This document contains amendments to 26 CFR part 1 under sections 171, 704, 721, 761, 1272, 1273, and 1275 of the Internal Revenue Code (Code). On January 22, 2003, proposed regulations (REG-103580-02, 2009-9 I.R.B. 543) relating to the tax treatment of noncompensatory options and convertible instruments issued by a partnership were published in the Federal Register (68 FR 2930). On March 28, 2003, corrections to the proposed regulations were published in the Federal Register (68 FR 15118). Because no requests to speak were submitted by April 29, 2003, the public hearing scheduled for Tuesday, May 20, 2003, was cancelled (see 68 FR 24903). The Treasury Department and the IRS received a number of comments in response to the proposed regulations. After consideration of the comments, the proposed regulations are adopted as revised by this Treasury decision. The final regulations apply to certain call options, warrants, convertible debt, and convertible equity that are not issued in connection with the performance of services (noncompensatory options). All comments are available at www.regulations.gov or upon request.

The final regulations describe certain of the income tax consequences of issuing, transferring, and exercising noncompensatory partnership options. The final regulations apply only if the call option, warrant, or conversion right grants the holder the right to acquire an interest in the issuer (or cash measured by the value of the interest). The final regulations generally provide that the exercise of a noncompensatory option does not cause recognition of gain or loss to either the issuing partnership or the option holder. In addition, the final regulations modify the regulations under section 704(b) regarding the maintenance of the partners’ capital accounts and the determination of the partners’ distributive shares of partnership items. Finally, the final regulations contain a characterization rule providing that the holder of a call option, warrant, convertible debt, or convertible equity issued by a partnership (or an eligible entity, as defined in §301.7701-3(a), that would become a partnership if the option holder were treated as a partner) is treated as a partner under certain circumstances.

A number of comments were received regarding the proposed regulations. The comments included requests for clarification and recommendations relating to (1) the issuance and exercise of noncompensatory options; (2) accounting for noncompensatory options; (3) the characterization rule; (4) the convertible bond provision; and (5) the application of the original issue discount provisions. Significant comments are further discussed in this preamble.

Like the proposed regulations, the final regulations under section 721 define a noncompensatory option as an option issued by a partnership, other than an option issued in connection with the performance of services. For this purpose, an option is defined as a call option or warrant to acquire an interest in the issuing partnership, the conversion feature of convertible debt, or the conversion feature of convertible equity.

The proposed regulations provide that section 721 does not apply to a transfer of property to a partnership in exchange for a noncompensatory option. Several commenters observed that the proposed regulations do not exclude options issued in satisfaction of interest or similar items, such as unpaid rent or royalties. Accordingly, the final regulations provide that section 721 does not apply to the transfer of property to a partnership in exchange for a noncompensatory option, or to the satisfaction of a partnership obligation with a noncompensatory option. The final regulations contain an example illustrating that a transfer of appreciated or depreciated property to a partnership in exchange for a noncompensatory option generally will result in the recognition of gain or loss by the option recipient. Under open transaction principles applicable to noncompensatory options, the partnership will not recognize income for receipt of the property while the option is outstanding. Notwithstanding the general rule, the Treasury Department and IRS believe it is appropriate to take into account the conversion right embedded in convertible equity as part of the underlying partnership interest. Accordingly, the final regulations provide that section 721 does apply to a contribution of property to a partnership in exchange for convertible equity in a partnership.

The proposed regulations provide that section 721 applies to the holder and the partnership upon the exercise of a noncompensatory option issued by the partnership. The final regulations generally adopt this rule. However, in response to comments requesting clarification, the final regulations also provide that section 721 generally applies to the exercise of a noncompensatory option when the exercise price is satisfied with property or cash contributed to the partnership, regardless of whether the terms of the option require or permit a cash payment.

The proposed regulations under section 721 do not apply to any interest on convertible debt that has been accrued by the partnership (including accrued original issue discount). A number of comments were received requesting clarification on the proper treatment of accrued but unpaid interest. Since the proposed regulations were issued and the comments received, final regulations under section 721 were published on November 17, 2011 (T.D. 9557, 2011-50 I.R.B. 838) addressing certain partnership debt-for-equity exchanges. Section 1.721-1(d)(2) provides:

The preamble to T.D. 9557 explains this provision as follows: “The IRS and the Treasury Department believe that the exception to section 721 for these items is necessary to prevent the conversion of ordinary income into capital gain.”

The Treasury Department and the IRS believe that similar considerations arise in the context of the exercise of noncompensatory options. Accordingly, the final regulations provide that section 721 does not apply to the transfer of a partnership interest to a noncompensatory option holder upon conversion of convertible debt in the partnership to the extent that the transfer is in satisfaction of the partnership’s indebtedness for unpaid interest (including accrued original issue discount) on convertible debt that accrued on or after the beginning of the convertible debt holder’s holding period for the indebtedness. Additionally, the final regulations provide that section 721 does not apply to the extent that the exercise price is satisfied with the partnership’s obligation to the option holder for unpaid rent, royalties, or interest (including accrued original issue discount) that accrued on or after the beginning of the option holder’s holding period for the obligation.

The proposed regulations do not specify whether, upon conversion of convertible debt in the partnership, the partnership is treated as satisfying its obligation for unpaid interest with a fractional interest in each partnership property. Under this “vertical slice” approach, the partnership could recognize gain or loss equal to the difference between the fair market value of each partial property deemed transferred to the creditor and the partnership’s adjusted basis in that partial property. The Treasury Department and the IRS believe that approach would be difficult to administer and may inappropriately accelerate gain or loss recognition. Therefore, the final regulations provide that the partnership will not recognize gain or loss upon the transfer of a partnership interest to a noncompensatory option holder upon conversion of convertible debt in the partnership to the extent that the transfer is in satisfaction of the partnership’s indebtedness for unpaid interest (including accrued original issue discount) on convertible debt that accrued on or after the beginning of the convertible debt holder’s holding period for the indebtedness. Additionally, the final regulations also provide that the issuing partnership will not recognize gain or loss upon the transfer of a partnership interest to an exercising option holder in satisfaction of the partnership’s obligation to the option holder for unpaid rent, royalties, or interest (including accrued original issue discount) that accrued on or after the beginning of the option holder’s holding period for the obligation. This treatment is consistent with the rules under §1.721-1(d)(2).

The rule in the proposed regulations providing for nonrecognition of gain or loss on the exercise of a noncompensatory option does not apply to any call option, warrant, or convertible debt issued by an eligible entity, as defined in §301.7701-3(a), that would become a partnership under §301.7701-3(f)(2) if the option, warrant, or conversion right were exercised. The Treasury Department and the IRS requested and received comments on whether the nonrecognition rule should be extended to such instruments. Commenters recommended that the nonrecognition rule should be extended to such instruments. However, some commenters noted that the extension of the proposed regulations to include a noncompensatory option issued by an eligible entity that would become a partnership under §301.7701-3(f)(2) upon exercise of the option would necessitate adjustments to the capital accounting requirements of the regulations, as applied to these entities. Without these adjustments, upon exercise of the option, the owner of the eligible entity would be treated as contributing all property owned by the eligible entity prior to exercise of the option to the new partnership, while the option holder would be treated as contributing only the exercise price and premium to the new partnership. The new partnership would have no unbooked unrealized gain in its property that it could allocate to the exercising option holder. Accordingly, the Treasury Department and the IRS have decided not to apply the rules of the final regulations to these instruments.

One commenter requested clarification of whether section 721(b) could apply to the exercise of a noncompensatory option under the regulations. Section 721(b) provides that section 721(a) does not apply to gain realized on a transfer of property to a partnership that would be treated as an investment company (within the meaning of section 351) if the partnership were incorporated. The Treasury Department and the IRS believe that section 721, including the provisions of section 721(b) and §1.721-1(a), applies to the exercise of noncompensatory options.

Several commenters requested guidance on the treatment of cash-settled options, particularly regarding whether the cash settlement of an option is treated as a sale or exchange of the option or as an exercise of the option followed by an immediate redemption of the newly-issued partnership interest. The Treasury Department and the IRS believe that the cash settlement of a noncompensatory option should be treated as a sale or exchange of the option and taxed under the rules of section 1234, rather than as a contribution to the partnership under section 721, followed by an immediate redemption (although the latter may, in certain instances, be treated as a sale of the option under the disguised sale rules). The final regulations provide that the settlement of a noncompensatory option in cash or property other than an interest in the issuing partnership is not a transaction to which section 721 applies.

The proposed regulations provide that section 721 does not apply to the lapse of a noncompensatory option. Accordingly, the lapse of a noncompensatory option generally results in the recognition of income by the partnership and loss by the holder of the lapsed option in an amount equal to the option premium. However, the proposed regulations do not address the character of the gain or loss recognized upon lapse, repurchase, sale, or exchange of the option.

While section 1234(b) provides that gain or loss from any closing transaction generally is treated as short term capital gain or loss to the grantor of an option, commenters were uncertain whether section 1234(b) applies to partnership interests because it is unclear whether partnership interests qualified as “securities” for purposes of section 1234(b). To eliminate this uncertainty, proposed regulations under section 1234(b) (REG-106918-08) are being published concurrently with these final regulations, which treat partnership interests as securities for this purpose. The preamble to those proposed regulations also addresses, and seeks comments on, the character of gain or loss to the option holder on the sale or exchange of, or loss on failure to exercise, an option.

In the event that the exercise of a noncompensatory option is followed by a redemption of the exercising option holder’s partnership interest, general tax principles, including the disguised sale rules of section 707(a)(2)(B), will apply in determining whether the transaction is actually a cash settlement of the noncompensatory option by the partnership.

The proposed regulations provide that if the exercise price of a noncompensatory option exceeds the capital account received by the option holder on the exercise of the noncompensatory option, the transaction will be given tax effect in accordance with its true nature. Similarly, the final regulations provide that, if the exercise price of a noncompensatory option exceeds the capital account received by the option holder on the exercise of the option, then general tax principles will apply to determine the tax consequences of the transaction. The final regulations are based on the premise that the partnership and the option holder will act in an economically rational way, such that an option holder generally will not exercise the option unless the capital account received will equal or exceed the exercise price. It should be noted that a noncompensatory option could be economically viable to exercise when the option holder receives a right to share in partnership capital that is less than the sum of the premium paid for the option and the exercise price of the option, provided that the exercise price alone does not exceed the capital account received. This simply reflects the fact that the premium is a sunk cost at the time the option holder exercises the option.

Under the proposed regulations, issuance of a noncompensatory option is not a permissive or mandatory revaluation event under Treas. Reg. §1.704-1(b)(2)(iv). One commenter noted that, as a result, unrealized gain in partnership property arising prior to the issuance of the option could be inappropriately shifted to the option holder upon exercise. The Treasury Department and the IRS agree. Therefore, the final regulations provide that the issuance by a partnership of a noncompensatory option (other than an option for a de minimis partnership interest) is a permissible revaluation event.

Under the proposed regulations, any revaluation during the period in which there are outstanding noncompensatory options generally must take into account the fair market value of any outstanding noncompensatory options. If the fair market value of outstanding noncompensatory options as of the date of the adjustment exceeds the consideration paid by the option holders to acquire the options, then the value of partnership property reflected on the partnership’s books must be reduced by that excess to the extent of the unrealized income or gain in partnership property (that has not been reflected in the capital accounts previously). This reduction is allocated only to properties with unrealized appreciation in proportion to their respective amounts of unrealized appreciation. Conversely, if the price paid by the option holders to acquire the outstanding noncompensatory options exceeds the fair market value of the options as of the date of the adjustment, then the value of partnership property reflected on the partnership’s books must be increased by that excess to the extent of the unrealized deduction or loss in partnership property (that has not been reflected in the capital accounts previously). This increase is allocated only to properties with unrealized depreciation in proportion to their respective amounts of unrealized depreciation.

