Service may credit the amount of the overpayment, including interest, against any internal revenue tax liability on the part of the person who made the overpayment and shall refund the balance to the person.

Revenue Ruling 74-611, 1974-2 C.B. 399, holds that if a husband and wife file a joint return, each spouse has a separate interest in the jointly reported income and a separate interest in any overpayment. However, filing a joint return does not create a new property interest for the husband or the wife. Id.

Revenue Ruling 80-7, 1980-1 C.B. 296, holds that if a husband and wife file a joint return showing an overpayment, the Service may credit one spouse’s interest in the overpayment against that spouse’s separate tax liability. The amount of the spouse’s interest in the overpayment is calculated by subtracting the spouse’s share of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

Revenue Ruling 85-70, 1985-1 C.B. 361, provides a two-step process to determine the amount of a joint overpayment that the Service may offset against one spouse’s separate tax liability if the spouses are domiciled in a community property state. First, if the joint overpayment is from wages that are community property income, then each spouse is considered to be the recipient of one-half of the aggregated wages regardless of whether the spouses may have earned different amounts of wages (the one-half rule). Accordingly, each spouse has a one-half interest in the overpayment, and the Service may offset the liable spouse’s one-half interest in the overpayment against the liable spouse’s separate federal tax liability regardless of whether state law provides that creditors may reach community property to satisfy the separate debts of a spouse. Id. Rev. Rul. 85-70 does not specifically address what portion of each spouse’s actual wages is treated as having been offset as a result of applying the one-half rule. Under the facts of Rev. Rul. 85-70, and specifically the assumed state laws, that analysis was not necessary. However, applying the second step of Rev. Rul. 85-70 in other cases may require a determination of the amount of each spouse’s actual wages that were offset after applying the one-half rule. For that purpose, each spouse under the first step of Rev. Rul. 85-70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

Second, Rev. Rul. 85-70 provides that state law may enable the Service to offset an additional portion of the joint overpayment from community property sources to satisfy a spouse’s separate federal tax liability. This additional right of offset is available if state law provides that creditors may reach community property to satisfy the separate debts of a spouse. (The amount potentially available to be offset under the second step of Rev. Rul. 85-70 is the amount remaining after application of the first step of that revenue ruling.) However, if state law provides that community property may not be reached to satisfy the premarital or other separate debts of either spouse, then the Service may not offset any portion of the non-liable spouse’s share of the overpayment from community property sources against the liable spouse’s separate tax liability. Id.

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse.

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

The first step is to identify the underlying source of the overpayment. The Service looks to the tax payments made by the spouses, including income tax withholding and estimated tax payments and other credits, such as the earned income tax credit, that gave rise to the overpayment. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87-52, 1987-1 C.B. 347, for guidance.

The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be characterized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

The third step is to offset the liable spouse’s share of the joint overpayment from a community property source against the liable spouse’s separate tax liability. Under Rev. Rul. 85-70, the Service may offset the liable spouse’s 50-percent interest in the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach the non-liable spouse’s share of the overpayment from a community property source. See Rev. Rul. 85-70.

The fifth step is to determine whether the Service may, under state law, reach a portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

Apply the five-step process to each situation.

(1) Step 1.

In Situation 1, Situation 2, and Situation 3, the overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2.

California, Idaho, and Louisiana law presume that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, and Situation 3, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because state law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, and Situation 3 is assumed to be from a community property source.

(3) Step 3.

Under California, Idaho, and Louisiana law, each spouse has a present and equal interest in all community property. In Situation 1, Situation 2, and Situation 3, the Service may offset Liable Spouse’s $500 share of the overpayment, which is from a community property source against Liable Spouse’s separate tax liability.

(4) Step 4.

In Situation 1 and Situation 2, under California and Idaho law respectively, a creditor may reach all of the community property to satisfy a debt incurred by Liable Spouse, regardless of whether the debt was incurred before or after marriage. In Situation 3, under Louisiana law, a creditor may reach all of the community property to satisfy a debt, regardless of whether the debt is a separate or community debt. Accordingly, in Situation 1, Situation 2, and Situation 3, the Service may offset the remaining $500 of the overpayment.

(5) Step 5.

Under California, Idaho, and Louisiana law, a creditor may reach all of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, and Situation 3, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

Situation 1. The Service may offset $1,000 of the overpayment against Liable Spouse’s separate tax liability.

Situation 2. The Service may offset $1,000 of the overpayment against Liable Spouse’s separate tax liability.

Situation 3. The Service may offset $1,000 of the overpayment against Liable Spouse’s separate tax liability.

Revenue Ruling 80-7 and Rev. Rul. 85-70 are amplified and clarified.

The principal author of this revenue ruling is Michael A. Skeen of the Office of the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact Michael A. Skeen at (202) 622-4910 (not a toll-free call).

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in Nevada, New Mexico, or Washington?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in Nevada, New Mexico, or Washington. Because these states have similar community property laws, Nevada, New Mexico, and Washington are addressed in one ruling. This ruling makes assumptions about the operation of state community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in Arizona or Wisconsin should refer to Rev. Rul. 2004-71; taxpayers domiciled in California, Idaho, or Louisiana should refer to Rev. Rul. 2004-72; and taxpayers domiciled in Texas should refer to Rev. Rul. 2004-74.

Situation 1, Nevada. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Nevada at all relevant times.

Nevada law presumes that property acquired during marriage by either husband, wife, or both, is community property, subject to limited exceptions. See Nev. Rev. Stat. section 123.220 (2003). This presumption may be rebutted. Forrest v. Forrest, 668 P.2d 275, 277 (Nev. 1983). Further, during marriage, each spouse has a 50 percent interest in the community property. See Nev. Rev. Stat. section 123.225 (2003). Generally, property owned by one spouse before marriage, or acquired during marriage by gift, bequest, devise, descent, or an award for personal damages, is separate property, and each spouse has a 100 percent interest in his or her separate property. See Nev. Rev. Stat. section 123.130 (2003).

Nevada law provides that a creditor may reach all of a liable spouse’s separate property and all of the community property to satisfy the liable spouse’s debts that arose during the marriage. See Hardy v. United States, Civil No. CV-N-94-0824 (D. Nev. 1997); Nelson v. United States, Civil No. CV-N-89-659 (D. Nev. 1993), aff’d, 53 F.3d 339 (9^th Cir. 1995); United States v. ITT Consumer Financial Corp, 816 F.2d 487, n. 12 (9^th Cir. 1987). However, a creditor may not reach any of the non-liable spouse’s separate property to satisfy the liable spouse’s debt that arose during the marriage. See Hardy v. United States, Civil No. CV-N-94-0824 (D. Nev. 1997). In addition, Nevada law provides that a creditor may not reach the non-liable spouse’s separate property or the non-liable spouse’s share of the community property to satisfy the liable spouse’s separate debts incurred or contracted prior to marriage. See Nev. Rev. Stat. section 123.050 (2003).

Situation 2, New Mexico. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in New Mexico at all relevant times, and Liable Spouse’s tax liability is a separate debt as defined by New Mexico law.

New Mexico law provides that property acquired during marriage by the husband, wife, or both is presumed to be community property, and each spouse has a 50 percent interest in community property. See N.M. Stat. Ann. section 40-3-12(A)(2002); Central Adjustment Bureau, Inc. v. Thevenet, 686 P.2d 954, 957-958 (N.M. 1984). This presumption may be rebutted. C & L Lumber and Supply, Inc. v. Texas American Bank/Galeria, 795 P.2d 502, 505 (N.M. 1990). Generally, property owned by a spouse before marriage is separate property, and each spouse has a 100 percent interest in all of his or her separate property. See N.M. Stat. Ann. section 40-3-8 (2002).

New Mexico law provides that a creditor may reach all of the separate property of the spouse or spouses who contracted or incurred the debt, and all of the community property to satisfy a community debt. See N.M. Stat. Ann. section 40-3-11(A) (2002). However, a creditor may not reach any of one spouse’s separate property to satisfy a community debt incurred by the other spouse. See Id. New Mexico law provides that a creditor may reach all of the liable spouse’s separate property and all of the liable spouse’s share of community property to satisfy a separate debt. See N.M. Stat. Ann. section 40-3-10(A) (2002). However, a creditor may not reach any of the non-liable spouse’s separate property to satisfy the liable spouse’s separate debt. See Id.

Under New Mexico law, a separate debt is defined as: (1) a debt contracted or incurred either before marriage or after entry of a decree of dissolution of marriage; (2) a debt contracted or incurred after a court has entered a decree pursuant to N.M. Stat. Ann. section 40-4-3 (proceeding for division of property, disposition of children or alimony without dissolution of marriage); (3) a debt designated by a court as a separate debt; (4) a debt contracted by a spouse during marriage which, at the time of creation, is identified to the creditor in writing as the separate debt of the contracting spouse; (5) a debt that arises from a tort committed either before marriage or after entry of a decree of dissolution of marriage; or (6) a debt declared unreasonable pursuant to N.M. Stat. Ann. section 40-3-10.1 (certain debts that did not contribute to the benefit of both spouses or their dependents). See N.M. Stat. Ann. section 40-3-9(A)(1) through (6) (2002). Community debt is defined as a debt, which is not a separate debt, contracted or incurred by one or both spouses during the marriage. See N.M. Stat. Ann. section 40-3-9(B) (2002). New Mexico law presumes that a debt incurred during marriage is community debt. See In re Fingado, 113 B.R. 37, 42 (Bankr. D.N.M. 1990), aff’d, 995 F.2d 175 (10^th Cir. 1993).

Situation 3, Washington. In Year 1, Liable Spouse, who is single, incurs a tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, reporting an overpayment of $1,000. The overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Washington state at all relevant times, and Liable Spouse’s tax liability is a separate debt as defined by Washington state law.

Washington state law defines community property as any property acquired during marriage, by one or both spouses, that is not separate property. See Wash. Rev. Code section 26.16.030 (2003). There is a rebuttable presumption under Washington state law that all property acquired during marriage is community property. See Dean v. Lehman, 18 P.3d 523, 528 (Wash. 2001)(en banc). Each spouse has an undivided 50-percent interest in all community property. See In re Towey’s Estate, 155 P.2d 273, 275 (Wash. 1945). Washington state law defines separate property as property owned by a spouse before marriage and property acquired during marriage by a spouse by gift, bequest, devise, or descent. See Wash. Rev. Code sections 26.16.010, 26.16.020 (2003). In addition, Washington state law defines as separate property any profits or income derived from separate property during marriage. See Wash. Rev. Code sections 26.16.010, 26.16.020 (2003).

Under Washington state law, a creditor may reach all of the community property, including the earnings of both spouses, to satisfy a community debt. See Pacific Gamble Robinson Co. v. Lapp, 622 P.2d 850, 854 (Wash. 1980). A creditor may reach all of a spouse’s separate property to satisfy a community debt incurred by that spouse; however, a creditor of a community debt may not reach the other spouse’s separate property. See Wash. Rev. Code sections 6.15.040, 26.16.010, 26.16.020 (2003). In general, under Washington state law, a creditor may not reach any of the community property to satisfy a separate debt. See Wash. Rev. Code section 26.16.200 (2003); Pacific Gamble Robinson Co., 622 P.2d at 854. However, under United States v. Overman, 424 F.2d 1142 (9^th Cir. 1970), the Service may reach the liable spouse’s 50-percent interest in the community property to satisfy a separate tax liability of the liable spouse. See also Draper v. United States, 243 F. Supp. 563 (W.D. Wash. 1965).

Under Washington state law, a debt incurred during marriage, for the benefit of the community, is a community debt. See In re Marriage of Hurd, 848 P.2d 185, 195-196 (Wash. App. 1993). Washington state law presumes that a debt is a community debt. See Pacific Gamble Robinson Co., 622 P.2d at 854. If a debt is not a community debt, then it is a separate debt. See Id.

Section 6402(a) of the Internal Revenue Code provides that, in the case of any overpayment, the Service may credit the amount of the overpayment, including interest, against any internal revenue tax liability on the part of the person who made the overpayment and shall refund the balance to the person.

Revenue Ruling 74-611, 1974-2 C.B. 399, holds that if a husband and wife file a joint return, each spouse has a separate interest in the jointly reported income and a separate interest in any overpayment. However, filing a joint return does not create a new property interest for the husband or the wife. Id.