The Treasury Department and the IRS have decided to retain these rules with certain modifications. The final regulations continue to provide that the adjustments to the value of partnership property reflected on the partnership’s books should generally be made to partnership properties on a pro rata basis. Several comments were received requesting additional guidance when certain properties are subject to special allocations to existing partners. The Treasury Department and the IRS agree that the final regulations should take into account the economic arrangement of the parties. Therefore, the final regulations provide that the adjustments must take into account the economic arrangement of the partners with respect to the property.

One commenter noted that, while the proposed regulations do not state how the fair market value of the outstanding option should be computed, the value that is consistently used in the examples in the proposed regulations is the liquidation value of the option assuming exercise. The commenter requested additional guidance on the determination of the fair market value of outstanding options. The Treasury Department and the IRS believe that additional guidance on the determination of fair market value is unnecessary and believe that the examples sufficiently illustrate that the fair market value of an outstanding option may be based on the liquidation value of the option assuming exercise.

The proposed regulations provide that an exercising noncompensatory option holder’s initial capital account is equal to the consideration paid to the partnership to acquire the noncompensatory option and the fair market value of any property (other than the option) contributed to the partnership upon the exercise of the noncompensatory option. The proposed regulations provide that upon the conversion of convertible equity, the fair market value of property contributed to the partnership includes the converting partner’s capital account immediately before the conversion. Because the converting partner’s pre-conversion capital account will not be eliminated because of the conversion, the Treasury Department and the IRS believe that this provision from the proposed regulations is unnecessary and could cause confusion. Therefore, the Treasury Department and the IRS have decided to remove this provision to eliminate confusion; no substantive change is intended by this revision.

Additionally, the proposed regulations provide that the capital account of a holder of convertible debt is credited with the adjusted basis of the debt and the accrued but unpaid qualified stated interest on the debt immediately before the conversion of the debt. One commenter noted that the regulations should credit the debt holder’s capital account with the adjusted issue price rather than the adjusted basis of the debt. Using adjusted issue price avoids creating a different tax result in cases in which the debt is converted by the original debt holder versus cases in which the debt is converted after a transfer of the debt at a price that reflected unrealized gain or loss attributable to the conversion right and/or changes in market interest rates. The Treasury Department and the IRS agree with this comment and, therefore, the final regulations credit the capital account of a convertible debt holder with the adjusted issue price of the debt and the accrued but unpaid qualified stated interest on the debt immediately before the conversion of the debt.

The proposed regulations require a partnership to revalue its property immediately following the exercise of a noncompensatory option, after the option holder has become a partner. The partnership must allocate the unrealized income, gain, loss, and deduction from this revaluation, first, to the noncompensatory option holder on exercise to the extent necessary to reflect the option holder’s right to share in partnership capital under the partnership agreement and, then, to the historic partners, to reflect the manner in which the unrealized income, gain, loss, or deduction in partnership property would be allocated among those partners if there were a taxable disposition of the property for its fair market value on that date. To the extent that unrealized appreciation or depreciation in the partnership’s property has been allocated to the capital account of the noncompensatory option holder on exercise, the holder will, under section 704(c) principles, recognize any income or loss attributable to that appreciation or depreciation as the underlying properties are sold, depreciated, or amortized. The final regulations adopt these provisions with some modifications.

Under the current section 704(b) regulations, a revaluation of partnership property pursuant to §1.704-1(b)(2)(iv)(f) is based on the fair market value of partnership property as of the date of the revaluation, as determined under §1.704-1(b)(2)(iv)(h). Several commenters to the proposed regulations recommended that the section 704(b) regulations be revised to permit revaluations of partnership property based on the fair market value of the partnership interest, rather than the fair market value of the partnership’s property. These values may differ because of restrictions on the transferability or liquidity of the partnership interest or other factors. The Treasury Department and the IRS have decided to continue requiring that revaluations be based on the fair market value of the partnership’s property. The Treasury Department and the IRS believe that changing the rules for all revaluations is beyond the scope of these final regulations.

Several comments were received requesting additional guidance on adjusting capital accounts upon exercise of an option when certain partnership properties are subject to special allocations to existing partners. The final regulations clarify that the allocations must take into account the economic arrangement of the partners with respect to the property.

Furthermore, several commenters requested additional guidance on how to adjust capital accounts upon exercise when the partnership owns multiple properties with unrealized income, gain, loss, or deduction. The final regulations clarify that allocations should be made on a pro rata basis from partnership property, subject to the requirement that the allocations take into account the economic arrangement of the partners. Thus, if the exercising partner’s right to share in partnership capital under the partnership agreement exceeds the sum of the premium and exercise price, then only income or gain may be allocated to the exercising partner from partnership properties with unrealized appreciation, in proportion to their respective amounts of unrealized appreciation (subject to the requirement that the allocations take into account the economic arrangement of the partners). Conversely, if the exercising partner’s right to share in partnership capital under the partnership agreement is less than the premium and exercise price, then only loss may be allocated to the exercising partner from partnership properties with unrealized loss, in proportion to their respective amounts of unrealized loss (subject to the requirement that the allocations take into account the economic arrangement of the partners).

One commenter recommended that the final regulations provide that the partnership may revalue its assets immediately before the exercise of the option (in addition to the revaluation that occurs immediately following the exercise of the option). This comment was made in response to one issue that arises when a revaluation event under §1.704-1(b)(2)(iv)(f) or (s) occurs while a noncompensatory option is outstanding and certain partnership property has increased in value. If, following the revaluation, but prior to the exercise of the option, the same property declines in value before the option is exercised, there may be insufficient unrealized income or gain in partnership property (that has not been allocated to the capital accounts of other partners) to allocate to the option holder’s capital account upon exercise. To address this issue, one commenter recommended that, for purposes of partnership property revaluations, the portion of the unrealized gain that is treated as “reflected in the capital accounts previously” be reduced by the historic partners’ share of the decline in asset value. The Treasury Department and the IRS have decided not to adopt these changes because the increased complexity that these new rules would add to the regulations outweighs the potential benefit.

Under the proposed regulations, if, after the allocations of unrealized gain and loss items to an exercising option holder, the exercising option holder’s capital account still does not reflect his right to share in partnership capital under the partnership agreement, the partnership must reallocate capital between the existing partners and the exercising option holder (a “capital account reallocation”). This capital account reallocation provision has been retained from the proposed regulations.

The proposed regulations require the partnership to make corrective allocations of gross income or loss to the partners in the year in which the option is exercised so as to take into account any shift in the partners’ capital accounts that occurs as a result of a capital account reallocation pursuant to the exercise of a noncompensatory option. Corrective allocations are allocations of tax items that differ from the partnership’s allocations of book items. If there are not sufficient actual partnership items in the year of exercise to conform the partnership’s tax allocations to the capital account reallocation, additional corrective allocations are required in succeeding taxable years until the capital account reallocation has been fully taken into account.

A number of comments were received regarding the requirement of corrective allocations in the proposed regulations. Some commenters recommended eliminating or substantially limiting the scope of corrective allocations. The Treasury Department and the IRS considered other alternatives but believe that corrective allocations are the most administrable alternative means to address the potential problem of income shifting when, prior to the exercise of a noncompensatory option, a partnership recognizes gain or loss that is, in part, economically attributable to the option holder, but is allocated entirely to the existing partners. Therefore, the final regulations retain the requirement for corrective allocations in certain circumstances.

The final regulations require corrective allocations to be made so as to take into account any capital account reallocation upon exercise of a noncompensatory option. Therefore, partnership items may be correctively allocated to the exercising option holder only of items properly allocable to a partner that suffered a capital account reduction and only to the extent such partner suffered a capital account reduction. This approach may result in corrective allocations not being fully made if a partner that suffered a capital account reduction on exercise is no longer a partner in the issuing partnership at the time a corrective allocation would otherwise be made.

The proposed regulations provide that corrective allocations are pro rata allocations of gross income and gain or gross loss and deduction. The proposed regulations do not require any matching of character between the income or loss that is correctively allocated, and gains or losses that were allocated to existing partners prior to the option’s exercise, but that were economically attributable to the option holder. Several commenters recommended that the regulations provide some type of matching requirement. The Treasury Department and the IRS believe that the complexity that could arise from a character matching requirement would outweigh the potential benefit of obtaining a more precise tax result for corrective allocations in some cases. Accordingly, the final regulations do not provide for a character matching requirement.

Additionally, some commenters requested guidance on making corrective allocations in a year in which the partnership has both gross income and gain and gross loss and deduction. In some cases, a corrective allocation that completely takes into account the capital shift may not be possible in a given year if only gross income and gain, or gross loss and deduction, are used. However, commenters noted that it may be possible to more fully take into account the capital shift if corrective allocations are made using a combination of gross income and gain and gross loss and deduction. The Treasury Department and IRS agree that combinations of gross income and gain and gross loss and deduction should be available for corrective allocations.

Accordingly, the final regulations provide a mechanism for making corrective allocations using combinations of gross income and gain and gross loss and deduction in certain circumstances. If the capital account reallocation is from the historic partners to the exercising option holder, then the corrective allocations must first be made with gross income and gain. If an allocation of gross income and gain alone does not completely take into account the capital account reallocation in a given year, then the partnership must also make corrective allocations using a pro rata portion of items of gross loss and deduction as to further take into account the capital account reallocation. Conversely, if the capital account reallocation is from the exercising option holder to the historic partners, then the corrective allocations must first be made with gross loss and deduction. If an allocation of gross loss and deduction alone does not completely take into account the capital account reallocation in a given year, then the partnership must also make corrective allocations using a pro rata portion of items of gross income and gain as to further take into account the capital account reallocation.

One commenter requested clarification on the application of section 706 to the corrective allocation provisions. Because the exercise of a noncompensatory option may cause the partners’ interests in the partnership to vary, the Treasury Department and the IRS believe that section 706 should apply in determining which items may be used for corrective allocations. Therefore, the final regulations also clarify that section 706 and its regulations and principles apply in determining the items of income, gain, loss, and deduction that may be subject to corrective allocation.

The proposed regulations do not address the impact of partnership mergers, divisions, and section 708 technical terminations on outstanding noncompensatory options. Some commenters requested guidance on these situations. The Treasury Department and the IRS believe that these issues are beyond the scope of these final regulations.

The proposed regulations generally respect noncompensatory options as such and do not characterize them as partnership equity. However, the proposed regulations characterize the holder of a noncompensatory option as a partner if the option holder’s rights are substantially similar to the rights afforded to a partner. This rule under the proposed regulations applies only if, as of the date that the noncompensatory option is issued, transferred, or modified, there is a strong likelihood that the failure to treat the option holder as a partner would result in a substantial reduction in the present value of the partners’ and the option holder’s aggregate Federal tax liabilities. The proposed regulations use a facts and circumstances test to determine whether a noncompensatory option holder’s rights are substantially similar to the rights afforded to a partner. The facts and circumstances for making this determination under the proposed regulations include, but are not limited to, whether the option is reasonably certain to be exercised and whether the option holder has partner attributes. The Treasury Department and the IRS have decided to retain these rules with certain modifications.

Some commenters criticized the breadth of the language in the proposed regulations that provides that all facts and circumstances will be considered in determining whether a noncompensatory option provides the holder with rights that are substantially similar to the rights afforded to a partner, suggesting instead that an exclusive list of factors be used. The Treasury Department and the IRS agree that the regulations should more specifically describe the circumstances in which an option holder will be considered to possess these rights. Therefore, the final regulations provide that a noncompensatory option provides its holder with rights that are substantially similar to the rights afforded to a partner if the option is reasonably certain to be exercised or if the option holder possesses partner attributes.

The proposed regulations list a number of non-exclusive factors that are used to determine whether a noncompensatory option is reasonably certain to be exercised, including the fair market value of the partnership interest that is the subject of the option, the exercise price of the option, the term of the option, the predictability and stability of the value of the underlying partnership interest, the fact that the option premium and exercise price (if the option is exercised) will become property of the partnership, and whether the partnership is expected to make distributions during the term of the option. With one exception, the final regulations adopt these factors and clarify that any other arrangements affecting or undertaken with a principal purpose of affecting the likelihood that the noncompensatory option will be exercised will be considered a factor in determining whether an option is reasonably certain to be exercised. Because the option premium represents a sunk cost to the option holder, and because the fact that the exercise price becomes property of the partnership is already reflected in the value of the partnership interest subject to the option, the final regulations do not include as a factor in the reasonable certainty test the fact that the option premium and exercise price will become property of the partnership.

Some commenters suggested that the characterization rule in the regulations adopt standards similar to those found in §1.1361-1(l) for determining whether there is a second class of stock in an S corporation, or those found in §1.1504-4 for determining whether a corporation is a member of an affiliated group. Commenters also recommended that the regulations provide for certain safe harbors and bright line tests for determining whether an option holder’s rights are substantially similar to the rights afforded to a partner, and whether there is a strong likelihood that the failure to treat the holder as a partner would result in a substantial reduction in the present value of the partners’ and the holder’s aggregate tax liabilities. After careful consideration of these comments, the Treasury Department and the IRS believe that limited safe harbors should be provided to limit the administrative burdens of the characterization rule. Accordingly, the final regulations provide two objective safe harbors, which are similar to two of the safe harbors in §1.1504-4 and §1.1361-1(l). However, these safe harbors apply only to the determination of whether a noncompensatory option is reasonably certain to be exercised, and not to the determination of whether a noncompensatory option holder possesses partner attributes.

The first safe harbor provides that a noncompensatory option is not considered reasonably certain to be exercised if it may be exercised no more than 24 months after the date of the applicable measurement event and it has a strike price equal to or greater than 110 percent of the fair market value of the underlying partnership interest on the date of the measurement event. The second safe harbor provides that a noncompensatory option is not considered reasonably certain to be exercised if the terms of the option provide that the strike price of the option is equal to or greater than the fair market value of the underlying partnership interest on the exercise date. For purposes of these safe harbors, an option whose strike price is determined by a formula is considered to have a strike price equal to or greater than the fair market value of the underlying partnership interest on the exercise date if the formula is agreed upon by the parties when the option is issued in a bona fide attempt to arrive at the fair market value on the exercise date and is to be applied based on the facts and circumstances in existence on the exercise date.

The safe harbors do not apply, however, if the parties to the noncompensatory option had a principal purpose of substantially reducing the present value of the aggregate Federal tax liabilities of the partners and the noncompensatory option holder.

The final regulations provide that failure of an option to satisfy one of these safe harbors does not affect the determination of whether the option is treated as reasonably certain to be exercised. Thus, options that do not satisfy the safe harbors may still be treated as not reasonably certain to be exercised under the facts and circumstances. Notwithstanding that an option is treated as not reasonably certain to be exercised on the date of one measurement event under either the safe harbors or the facts and circumstances test, the option may be treated as reasonably certain to be exercised at the time of a subsequent measurement event if the safe harbors and facts and circumstances test are no longer satisfied. Furthermore, even if an option is not reasonably certain to be exercised under either the safe harbors or the facts and circumstances test, the noncompensatory option may still be found to provide its holder with rights substantially similar to those afforded a partner under the partner attributes test.

The proposed regulations contain an example describing an option issued by a partnership with reasonably predictable earnings and concluding, based on the facts of the example, that the option described is reasonably certain to be exercised. Commenters stated that the example involved unrealistic facts demonstrating reasonably predictable earnings, and that the example wrongly implied that low volatility suggests a reasonable certainty of exercise. Upon further consideration of this example, the Treasury Department and the IRS have decided to delete the example from the final regulations.

The proposed regulations provide that partner attributes include the extent to which the option holder shares in the economic benefit and detriment of partnership income and loss and the extent to which the option holder has the right to control or restrict the activities of the partnership. Some commenters requested clarification of this definition of partner attributes. Because all options issued by a partnership allow the holder to share, to some extent, in the economic benefit and detriment of partnership income and loss, the Treasury Department and the IRS agree that this language should be clarified.

The final regulations provide that the determination of whether a noncompensatory option holder possesses partner attributes is based on all the facts and circumstances, including whether the option holder, directly or indirectly, through the option agreement or a related agreement, is provided with voting or managerial rights in the partnership. Additionally, the final regulations provide that an option holder has partner attributes if, based on all the facts and circumstances, (1) the option holder is provided with rights (through the option agreement or a related agreement) that are similar to rights ordinarily afforded to a partner to participate in partnership profits through present possessory rights to share in current operating or liquidating distributions with respect to the underlying partnership interest; or (2) the option holder, directly or indirectly, undertakes obligations (through the option agreement or a related agreement) that are similar to obligations undertaken by a partner to bear partnership losses. In this way, the Treasury Department and the IRS believe that the final regulations clarify that the economic benefits and burdens relevant to the partner attributes test are those beyond the economic benefits and burdens inherent in basic option transactions.

As to an option holder’s ability to control or restrict the activities of the partnership, some commenters stated that an option holder should not be considered to possess partner attributes solely because the holder has the ability to restrict partnership distributions or dilutive issuances of partnership equity while the option is outstanding. Option holders often are given such rights as a means of protecting the value of the option holder’s potential future partnership interest. The Treasury Department and the IRS agree that such rights are reasonable restrictions that, by themselves, should not automatically lead to a conclusion that the option holder possesses partner attributes. Accordingly, the final regulations provide that a noncompensatory option holder will not ordinarily be considered to possess partner attributes solely because the noncompensatory option agreement significantly controls or restricts, or the noncompensatory option holder has the right to significantly control or restrict, a partnership decision that could substantially affect the value of the underlying partnership interest. In particular, the following rights of the option holder will not be treated as partner attributes: (1) the ability to impose reasonable restrictions on partnership distributions or dilutive issuances of partnership equity or options while the noncompensatory option is outstanding; and (2) the ability to choose the partnership’s section 704(c) method for partnership properties.

Some commenters requested clarification on the analysis of partner attributes for an option holder who is also a partner in the issuing partnership. The proposed regulations provide that rights possessed by an option holder solely by virtue of owning a partnership interest and not by virtue of holding a noncompensatory option are not taken into account in determining whether the option holder has partner attributes, provided those rights are no greater than those held by other partners owning substantially similar interests. Commenters noted that, in some cases, there may be partners, such as managing or general partners, with unique interests that are not comparable to the interests of any other partners. The Treasury Department and the IRS agree that the regulations should address these situations. Accordingly, the final regulations provide that rights in the issuing partnership possessed by a noncompensatory option holder solely by virtue of owning an interest in the issuing partnership are not taken into account, provided that those rights are no greater than the rights granted to other partners owning substantially similar interests in the partnership and who do not hold noncompensatory options in the partnership. Additionally, the final regulations provide that if all of the partners owning substantially similar interests in the issuing partnership also hold noncompensatory options in the partnership, or if none of the other partners owns substantially similar interests in the partnership, then all facts and circumstances will be considered in determining whether the rights in the partnership possessed by the option holder are possessed solely by virtue of owning a partnership interest. If those rights are possessed solely by virtue of owning a partnership interest, the final regulations provide that they are not taken into account.

Additionally, in response to comments, the final regulations provide that for purposes of determining whether an option holder has partner attributes, the option holder will be treated as owning all partnership interests and noncompensatory options issued by the partnership that are owned by any person related to the option holder. For example, if the holder of a noncompensatory option is related to a person that owns an interest in the issuing partnership, and the interest provides the related person with partner attributes that are greater than the rights granted to other partners owning substantially similar interests in the partnership, the option will be characterized as a partnership interest under the final regulations if the strong likelihood test is satisfied. This provision is intended to prevent avoidance of the partner attributes test by planning among related parties. The Treasury Department and the IRS continue to study the extent to which financial instruments and partnership interests owned by related persons should be taken into account under the reasonable certainty test.

The proposed regulations contain an example describing a deep in the money option and concluding, based on the facts of the example, that the option holder possesses partner attributes. Commenters stated that the example added little to the existing guidance provided by the common law rule. Upon further consideration of this example, the Treasury Department and the IRS have decided to delete the example from the final regulations.

The Treasury Department and the IRS received a number of comments regarding the provision in the proposed regulations that the characterization rule applies only if there is a strong likelihood that the failure to treat the option holder as a partner would result in a substantial reduction in the present value of the partners’ and the holder’s aggregate tax liabilities. Some commenters recommended that the regulations adopt language similar to that contained in §1.704-1(b)(2)(iii)(b)(2) and (c)(2), which provides that, in determining whether there is a reduction in the partners’ total tax liability, tax consequences that result from the interaction of the allocation(s) with partner tax attributes that are unrelated to the partnership are taken into account. Similarly, in determining whether there would be a substantial reduction in the present value of the partners’ and option holder’s aggregate tax liabilities, commenters noted that it is appropriate to consider partner and option holder tax attributes that are unrelated to the partnership, and the interaction of those attributes with the option.

The Treasury Department and the IRS agree that it would be helpful for the regulations to specify certain factors that are considered in determining whether there is a strong likelihood that the failure to treat a noncompensatory option holder as a partner would result in a substantial reduction in the present value of the partners’ and the option holder’s aggregate Federal tax liabilities. The final regulations provide that all facts and circumstances should be considered in making this determination, including: (1) the interaction of the allocations of the issuing partnership and the partners’ and noncompensatory option holder’s Federal tax attributes (taking into account tax consequences that result from the interaction of the allocations with the partners’ and noncompensatory option holder’s Federal tax attributes that are unrelated to the partnership); (2) the absolute amount of the Federal tax reduction; (3) the amount of the reduction relative to overall Federal tax liability; and (4) the timing of items of income and deductions.

Additionally, to more specifically address the application of the strong likelihood test when a look-through entity (as defined in §1.704-1(b)(2)(iii)(d)(2)) is a party, the final regulations provide that if a partner or option holder is a look-through entity, such as a partnership or an S corporation, then the tax attributes of that entity’s ultimate owners (that are not look-through entities) will be taken into account in determining whether there is a strong likelihood of a substantial tax reduction. The final regulations also provide that, if a partner is a member of a consolidated group, then tax attributes of the consolidated group and of another member with respect to a separate return year will be taken into account in determining whether there is a strong likelihood of a substantial tax reduction.

The proposed regulations test a noncompensatory option under the characterization rule upon issuance, transfer, or modification of the option. A number of comments were received recommending clarification, or narrowing of the list, of events that will trigger a testing of the option after original issuance. Several commenters argued that only material modifications of an option should lead to re-testing under the characterization rule. Several commenters also recommended restricting the types of transfers that will trigger testing of the option under the characterization rule, or removing the requirement to test upon transfer entirely. In response to these comments, the final regulations provide a more detailed description of the events that will trigger application of the characterization rule to a noncompensatory option.

The final regulations provide that the characterization rule will be applied upon the occurrence of a measurement event with respect to the noncompensatory option. The final regulations define a measurement event as: (1) issuance of the noncompensatory option; (2) an adjustment of the terms (modification) of the noncompensatory option or of the underlying partnership interest (including an adjustment pursuant to the terms of the noncompensatory option or the underlying partnership interest); or (3) transfer of the noncompensatory option if either (A) the term of the option exceeds 12 months, or (B) the transfer is pursuant to a plan in existence at the time of the issuance or modification of the noncompensatory option that has as a principal purpose the substantial reduction of the present value of the aggregate Federal tax liabilities of the partners and the noncompensatory option holder.

Additionally, in response to the comments, the Treasury Department and the IRS believe that it is appropriate to limit testing under the characterization rule to provide certainty for both taxpayers and the IRS, particularly in circumstances in which there is little potential for abuse. Therefore, the final regulations do not treat the following events as measurement events: (1) a transfer of the noncompensatory option that would otherwise be a measurement event if the transfer is at death or between spouses or former spouses under section 1041, or in a transaction that is disregarded for Federal tax purposes; (2) a modification that neither materially increases the likelihood that the option will be exercised nor provides the option holder with partner attributes; (3) a change in the strike price of a noncompensatory option, or in the interests in the issuing partnership that may be issued or transferred pursuant to the option, made pursuant to a bona fide, reasonable adjustment formula that has the intended effect of preventing dilution of the interests of the option holder; and (4) any other event as provided in guidance published in the Internal Revenue Bulletin. The Treasury Department and the IRS believe that these limitations will minimize the burden on taxpayers that could arise from frequent testings under the characterization rule in many situations, while preserving the ability of the IRS to enforce the characterization rule in appropriate circumstances.