Revenue Ruling 80-7, 1980-1 C.B. 296, holds that if a husband and wife file a joint return showing an overpayment, the Service may credit one spouse’s interest in the overpayment against that spouse’s separate tax liability. The amount of the spouse’s interest in the overpayment is calculated by subtracting the spouse’s share of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

Revenue Ruling 85-70, 1985-1 C.B. 361, provides a two-step process to determine the amount of a joint overpayment that the Service may offset against one spouse’s separate tax liability if the spouses are domiciled in a community property state. First, if the joint overpayment is from wages that are community property income, then each spouse is considered to be the recipient of one-half of the aggregated wages regardless of whether the spouses may have earned different amounts of wages (the one-half rule). Accordingly, each spouse has a one-half interest in the overpayment, and the Service may offset the liable spouse’s one-half interest in the overpayment against the liable spouse’s separate federal tax liability regardless of whether state law provides that creditors may reach community property to satisfy the separate debts of a spouse. Id. Rev. Rul. 85-70 does not specifically address what portion of each spouse’s actual wages is treated as having been offset as a result of applying the one-half rule. Under the facts of Rev. Rul. 85-70, and specifically the assumed state laws, that analysis was not necessary. However, applying the second step of Rev. Rul. 85-70 in other cases may require a determination of the amount of each spouse’s actual wages that were offset after applying the one-half rule. For that purpose, each spouse under the first step of Rev. Rul. 85-70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

Second, Rev. Rul. 85-70 provides that state law may enable the Service to offset an additional portion of the joint overpayment from community property sources to satisfy a spouse’s separate federal tax liability. This additional right of offset is available if state law provides that creditors may reach community property to satisfy the separate debts of a spouse. (The amount potentially available to be offset under the second step of Rev. Rul. 85-70 is the amount remaining after application of the first step of that revenue ruling.) However, if state law provides that community property may not be reached to satisfy the premarital or other separate debts of either spouse, then the Service may not offset any portion of the non-liable spouse’s share of the overpayment from community property sources against the liable spouse’s separate tax liability. Id.

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse.

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

The first step is to identify the underlying source of the overpayment. The Service looks to the tax payments made by the spouses, including income tax withholding and estimated tax payments and other credits, such as the earned income tax credit, that gave rise to the overpayment. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87-52, 1987-1 C.B. 347, for guidance.

The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be characterized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

The third step is to offset the liable spouse’s share of the overpayment from a community property source against the liable spouse’s separate tax liability. Under Rev. Rul. 85-70, the Service may offset the liable spouse’s 50-percent interest in the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach the non-liable spouse’s share of the overpayment from a community property source. See Rev. Rul. 85-70.

The fifth step is to determine whether the Service may, under state law, reach a portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

Apply the five-step process to each situation.

(1) Step 1.

In Situation 1, Situation 2, and Situation 3, the overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2.

Nevada, New Mexico, and Washington state law presume that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, and Situation 3, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because state law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, and Situation 3 is assumed to be from a community property source.

(3) Step 3.

Under Nevada, New Mexico, and Washington state law, each spouse has a present and equal interest in all community property. In Situation 1, Situation 2, and Situation 3, the Service may offset Liable Spouse’s $500 share of the overpayment against Liable Spouse’s separate tax liability.

(4) Step 4.

Under Nevada, New Mexico, and Washington state law, the amount of community property that a creditor may reach depends on the character of the debt. In Situation 1, Liable Spouse’s tax liability arose before marriage. Nevada law distinguishes between debts that arose before or during the marriage. For debts that arose before marriage, a creditor may not reach either Non-Liable Spouse’s portion of community property or Non-Liable Spouse’s separate property. Accordingly, the Service may not offset any portion of Non-Liable Spouse’s share of the overpayment against Liable Spouse’s tax liability.

In Situation 2, Liable Spouse’s tax liability is a separate debt under New Mexico law. In Situation 3, Liable Spouse’s tax liability is a separate debt under Washington state law. New Mexico and Washington state law distinguish between community debts and separate debts. For a community debt (e.g., a tax liability of one spouse that arose during the marriage by filing separate returns), a creditor may reach Liable Spouse’s and Non-Liable Spouse’s share of community property to satisfy the Liable Spouse’s separate tax liability. However, if the debt is a separate debt (e.g., a tax liability of one spouse that arose before marriage), a creditor may reach Liable Spouse’s share of community property, but a creditor may not reach Non-Liable Spouse’s share of community property. Because Liable Spouse’s tax liability is a separate debt in Situation 2 and Situation 3, the Service may not offset any portion of Non-Liable Spouse’s share of the overpayment against Liable Spouse’s separate tax liability.

(5) Step 5.

Under Nevada, New Mexico, and Washington state law, a creditor may reach all of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, and Situation 3, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

Situation 1. The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

Situation 2. The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

Situation 3. The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

Revenue Ruling 80-7 and Rev. Rul. 85-70 are amplified and clarified.

The principal author of this revenue ruling is Michael A. Skeen of the Office of the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact Michael A. Skeen at (202) 622-4910 (not a toll-free call).

What amount of an overpayment reported on a joint return may the Internal Revenue Service apply against one spouse’s separate tax liability if the spouses are domiciled in Texas?

This ruling addresses how offsets apply for taxpayers filing joint returns and domiciled in Texas. This ruling makes assumptions about the operation of Texas community property laws which are highly dependent on facts and circumstances. Therefore, taxpayers are cautioned to check current state law and apply it to their particular facts. Taxpayers domiciled in Arizona or Wisconsin should refer to Rev. Rul. 2004-71; taxpayers domiciled in California, Idaho, or Louisiana should refer to Rev. Rul. 2004-72; and taxpayers domiciled in Nevada, New Mexico or Washington should refer to Rev. Rul. 2004-73.

Situation 1. In Year 1, Liable Spouse, who is single, incurs a federal tax liability of $20,000. Liable Spouse does not pay this tax liability. In Year 2, Liable Spouse and Non-Liable Spouse marry. In Year 4, Liable Spouse and Non-Liable Spouse file a joint return for Year 3, claiming an overpayment of $1,000. This overpayment results from income taxes withheld from Liable Spouse’s and Non-Liable Spouse’s wages during Year 3. Liable Spouse and Non-Liable Spouse are domiciled in Texas at all relevant times.

Applying Rev. Rul. 80-7, 1980-1 C.B. 296, the Service determines that $750 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $250 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition.

Texas law defines separate property as property owned by a spouse before marriage; property acquired by spouse during marriage by gift, devise or descent; and any damages recovered by a spouse for personal injuries that do not represent loss of earning capacity during marriage. See Tex. Fam. Code Ann. section 3.001 (2002). Texas law defines community property as property, other than separate property, acquired by either spouse during marriage. See Tex. Fam. Code Ann. section 3.002 (2002). Each spouse has a 50-percent interest in community property. See Broday v. United States, 455 F.2d 1097 (5^th Cir. 1972). There is a rebuttable presumption under Texas law that all property acquired during marriage is community property. See Tex. Fam. Code Ann. section 3.003 (2002).