Some commenters also requested that the regulations clarify whether the issuance, transfer, or modification of one noncompensatory option would trigger testing under the characterization rule of all other outstanding noncompensatory options issued by the same partnership. Under the final regulations, testing under the characterization rule occurs only on the date a measurement event occurs with respect to a particular noncompensatory option. Measurement events should be determined individually for each noncompensatory option issued by a partnership. For example, the modification of one noncompensatory option generally would be a measurement event for that particular option, and it would not be a measurement event for all other noncompensatory options issued by the partnership.

In addition, to address transfers of interests in the issuing partnership and situations involving look-through entities, proposed regulations under section 761 (REG-106918-08) are being published concurrently with these final regulations. Those proposed regulations would add three measurement events to the list above, but apply only if those measurement events are pursuant to a plan in existence at the time of the issuance or modification of the noncompensatory option that has as a principal purpose the substantial reduction of the present value of the aggregate Federal tax liabilities of the partners and the noncompensatory option holder. The proposed measurement events are: (1) issuance, transfer, or modification of an interest in, or liquidation of, the issuing partnership; (2) issuance, transfer, or modification of an interest in any look-through entity that directly, or indirectly through one or more look-through entities, owns the noncompensatory option; and (3) issuance, transfer, or modification of an interest in any look-through entity that directly, or indirectly through one or more look-through entities, owns an interest in the issuing partnership. The Treasury Department and the IRS believe that the first of these proposed measurement events is necessary because it is inconsistent to test a noncompensatory option under the characterization rule upon transfer of the noncompensatory option, but not upon transfer of an interest in the issuing partnership, because either type of transfer may change the analysis of whether there is a strong likelihood that the failure to treat the option holder as a partner would result in a substantial reduction in the present value of the partners’ and option holder’s aggregate tax liabilities. The Treasury Department and the IRS believe that the second and third proposed measurement events are necessary to prevent avoidance of the characterization rule through the use of look-through entities.

Some commenters requested clarification regarding the timing of the characterization of a noncompensatory option as a partnership interest under the regulations. For example, some commenters questioned whether an option that was characterized as a partnership interest upon transfer would be treated as transferred and then exercised by the transferee or exercised by the transferor and then transferred. The Treasury Department and the IRS believe that the tax consequences to the transferor and transferee upon a transfer of the option should be similar to the tax consequences upon a transfer of the underlying partnership interest. Accordingly, the final regulations provide that characterization of an option as a partnership interest under the regulations applies upon the issuance of the option, or immediately before any other measurement event that gave rise to the characterization. Under this approach, if the characterization rule applied upon a transfer of a noncompensatory option, a section 743 adjustment for the benefit of the transferee would be made if the issuing partnership had a section 754 election in effect.

Some commenters questioned whether, once a noncompensatory option was characterized as a partnership interest under the characterization rule, the characterization rule could ever operate to re-characterize the interest as a noncompensatory option once again. The Treasury Department and the IRS believe that the characterization rule operates to treat noncompensatory options as partnerships interests in appropriate circumstances, and it should not be interpreted to treat partners as noncompensatory option holders. Accordingly, the final regulations provide that once a noncompensatory option is treated as a partnership interest, in no event may it be characterized as an option thereafter.

Finally, some commenters questioned whether general tax principles would continue to apply to the characterization of a noncompensatory option that, in substance, represents a current partnership interest. Because these rules in the final regulations are intended to supplement rather than supplant general tax principles, the Treasury Department and the IRS believe it is appropriate for general tax principles to continue to apply, in addition to the characterization rule of the regulations. Thus, the final regulations clarify that an option that is not treated as a partnership interest under the regulations may still be treated as a partnership interest under general principles of law. For example, if upon the issuance of a noncompensatory option, the option in substance constitutes a partnership interest under general tax principles, then the option will be treated as a partnership interest for Federal tax purposes, even if it is unlikely that the aggregate tax liabilities of the option holder and partners would be substantially reduced by the failure to treat the option holder as a partner. For this purpose, general tax principles include principles of tax law derived from the Internal Revenue Code, Treasury Regulations, case law, and administrative guidance issued by the IRS.

Section 171(b)(1) provides that the amount of bond premium on a convertible bond does not include any amount attributable to the conversion features of the bond. A holder of partnership convertible debt who purchases the debt at a premium would generally be subject to the section 171 bond premium amortization rules. One commenter suggested that the regulations under §1.171-1(e)(1)(iii) be clarified to state that such regulations apply to debt that is convertible into an interest in the partnership issuing the debt. The final regulations adopt this comment.

The original issue discount (OID) provisions provide special rules for debt instruments convertible into the stock of the issuer or a party related to the issuer. See §§1.1272-1(e), 1.1273-2(j), and 1.1275-4(a)(4). The proposed regulations proposed to apply these special rules to debt instruments convertible into partnership interests. These final regulations adopt these proposed amendments. Accordingly, the final regulations amend the OID provisions to treat partnership interests as stock for purposes of the special rules for convertible debt instruments. Treating convertible debt issued by partnerships and corporations differently for purposes of these special rules could create unjustified distinctions between the taxation of instruments that are economically equivalent.

These final regulations apply to noncompensatory options that are issued on or after February 5, 2013.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses, and no comments were received.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.171-1 is amended by adding a sentence at the end of paragraph (e)(1)(iii)(C) to read as follows:

This document contains final regulations that amend the Income Tax Regulations (26 CFR part 1) under section 36B of the Internal Revenue Code (Code) regarding whether health coverage under an employer-sponsored plan is affordable for individuals who are eligible to enroll in the plan by reason of their relationship to an employee (related individuals).

On August 17, 2011, a notice of proposed rulemaking (REG-131491-10, 2011-36 I.R.B. 208) was published in the Federal Register (76 FR 50931). On May 23, 2012, final regulations (T.D. 9590, 2012-24 I.R.B. 986) were published in the Federal Register (77 FR 30377). The final regulations reserved a rule (§1.36B-2(c)(3)(v)(A)(2)) for determining affordability of employer-sponsored coverage for related individuals. Written comments responding to the proposed and final regulations were received. The comments are available for public inspection at www.regulations.gov or on request. A public hearing was held on November 17, 2011. After consideration of all the comments, the proposed rule is adopted without change by this Treasury decision.

The proposed regulations provided that, for taxable years beginning before January 1, 2015, an eligible employer-sponsored plan is affordable for related individuals if the portion of the annual premium the employee must pay for self-only coverage (the required contribution percentage) does not exceed 9.5% of the taxpayer’s household income. While several comments supported this rule, other comments asserted that the affordability of coverage for related individuals should be based on the portion of the annual premium the employee must pay for family coverage.

These final regulations adopt the proposed rule without change. The language of section 36B, through a cross-reference to section 5000A(e)(1)(B), specifies that the affordability test for related individuals is based on the cost of self-only coverage. By contrast, section 5000A, which establishes the shared responsibility payment applicable to individuals for failure to maintain minimum essential coverage, addresses affordability for employees in section 5000A(e)(1)(B) and, separately, for related individuals in section 5000A(e)(1)(C). Thus, proposed regulations under section 5000A, which the Treasury Department is releasing concurrently with these final regulations, provide that, for purposes of applying the affordability exemption from the shared responsibility payment in the case of related individuals, the required contribution is based on the premium the employee would pay for employer-sponsored family coverage.

These final regulations apply to taxable years ending after December 31, 2013.

This Treasury decision is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. Section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and, because the regulations do not impose a collection of information requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking that preceded these final regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.36B-2 is amended by revising paragraphs (c)(3)(v)(A)(2) and (c)(3)(v)(D), Example 2 to read as follows:

A taxable employer that hires a member of a targeted group (as defined in § 51(d)(2) through (10), other than a qualified veteran described in § 51(d)(3)) on or after January 1, 2012, and on or before March 31, 2013, will be considered to have satisfied the requirements of § 51(d)(13)(A)(ii) if it submits the completed Form 8850 to the DLA to request certification not later than April 29, 2013.

An employer that hires any qualified veteran described in § 51(d)(3) on or after January 1, 2013, and on or before March 31, 2013, will be considered to have satisfied the requirements of § 51(d)(13)(A)(ii) if it submits the completed Form 8850 to the DLA to request certification not later than April 29, 2013.

This document contains proposed amendments to 26 CFR part 1 under sections 761 and 1234 of the Internal Revenue Code (Code). On January 22, 2003, proposed regulations (REG-103580-02, 2003-9 I.R.B. 543) relating to the tax treatment of noncompensatory options and convertible instruments issued by a partnership (noncompensatory partnership option regulations) were published in the Federal Register (68 FR 2930). Final regulations in this issue of the Bulletin contain amendments to the Income Tax Regulations (26 CFR Part 1), which finalize the proposed regulations. However, the Treasury Department and the IRS have decided to propose amendments to the regulations expanding the characterization rule measurement events to include certain transfers of interests in the issuing partnership and other look-through entities.

Additionally, the Treasury Department and the IRS received comments on the proposed regulations expressing uncertainty as to whether section 1234(b) applies to the grantor of an option on a partnership interest on the lapse or repurchase of the option. The comments indicated that it was unclear whether the term “securities,” as used in section 1234(b)(2)(B), includes partnership interests. After consideration of all comments received, the IRS and Treasury Department believe that it is appropriate to propose an amendment to the regulations under section 1234(b) to expressly treat partnership interests as securities for purposes of section 1234(b).

The final regulations being published elsewhere in this issue of the Bulletin, relating to the tax treatment of noncompensatory partnership options, contain a characterization rule providing that the holder of a noncompensatory option is treated as a partner under certain circumstances. Under the characterization rule, a noncompensatory option is treated as a partnership interest if, on the date of a measurement event (1) the noncompensatory option provides the option holder with rights that are substantially similar to the rights afforded a partner, and (2) there is a strong likelihood that the failure to treat the holder of the noncompensatory option as a partner would result in a substantial reduction in the present value of the partners’ and noncompensatory option holder’s aggregate Federal tax liabilities. The final regulations define a measurement event as: (1) issuance of the noncompensatory option; (2) an adjustment of the terms (modification) of the noncompensatory option or of the underlying partnership interest (including an adjustment pursuant to the terms of the noncompensatory option or the underlying partnership interest); or (3) transfer of the noncompensatory option if either (A) the option may be exercised (or settled) more than 12 months after its issuance, or (B) the transfer is pursuant to a plan in existence at the time of the issuance or modification of the noncompensatory option that has as a principal purpose the substantial reduction of the present value of the aggregate Federal tax liabilities of the partners and the noncompensatory option holder.

The Treasury Department and the IRS believe it is appropriate to expand the list of measurement events to include certain transfers of interests in the issuing partnership and look-through entities. The proposed regulations add three measurement events to the list above, but apply only if those measurement events are pursuant to a plan in existence at the time of the issuance or modification of the noncompensatory option that has as a principal purpose the substantial reduction of the present value of the aggregate Federal tax liabilities of the partners and the noncompensatory option holder. The three additional measurement events are: (1) issuance, transfer, or modification of an interest in, or liquidation of, the issuing partnership; (2) issuance, transfer, or modification of an interest in any look-through entity that directly, or indirectly through one or more look-through entities, owns the noncompensatory option; and (3) issuance, transfer, or modification of an interest in any look-through entity that directly, or indirectly through one or more look-through entities, owns an interest in the issuing partnership. The Treasury Department and the IRS believe that the first of these measurement events is necessary because it is inconsistent to test a noncompensatory option under the characterization rule upon transfer of the noncompensatory option, but not upon transfer of an interest in the issuing partnership, because either type of transfer may change the analysis of whether there is a strong likelihood that the failure to treat the option holder as a partner would result in a substantial reduction in the present value of the partners’ and option holder’s aggregate tax liabilities. The Treasury Department and the IRS believe that the second and third measurement events are necessary to prevent avoidance of the characterization rule through the use of look-through entities.

Like the measurement events in the final regulations, the three measurement events in the proposed regulations are subject to exceptions in §1.761-3(c)(2). The Treasury Department and the IRS believe that the limitations on these measurement events will reduce the administrative burden associated with testing under the characterization rule upon these events.

The Treasury Department and the IRS request comments on the appropriate procedures for notifying the partners and the partnership upon the occurrence of a measurement event.

In response to comments, the proposed regulations address the application of section 1234(b) to the grantor of an option on a partnership interest on the lapse or repurchase of the option. Section 1234(b) provides that, in the case of the grantor of an option, gain or loss from any closing transaction with respect to, and gain on lapse of, an option in property shall be treated as gain or loss from the sale or exchange of a capital asset held not more than one year. Section 1234(b)(2)(B) defines the term property to mean stock and securities (including stocks and securities dealt with on a when issued basis), commodities, and commodity futures. Accordingly, for section 1234(b) to apply to a closing transaction with respect to, or lapse of, an option on a partnership interest, a partnership interest would have to be a security and, thus, property within the meaning of section 1234(b)(2)(B). The proposed regulations provide that the term “securities” as used in section 1234(b)(2)(B) includes partnership interests. As a result, in the case of the grantor of an option on a partnership interest, gain or loss from any closing transaction with respect to, and gain on lapse of, the option is generally treated under the proposed regulations as gain or loss from the sale or exchange of a capital asset held not more than 1 year.

With respect to an option holder, under section 1234(a), gain or loss on the sale or exchange of, or loss on failure to exercise, an option is considered gain or loss from the sale or exchange of property that has the same character as the property to which the option relates would have in the hands of the taxpayer. Although a partnership interest is generally considered a capital asset, section 751(a) may apply to recharacterize a portion of a partner’s gain on the sale or exchange of a partnership interest as ordinary. A number of commenters on the noncompensatory partnership option proposed regulations questioned whether section 751 applies to the lapse, repurchase, sale, exchange, or other termination of a noncompensatory option.

The Treasury Department and the IRS continue to study this issue and request comments on (1) if section 751(a) applies to the lapse, repurchase, sale, or exchange of a noncompensatory option, (a) how the option holder’s share of income or loss from section 751 property would be determined under §1.751-1(a)(2), and (b) how a partner in the issuing partnership that transfers its partnership interest while the option is outstanding would determine its share of income or loss from section 751 property under §1.751-1(a)(2) (that is, should it be reduced by the amount of income or loss from section 751 property attributable to the option holder); and (2) if section 751(a) does not apply to the lapse, repurchase, sale, or exchange of a noncompensatory option, what measures, if any, should be taken to ensure that ordinary income is not permanently eliminated.

To coordinate the proposed regulations with the final noncompensatory partnership option regulations, the proposed regulations are proposed to have the same effective date as the final noncompensatory partnership option regulations. Therefore, the proposed regulations are proposed to apply to options issued on or after February 5, 2013.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation, and because the regulation does not impose a collection of information requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments are available at www.regulations.gov or upon request. A public hearing may be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.761-3 is amended by adding paragraph (c)(1)(iv) to read as follows:

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:M:S, Washington, DC 20224.

Comments on the collection of information should be received by April 2, 2013. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of information;

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in these proposed regulations is in §1.5000A-3 and §1.5000A-4. The collection of information is necessary to determine whether the shared responsibility payment provision applies to a taxpayer and compute any shared responsibility payment imposed on a taxpayer. The likely respondents are individuals required to file Federal income tax returns under section 6012(a)(1) of the Internal Revenue Code (Code).

The burden for the collection of information contained in proposed regulation §1.5000A-3 and §1.5000A-4 will be reflected in the burden on a form that the IRS will create to request the information in the proposed regulation.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Under the Patient Protection and Affordable Care Act, Public Law 111-148 (124 Stat. 119 (2010)) and the Health Care and Education Reconciliation Act of 2010, Public Law 111-152 (124 Stat. 1029 (2010)) (collectively, the Affordable Care Act), the Federal government, State governments, insurers, employers, and individuals are entrusted with shared responsibility to reform and improve the availability, quality, and affordability of health insurance coverage in the United States. The Affordable Care Act expands Medicaid eligibility for residents of electing States and increases Federal funding for the expansion. The Affordable Care Act also provides individuals and small businesses the ability to purchase private health insurance through State-based, State Partnership, or Federally facilitated competitive market places called Affordable Insurance Exchanges (Exchanges). Through Exchanges, insurance companies will compete for business on a level playing field and qualified consumers will have a choice of health plans to fit their needs.

In addition, the Affordable Care Act includes various insurance market reforms to increase the ability of individuals to enroll in health insurance coverage regardless of preexisting conditions and to eliminate the ability of insurers to charge higher premium prices based on factors other than age, tobacco use, rating area, or family size. Moreover, the Affordable Care Act builds upon the existing private employer-based health insurance system to ensure continued access to high quality health insurance coverage at low cost.

Finally, to ensure effective and efficient implementation of the insurance market reforms, the Affordable Care Act requires a nonexempt individual to maintain minimum essential coverage or make a shared responsibility payment. Section 1501(b) of the Affordable Care Act added section 5000A to a new chapter 48 of subtitle D (Miscellaneous Excise Taxes) of the Code effective for months beginning after December 31, 2013. Section 5000A was subsequently amended by the TRICARE Affirmation Act of 2010, Public Law 111-159 (124 Stat. 1123) and Public Law 111-173 (124 Stat. 1215).

Section 5000A provides nonexempt individuals with a choice: maintain minimum essential coverage for themselves and any nonexempt family members or include an additional payment with their Federal income tax return. Section 5000A(a) and section 5000A(b) provide that nonexempt individuals must have minimum essential coverage for each month beginning after December 31, 2013, or make an additional payment (the shared responsibility payment) with their Federal income tax return for the taxable year that includes such month. Under section 5000A(b)(3)(A), a taxpayer is liable for the shared responsibility payment if any nonexempt individual who may be claimed by the taxpayer as a dependent for a taxable year does not have minimum essential coverage in a month included in that taxable year. Married taxpayers filing a joint return for any taxable year are jointly liable for any shared responsibility payment imposed for the year.

Many individuals are exempt from the shared responsibility payment, including some whose religious beliefs conflict with acceptance of the benefits of private or public insurance and those who do not have an affordable health insurance coverage option available. Section 1311(d)(4)(H) of the Affordable Care Act (42 U.S.C. 18031(d)(4)(H)) directs Exchanges to issue to qualified individuals certificates of exemption from the requirement to maintain minimum essential coverage or the shared responsibility payment under section 5000A. Section 1411 of the Affordable Care Act (42 U.S.C. 18081) generally provides procedures for determining an individual’s eligibility for various benefits relating to health coverage, including exemptions from the application of section 5000A. The Department of Health and Human Services and the Department of the Treasury are working in close coordination to release regulations and other guidance related to Exchanges.

On March 27, 2012, the Department of Health and Human Services released final regulations related to the establishment of, and the standards applicable to, Exchanges (45 CFR 155.10 and following sections (Exchange regulations)). Section 155.200(b) of the Exchange regulations directs an Exchange to issue exemption certificates in accordance with sections 1311(d)(4)(H) and 1411 of the Affordable Care Act (42 USC 18031(d)(4)(H), 18081). The Department of Health and Human Services is publishing proposed regulations detailing the standards by which Exchanges will issue certificates of exemption under section 5000A. Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage Provisions (to be codified at 45 CFR 155.600 and following sections).

Section 5000A(d) and (e) describe individuals who are exempt from making the shared responsibility payment even if they do not have minimum essential coverage for a given month. Under section 5000A(d)(2)(A), an individual is exempt for a month for which an Exchange certifies that the individual is a member of a recognized religious sect or a division thereof described in section 1402(g)(1) and is an adherent of established tenets or teachings of that sect or division. Section 1402(g)(1) provides an exemption from self-employment tax for members of a qualified religious sect or division thereof. A qualified religious sect or division thereof described in section 1402(g)(1) is a sect or division thereof that the Commissioner of Social Security finds: (1) has established tenets or teachings by reason of which its members and adherents are conscientiously opposed to acceptance of the benefits of any private or public insurance that makes payments in the event of death, disability, old age, or retirement or makes payments toward the cost of, or provides services for, medical care (including the benefits of any insurance system established by the Social Security Act); (2) maintains, and has maintained for a substantial period of time, a practice whereby its members make provision for its dependent members that is reasonable in view of their general level of living; and (3) has been in existence at all times since December 31, 1950.

Section 5000A(d)(2)(B) provides that an individual is exempt for a month that the individual is a member of a health care sharing ministry. A health care sharing ministry is an organization: (1) which is described in section 501(c)(3) and exempt from tax under section 501(a); (2) members of which share a common set of ethical or religious beliefs and share medical expenses among themselves in accordance with those beliefs, and regardless of the State in which a member resides or is employed; (3) members of which retain membership even after they develop a medical condition; (4) which has itself (or a predecessor of which has) been in existence at all times since December 31, 1999; (5) members of which have continuously and without interruption shared medical expenses since at least December 31, 1999; and (6) which conducts an annual audit performed by an independent certified public accounting firm in accordance with generally accepted accounting principles the report of which is made available to members of the public upon request.

Section 5000A(d)(3) provides that an individual is exempt for a month that the individual is neither a citizen or national of the United States nor an alien lawfully present in the United States.

Section 5000A(d)(4) provides that an individual is exempt for a month that the individual is incarcerated, except for incarceration pending the disposition of charges.

Section 5000A(e)(1) provides that an individual is exempt for a month for which the individual lacks access to affordable minimum essential coverage. For this purpose, an individual lacks access to affordable coverage if the individual’s required contribution (determined on an annual basis) for minimum essential coverage exceeds a percentage (8 percent for 2014) of the individual’s household income for the most recent taxable year for which the Secretary of Health and Human Services, in consultation with the Secretary, determines information is available.

In general, section 5000A(c)(4)(B) defines a taxpayer’s household income as the sum of the taxpayer’s modified adjusted gross income and the modified adjusted gross income of any other member of a taxpayer’s family (that is, individuals for whom the taxpayer properly claims a deduction under section 151 (relating to the personal exemption deduction)) who are required to file a Federal income tax return. Under section 5000A(c)(4)(C), modified adjusted gross income means adjusted gross income (within the meaning of section 62) increased by amounts excluded from gross income under section 911 and tax-exempt interest a taxpayer receives or accrues in the taxable year. Unlike section 36B(d)(2)(B), modified adjusted gross income for purposes of section 5000A does not include Social Security benefits that are not includable in gross income. For purposes of determining the affordability of minimum essential coverage under section 5000A(e)(1), the taxpayer’s household income is increased by the portion of the required contribution made through a salary reduction arrangement and excluded from gross income.

For purposes of determining household income, a taxpayer’s family includes all individuals for whom the taxpayer properly claims a personal exemption deduction under section 151 for the taxable year. See also §1.36B-1(d). Taxpayers may claim a personal exemption deduction for themselves, a spouse, and each of their dependents. Section 152 provides that a taxpayer’s dependent may be a qualifying child or qualifying relative, including an unrelated individual who lives with the taxpayer.

For an employee eligible to purchase coverage under an eligible employer-sponsored plan, the required contribution for purposes of the exemption under section 5000A(e)(1) is the employee’s share of the annual premium for self-only coverage. For an individual eligible to purchase coverage under an eligible employer-sponsored plan because the individual is related to an employee, the determination of whether the individual’s coverage is affordable is made by reference to the employee’s required contribution. For all individuals who are ineligible to purchase coverage under an eligible employer-sponsored plan, the required contribution is the annual premium for the lowest cost bronze plan available on the Exchange where the individual lives reduced by the credit allowable under section 36B for the taxable year (determined as if the individual enrolled in a plan through such Exchange for the entire taxable year).