Texas law distinguishes between community property subject to the joint management, control, and disposition of both spouses, and community property subject to one spouse’s sole management, control, and disposition. See Tex. Fam. Code Ann. section 3.102 (2002). A spouse has sole management, control, and disposition over community property that spouse would have owned if that spouse were single. See Tex. Fam. Code Ann. section 3.102(a) (2002). This community property includes personal earnings; revenue from separate property; damages recovered from personal injuries; and the increase in value, mutations and revenue of all property subject to a spouse’s sole management, control, and disposition. See Tex. Fam. Code Ann. section 3.102(a)(1) through (4) (2002). Texas law defines community property subject to joint management, control, and disposition as all community property that is not subject to a spouse’s sole management, control, and disposition, and is not otherwise subject to an agreement of the spouses. See Tex. Fam. Code Ann. section 3.102(c) (2002).

Although each spouse has a 50 percent interest in the community property, Texas law limits the types of community property that a creditor may reach to satisfy a spouse’s separate liability. See Tex. Fam. Code Ann. section 3.202 (2002). Texas law allows a creditor to reach all of the community property subject to the liable spouse’s sole management, control, and disposition to satisfy the spouse’s separate liability. See Tex. Fam. Code Ann. section 3.202(c) (2002). In addition, a creditor may reach all community property subject to the spouses’ joint management, control, and disposition, and all of the liable spouse’s separate property, whether the debt was incurred before or during marriage. See Tex. Fam. Code Ann. section 3.202(c) (2002). A creditor may not reach any portion of the community property subject to the non-liable spouse’s sole management, control, and disposition, or the non-liable spouse’s separate property. See Tex. Fam. Code Ann. section 3.202(c) (2002). However, under Medaris v. United States, 884 F.2d 832 (5^th Cir. 1989), the Service may reach the liable spouse’s 50-percent interest in the non-liable spouse’s sole management community property to satisfy a separate federal tax liability of the liable spouse.

Situation 2. Same facts as Situation 1, except that $250 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $750 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition.

Situation 3. Same facts as Situation 1, except that the entire overpayment resulted solely from income tax withholding from Non-Liable Spouse’s wages, and the entire overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition.

Section 6402(a) of the Internal Revenue Code provides that, in the case of any overpayment, the Service may credit the amount of the overpayment, including interest, against any internal revenue tax liability on the part of the person who made the overpayment and shall refund the balance to the person.

Revenue Ruling 74-611, 1974-2 C.B. 399, holds that if a husband and wife file a joint return, each spouse has a separate interest in the jointly reported income and a separate interest in any overpayment. However, filing a joint return does not create a new property interest for the husband or the wife. Id.

Revenue Ruling 80-7, 1980-1 C.B. 296, holds that if a husband and wife file a joint return showing an overpayment, the Service may credit one spouse’s interest in the overpayment against that spouse’s separate tax liability. The amount of the spouse’s interest in the overpayment is calculated by subtracting the spouse’s share of the joint tax liability, determined under a separate tax formula, from the spouse’s contribution towards the joint tax liability. Under the separate tax formula, a spouse’s share of the joint tax liability is calculated as follows:

Revenue Ruling 85-70, 1985-1 C.B. 361, provides a two-step process to determine the amount of a joint overpayment that the Service may offset against one spouse’s separate tax liability if the spouses are domiciled in a community property state. First, if the joint overpayment is from wages that are community property income, then each spouse is considered to be the recipient of one-half of the aggregated wages regardless of whether the spouses may have earned different amounts of wages (the one-half rule). Accordingly, each spouse has a one-half interest in the overpayment, and the Service may offset the liable spouse’s one-half interest in the overpayment against the liable spouse’s separate federal tax liability regardless of whether state law provides that creditors may reach community property to satisfy the separate debts of a spouse. Id. Rev. Rul. 85-70 does not specifically address what portion of each spouse’s actual wages is treated as having been offset as a result of applying the one-half rule. Under the facts of Rev. Rul. 85-70, and specifically the assumed state laws, that analysis was not necessary. However, applying the second step of Rev. Rul. 85-70 in other cases may require a determination of the amount of each spouse’s actual wages that were offset after applying the one-half rule. For that purpose, each spouse under the first step of Rev. Rul. 85-70 is treated as receiving one half of the wages from each community property source (or, collectively, one-half of the aggregated wages) and as such being entitled to receive one-half of the income tax withheld from each community property source.

Second, Rev. Rul. 85-70 provides that state law may enable the Service to offset an additional portion of the joint overpayment from community property sources to satisfy a spouse’s separate federal tax liability. This additional right of offset is available if state law provides that creditors may reach community property to satisfy the separate debts of a spouse. (The amount potentially available to be offset under the second step of Rev. Rul. 85-70 is the amount remaining after application of the first step of that revenue ruling.) However, if state law provides that community property may not be reached to satisfy the premarital or other separate debts of either spouse, then the Service may not offset any portion of the non-liable spouse’s share of the overpayment from community property sources against the liable spouse’s separate tax liability. Id.

Five-step process to determine amount of joint overpayment that the Service may offset against separate federal tax liability of one spouse.

A five-step process is required to determine the amount of a joint overpayment that the Service may, pursuant to section 6402(a), offset against the separate federal tax liability of one spouse.

The first step is to identify the underlying source of the overpayment. The Service looks to the tax payments made by the spouses, including income tax withholding and estimated tax payments and other credits. If the earned income tax credit is a source of the overpayment, see Rev. Rul. 87-52, 1987-1 C.B. 347, for guidance.

The second step is to characterize the underlying source of the overpayment as either separate or community property. Because an overpayment will be characterized in the same manner as the source of the overpayment, an overpayment will be characterized as community property, separate property, or as part community property and part separate property, depending on the character of the source of the overpayment. If the overpayment is part community property and part separate property, the portion of the overpayment attributable to a separate property source must be subtracted from the remainder of the overpayment. The portion of the overpayment attributable to a separate property source is calculated as follows:

The third step is to offset the liable spouse’s share of the overpayment from a community property source against the liable spouse’s separate tax liability. Under Rev. Rul. 85-70, the Service may offset the liable spouse’s 50-percent interest in the overpayment from a community property source to satisfy the liable spouse’s separate tax liability.

The fourth step is to determine whether, under state law, the Service may reach any other portion of the overpayment from a community property source. See Rev. Rul. 85-70.

The fifth step is to determine whether the Service may, under state law, reach any portion of the overpayment from a separate property source of the liable spouse or the non-liable spouse.

Apply the five-step process to each situation.

(1) Step 1.

In Situation 1, Situation 2, and Situation 3, the Year 3 joint overpayment is from income taxes withheld in Year 3 from Liable Spouse’s and Non-Liable Spouse’s wages.