Section 5000A(e)(2) provides that an individual is exempt for a month included in a calendar year if the individual’s household income for the most recent taxable year for which information is available is less than the amount of gross income specified in section 6012(a)(1) for the taxpayer. Section 6012(a)(1) provides, for each filing status, gross income thresholds above which individuals are required to file Federal income tax returns.

As described in this preamble, income-based exemptions under section 5000A(e)(1) and section 5000A(e)(2) rely upon household income for the most recent taxable year that the Secretary of Health and Human Services, after consultation with the Secretary of Treasury, determines information is available. The Secretary of Health and Human Services, after consultation with the Secretary of the Treasury, determined that the household income for these exemptions that is available and relevant is the household income for the year for which an exemption is being claimed. See section III.A.3.b. of the preamble to Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage Provisions (to be codified at 45 CFR 155.600 and following sections, and 45 CFR 156.600 and following sections). The determination by the Secretary of Health and Human Services is reflected in the proposed regulations.

Section 5000A(e)(3) provides that an individual is exempt for a month that the individual is a member of an Indian tribe as defined in section 45A(c)(6). Section 45A(c)(6) describes certain Federally recognized Indian tribes (including any qualified Alaska Native village or regional or village corporation). The Federally recognized Indian tribes are listed in Indian Entities Recognized and Eligible to Receive Services from the United States Bureau of Indian Affairs, 75 Fed. Reg. 60810 (Oct. 1, 2010), as supplemented by 75 Fed. Reg. 661124 (Oct. 27, 2010), or its successor.

Under section 5000A(e)(4), an individual is exempt for a month the last day of which occurs in a period when the individual does not have minimum essential coverage for a continuous period of less than three months (a short coverage gap). The length of a gap in coverage is determined without regard to the calendar years in which months in the gap occur. If an individual has more than one short coverage gap in a calendar year, the exemption applies only to the earliest short coverage gap. Section 5000A(e)(4) authorizes the Secretary to issue regulations that provide for collecting the shared responsibility payment in cases where gaps in coverage straddle more than one taxable year.

Section 5000A(e)(5) provides that an individual is exempt for a month that the Exchange determines, in accordance with guidance promulgated by the Secretary of Health and Human Services, the individual suffered a hardship that prevented the individual from obtaining coverage under a qualified health plan. The Department of Health and Human Services is proposing rules on the criteria for application of the hardship exemption. Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage (to be codified at 45 CFR 155.605(g)).

Under section 5000A(c), the amount of the shared responsibility payment for any taxable year is generally the sum of monthly penalty amounts for all months in the taxable year in which any nonexempt individual for whom the taxpayer is liable under section 5000A(b) did not have minimum essential coverage. The shared responsibility payment amount for any taxable year may not exceed an amount equal to the national average premium for bronze-level qualified health plans offered through Exchanges for the applicable family size involved.

The monthly penalty amount for a month is equal to ¹/₁₂ of the greater of the following amounts: (1) the flat dollar amount or (2) the percentage of income. The flat dollar amount is the lesser of the following amounts: (a) the sum of the applicable dollar amounts for all nonexempt individuals without minimum essential coverage for whom the taxpayer is liable or (b) 300 percent of the applicable dollar amount. The applicable dollar amount is $95 for 2014, $325 for 2015, and $695 for 2016, and will be increased for calendar years beginning after 2016 by a cost-of-living adjustment. If a nonexempt individual has not attained the age of 18 as of the beginning of a month, the applicable dollar amount for that individual is one-half of the regular applicable dollar amount.

The percentage of income is calculated as the excess of the taxpayer’s household income over the taxpayer’s Federal income tax return filing threshold under section 6012(a)(1), multiplied by a percentage figure. The percentage figure is 1 percent for taxable years beginning in 2014, 2 percent for taxable years beginning in 2015, and 2.5 percent for taxable years beginning after 2015.

Section 5000A(f) defines minimum essential coverage as one of the following: (1) coverage under a specified government sponsored program, (2) coverage under an eligible employer-sponsored plan, (3) coverage under a health plan offered in the individual market within a State, (4) coverage under a grandfathered health plan, and (5) other health benefits coverage that the Secretary of Health and Human Services, in coordination with the Secretary, recognizes for purposes of section 5000A(f).

Under section 5000A(f)(1)(A), specified government sponsored programs include the following: (1) the Medicare program under part A of title XVIII of the Social Security Act, (2) the Medicaid program under title XIX of the Social Security Act, (3) the Children’s Health Insurance Program (CHIP) under title XXI of the Social Security Act, (4) medical coverage under chapter 55 of title 10, United States Code, including the TRICARE program, (5) veterans health care programs under chapter 17 or 18 of title 38, as determined by the Secretary of Veterans Affairs, in coordination with the Secretary of Health and Human Services and the Secretary of Treasury, (6) a health plan under section 2504(e) of title 22 relating to Peace Corps volunteers, and (7) the Nonappropriated Fund Health Benefits Program of the Department of Defense, established under section 349 of the National Defense Authorization Act for Fiscal Year 1995, Public Law 103-337 (10 U.S.C. 1587 note).

Under section 5000A(f)(2), an eligible employer-sponsored plan is, with respect to an employee, a group health plan or group health insurance coverage offered by an employer to the employee that is: (1) a governmental plan, within the meaning of section 2791(d)(8) of the Public Health Service Act, or (2) any other plan or coverage offered in the small or large group market within a State. An eligible employer-sponsored plan also includes a grandfathered health plan offered in a group market.

Under section 1251 of the Affordable Care Act (42 U.S.C. 18011), a grandfathered health plan is a group health plan or health insurance coverage that provided coverage as of the enactment date of the Affordable Care Act (March 23, 2010) or in which an individual was enrolled as of that date. See also §54.9815-1251T(a) (providing guidance regarding grandfathered health plans).

As described in this preamble, the Department of Health and Human Services, in coordination with the Treasury Department, may designate other health benefits coverage as minimum essential coverage. The Department of Health and Human Services is proposing a regulation that provides criteria and a process by which other types of coverage may be designated as minimum essential coverage. Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage Provisions (to be codified at 45 CFR 156.600 and following sections).

Under section 5000A(f)(3), health coverage that consists of coverage of certain excepted benefits specified in section 2791(c) of the Public Health Service Act (42 U.S.C. 300gg-91(c)) is not minimum essential coverage. There are four categories of excepted benefits. The first category includes accidental death and dismemberment coverage, disability insurance, general liability insurance, automobile liability insurance, workers’ compensation, credit-only insurance (for example, mortgage insurance), and coverage for employer-provided on-site medical clinics. See 42 U.S.C. 300gg-91(c)(1). The second category of excepted benefits includes limited-scope dental or vision benefits, long-term care benefits, and benefits provided under certain health flexible spending arrangements. See 42 U.S.C. 300gg-91(c)(2). The third category of excepted benefits includes, but only if offered under a policy, certificate, or contract of insurance separate from, and not coordinated with, any group or individual health plan maintained by the same plan sponsor, coverage only for a specified disease or illness (for example, cancer-only policies) or fixed indemnity insurance (for example, a policy that pays a fixed dollar amount, such as $100, per day of hospitalization or illness regardless of the amount of medical expense incurred). See 42 U.S.C. 300gg-91(c)(3). The last category of excepted benefits includes, but only if offered under a policy, certificate, or contract of insurance separate from the primary health coverage, Medicare supplemental polices (also known as Medigap or MedSupp insurance), TRICARE supplemental policies, and similar supplemental coverage to coverage under a group health plan. See 42 U.S.C. 300gg-91(c)(4).

Under section 5000A(f)(4), an individual is treated as having minimum essential coverage for a month: (1) if the individual is a bona fide resident of a United States possession for the month or (2) if the month occurs during any period described in section 911(d)(1)(A) or section 911(d)(1)(B) that is applicable to the individual. Section 911(d)(1)(A) is applicable to a citizen of the United States who has a tax home outside the United States and is a bona fide resident of a foreign country or countries during an uninterrupted period that includes an entire taxable year. For example, an individual who resides abroad for an entire calendar year is treated as having minimum essential coverage for each month of that calendar year regardless of whether the individual has health coverage of any type. Section 911(d)(1)(B) is applicable to a U.S. citizen or U.S. resident (within the meaning of section 7701(b)) who has a tax home outside the United States and is present in a foreign country or countries for at least 330 full days during a period of 12 consecutive months. In general, an individual who meets either of the foregoing residency requirements under section 911(d)(1) is treated as a qualified individual for purposes of section 911 and may elect to exclude certain foreign earned income and housing costs from gross income.

Under section 5000A(b)(2), an individual liable for the shared responsibility payment under section 5000A must report the payment with the individual’s Federal income tax return for the taxable year including the month or months for which the payment is owed.

Under section 5000A(g)(1), the shared responsibility payment is payable upon notice and demand by the Secretary. The shared responsibility payment is generally assessed and collected in the same manner as an assessable penalty under subchapter B of chapter 68 (sections 6671 through 6725). Unlike the assessable penalties, however, the Secretary may not file notice of lien or levy on the taxpayer’s property for failing to pay the assessed shared responsibility payment. Further, a taxpayer may not be subject to criminal prosecution or penalty for failing to pay the assessed shared responsibility payment in a timely manner.

The proposed regulations provide that, for a month, a nonexempt individual must either have minimum essential coverage or pay the shared responsibility payment.

The proposed regulations provide that, for any calendar month, an individual is treated as having minimum essential coverage if the individual is enrolled in and entitled to receive benefits under a program or plan that is minimum essential coverage for at least one day during the month.

Under section 5000A(b)(3)(A), if an individual with respect to whom the shared responsibility payment is imposed for a month is another individual’s dependent (as defined in section 152) for the taxable year including that month, the other individual is liable for the shared responsibility payment for the dependent. The proposed regulations clarify that a taxpayer is liable for the shared responsibility payment imposed with respect to any individual for a month in a taxable year for which the taxpayer may claim a personal exemption deduction for the individual (that is, the dependent) for that taxable year. Whether the taxpayer actually claims the individual as a dependent for the taxable year does not affect the taxpayer’s liability for the shared responsibility payment for the individual.

The proposed regulations provide special rules for determining liability for the shared responsibility payment attributable to individuals who are adopted or placed in foster care during a taxable year. If a taxpayer legally adopts a child and is entitled to claim the child as a dependent under section 151 for the taxable year when the adoption occurs, the taxpayer is not liable for a shared responsibility payment attributable to the child for the months before the adoption. Conversely, if a taxpayer who is entitled to claim a child as a dependent under section 151 for the taxable year places the child for adoption during the year, the taxpayer is not liable for a shared responsibility payment attributable to the child for the months after the adoption.

The proposed regulations define shared responsibility family to include all individuals for whom a taxpayer (including a spouse, if married filing jointly) is liable for the shared responsibility payment. The proposed regulations clarify that a taxpayer who is an exempt individual remains liable for a shared responsibility payment imposed for a nonexempt dependent who does not have minimum essential coverage.

Section 5000A(b)(3)(B) provides that, if an individual for whom the shared responsibility payment is imposed for a month files a joint return for the taxable year including that month, the individual and the individual’s spouse are jointly liable for the shared responsibility payment. The proposed regulations clarify that whether one spouse is an exempt individual does not affect the joint liability of the two spouses for the shared responsibility payment.

Section 5000A(f)(1)(A) specifies several government sponsored programs as providing minimum essential coverage by referring to the Federal law authorizing a particular program. In most cases, the relevant law describes a single program or a discrete portion of a larger program. For example, section 5000A(f)(1)(A)(i) lists Part A of the Medicare program under title XVIII of the Social Security Act. However, in some cases, the relevant law establishes programs with limited coverage. For instance, some of the programs under title XIX of the Social Security Act do not provide a scope of benefits comparable to the primary Medicaid program under the same title. In addition, the Secretary of Veterans Affairs, in coordination with the Secretaries of Health and Human Services and Treasury, determined that only certain health care programs under chapter 17 or 18 of title 38, United States Code provide comprehensive benefits. The programs with limited coverage are similar to coverage consisting of excepted benefits that is not minimum essential coverage under section 5000A(f)(3). Accordingly, the proposed regulations identify limited benefit programs under title XIX of the Social Security Act that are not minimum essential coverage and specify comprehensive health care programs under chapter 17 or 18 of title 38, United States Code, that are minimum essential coverage.