(2) Step 2.

Texas law presumes that all property acquired during marriage by either spouse or both spouses, including wages, is community property. In Situation 1, Situation 2, and Situation 3, the overpayment results from income tax withholding from Liable Spouse’s and Non-Liable Spouse’s wages. Because Texas law presumes that wages are community property, the entire overpayment in Situation 1, Situation 2, and Situation 3 is assumed to be from a community property source.

(3) Step 3.

Under Texas law, each spouse has a present and equal interest in all community property. In Situation 1, the Service applies Rev. Rul. 80-7 and determines that $750 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $250 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Rev. Rul. 85-70 and Medaris v. United States, 884 F.2d 832 (5^th Cir. 1989), the Service may offset $375 of the income tax withholding attributable to Liable Spouse’s wages and $125 of the income tax withholding attributable to Non-Liable Spouse’s wages. Accordingly, in Situation 1, the Service may offset $500 of the overpayment against Liable Spouse’s Year 1 tax liability.

In Situation 2, the Service applies Rev. Rul. 80-7 and determines that $250 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $750 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Rev. Rul. 85-70 and Medaris, the Service may offset $125 of the income tax withholding attributable to Liable Spouse’s wages and $375 of the income tax withholding attributable to Non-Liable Spouse’s wages. Accordingly, in Situation 2, the Service may offset $500 of the overpayment against Liable Spouse’s Year 1 tax liability.

In Situation 3, the Service applies Rev. Rul. 80-7 and determines that none of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition, and $1,000 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Rev. Rul. 85-70 and Medaris, the Service may offset $500 of the income tax withholding attributable to Non-Liable Spouse’s wages. Accordingly, in Situation 3, the Service may offset $500 of the overpayment against Liable Spouse’s Year 1 tax liability.

(4) Step 4.

Under Texas law, the amount of community property that a creditor may reach depends on the nature of the property. In Situation 1, Situation 2, and Situation 3, under Texas law, the Service may reach all community property subject to Liable Spouse’s sole management, control, and disposition, and all community property subject to Liable Spouse’s and Non-Liable Spouse’s joint management, control, and disposition.

In Situation 1, $750 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $375 of the $750 overpayment that is attributable to community property subject to Liable Spouse’s sole management, control, and disposition.

Further, $250 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, in addition to the amount offset in Step 3, the Service may not offset the remaining portion of the overpayment from community property sources subject to Non-Liable Spouse’s sole management, control, and disposition.

In Situation 2, $250 of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, and in addition to the amount offset in Step 3, the Service may offset the remaining $125 of the $250 overpayment that is attributable to community property subject to Liable Spouse’s sole management, control, and disposition.

Further, $750 of the overpayment is attributable to community property subject to Non-Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, in addition to the amount offset in Step 3, the Service may not offset the remaining portion of the overpayment from community property sources subject to Non-Liable Spouse’s sole management, control, and disposition.

In Situation 3, none of the overpayment is attributable to community property subject to Liable Spouse’s sole management, control, and disposition. Applying Texas law in Step 4, in addition to the amount offset in Step 3, the Service may not offset the remaining portion of the overpayment from community property sources.

(5) Step 5.

Under Texas state law, a creditor may reach 100 percent of Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. A creditor may not, however, reach any of Non-Liable Spouse’s separate property to satisfy Liable Spouse’s separate tax liability. In Situation 1, Situation 2, and Situation 3, no part of the overpayment is from a separate property source. Accordingly, there is no separate property that the Service may offset against the Liable Spouse’s separate tax liability.

Situation 1. The Service may offset $875 of the overpayment against Liable Spouse’s separate tax liability.

Situation 2. The Service may offset $625 of the overpayment against Liable Spouse’s separate tax liability.

Situation 3. The Service may offset $500 of the overpayment against Liable Spouse’s separate tax liability.

Revenue Ruling 80-7 and Rev. Rul. 85-70 are amplified and clarified.

The principal author of this revenue ruling is Michael A. Skeen of the Office of the Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this revenue ruling, contact Michael A. Skeen at (202) 622-4910 (not a toll-free call).

Section 613A(c)(6)(C) of the Internal Revenue Code defines the term “applicable percentage” for purposes of determining percentage depletion for oil and gas produced from marginal properties. The applicable percentage is the percentage (not greater than 25 percent) equal to the sum of 15 percent, plus one percentage point for each whole dollar by which $20 exceeds the reference price (determined under § 29(d)(2)(C)) for crude oil for the calendar year preceding the calendar year in which the taxable year begins. The reference price determined under § 29(d)(2)(C) for the 2003 calendar year is $27.56.

Table 1 contains the applicable percentages for marginal production for taxable years beginning in calendar years 1991 through 2004.

The principal author of this notice is Eric B. Lee of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact Mr. Lee at (202) 622-3120 (not a toll-free call).

Section 43(b)(3)(B) of the Internal Revenue Code requires the Secretary to publish an inflation adjustment factor. The enhanced oil recovery credit under § 43 for any taxable year is reduced if the “reference price,” determined under § 29(d)(2)(C), for the calendar year preceding the calendar year in which the taxable year begins, is greater than $28 multiplied by the inflation adjustment factor for that year.

The term “inflation adjustment factor” means, with respect to any calendar year, a fraction the numerator of which is the GNP implicit price deflator for the preceding calendar year and the denominator of which is the GNP implicit price deflator for 1990.

Because the reference price for the 2003 calendar year ($27.56) does not exceed $28 multiplied by the inflation adjustment factor for the 2004 calendar year, the enhanced oil recovery credit for qualified costs paid or incurred in 2004 is determined without regard to the phase-out for crude oil price increases.

Table 1 contains the GNP implicit price deflator used for the 2004 calendar year, as well as the previously published GNP implicit price deflators used for the 1991 through 2003 calendar years.

* Beginning in 1995, the GNP implicit price deflator was rebased relative to 1992. The 1990 GNP implicit price deflator used to compute the 1996 § 43 inflation adjustment factor is 93.6.

** Beginning in 1997, two digits follow the decimal point in the GNP implicit price deflator. The 1990 GNP price deflator used to compute the 1998 § 43 inflation adjustment factor is 93.63.

*** Beginning in 1999, the GNP implicit price deflator was rebased relative to 1996. The 1990 GNP implicit price deflator used to compute the 2000 § 43 inflation adjustment factor is 86.53.

Table 2 contains the inflation adjustment factor and the phase-out amount for taxable years beginning in the 2004 calendar year as well as the previously published inflation adjustment factors and phase-out amounts for taxable years beginning in 1991 through 2003 calendar years.

The principal author of this notice is Eric B. Lee of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this notice, contact Mr. Lee at (202) 622-3120 (not a toll-free call).

This notice provides guidance as to the corporate bond weighted average interest rate and the permissible range of interest rates specified under § 412(b)(5)(B)(ii)(II) of the Internal Revenue Code. In addition, it provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II), and the weighted average interest rate and permissible ranges of interest rates based on the 30-year Treasury securities rate.

Sections 412(b)(5)(B)(ii) and 412(l)(7)(C)(i), as amended by the Pension Funding Equity Act of 2004, provide that the interest rates used to calculate current liability and to determine the required contribution under § 412(l) for plan years beginning in 2004 or 2005 must be within a permissible range based on the weighted average of the rates of interest on amounts invested conservatively in long term investment grade corporate bonds during the 4-year period ending on the last day before the beginning of the plan year.

Notice 2004-34, 2004-18 I.R.B. 848, provides guidelines for determining the corporate bond weighted average interest rate and the resulting permissible range of interest rates used to calculate current liability. That notice establishes that the corporate bond weighted average is based on the monthly composite corporate bond rate derived from designated corporate bond indices.

The composite corporate bond rate for June 2004 is 6.18 percent. Pursuant to Notice 2004-34, the Service has determined this rate as the average of the monthly yields for the included corporate bond indices for that month.

The following corporate bond weighted average interest rate was determined for plan years beginning in the month shown below.

Section 417(e)(3)(A)(ii)(II) defines the applicable interest rate, which must be used for purposes of determining the minimum present value of a participant’s benefit under § 417(e)(1) and (2), as the annual rate of interest on 30-year Treasury securities for the month before the date of distribution or such other time as the Secretary may by regulations prescribe. Section 1.417(e)-1(d)(3) of the Income Tax Regulations provides that the applicable interest rate for a month is the annual interest rate on 30-year Treasury securities as specified by the Commissioner for that month in revenue rulings, notices or other guidance published in the Internal Revenue Bulletin.

Section 404(a)(1) of the Code, as amended by the Pension Funding Equity Act of 2004, permits an employer to elect to disregard subclause (II) of § 412(b)(5)(B)(ii) to determine the maximum amount of the deduction allowed under § 404(a)(1).

The rate of interest on 30-year Treasury securities for June 2004 is 5.41 percent. Pursuant to Notice 2002-26, 2002-1 C.B. 743, the Service has determined this rate as the monthly average of the daily determination of yield on the 30-year Treasury bond maturing in February 2031.

The following 30-year Treasury rates were determined for the plan years beginning in the month shown below.

The principal authors of this notice are Paul Stern and Tony Montanaro of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this notice, please contact the Employee Plans’ taxpayer assistance telephone service at 1-877-829-5500 (a toll-free number), between the hours of 8:00 a.m. and 6:30 p.m. Eastern time, Monday through Friday. Mr. Stern may be reached at 1-202-283-9703. Mr. Montanaro may be reached at 1-202-283-9714. The telephone numbers in the preceding sentences are not toll-free.

This revenue procedure sets forth circumstances under which an insurance company that makes incentive payments to health care providers will be permitted to include those payments in discounted unpaid losses without regard to § 404 of the Internal Revenue Code. The revenue procedure also provides procedures under which a taxpayer may obtain automatic consent of the Commissioner to change its method of accounting for such payments.

.01 Section 404(a) provides that if compensation is paid or accrued on account of any employee under a plan deferring the receipt of compensation, the compensation is not deductible under chapter 1 of subtitle A (§§ 1 through 1400L), but if the compensation would otherwise be deductible, it is deductible under § 404, subject to the limitations imposed by § 404 as to the amounts deductible in any year.

.02 Section 404(a)(5) provides the general rule that compensation paid under a nonqualified plan (contributions to which are not deductible under §§ 404(a)(1), (2), or (3)) of deferred compensation is deductible in the taxable year in which an amount attributable to the contribution is includible in the gross income of employees participating in the plan.

.03 Section 404(b) provides that if there is no plan, but there is a method or arrangement that has the effect of a plan deferring the receipt of compensation, § 404(a) shall apply as if there were a plan.

.04 Section 404(d) extends the application of § 404(a) to benefits or compensation paid to nonemployees by providing that if a plan would be covered by § 404(a) (as modified by § 404(b)) but for the fact that no employer-employee relationship exists, the contributions or compensation (if otherwise deductible under chapter 1 of subtitle A) shall be deductible for the taxable year in which an amount attributable to the compensation is includible in the gross income of the persons participating in the plan.

.05 Section 1.404(b)-1T, Q&A-1, of the temporary Income Tax Regulations provides, in part, that section 404(a) and (d) govern the deduction of compensation paid or incurred with respect to plans, or methods or arrangements, however denominated, that defer the receipt of any amount of compensation or benefit, including fees and other payments. Under §§ 404(a) and (b), if otherwise deductible, a contribution paid or incurred with respect to a nonqualified plan, or method or arrangement, is deductible in the taxable year of the employer in which or with which ends the taxable year of the employee in which the amount attributable to the contribution is includible in the gross income of the employee (without regard to any applicable exclusions under chapter 1, Subtitle A).

.06 Section 1.404(d)-1T provides, in part, that in the case of deferred benefits or compensation for service providers with respect to which there is no employer-employee relationship, §§ 404(a) and (b) and the regulations thereunder apply as if the person providing the services were the employee and the person to whom the services are provided were the employer.

.07 Section 1.404(b)-1T, Q&A-2(a), provides that a plan, or method or arrangement, defers the receipt of compensation or benefits to the extent an employee receives compensation or benefits thereunder more than a brief period of time after the end of the employer’s taxable year in which the services creating the right to such compensation or benefits are performed. The determination whether a plan, or method or arrangement, defers the receipt of compensation or benefits is made separately with respect to each employee and each amount of compensation or benefit.

.08 Section 1.404(b)-1T, Q&A-2(b)(1), provides that a plan, or method or arrangement, is presumed to be one that defers the receipt of compensation for more than a brief period of time after the end of an employer’s taxable year to the extent that compensation is received after the 15^th day of the third month after the end of the employer’s taxable year in which the services are rendered (the 2 month period).

.09 Under § 1.404(b)-1T, Q&A-2(b)(2), the taxpayer may rebut this presumption only by demonstrating that it was impracticable to avoid the deferral of the receipt by an employee of the amount of compensation or benefits beyond the applicable 2 month period and that, as of the end of the employer’s taxable year, such impracticability was unforeseeable.