Section 5000A(f)(2) defines eligible employer-sponsored plan, for an employee, as a group health plan or group health insurance coverage offered by an employer to the employee that is either of the following: (1) a governmental plan (within the meaning of section 2791(d)(8) of the Public Health Service Act (PHSA) (42 U.S.C. 300gg-91(d)(8)) or (2) any other plan or coverage offered in the small or large group market within a State. The terms group health plan and group health insurance coverage are not defined in section 5000A. However, section 5000A(f)(5) provides that any term used in section 5000A that is also used in title I of the Affordable Care Act has the same meaning as when used in that title.

Section 1301(b)(3) of the Affordable Care Act (42 U.S.C. 18021(b)(3)) provides that group health plan has the same meaning as in section 2791(a) of the PHSA (42 U.S.C. 301gg-91(a)(1)). Section 2791(a) of the PHSA provides that group health plan means an employee welfare benefit plan (as defined in section 3(1) of the Employee Retirement Income Security Act of 1974 (ERISA) (29 U.S.C. 1002(1)) to the extent that the plan provides medical care (as defined in section 2791(a)(2) of the PHSA and including items and services paid for as medical care) to employees and their dependents directly or through insurance, reimbursement, or otherwise. Section 3(1) of ERISA defines employee welfare benefit plan as any plan, fund, or program established or maintained by an employer or by an employee organization, or by both, to the extent that the plan, fund, or program is established or maintained for the purpose of providing for its participants or their beneficiaries, through the purchase of insurance or otherwise, various benefits, which may include medical, surgical, or hospital care or benefits.

Group health plans within the meaning of section 1301(b)(3) of the Affordable Care Act (42 U.S.C. 18021(b)(3)) include both insured health plans and self-insured health plans. Accordingly, a self-insured group health plan is an eligible employer-sponsored plan.

Employers are required to offer certain former employees continuation coverage under Federal or State law. Many employers offer health benefits coverage to retired employees. Under the PHSA and ERISA, group health plans and employee welfare benefit plans, respectively, include plans offered to former employees. Accordingly, the proposed regulations clarify that coverage provided by an employer to a former employee, including coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA), Public Law 99-272 (100 Stat. 82), and retiree health coverage, qualifies as coverage under an eligible employer-sponsored plan.

Under section 5000A(f)(1)(E), the Secretary of Health and Human Services, in coordination with the Secretary of the Treasury, may designate other health benefits coverage as minimum essential coverage. The Department of Health and Human Services is proposing rules providing standards for determining whether certain other types of health insurance coverage constitute minimum essential coverage and procedures for plan sponsors to follow for a plan to be identified as minimum essential coverage under section 5000A. Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage Provisions (to be codified at 45 CFR 156.600 and following sections).

The term applicable individual is used in section 5000A to describe an individual who is subject to the minimum essential coverage provision under section 5000A(a). Section 5000A(d)(2) through section 5000A(d)(4) describe one category of individuals who are not applicable individuals for purposes of section 5000A. Section 5000A(e)(1) through 5000A(e)(5) describe another category of individuals who are exempt from liability for the shared responsibility payment imposed under section 5000A(b). Although the two categories are distinct in the statute, the consequence for individuals described in either category is the same: individuals in both categories are not subject to the shared responsibility payment for not maintaining minimum essential coverage. Accordingly, the proposed regulations refer to all individuals described in section 5000A(d)(2), (d)(3), or (d)(4), or section 5000A(e)(1), (e)(2), (e)(3), (e)(4), or (e)(5), as exempt individuals. For a month, a nonexempt individual is any individual who is alive for the entire month and is not an exempt individual for the month.

The proposed regulations provide that, in general, an individual is treated as an exempt individual for a month if the individual is an exempt individual for at least one day in the month. In the case of certain individuals who are nonresident aliens (as defined in section 7701(b)(1)(B)), individuals whose household income falls below the return filing threshold, and individuals who experience short coverage gaps, the proposed regulations provide rules on how to determine whether an individual is exempt for a particular month. An individual is exempt for all months included in a taxable year when the individual is a nonresident alien. In the case of an individual whose household income falls below the return filing threshold for a taxable year, the individual is exempt for all months in the taxable year. In the case of an individual experiencing a coverage gap, the individual is exempt for a month included in the first short coverage gap in a calendar year.

Under section 5000A(d)(2)(A), an individual is exempt for a month that the individual has in effect a religious conscience exemption certification. Only an Exchange may grant a religious conscience exemption certification. Individuals who are members of a recognized religious sect or division thereof described in section 1402(g)(1) and who are adherents of the established tenets or teachings of the sect or division are eligible to receive a religious conscience exemption certification.

The proposed regulations clarify that an individual who is not a citizen or national of the United States is exempt for a month if the individual is not lawfully present in the United States in that month within the meaning of 45 CFR 155.20 (referring to lawful immigration status within the United States). In addition, an individual who is not a citizen or national of the United States is treated as not lawfully present in the United States for a month in a taxable year if the individual is a nonresident alien as defined in section 7701(b)(1)(B) for that taxable year.

Section 5000A(d)(4) provides that an individual is exempt for a month for which the individual is incarcerated (other than incarceration pending the disposition of charges). The proposed regulations clarify that an individual confined for at least one day in a jail, prison, or similar penal institution or correctional facility after the disposition of charges is exempt for the month that includes the day.

Section 5000A(e)(1)(A) provides that an individual is exempt for a month for which the individual does not have access to affordable minimum essential coverage. For this purpose, an individual does not have access to affordable coverage for a month if the individual’s required contribution (determined on an annual basis) for coverage for the month exceeds 8 percent of the taxpayer’s household income for the taxable year. Under section 5000A(e)(1)(D), for any plan year beginning after 2014, the 8 percent figure is replaced by the percentage figure that the Secretary of Health and Human Services determines reflects the excess of the rate of premium growth between the preceding calendar year and 2013 over the rate of income growth for the same period.

For purposes of determining affordability of coverage, in accordance with section 5000A(e)(1)(A), the proposed regulations require that the taxpayer’s household income be increased by the portion of the required contribution made through a salary reduction arrangement and excluded from gross income. In many cases, information on the excluded amount may not be available to the IRS or to the employee. Comments are requested on practicable ways, if any, in which the required adjustment to household income may be made with the information available under sections 6051, 6055, 6056, or other provisions of the Code.

If an individual is eligible for coverage under an eligible employer-sponsored plan, whether as an employee or as an individual related to an employee, the individual’s qualification for the lack of affordable coverage exemption is determined solely by reference to the cost of coverage under the eligible employer-sponsored plan. The proposed regulations clarify that an employee or related individual is treated as eligible for coverage under an eligible employer-sponsored plan for each month included in the plan year if the employee or related individual could have enrolled in the plan for that month during an open or special enrollment period.

The proposed regulations also clarify that an employed individual who is eligible for coverage under an eligible employer-sponsored plan offered by the individual’s employer is not treated as eligible as a related individual for coverage under a plan offered by the employer of another employed individual. Thus, if two or more members of a family are employed and their respective employers offer self-only and family coverage under eligible employer-sponsored plans, each employed individual determines the affordability of coverage using the premium for the self-only coverage offered by the individual’s employer. Neither individual may determine the affordability of coverage using the premium for family coverage offered by the other individual’s employer. In these cases, each employed individual’s self-only coverage may be treated as affordable, even though the aggregate cost of covering all employed individuals may exceed 8 percent of the family’s household income. The Department of Health and Human Services is proposing rules that would permit families in these circumstances to qualify for the hardship exemption described in section 5000A(e)(5). Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage Provisions (to be codified at 45 CFR 155.605(g)).

The proposed regulations provide that employee includes a former employee. Thus, an individual eligible to enroll in retiree coverage under a group health plan that is an eligible employer-sponsored plan as defined in section 5000A(f)(2) is treated as eligible to purchase minimum essential coverage under an eligible employer-sponsored plan under the same rules applicable to current employees. The treatment of former employees is consistent with other provisions of the Code, the PHSA, and ERISA that apply to group health plans of employers.

In addition, the proposed regulations provide that an individual eligible to enroll in continuation coverage required under Federal law, such as COBRA, or a comparable State law is eligible to purchase minimum essential coverage under an eligible employer-sponsored plan only if the individual enrolls in the coverage. This treatment of former employees eligible for continuation coverage is consistent with the rules provided in §1.36B-2(c)(3)(iv).

Section 5000A(e)(1)(B)(i) provides that, in the case of an employee eligible to purchase minimum essential coverage through an eligible employer-sponsored plan, the required contribution is the portion of the annualized premium that the individual would pay (without regard to whether paid through salary reduction or otherwise) for self-only coverage. The proposed regulations clarify that, for an employee eligible for coverage under an eligible employer-sponsored plan, the required contribution is the portion of the annual premium that the employee would pay for the lowest cost self-only coverage.

Section 5000A(e)(1)(C) provides that, in the case of a related individual eligible to purchase minimum essential coverage under an eligible employer-sponsored plan because of the individual’s relationship with an employee, the related individual’s affordability determination is made by reference to the employee’s required contribution. The proposed regulations provide that a related individual is an individual who is eligible for coverage under an eligible employer-sponsored plan because of a relationship to an employee and for whom a personal exemption deduction under section 151 is properly claimed on the employee’s Federal income tax return. For example, an employee’s spouse is treated as a related individual if the spouse files a joint return with the employee and is eligible for employer-sponsored coverage only under the plan offered to the employee. An individual who is eligible to enroll in an eligible employer-sponsored plan by reason of a relationship to an employee, but who is not claimed as a dependent by the employee, is not treated as a related individual. For purposes of section 5000A, the unclaimed dependent’s household income is independently determined.

The proposed regulations clarify that if an employee or related individual is eligible to enroll in an eligible employer-sponsored plan, any eligibility for other coverage (for example, government sponsored minimum essential coverage) is disregarded for purposes of the exemption for lack of affordable coverage.

The proposed regulations further clarify that the required contribution for a related individual’s coverage is determined by reference to the premium for the lowest cost coverage under the eligible employer-sponsored plan in which the employee and all related individuals who are included in the employee’s family and not otherwise exempt are eligible to enroll. Thus, the required contribution for a spouse and claimed dependents (who are not otherwise exempt) is the premium that the employee would pay for the lowest cost coverage covering the employee, the spouse, and the claimed dependents. The required contribution for self-only coverage under an eligible employer-sponsored plan may cost less than 8 percent of household income, while the required contribution for family coverage under the same employer plan may cost more than 8 percent of household income. In such a case, the employee is not exempt under section 5000A(e)(1), while the employee’s spouse and claimed dependents are exempt.

Finally, some individuals who are claimed as dependents by a taxpayer may not be eligible for coverage under the taxpayer’s eligible employer-sponsored plan. The affordability of coverage for these individuals is determined in the manner that applies to them individually. Thus, if a taxpayer is not allowed to enroll a niece who is the taxpayer’s dependent in the taxpayer’s eligible employer-sponsored plan, the required contribution for the niece is not determined by reference to the cost of coverage under the plan. Instead, unless the niece is eligible for coverage under another eligible employer-sponsored plan, her required contribution is determined under the rules applicable to individuals eligible only to purchase coverage in the individual market.

Section 5000A(e)(1)(B)(ii) defines the term required contribution for an individual eligible only to purchase coverage in the individual market. The proposed regulations clarify that, for any individual who is not an employee or related individual eligible for minimum essential coverage under an eligible employer-sponsored plan, the required contribution is the premium for the lowest cost bronze plan available in the individual market through the Exchange serving the rating area where the individual resides, reduced by the maximum amount of any premium tax credit that would be allowable if the individual were enrolled in the plan offered through the Exchange.