.10 Section 832(a) defines the taxable income of an insurance company subject to tax under § 831 as the gross income defined in § 832(b)(1), less the deductions authorized by § 832(c).

.11 Section 832(b)(1) provides that the gross income of an insurance company subject to tax under § 831 includes the combined gross amount earned during the taxable year from investment income and from underwriting income, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Association of Insurance Commissioners.

.12 Section 832(b)(3) defines underwriting income as the premiums earned on insurance contracts during the taxable year, less losses incurred and expenses incurred.

.13 Section 832(c)(4) authorizes a deduction for “losses incurred” on insurance contracts during the taxable year, as defined in § 832(b)(5).

.14 Section 832(b)(5) defines losses incurred during the taxable year on insurance contracts as follows: (1) from losses paid during the taxable year, deduct salvage and reinsurance recovered; (2) to the results so obtained, add all unpaid losses on life insurance contracts plus all discounted unpaid losses (as defined in § 846) outstanding at the end of the taxable year and deduct all unpaid losses on life insurance contracts plus all discounted unpaid losses outstanding at the end of the preceding taxable year; (3) to the results so obtained, add estimated salvage and reinsurance recoverable as of the end of the preceding taxable year and deduct estimated salvage and reinsurance recoverable as of the end of the taxable year.

.15 Section 1.832-4(b) provides, in part, that the part of the deduction for losses incurred that represents unpaid losses must comprise only actual unpaid losses. These losses must be stated in amounts that, based on the facts of each case and the company’s experience with similar cases, represent a fair and reasonable estimate of the amount the company will be required to pay. Amounts included in, or added to, the estimates of unpaid losses that, in the opinion of the director, are in excess of a fair and reasonable estimate will be disallowed as a deduction. The director may require any insurance company to submit such detailed information with respect to its actual experience as is deemed necessary to establish the reasonableness of the deduction for “losses incurred.”

.16 Section 846 provides that the amount of discounted unpaid losses as of the end of the taxable year attributable to any accident year is equal to the present value of the losses, determined by using the amount of undiscounted unpaid losses at such time, the applicable interest rate, and the applicable loss payment pattern. Section 846(b)(1) provides, in general, that the term “undiscounted unpaid losses” means the unpaid losses shown in the annual statement filed by the taxpayer for the year ending with or within the taxable year of the taxpayer. For purposes of determining discounted unpaid losses attributable to accident and health insurance contracts (other than certain disability insurance contracts), § 846(f)(6)(B) provides that the unpaid losses are considered to be paid in the middle of the taxable year following the accident year.

.17 Under § 446(e) and § 1.446-1(e)(2)(i), a taxpayer generally must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the terms and conditions necessary to obtain consent to change a method of accounting. Rev. Proc. 2002-9, 2002-1 C.B. 327 (as modified and clarified by Announcement 2002-17, 2002-1 C.B. 561, modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696, and amplified, clarified, and modified by Rev. Proc. 2002-54, 2002-2 C.B. 432), provides procedures by which a taxpayer may obtain automatic consent to change to a method of accounting described in the Appendix of Rev. Proc. 2002-9.

.18 Many taxpayers that are taxable under Part II of subchapter L of Chapter 1, including both health insurance companies and health maintenance organizations (HMOs), have developed arrangements with physicians and other health care providers that encourage participating providers to provide quality health care to subscribers in a cost-efficient manner. Under one such arrangement, a portion of the provider’s fees is held back and paid after the end of the insurer’s taxable year if certain objectives are met. Under another such arrangement, the provider is entitled to a bonus payment if specified objectives are met. The objectives set by the insurer often relate to cost savings, profitability, number of claims, quality of care, or preventive medicine. The terms of these incentive programs are not negotiated between the taxpayers and the health care providers and the taxpayers do not offer providers the alternative of not participating in these arrangements.

.19 The incentive payments described in Section 2.18 often are based on data for a performance period that can only be collected after the end of the taxpayer’s taxable year. As a result, the payments often are made to providers more than 2 months after the end of the taxpayer’s taxable year.

.20 For purposes of the annual statements filed with their state insurance commissioners, health insurers and HMOs treat the amount of incentive payments made to health care providers during the year as part of claims paid. The taxpayers also are required to include estimates of the liability for incentive payments incurred during the year as part of their total incurred but not paid claims reserves. The taxpayers usually determine the liability for incentive payments on the basis of an actuarial calculation, taking into account the relevant contractual arrangements with health care providers, the contractually defined experience outcomes by which the incentive payments will become payable to the health care providers, and an analysis of the taxpayers’ aggregate health care costs through the valuation date.

.21 Applying § 404 and the regulations thereunder to incentive payments made by the taxpayers would create a substantial administrative burden for the taxpayers and the Service, since the liabilities for incentive payments shown on the annual statements filed by health insurance companies and HMOs generally are not broken down into amounts that will be owed to specific health care providers. In light of existing rules and limitations placed on the deductibility of loss reserves under subchapter L, and in order to reduce controversy regarding the treatment of these incentive payments, the Service has decided that it will not apply § 404 to provider incentive payments described in section 4 of this revenue procedure.

This revenue procedure applies to taxpayers using or changing to the method of accounting for provider incentive payments set forth in section 5 of this revenue procedure.

A payment by a taxpayer to a health care provider is a “provider incentive payment” within the meaning of this revenue procedure if—

.01 the taxpayer is taxable as an insurance company under Part II of subchapter L;

.02 the payment is made pursuant to a written arrangement the purpose of which is to encourage participating health care providers to provide quality health care to the taxpayer’s subscribers in a cost-efficient manner;

.03 the taxpayer’s liability for the payment is dependent on the attainment of one or more preestablished goals during a performance period consisting of not more than 12 consecutive months;

.04 the terms of the arrangement pursuant to which the payment is made are established unilaterally by the taxpayer, and are not negotiated with the health care providers;

.05 the taxpayer normally makes payments to health care providers under the arrangement within 12 months after the close of the performance period referred to in section 4.03 of this revenue procedure;

.06 deferring the receipt of income by the health care provider or otherwise providing a tax benefit to the provider is not a principal purpose of the arrangement;

.07 the taxpayer records a liability for the payment on its annual statement filed for state regulatory purposes, and includes this liability in the determination of discounted unpaid losses under § 846; and

.08 the health care provider is not an employee, and is not providing health care as an agent, of the taxpayer.

A taxpayer that makes provider incentive payments within the meaning of this revenue procedure is permitted to include those payments in discounted unpaid losses without regard to § 404.

.01 Change in method of accounting. A change in an insurance company’s method of deducting provider incentive payments to the method provided in section 5 of this revenue procedure is a change in method of accounting to which the provisions of §§ 446 and 481 apply. If a taxpayer within the scope of this revenue procedure wants to change its method of deducting the liability for provider incentive payments to the method provided in section 5 of this revenue procedure, the taxpayer must follow the automatic change in method of accounting provisions of Rev. Proc. 2002-9, with the following modifications:

(1) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply to a taxpayer that wants to make the change for either its first or second taxable year ending on or after December 31, 2003.

(2) A taxpayer that wants to make the change for its first taxable year ending on or after December 31, 2003, and that on or before September 24, 2004, files its original federal income tax return for that year, and that did not change to the method described in section 5 of this revenue procedure on that return is not required to comply with the filing requirement in section 6.02(3)(a) of Rev. Proc. 2002-9, provided the taxpayer complies with the following filing requirements. The taxpayer must instead complete and file the Form 3115, Application for Change in Accounting Method, in duplicate. The original Form 3115 must be attached to an amended federal income tax return for the taxpayer’s first taxable year ending on or after December 31, 2003. This amended return must be filed no later than January 24, 2005. The copy of the Form 3115 must be filed with the national office (see section 6.02(6) of Rev. Proc. 2002-9 for the address) no later than when the taxpayer’s amended return is filed; and

(3) For purposes of Line 1a of Form 3115, the designated number for the automatic accounting method change is “90”.

.02 Audit protection. If a taxpayer within the scope of this revenue procedure currently uses a method consistent with the method described in section 5 of this revenue procedure, the method of accounting for the taxpayer’s provider incentive payments will not be raised as an issue by the Service in a taxable year that ends before December 31, 2003. Also, if a taxpayer currently uses a method consistent with the method described in section 5 of this revenue procedure, and its use of that method is an issue under consideration (within the meaning of section 3.09 of Rev. Proc. 2002-9) in examination, before an appeals office, or before the U.S. Tax Court for any taxable year that ends before December 31, 2003, that issue will not be further pursued by the Service.

This revenue procedure is effective for taxable years ending on or after December 31, 2003.

Rev. Proc. 2002-9 is modified and amplified to include this automatic change in method of accounting in section 4B of the APPENDIX.

The principal authors of this revenue procedure are Gary E. Geisler of the Office of Associate Chief Counsel (Financial Institutions & Products) and William C. Schmidt of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue procedure, contact Mr. Geisler at (202) 622-3970 (not a toll-free call) or Mr. Schmidt at (202) 622-6030 (not a toll-free call).

This Announcement is issued pursuant to the Conference Report to H.R. 4577 (Pub. L. 106-554), The Community Renewal Tax Relief Act of 2000, which requires that the Secretary of the Treasury make publicly available an annual report relating to the Pre-Filing Agreement (“PFA”) program operations for the preceding calendar year. The Conference Report states that the report is to include: (1) the number of pre-filing agreements completed, (2) the number of applications received, (3) the number of applications withdrawn, (4) the types of issues which are resolved by completed agreements, (5) whether the program is being utilized by taxpayers who were previously subject to audit, (6) the average length of time required to complete an agreement, (7) the number, if any, and subject of technical advice and Chief Counsel advice memoranda issued to address issues arising in connection with any pre-filing agreement, (8) any model agreements, and (9) any other information the Secretary deems appropriate. This is the fourth annual report. It provides information concerning activity under the permanent PFA program (Rev. Proc. 2001-22, 2001-1 C.B. 745), during calendar year 2003.

The Large and Mid-Size Business Division (“LMSB”) within the Internal Revenue Service serves corporations and partnerships with assets greater than $10 million. In 2003, approximately 150,000 corporations and partnerships filed returns reporting assets in this range. The returns filed by these taxpayers present a wide variety of complex issues. The largest of these taxpayers deal with the IRS on a continuous basis.

One of LMSB’s strategic initiatives is issue management. Through effective issue management, LMSB seeks to resolve issues of tax controversy on a more current basis. This includes, but is not limited to, increasing the efficiency of the examination process and seeking alternative issue resolution tools. The Pre-Filing Agreement program was designed to support LMSB’s issue management strategy. LMSB believes the Pre-Filing Agreement program reduces taxpayer burden and makes more effective use of IRS resources by resolving or eliminating tax controversy before the tax return is filed.

The PFA program is designed to permit a taxpayer to resolve, before the filing of a return, the treatment of an issue that otherwise would likely be disputed in a post-filing examination. The PFA program is intended to produce agreement on factual issues and apply settled legal principles to those facts. A PFA is a specific matter closing agreement under § 7121 of the Internal Revenue Code and resolves the subject of the PFA for a specified taxable period. Execution of a PFA that resolves issues prior to filing permits taxpayers to avoid costs, burdens and delays that are frequently incident to post-filing examination disputes between taxpayers and the IRS.

A pro forma or model agreement does not exist for a PFA Closing Agreement. A PFA represents a specific matter closing agreement under § 7121. The closing agreements entered into under this program were prepared with assistance from the Office of Chief Counsel and conform to the guidance provided in Rev. Proc. 68-16.

The PFA Program is available to all taxpayers under the jurisdiction of LMSB. During calendar year 2003, 42 taxpayers submitted PFA requests.These taxpayers included both Coordinated Industry Case (CIC) taxpayers that are typically subject to examination on a continuing basis and Industry Case (IC) taxpayers that are subject to examination on a less frequent basis. Of the 42 requests, 34 were from CIC taxpayers and eight were from IC taxpayers. Of the 18 cases that resulted in closing agreements during calendar year 2003, 13 were with CIC taxpayers and five were with IC taxpayers.

The average elapsed time to resolve the 18 cases that resulted in closing agreements in calendar year 2003 (the applications for which were received in 2001, 2002 and 2003) was 299.4 days.

Overall, the PFA program is meeting the LMSB strategic program objectives as provided in its issue management strategic initiative. The following benchmarks reflect the overall progress of the PFA Program:

Although the number of cases resolved in the PFA Program increased in 2003, the total processing time has also increased, particularly in the Phase II PFA Evaluation Process. This trend, which is due in part to the increasing complexity of issues presented by taxpayers for PFA consideration, has continued since the PFA Program became fully operational in 2001. LMSB is assessing how it might reduce the total amount of time elapsed during the PFA process and improve the efficacy of the PFA process in general.

The principal author of this announcement is J. Michael Mann, in the Office of Pre-Filing and Technical Guidance, Large and Mid-Size Business Division. For further information regarding this announcement, contact Mr. Mann at (202) 283-8424 (not a toll-free call).

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:

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.