As explained in this preamble, under the proposed regulations, both the annual premium for the applicable lowest cost bronze plan and the credit allowable under section 36B are determined by reference to coverage for those members of the individual’s family who are not otherwise exempt (nonexempt family). Consequently, the required contribution is the same for all members of a nonexempt family who are ineligible for coverage under an eligible employer-sponsored plan.

The proposed regulations provide that the lowest cost bronze plan is the lowest cost bronze-level qualified health plan available in the Exchange serving the rating area that would cover all members of the nonexempt family who are ineligible for coverage under an eligible employer-sponsored plan. Accordingly, the premium for the lowest cost bronze plan is the same for all individuals in a nonexempt family.

The proposed regulations provide special rules for determining the premium for the lowest cost bronze plan if the Exchange does not offer a bronze-level plan that would cover the taxpayer’s entire nonexempt family. The proposed regulations provide that, in general, the premium for the lowest cost bronze plan is the sum of the premiums for the lowest cost bronze plans that would, taken together, cover the taxpayer’s nonexempt family (for example, for an uncle and two adult dependent nieces, a self-only plan for the uncle and a two-adult or family plan for the nieces). Alternatively, the proposed regulations provide that a taxpayer may elect to use the premium for the lowest cost bronze plan that would apply to a set of individuals that have the same characteristics as the taxpayer’s nonexempt family (such as one adult plus children) as if one plan covered all members of the taxpayer’s shared responsibility family.

In general, a premium tax credit is allowable under section 36B for any coverage month (within the meaning of §1.36B-3(c)) that occurs in a taxable year in which a taxpayer is an applicable taxpayer (within the meaning of §1.36B-2(b)). A month is not a coverage month for an individual, and thus no premium tax credit is allowable for the individual’s coverage, if the individual is eligible for minimum essential coverage other than coverage offered in the individual market for that month. In general, an applicable taxpayer is a taxpayer whose household income for the taxable year is between 100 percent and 400 percent of the Federal poverty line for the taxpayer’s family size.

Section 36B(b)(1) provides that the premium tax credit for any taxable year is the sum of the premium assistance amounts with respect to all coverage months occurring in the taxable year. Under section 36B(b)(2), for any coverage month, the premium assistance amount is the lesser of the following: (1) the monthly premiums for the month for one or more qualified health plans in which the taxpayer or a member of the taxpayer’s family (coverage family) is enrolled through the Exchange serving the rating area where they reside or (2) any excess of the adjusted monthly premium for the month for the applicable second lowest cost silver plan for the taxpayer over an amount equal to ¹/₁₂ of the product of the applicable percentage and the taxpayer’s household income for the taxpayer. Section 36B, therefore, calculates the allowable credit by treating the family as a single, aggregated unit.

The proposed regulations take a similar family-unit approach to determine the affordability of Exchange coverage. The proposed regulations provide that, for purposes of section 5000A, each individual in the taxpayer’s nonexempt family is treated as having enrolled in a qualified health plan through the appropriate Exchange for purposes of determining the credit allowable under section 36B. Therefore, for each individual, a month is treated as a coverage month if the individual is ineligible for minimum essential coverage other than coverage in the individual market for the month. The proposed regulations further provide that the premium assistance amount for the month is the amount that would be allowable under the rules of section 36B if each member of the individual’s nonexempt family enrolled in a qualified health plan through an Exchange. Accordingly, for a month that an individual included in a nonexempt family is eligible for minimum essential coverage other than coverage in the individual market, the month is not a coverage month for that individual, the individual is not included in the coverage family for purposes of section 36B, and no premium assistance amount is allowable for the coverage attributable to such individual.

Section 5000A(e)(2) provides that an individual is exempt for a month in a calendar year if the individual’s household income for the taxable year is less than the amount of gross income specified in section 6012(a)(1) with respect to the taxpayer. The proposed regulations refer to “the amount of gross income specified in section 6012(a)(1) with respect to the taxpayer” (that is, the minimum amount of gross income that triggers the individual’s requirement to file a Federal income tax return under that section) as the applicable filing threshold.

The proposed regulations further clarify that, for any individual who is properly claimed as a dependent, the applicable filing threshold is that of the taxpayer who claims the individual as a dependent. Therefore, if a taxpayer is exempt under section 5000A(e)(2), any individual the taxpayer properly claims as a dependent also is exempt as well. The Treasury Department and the IRS recognize that some taxpayers who do not have sufficient gross income to trigger a return filing requirement nevertheless may have household income that exceeds the return filing threshold. For example, if a taxpayer whose gross income is below the applicable filing threshold files a Federal income tax return in order to claim certain tax benefits (such as the earned income credit or additional child tax credit) and claims a dependent whose gross income triggers a return filing requirement, the household income (which combines the taxpayer’s and the dependent’s income) may exceed the filing threshold. The Department of Health and Human Services is proposing rules providing that individuals in this circumstance may qualify for a hardship exemption. Patient Protection and Affordable Care Act; Exchange Functions: Eligibility for Exemptions; Minimum Essential Coverage Provisions (to be codified at 45 CFR 155.605(g)). The Treasury Department and the IRS are considering additional methods of accommodating individuals in these circumstances.

The proposed regulations clarify that a continuous period without minimum essential coverage is determined by reference to calendar months (for example, January or February) in conjunction with the coverage rule in §1.5000A-1(b). Therefore, if an individual is enrolled in and entitled to receive benefits under a plan identified as minimum essential coverage for one day in a calendar month, the month is not included in the continuous period when determining the application of the short coverage gap exemption. As a result, the proposed regulations provide that an individual qualifies for the short coverage gap exemption if the continuous period without minimum essential coverage is less than three full calendar months and is the first short coverage gap in the individual’s taxable year.

In general, section 5000A(e)(4)(B)(i) provides that the length of a continuous period is determined without regard to the calendar years in which months in the period occur. However, whether an individual had coverage during the last month, or the last two months, of a taxable year affects the determination of whether any gap in coverage that the individual experiences in the first month, or the first and second months, of the following taxable year qualifies as a short coverage gap. Accordingly, if a calendar year taxpayer has a continuous period of 3 months or longer that starts in November or December of one taxable year and ends in the next taxable year, then January and any ensuing months of the second taxable year that are included in the period are ineligible for the short coverage gap exemption.

Section 5000A(e)(4) expressly authorizes the Secretary to prescribe rules for the collection of the shared responsibility payment in cases in which continuous periods include months in more than one taxable year. Each Federal income tax return covers a single taxable year and requires the taxpayer to account for coverage of the taxpayer’s shared responsibility family during the months included in that taxable year. To require a taxpayer to take into account months in the following taxable year may delay or impede the taxpayer’s ability to file a timely Federal income tax return. Accordingly, to provide taxpayers with certainty when filing their Federal income tax returns, the proposed regulations provide that an individual who lacks minimum essential coverage for a period no longer than the last two months of a taxable year will be deemed to have a short coverage gap exemption for those months if the short coverage gap is the first to occur in that taxable year, without regard to whether the individual is covered during the first months of the following taxable year.

The proposed regulations clarify that, for purposes of determining whether a short coverage gap applies, an individual is treated as covered under minimum essential coverage for a month in which the individual qualifies for a section 5000A exemption (other than the short coverage gap exemption). Therefore, the short coverage exemption applies to a month in which no other section 5000A exemption applies, and a month in which an individual is otherwise exempt is not taken into account in determining the length of the continuous period without coverage.

The exemptions for members of recognized religious sects or divisions and for individuals who have suffered a hardship are available only to individuals who have been certified as meeting the relevant criteria by the Exchange serving the rating area where the individuals seeking the exemption reside.

In addition, Exchanges will provide, upon request, exemption certifications for members of health care sharing ministries, incarcerated individuals, and members of Indian tribes. If an individual receives an exemption certification from an Exchange, the taxpayer who is responsible for accounting for that individual’s coverage must provide information about the certification on the taxpayer’s Federal income tax return. Alternatively, a taxpayer may claim any of these exemptions on the taxpayer’s Federal income tax return for the taxable year.

Finally, the income-based exemptions for individuals who lack affordable coverage or have household income below the applicable income tax return filing threshold and the exemption for short coverage gaps may be claimed only on the individual’s Federal income tax return for the applicable year. Thus, an individual claiming the affordability exemption under section 5000A(e)(1) for part or all of a taxable year will do so on the Federal income tax return that reports the individual’s income establishing qualification for the exemption. An individual who has household income below the applicable Federal income tax return filing threshold and files a Federal income tax return may claim the exemption under section 5000A(e)(2) on the return. However, an individual who has household income below the applicable Federal income tax return filing threshold is not required to file a Federal income tax return to claim the exemption under section 5000A(e)(2).

Pursuant to section 6001, taxpayers are required to maintain all records and information substantiating any claim for exemption on the taxpayer’s Federal income tax return, regardless of whether the individual was certified by an Exchange as qualifying for an exemption or first claimed the exemption on a Federal income tax return.

Under section 5000A(b)(1) and 5000A(b)(3)(A), a taxpayer is liable for the shared responsibility payment with respect to any nonexempt individual who is included in the taxpayer’s shared responsibility family. The maximum annual amount of the shared responsibility payment for a taxpayer is the national average premium for the bronze level plan available through Exchanges that provides coverage for the applicable family size involved. The proposed regulations clarify that the applicable family size involved for purposes of identifying the appropriate bronze level plan includes only the nonexempt members of the taxpayer’s shared responsibility family who do not have minimum essential coverage.

Under section 5000A(c), the annual amount of the shared responsibility payment is the lesser of the applicable national average bronze plan premium or the sum of the monthly penalty amounts. The monthly penalty amount may vary month to month because of changes in the composition of the taxpayer’s shared responsibility family. To provide a meaningful value with which the sum of the monthly penalty amounts are compared, the proposed regulations provide that the applicable national average bronze plan premium must similarly be determined for each month and then aggregated for comparison with the sum of the monthly penalty amounts. Consequently, the applicable national average bronze plan premium may vary from month to month during the year to account for changes in the taxpayer’s shared responsibility family.

Section 5000A(b)(2) provides that the shared responsibility payment for a month must be included with a taxpayer’s Federal income tax return for the taxable year that includes the month. The proposed regulations clarify that the time for assessing the shared responsibility payment is the same time as that prescribed by section 6501 for the taxable year including the month for which the taxpayer is liable for the payment.

Section 5000A(g)(1) provides that the shared responsibility payment is payable upon notice and demand by the Secretary and, except as provided in section 5000A(g)(2), is assessed and collected in the same manner as an assessable penalty under subchapter B of chapter 68 of the Code (sections 6671 through 6725). The proposed regulations clarify that the shared responsibility payment is not subject to deficiency procedures of subchapter B of chapter 63 of the Code. In addition, the proposed regulations clarify that interest on the shared responsibility payment accrues in accordance with the rules in section 6601. The proposed regulations further provide that the Secretary may offset any liability for the shared responsibility payment against any overpayment due the taxpayer, in accordance with section 6402(a).

These regulations are proposed to apply for months beginning after December 31, 2013.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to the proposed regulations. Pursuant to the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it is hereby certified that the proposed regulations will not have a significant economic impact on a substantial number of small entities. The applicability of the proposed regulations is limited to individuals, who are not small entities as defined by the RFA (5 U.S.C. 601). Accordingly, the RFA does not apply. Therefore, a regulatory flexibility analysis is not required. Pursuant to section 7805(f) of the Code, the proposed regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before the proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the “Addresses” heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments will be available at www.regulations.gov or upon request.

A public hearing has been scheduled for May 29, 2013, beginning at 10:00 a.m., in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of §601.601(a)(3) of this chapter apply to the hearing. Persons who wish to present oral comments at the hearing must submit electronic or written comments, and an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by May 3, 2013. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805* * *

Section 1.5000A-4 also issued under 26 U.S.C. 5000A(e)(4).

Par 2. Sections 1.5000A-0 through 1.5000A-5 are added to read as follows: