This document contains the annual report to the public concerning Advance Pricing Agreements (APAs) and the experience of the APA program during calendar year 2004. This document does not provide guidance regarding the application of the arm’s length standard; rather, it reports on the structure and activities of the APA program.

Health reimbursement arrangements. This ruling addresses the income tax treatment under section 105 of the Code of amounts received by employees from employer-provided reimbursement plans. Notice 2002-45 amplified.

Proposed regulations under section 1441 of the Code would implement certain changes announced in Notice 2001-4, 2001-1 C.B. 267; Notice 2001-11, 2001-1 C.B. 464; and Notice 2001-43, 2001-2 C.B. 72. In addition, these regulations would provide guidance under section 411 of the American Jobs Creation Act of 2004. A public hearing is scheduled for July 20, 2005.

This notice provides interim procedures for partnerships and their partners to comply with the mandatory basis adjustment provisions of sections 734 and 743 of the Code. This notice also provides interim procedures for electing investment partnerships and their partners to comply with sections 743(e) and 6031(f).

This procedure provides general rules and specifications from the Service for paper and computer-generated substitutes of the extensively revised January 2005 versions of Form 941, Employer’s Quarterly Federal Tax Return, and Schedule B (Form 941), Report of Tax Liability for Semiweekly Schedule Depositors. Rev. Proc. 2005-21 will be reproduced as Publication 4436, General Rules and Specifications for Substitute Form 941 and Schedule B (Form 941).

This procedure provides a safe harbor procedure under which the Service will disregard a spousal right of election for purposes of determining whether the CRAT or CRUT meets the requirements of section 664(d)(1)(B) or (d)(2)(B) of the Code continuously since its creation if the spouse irrevocably waives the right of election in the manner prescribed.

This procedure provides a safe harbor procedure under which the Service will disregard a spousal right of election for purposes of determining whether the CRAT or CRUT meets the requirements of section 664(d)(1)(B) or (d)(2)(B) of the Code continuously since its creation if the spouse irrevocably waives the right of election in the manner prescribed.

This procedure provides a safe harbor procedure under which the Service will disregard a spousal right of election for purposes of determining whether the CRAT or CRUT meets the requirements of section 664(d)(1)(B) or (d)(2)(B) of the Code continuously since its creation if the spouse irrevocably waives the right of election in the manner prescribed.

This procedure provides general rules and specifications from the Service for paper and computer-generated substitutes of the extensively revised January 2005 versions of Form 941, Employer’s Quarterly Federal Tax Return, and Schedule B (Form 941), Report of Tax Liability for Semiweekly Schedule Depositors. Rev. Proc. 2005-21 will be reproduced as Publication 4436, General Rules and Specifications for Substitute Form 941 and Schedule B (Form 941).

Are amounts paid to an employee under a reimbursement plan that provides for the payment of unused reimbursement amounts in cash or other benefits excludable from gross income under § 105(b) of the Internal Revenue Code (the Code)?

Section 61(a)(1) provides that, except as otherwise provided in Subtitle A, gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items. Section 1.61-21(a)(3) and (4) of the Income Tax Regulations state that a fringe benefit provided in connection with the performance of services shall be considered to have been provided as compensation to the person performing such services.

Section 106 provides that the gross income of an employee does not include employer-provided coverage under an accident or health plan. Section 1.106-1 of the regulations provides that the gross income of an employee does not include contributions which the employee’s employer makes to an accident or health plan for compensation (through insurance or otherwise) for personal injuries or sickness to the employee or the employee’s spouse or dependents.

Section 105(a) provides that, except as otherwise provided in § 105, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer.

Section 105(e) states that amounts received under an accident or health plan for employees are treated as amounts received through accident or health insurance for purposes of § 105. Section 1.105-5(a) of the regulations states that an accident or health plan is an arrangement for the payment of amounts to employees in the event of personal injuries or sickness.

Section 105(b) states that except in the case of amounts attributable to (and not in excess of) deductions allowed under § 213 (relating to medical expenses) for any prior taxable year, gross income does not include amounts referred to in § 105(a) if such amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by the taxpayer for the medical care (as defined in § 213(d)) of the taxpayer or the taxpayer’s spouse or dependents (as defined in § 152, determined without regard to § 152(b)(1), (b)(2), and (d)(1)(B)).

Section 1.105-2 of the regulations provides that only amounts that are paid specifically to reimburse the taxpayer for expenses incurred by the taxpayer for the prescribed medical care are excludable from gross income. Section 105(b) does not apply to amounts that the taxpayer would be entitled to receive irrespective of whether or not the taxpayer incurs expenses for medical care. Accordingly, if an employee is not paid specifically to reimburse medical care expenses but is entitled to receive the payment irrespective of whether any medical expenses have been incurred, none of the payments are excludable from gross income under § 105(b) whether or not the employee has incurred medical expenses during the year.

Part I of Notice 2002-45, 2002-2 C.B. 93, describes the tax treatment of health reimbursement arrangements (HRAs). The notice explains that a tax-favored HRA is an arrangement that is paid for solely by the employer and not pursuant to a salary reduction election or otherwise under a § 125 cafeteria plan, reimburses the employee for medical care expenses (as defined in § 213(d)) incurred by the employee and by the employee’s spouse and dependents, and provides reimbursements up to a maximum dollar amount with any unused portion of that amount at the end of the coverage period carried forward to subsequent coverage periods.

Part II of Notice 2002-45 states that to qualify for the exclusion from gross income, an HRA may only provide benefits that reimburse expenses for medical care as defined in § 213(d). An HRA does not qualify for the exclusion under § 105(b) if any person has the right to receive cash or any other taxable or non-taxable benefit under the arrangement other than the reimbursement of medical care expenses. If any person has such a right, currently or for any future year, all distributions to all persons made from the arrangement in the current year are included in gross income, even amounts paid to reimburse medical care expenses. The notice specifically states that arrangements providing for the payment of a death benefit, a bonus, or a separation payment without regard to medical care expenses do not qualify for tax-favored treatment.

Notice 2002-45 notes that arrangements formally outside the HRA that provide for the adjustment of an employee’s compensation or an employee’s receipt of any other benefit will be considered in determining whether the arrangement is an HRA and whether the benefits are eligible for the exclusion from gross income.

Rev. Rul. 75-539, 1975-2 C.B. 45, describes two labor contracts. Contract A provides that upon retirement, an employee will receive a portion of accumulated unused sick leave credits as a cash payment or, at the election of the employee, the payment may be applied to continue the employee’s participation in the employer’s health plan. Contract B provides that the value of a portion of the accumulated unused sick leave credits will be used to pay for continued participation in the employer’s health plan. Under no circumstances under Contract B may the retired employee, the retired employee’s spouse or dependents receive this payment in cash.

Rev. Rul. 75-539 holds that, under Contract A, the value of unused accumulated sick leave credits used to continue health coverage is constructively received by the retired employee under § 451, and therefore is includible in the retired employee’s gross income. Under Contract A, the amount of premium payments is considered an employee contribution out of salary and not a contribution by the employer under § 106. However, under Contract B, the value of the unused accumulated sick leave credits, which may not be received in cash, is not constructively received by the retired employee, but is a contribution by the employer to the employer’s health plan that is excludable from the retired employee’s gross income under § 106.

The reimbursement plan described in Situation 1 is an HRA that meets the requirements for tax-favored treatment under §§ 106 and 105(b). The Plan in Situation 1 is an employer-provided accident or health plan under § 106 and payments are limited solely to reimbursements of previously substantiated medical care expenses incurred by current and former employees and their spouses and dependents. No person has the right, currently or in the future, to receive cash or any other taxable or nontaxable benefit under the Plan other than the reimbursement of substantiated medical care expenses as required by § 105(b).

On the other hand, the reimbursement plans described in Situations 2 through 4 do not meet the requirements for tax-favored treatment. The Plan in Situation 2 provides for a cash payment equal to all or a portion of the unused reimbursement amount available at the end of the plan year or upon termination of employment, if earlier. The Plan in Situation 3 provides for a death benefit upon the death of the employee of all or a portion of the unused reimbursement amount without regard to medical care expenses. The Plan in Situation 4 permits conversion of unused reimbursement amounts to cash or other benefits regardless of whether or not medical expenses have been incurred. Although the “option plan” in Situation 4 purports to be formally outside the reimbursement arrangement, the option plan and the reimbursement arrangement constitute one plan. Accordingly, because the Plans in Situations 2 through 4 pay amounts “irrespective” of whether medical care expenses have been incurred, no amount paid under the Plans to any person is excludable from gross income under § 105(b). See also Rev. Rul. 2002-80, 2002-2 C.B. 925, and Rev. Rul. 2003-43, 2003-1 C.B. 935.

Amounts paid to an employee under a reimbursement plan that provides for the payment of unused reimbursement amounts in cash or other benefits are not excludable from gross income under § 105(b). Thus, amounts paid from plans as described in Situations 2 through 4 are not excludable from gross income under § 105(b). In Situations 2 through 4, none of the payments made from the arrangements during the plan year to any person, including amounts paid to reimburse medical expenses, are excluded from gross income. On the other hand, contributions to and amounts paid from a plan as described in Situation 1 are excludable from the gross income of an employee under §§ 106 and 105(b).

This ruling applies to any purported employer-provided medical reimbursement arrangement, regardless of how the arrangement is characterized, that provides for the receipt by the employee or any other person of cash or any other taxable or nontaxable benefit or any combination of such benefits (including, but not limited to the benefits described in Situations 2 through 4) other than the reimbursement of medical care expenses of employees and their spouses and dependents. Moreover, this ruling applies to employer-provided reimbursement arrangements that are limited only to retired employees, as well as to employer-provided arrangements that cover active employees or both active employees and retirees.

This revenue ruling addresses only reimbursement arrangements paid for solely by an employer under the specific Code sections mentioned and not pursuant to salary reduction or otherwise under a § 125 cafeteria plan. No inference is intended as to §§ 401, 403, 408, 409A, and 457 of the Internal Revenue Code.

Notice 2002-45, 2002-2 C.B. 93, is amplified.

For reimbursement arrangements within the SCOPE of this revenue ruling, the ruling is effective for plan years beginning after December 31, 2005.

The principal author of this revenue ruling is Barbara E. Pie of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this revenue ruling, contact Ms. Pie at (202) 622-6080 (not a toll-free call).

The American Jobs Creation Act of 2004, P.L. 108-357, 118 Stat. 1418 (the Act), was enacted on October 22, 2004. The Treasury Department and the Internal Revenue Service intend to issue regulations implementing §§ 833 and 834 of the Act, which amended §§ 704, 734, 743, and 6031 of the Internal Revenue Code. This notice provides interim procedures for partnerships and their partners to comply with the mandatory basis provisions of §§ 734 and 743, as amended by the Act. This notice also provides interim procedures for electing investment partnerships (EIPs) and their partners to comply with §§ 743(e) and 6031(f), as provided in § 833(b) of the Act.

Section 833(c) of the Act requires basis adjustments to be made following certain distributions from partnerships for which no § 754 election is in effect. As amended by § 833(c) of the Act, § 734(a) and (b) requires a partnership to reduce its basis in partnership property upon a distribution of partnership property after October 22, 2004, if there is a “substantial basis reduction.” Under § 734(d), there is a substantial basis reduction if a downward adjustment of more than $250,000 would be made to the basis of partnership assets if a section 754 election were in effect at the time of the distribution. EIPs, like other partnerships, are required to make any basis adjustments that are required under § 734 upon the distribution of partnership property.

Section 833(b) of the Act requires basis adjustments to be made following certain transfers of interests in partnerships for which no § 754 election is in effect. As amended by § 833(b) of the Act, § 743(a) and (b) requires a partnership to reduce the basis of partnership property upon a transfer after October 22, 2004, of an interest in the partnership by sale or exchange or upon the death of a partner, if, at the time of the relevant transfer, the partnership has a “substantial built-in loss.” Section 743(d)(1) provides that, for purposes of § 743, a partnership has a substantial built-in loss with respect to a transfer of a partnership interest if the partnership’s adjusted basis in the partnership’s property exceeds by more than $250,000 the fair market value of the property.

Section 833(b) of the Act also provides that an EIP is not treated as having a substantial built-in loss, and thus is not required to make basis adjustments to partnership property, with respect to any transfer of a partnership interest occurring while an election to be treated as an EIP is in effect. In lieu of the partnership basis adjustments otherwise required under § 743, a partner-level loss disallowance rule applies. Section 743(e)(2) provides that, in the case of a transfer of an interest in an EIP, the transferee partner’s distributive share of the losses, without regard to gains, from the sale or exchange of partnership property is not allowed, except to the extent that it is established that the losses exceed the loss recognized on the transfer of the partnership interest by the transferor partner (or by a prior transferor to the extent not fully offset by a prior disallowance under § 743(e)(2)). Under § 743(e)(3), losses disallowed under this rule do not decrease the transferee partner’s basis in its partnership interest. Section 743(e) is to be applied without regard to any termination of the partnership under § 708(b)(1)(B). In the case of a basis reduction to property distributed to the transferee partner in a nonliquidating distribution, § 743(e)(5) provides that the amount of the transferor’s recognized loss taken into account under § 743(e)(2) is reduced by the amount of the basis reduction under § 732(a)(2).

Section 743(e)(6), as added by the Act, provides that an EIP means any partnership if (A) the partnership makes an election to have § 743(e) apply, (B) the partnership would be an investment company under section 3(a)(1)(A) of the Investment Company Act of 1940 but for an exemption under paragraph (1) or (7) of section 3(c) of such Act, (C) the partnership has never been engaged in a trade or business, (D) substantially all of the assets of the partnership are held for investment, (E) at least 95 percent of the assets contributed to the partnership consist of money, (F) no assets contributed to the partnership had an adjusted basis in excess of fair market value at the time of contribution, (G) all partnership interests of the partnership are issued by the partnership pursuant to a private offering before the date which is 24 months after the date of the first capital contribution to the partnership, (H) the partnership agreement of the partnership has substantive restrictions on each partner’s ability to cause a redemption of the partner’s interest, and (I) the partnership agreement of the partnership provides for a term that is not in excess of 15 years. However, in the case of an EIP which is in existence on June 4, 2004, § 743(e)(6)(H) does not apply to the partnership, and § 743(e)(6)(I) is applied by substituting “20 years” for “15 years”.

Section 743(e)(7) provides that the Secretary shall prescribe regulations as may be appropriate to carry out the purposes of § 743(e), including regulations for applying § 743(e) to tiered partnerships.

Section 6031(f) provides that in the case of any EIP, the information required under § 6031(b) to be furnished to any partner to whom § 743(e)(2) applies shall include information as is necessary to enable the partner to compute the amount of losses disallowed under § 743(e).

Sections 1.734-1(d) and 1.743-1(k) of the Income Tax Regulations require partnerships and partners to provide certain statements following distributions with respect to partnership interests, and transfers of partnership interests, in partnerships for which an election under § 754 is in effect. The Treasury Department and the Service intend to amend the regulations under §§ 734 and 743 to require partnerships and partners to provide statements, similar to those contained in §§ 1.734-1(d) and 1.743-1(k), following any distributions and transfers that trigger basis adjustments under § 833(b) or (c) of the Act.

Until further guidance is provided, partnerships that are required to reduce the bases of partnership properties under § 833(c) of the Act must comply with § 1.734-1(d) as if an election under § 754 were in effect at the time of the relevant distribution. Partnerships that are required to reduce the bases of partnership properties under § 833(b) of the Act must comply with § 1.743-1(k)(1) as if an election under § 754 were in effect at the time of the relevant transfer. The transferee of an interest in a partnership that is required to reduce the bases of partnership properties under § 833(b) of the Act must comply with § 1.743-1(k)(2), within the time prescribed under § 1.743-1(k)(2) (or, if later, by May 19, 2005), as if an election under § 754 were in effect at the time of the relevant transfer. In addition, partnerships that are required to reduce the bases of partnership properties under § 833(b) of the Act may rely on, and must comply with, § 1.743-1(k)(3), (4), and (5) as if an election under § 754 were in effect at the time of the relevant transfer.

Until further guidance is provided, a partnership must make the election to be treated as an EIP by attaching a written statement to an original or amended partnership return for the taxable year for which the election is effective. The statement must (i) set forth the name, address, and tax identification number of the partnership making the election, (ii) contain a representation that the partnership is eligible to make the election under § 743(e)(6)(A), and (iii) contain a declaration that the partnership elects under § 743(e) to be treated as an EIP. If a partnership has filed a return with respect to a taxable year that includes October 22, 2004, and desires to elect to be treated as an EIP for transfers after October 22, 2004, but did not attach a statement satisfying the requirements of this paragraph, then the partnership must file an amended return with a statement satisfying those requirements.

For the election to be valid, the original or amended return must be filed not later than six months after the time prescribed by § 1.6031(a)-1(e) of the Procedure and Administration Regulations (excluding extensions thereof) for filing the return for the taxable year for which the election is effective. Once an election is made, it is effective for all succeeding taxable years, unless terminated or revoked, as described below. In the case of an election filed for the partnership’s taxable year that includes October 22, 2004, the election is effective for all transfers occurring after October 22, 2004. In all other cases, the election is effective for all transfers during the partnership’s taxable year for which the election is effective. A partnership that has an election under § 754 in effect is ineligible to make an election to be treated as an EIP. If the partnership is not otherwise required to file a partnership return, the election to be an EIP shall be made in accordance with the rules of § 1.6031(a)-1(b)(5).

The election to be treated as an EIP shall terminate if the partnership fails to meet the definition of an EIP. In this case, the partnership will become subject to the mandatory basis adjustment rules with respect to the first transfer of a partnership interest that occurs after the partnership ceases to meet the definition of an EIP and to each subsequent transfer. An EIP also may terminate its election to be treated as an EIP without the consent of the Commissioner by filing an election under § 754. In this case, the partnership will become subject to the mandatory basis adjustment rules with respect to the first transfer of a partnership interest that occurs after the effective date of the election under § 754. In all other cases, except as provided in future guidance, a partnership having an election in effect to be treated as an EIP may revoke the election only with the consent of the Commissioner. The application for consent to revoke the election must be submitted to the Service in the form of a letter ruling request. If an election to be treated as an EIP is terminated, any losses that are subsequently allocated to a partner to whom a partnership interest was transferred while the EIP election was in effect shall remain subject to disallowance under § 743(e)(2).

Until further guidance is issued, if an EIP allocates losses with a different character from the sale or exchange of property to the transferee (such as ordinary or § 1231 losses and capital losses) and the losses allocated to that partner are limited by § 743(e)(2), then a proportionate amount of the losses disallowed under § 743(e)(2) shall consist of each loss of a separate character that is allocated to the transferee partner.

As noted above, a partnership that is engaged in a trade or business, or that has previously engaged in a trade or business, is not eligible to elect to be treated as an EIP. The Treasury Department and the Service are studying the conditions under which a partnership (“upper-tier partnership”) that holds interests in one or more partnerships (“lower-tier partnerships”) that are engaged in a trade or business should be treated as engaged in a trade or business.

Until further guidance is issued, an upper-tier partnership will not be treated as engaged in the trade or business of a lower-tier partnership if, at all times during the period in which the upper-tier partnership owns an interest in the lower-tier partnership, the adjusted basis of its interest in the lower-tier partnership is less than 25 percent of the total capital that is required to be contributed to the upper-tier partnership by its partners during the entire term of the upper-tier partnership. This notice does not address the situation in which the upper-tier partnership’s adjusted basis in its lower-tier partnership interest is, at any time, 25 percent or more of the total capital that is required to be contributed to the upper-tier partnership by its partners during the entire term of the upper-tier partnership.

The Treasury Department and the Service specifically request comments on rules that may be appropriate for future guidance. Factors that may be relevant in future guidance in determining whether an upper-tier partnership is treated as engaged in a trade or business that is conducted by a lower-tier partnership include (i) the relative amount of the upper-tier partnership’s investment in the lower-tier partnership as compared to the total capital that is required to be contributed to the upper-tier partnership by its partners during the entire term of the upper-tier partnership, (ii) the degree to which the upper-tier partnership participates in the management of the lower-tier partnership’s activities, and (iii) the motivations for the formation of the upper-tier partnership in making the investments in the lower-tier partnership.

The Treasury Department and the Service may adopt rules in future guidance that are more restrictive than the safe harbor provided for above. If a partnership that qualifies as an EIP under the safe harbor does not qualify as an EIP under future guidance, the partnership’s election to be treated as an EIP will terminate for transfers occurring on or after the date on which such future guidance becomes effective.

A. Transfer of Partnership Interest

PRS is a partnership which does not have an election under § 754 in effect. PRS has no liabilities. The fair market value of PRS’s assets is $4 million and the adjusted basis of PRS’s assets is $4.3 million. Under § 743(d), PRS has a substantial built-in loss because the adjusted basis of the partnership property exceeds the fair market value of the partnership property by more than $250,000. A, a partner of PRS, sells a 25 percent partnership interest in PRS to B for its fair market value of $1 million. Under § 743(b), an adjustment is required to the adjusted basis of PRS’s assets with respect to B. Under Section 3 of this notice, B must provide the written notice described in § 1.743-1(k)(2) to PRS within 30 days after the sale, and PRS must attach the statement described in § 1.743-1(k)(1) to the partnership return for the year of the transfer.

B. Distribution of Partnership Property

A and B each contribute $2.5 million and C contributes $5 million to a newly formed partnership, PRS, which does not have an election under § 754 in effect. PRS has no liabilities. PRS purchases LMN stock for $3 million and XYZ stock for $7 million. The value of each stock declines to $1 million. PRS distributes LMN stock to C in complete liquidation of C’s interest in PRS. Under § 732(b), the basis of LMN stock in C’s hands is $5 million and C would recognize a loss of $4 million if the LMN stock were sold for $1 million. There is a substantial basis reduction within the meaning of § 734(d), because the $2 million increase in the adjusted basis of LMN stock (described in § 734(b)(2)(B)) is greater than $250,000. Under § 734(b), PRS is required to decrease the basis of XYZ stock by $2 million (the amount by which the basis of LMN stock was increased), leaving a basis of $5 million remaining in the XYZ stock. Under Section 3 of this notice, PRS must attach the statement described in § 1.734-1(d) to the partnership return for the year of the distribution.

C. EIP

(i) PRS is a domestic partnership with a calendar year taxable year that desires to elect to be treated as an EIP for 2004 and all succeeding taxable years. PRS and all of its partners have a calendar year taxable year. PRS has no liabilities. Other than the making of the election, PRS meets all other requirements to be an EIP under § 743(e)(6). PRS elects to be treated as an EIP by attaching a statement to its income tax return for 2004 in accordance with Section 4 of this notice.

(ii) Between October 22 and December 31, 2004, the only transfer of a partnership interest in PRS occurred on November 30, 2004, when A transferred a 10 percent partnership interest to C. The purchase price for the 10 percent partnership interest was $3,000,000. A’s adjusted basis in A’s partnership interest on December 31, 2003, was $3,000,000. In 2004, the partnership’s only items of income, gain, loss, and deduction are $3 million of long-term capital gain and $2 million of long-term capital loss. Because PRS has elected to be treated as an EIP, PRS must separately state this gain and loss on its return in accordance with Section 5.B of this notice.

(iii) If A had remained a partner for the entire year, A’s distributive share of the partnership’s items would have been $300,000 of long-term capital gain and $200,000 of long-term capital loss. Assume that under § 706, A’s distributive share of these items are properly determined to be 334/365 of each of these amounts, or $274,521 of long-term capital gain and $183,014 of long-term capital loss, and that C’s distributive shares of these items are properly determined to be 31/365 of each of these amounts, or $25,479 of long-term capital gain and $16,986 of long-term capital loss.

(iv) PRS must provide a statement to all of its partners in accordance with Section 5.C of this notice. The statement must be attached to each partner’s Schedule K-1 for PRS’s taxable year ending December 31, 2004. Assume that A receives A’s Schedule K-1 on March 12, 2005. Within 30 days after receiving this Schedule K-1, A must provide statements to C and EIP as described in Section 5.A of this notice.

(v) The adjusted basis in A’s partnership interest on November 30, 2004, $3,091,507, equals A’s adjusted basis on December 31, 2003, $3,000,000, plus A’s distributive share of partnership gain in 2004, $274,521, less A’s distributive share of partnership loss in 2004, $183,014. The amount of loss recognized by A on the sale of A’s partnership interest is $91,507, which equals the adjusted basis in A’s partnership interest on the date of the sale, $3,091,507, less the amount realized by A, $3,000,000. Thus, the first $91,507 of gross loss allocated to C is disallowed under § 743(e)(2). The entire amount of C’s long-term capital loss in 2004, $16,986, is disallowed under § 743(e)(2). The first $74,521 of any gross loss allocated to C in future years will also be disallowed under § 743(e)(2), regardless of whether PRS is an EIP in those future years.

(vi) C’s adjusted basis as of December 31, 2004, is $3,025,479, the sum of C’s purchase price paid for A’s interest, $3,000,000, plus the distributive share of gain allocated to C, $25,479. Under § 743(e)(3), the $16,986 loss allocated to C, but disallowed under § 743(e)(2), does not reduce the basis of C’s partnership interest.

The Treasury Department and the Service intend to issue further guidance implementing §§ 833 and 834 of the Act, including guidance addressing the application of these provisions to tiered partnership structures. Comments are requested concerning the scope and content of this guidance. In particular, comments are requested concerning the application of these provisions to tiered partnerships and the reporting obligations that should be imposed on tiered partnerships and their partners. As stated earlier, comments are also requested on the rules provided in Section 7 of this notice. Comments should be submitted in writing on or before July 19, 2005, and should include a reference to Notice 2005-32. Comments may be submitted to CC:PA:LPD:PR (Notice 2005-32), Room 5226, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Alternatively, comments may be submitted electronically via the following e-mail address: Notice.Comments@irscounsel.treas.gov. Please include “Notice 2005-32” in the subject line of any electronic communications.

Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 5 p.m. to CC:PA:LPD:PR (Notice 2005-32), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224.

The collections of information contained in this notice have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1939.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collections of information in this notice are in Sections 3, 4, and 5. This information is required, and will be used, to assure compliance with the new provisions of the American Jobs Creation Act of 2004. The collections of information are required to obtain a benefit or are mandatory. The likely respondents are individuals and businesses or other for-profit institutions.

The estimated total annual reporting burden and/or recordkeeping burden is 552,100 hours.

The estimated annual average burden per respondent/recordkeeper varies from is 0.05 hours to 3 hours, depending on individual circumstances, with an estimated average of 2.07 hours.

The estimated number of respondents and/or recordkeepers is 266,400.

The estimated annual frequency of responses (used for reporting requirements only) is various.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

The principal author of this notice is Sean I. Kahng of the Office of Associate Chief Counsel (Passthroughs & Special Industries). However, other personnel from the Treasury Department and the Service participated in its development. For further information regarding this notice, contact Mr. Kahng at (202) 622-3050 (not a toll-free call).

.01 The purpose of this publication is to provide general rules and specifications from the Internal Revenue Service (IRS) for paper and computer-generated substitutes for the newly revised January 2005 version of Form 941, Employer's Quarterly Federal Tax Return, and Schedule B (Form 941), Report of Tax Liability for Semiweekly Schedule Depositors.

.02 This publication provides measurements and printing specifications for substitute Form 941 and Schedule B (Form 941). If you need more in-depth information on who must complete the forms and how to complete them, see the Instructions for Form 941 and Publication 15 (Circular E), Employer's Tax Guide, or visit the IRS website at www.irs.gov.

.03 Forms should not be submitted to the IRS for specific approval. If you are uncertain of any specification and want it clarified, you may submit a letter citing the specification and your understanding of the specification, and enclose an example of the form (if appropriate) to:

Note. Allow at least 30 days for the IRS to respond.

.04 However, software developers and form producers should send a blank copy of their substitute Form 941 and Schedule B (Form 941) in pdf format to Victor.V.Martin@irs.gov. The purpose is not specifically for approval but to assist the IRS in preparing to scan these forms. Submitters will only receive comments if a significant problem is discovered through this process. Submitters are not expected to delay marketing their forms in order to receive feedback. In no case should submitters include “live” taxpayer data.

.01 We extensively revised Form 941 and Schedule B (Form 941) to enable the IRS to scan the forms and to make them easier to complete. Optical scanning of tax returns enables the IRS to capture data more accurately and efficiently. This will reduce our need to contact filers because of an error in recording amounts reported on their returns.

.02 Because scanning requires conformity, we are publishing this revenue procedure to provide specifications for producing substitutes for the new revisions of Form 941 and Schedule B (Form 941). It is acceptable to produce substitutes of Form 941 and Schedule B (Form 941) using the official IRS form as posted on the IRS website or to produce substitutes based on the format developed by the software industry, which uses a 6x10 grid. Either format must be precisely followed.

.03 We now require filers to check a box at the top of Form 941 to indicate the tax period. We also require that line 1 (“number of employees”) be completed for each quarter. We combined income and social security tax adjustments into a single line (line 7) and no longer require a supporting statement for tips or group-term life insurance adjustments. Because Form 941 is now two pages, filers must enter their name, Employer Identification Number (EIN), and signature on page 2.

.04 There is a new form for reporting discrepancies between Forms 941 and Forms W-2. We recently developed Schedule D (Form 941), Report of Discrepancies Caused by Acquisitions, Statutory Mergers, or Consolidations. You may use Schedule D (Form 941) to explain the discrepancies between what an employer reported to the Social Security Administration on Form W-2 and what the employer reported to the IRS on Form 941, if the discrepancies are caused by acquisitions, statutory mergers, or consolidations. Areas where discrepancies may occur include social security wages, social security tips, Medicare wages and tips, federal income tax withheld, and advanced earned income payments. We did not include specifications for Schedule D (Form 941) in the exhibits (Section 7) because scanning of Schedule D (Form 941) is not available at this time. However, any substitute paper or computer-generated paper forms should generally follow the specifications for Form 941.

.01 Do not submit substitute Form 941 and Schedule B (Form 941) to the IRS for approval. Substitute Form 941 and Schedule B (Form 941) that completely conform to the specifications contained in this revenue procedure do not require prior approval from the IRS. Substitute forms filed with the IRS that do not conform may be returned.

.02 Print the form on paper that is 8.5 inches wide by 11 inches deep.

.03 Use white paper that meets generally-accepted weight, color, and quality standards (minimum 20lb. white bond paper).

Note. Reclaimed fiber in any percentage is permitted provided that the requirements of this standard are met.

.04 The IRS prefers printing Form 941 on both sides of a single sheet of paper, but it is acceptable to print on one side of each of two separate sheets of paper.

.05 Make substitute paper forms as identical to the official IRS-printed forms as possible.

.06 Print using nonreflective black inks.

.07 Use typefaces that are substantially identical in size and shape to the official forms and use rules and shading that are substantially identical to those on the official forms.

.08 Print the form ID codes in the upper right-hand corner of each form using nonreflective black, carbon-based, 12-point (minimum 10-point required) OCR-A font. Use the official paper over-the-counter IRS forms to develop your substitute paper forms. Print “9501” on page 1 of Form 941, “9502” on page 2 of Form 941, and “9503” on Schedule B (Form 941). See Section 4 for form ID codes for software-generated forms.

.09 Print the OMB number in the same location as on the official forms.

.10 Print all entry boxes and checkboxes exactly as shown on the official forms.

.11 Print your IRS-issued three-letter substitute form printer source code in the middle at the bottom of page 1 of Form 941.

.12 Print “For Privacy Act and Paperwork Reduction Act Notice, see the back of the Payment Voucher” at the bottom of page 1 of Form 941.

.13 Print “For Paperwork Reduction Act Notice, see separate instructions" at the bottom of Schedule B (Form 941).

.14 Do not print the form catalog number (“Cat. No.”) at the bottom of the forms or instructions.

.15 Do not print the Government Printing Office (GPO) symbol at the bottom of the forms or instructions.

.16 See Exhibits A and B in Section 7.

.01 You may use the 6x10 grid exhibits (C and D) at the end of this document to develop a software version of Form 941 and Schedule B (Form 941). Please follow the specifications exactly to develop the fields.

.02 If you are developing software that is designed using the 6x10 grid in the exhibits, you may make the following modifications. See Exhibits C and D in Section 7.

.03 If producing both the form and the data or the form only, print your 3-letter IRS-issued form printer source code in Row 63, Columns 49-51 on page 1 of Form 941.

.04 If producing only the data on the form, print your 4-digit software industry form code in Row 4, Columns 58-61 on page 1 of Form 941. See the National Association of Computerized Tax Processors (NACTP) website at www.nactp.org for information on these codes.

.05 Print “For Privacy Act and Paperwork Reduction Act Notice, see the Payment Voucher” at the bottom of page 1 of Form 941.

.06 Print “For Paperwork Reduction Act Notice, see separate instructions" at the bottom of Schedule B (Form 941).

.07 Do not print the form catalog number (“Cat. No.”) at the bottom of the forms or instructions.

.08 Do not print the Government Printing Office (GPO) symbol at the bottom of the forms or instructions.

.09 To enable accurate scanning and processing, enter data on Form 941 and Schedule B (Form 941) as follows:

.01 The Paperwork Reduction Act (the Act) of 1995 (Public Law 104-13) requires that:

.02 This information must be provided to any users of official or substitute IRS forms or instructions.

.03 The OMB requirements for substitute IRS forms are:

.04 If no instructions are provided to users on your forms, you must furnish to them the exact text of the Privacy Act and Paperwork Reduction Act Notice.

.01 You can order official IRS forms and information copies of federal tax materials by calling the IRS National Distribution Center at 1-800-829-3676. Other ways to get federal tax material include:

.02 The IRS also offers an alternative to downloading electronic files and provides current and prior year access to tax forms and instructions through its Federal Tax Forms CD-ROM. Order Publication 1796, IRS Federal Tax Products CD-ROM, by using the IRS website at www.irs.gov/cdorders or by calling 1-877-CDFORMS (1-877-233-6767).

.01 Please follow the specifications indicated in the following exhibits to produce substitute Form 941 and Schedule B (Form 941).

.02 These forms are subject to review and possible change as required. Therefore, employers are cautioned against overstocking supplies of privately-printed substitutes.

.03 Do not submit substitute Form 941 and Schedule B (Form 941) to the IRS for approval. Substitute Form 941 and Schedule B (Form 941) that completely conform to the specifications contained in this revenue procedure may be privately printed without prior approval from the IRS. Substitute forms filed with the IRS that do not conform may be returned. See Section 3 of this publication.

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.01 This revenue procedure applies to any charitable remainder annuity trust (CRAT) or charitable remainder unitrust (CRUT) that is created by the grantor, G, if, under applicable state law, G’s surviving spouse, S, has a right of election exercisable on G’s death to receive an elective, statutory share of G’s estate, and such share could be satisfied in whole or in part from assets of the CRAT or CRUT in violation of § 664(d)(1)(B) or (d)(2)(B) of the Internal Revenue Code. In general, only inter vivos CRATs or CRUTs are within the scope of this revenue procedure.

.02 This revenue procedure provides a safe harbor procedure under which the Internal Revenue Service will disregard the right of election for purposes of determining whether the CRAT or CRUT meets the requirements of § 664(d)(1)(B) or (d)(2)(B) continuously since its creation if S irrevocably waives the right of election in the manner prescribed in this revenue procedure. For trusts created before June 28, 2005, the Service will disregard the right of election, even without a waiver, but only if S does not exercise the right of election.

.03 The safe harbor procedure provided by this revenue procedure is not available to a CRAT or CRUT if S exercises the right of election.

.01 In general, a testator is free to dispose of property in accordance with the testator’s own wishes. However, in most jurisdictions, state statutes protect S from disinheritance. In most common law jurisdictions, these statutes are in the form of elective share provisions, many of which are based on the elective share provisions of the Uniform Probate Code (UPC), §§ 2-201- 2-214 (amended 1993). Elective share statutes provide S the right to elect to receive a statutory share of G’s estate, regardless of whether G made any bequests to S. For purposes of this revenue procedure, S’s statutory share of G’s estate will be referred to as an “elective share” and the right to elect to receive an elective share will be referred to as a “right of election”, regardless of what terms different jurisdictions may use to describe these concepts.

.02 In some states, the elective share is based solely on the probate estate but, in others, G’s estate is defined more broadly for purposes of computing the elective share and may include assets of the CRAT or CRUT. In states that have adopted the elective share provisions of the UPC, S has the right of election to take a percentage (generally determined by the duration of the marriage, but subject to a minimum dollar amount in some cases) of the “augmented estate” provided that certain requirements are met. UPC § 2-202. The augmented estate includes G’s net probate estate, as well as certain nonprobate assets of G, certain property transferred by G to others (including to S) during life, and certain other property. UPC §§ 2-202 and 2-207. The assets of the CRAT or CRUT may be included in the augmented estate and, therefore, may be used to determine and satisfy the elective share amount. UPC § 2-209. In some states, the CRAT or CRUT assets may be used to satisfy the elective share only after other property in the augmented estate first has been exhausted.

.03 Sections 664(d)(1)(B) (in the case of a CRAT) and (d)(2)(B) (in the case of a CRUT) provide that no amount other than the annuity payments described in § 664(d)(1)(A) or the unitrust payments described in § 664(d)(2)(A), respectively, (other than qualified gratuitous payments described in §§ 664(d)(1)(C) and (d)(2)(C)) may be paid to or for the use of any person other than an organization described in § 170(c). The requirements of §§ 664(d)(1)(B) and (d)(2)(B) are not satisfied in situations in which S may exercise the right of election to receive an elective share and the share could include assets of the CRAT or CRUT, because the mere existence of the right of election under applicable law, whether or not exercised, and the resulting possibility that the CRAT or CRUT may be invaded for the benefit of S, causes the trust to fail to qualify under § 664(d).

.04 The Service believes that, in the interest of sound tax administration and to reduce the burden on taxpayers, it is appropriate to provide a safe harbor procedure that, if followed, will cause the right of election to be disregarded for purposes of determining whether a CRAT or CRUT that is within the scope of this revenue procedure meets the requirements of § 664(d) continuously from the date the trust is created. This procedure generally requires that S irrevocably waive the right of election with regard to the assets of the CRAT or CRUT to ensure that no part of the trust will be used to satisfy the elective share.

.05 No waiver of the right of election is required if the applicable state law does not provide S with a right of election, exercisable at the time of G’s death, to receive an elective share of G’s estate. For example, in community property jurisdictions, elective share provisions are generally unnecessary because S typically has vested ownership in one-half of the community property. Additionally, no waiver is required if, under applicable state law, S’s elective share of G’s estate may not include any assets of the CRAT or CRUT (other than the annuity or unitrust interest payable to S as the named recipient). For example, no waiver is required if, under applicable state law, the trust’s property is excluded from the base for computing the elective share by reason of G’s receipt of adequate and full consideration for the transfer or the written consent to or joinder in the transfer by S and, in fact, the consideration is paid or the consent or joinder is given.

.01 In General. With respect to any CRAT or CRUT within the scope of this revenue procedure, S’s right of election to receive an elective share of G’s estate, if the share could include any assets of a CRAT or CRUT created or funded by G, will be disregarded for purposes of determining whether the CRAT or CRUT has met the requirements of § 664(d)(1)(B) or (d)(2)(B) continuously since its creation if all of the requirements of section 3 of this revenue procedure are satisfied. For CRATs and CRUTs within the scope of this revenue procedure created by G on or after June 28, 2005, the failure of S to waive the right of election in accordance with the requirements of this revenue procedure will result in the CRAT or CRUT failing to qualify under § 664(d) continuously since its creation, whether or not S exercises the right of election. For CRATs and CRUTs within the scope of this revenue procedure created by G before June 28, 2005, the failure of S to waive the right of election, combined with S’s exercise of that right of election, will result in the CRAT or CRUT failing to qualify under § 664(d) continuously since its creation. Thus, for all CRATs and CRUTs, regardless of when they were created, a waiver under this revenue procedure of S’s right of election will provide certainty that the right of election will not cause the trust to fail to qualify under § 664(d) continuously since its creation.

.02 Waiver Effective Under State Law. S must irrevocably waive the right of election to whatever extent necessary to ensure that no part of the trust (other than the annuity or unitrust interest of which S is the named recipient under the terms of the trust) may be used to satisfy the elective share. A valid waiver of the elective share or right of election will satisfy the requirements of the preceding sentence if the waiver is valid under applicable state law, in writing, and signed and dated by S. This revenue procedure does not require a waiver of S’s right as the named recipient to receive the annuity or unitrust payment from the CRAT or CRUT.

.03 Timing of Waiver. For CRATs or CRUTs created by G on or after June 28, 2005, section 3.02 of this revenue procedure must be satisfied on or before the date that is 6 months after the due date (excluding extensions of time to file actually granted) of Form 5227, Split-Interest Trust Information Return, for the year in which the later of the following occurs:

(1) the creation of the trust;

(2) the date of G’s marriage to S;

(3) the date G first becomes domiciled or resident in a jurisdiction whose law provides a right of election that could be satisfied from assets of the trust; or

(4) the effective date of applicable state law creating a right of election.

.04 Trustee To Retain Copy. A copy of the signed waiver must be provided to the trustee of the CRAT or CRUT. The trustee must retain the copy in the official records of the trust so long as the contents thereof may become material in the administration of any internal revenue law. See § 1.6001-1(e) of the Income Tax Regulations.

In each of the following examples, G created a CRAT that provides an annuity to G for G’s life. Upon G’s death, the remainder of the trust will pass to an organization that meets the requirements of § 170(c). In each example (except Example 3), at the time the CRAT is created, applicable state law provides S a right of election to receive an elective share of G’s estate and the share would include (and could be satisfied from) assets of the trust.

.01 Example 1. G creates the trust in 2007 while married to S. On or before the date that is 6 months after the due date (excluding extensions of time to file actually granted) of the Form 5227 for the trust for calendar year 2007, S irrevocably waives S’s right of election to receive an elective share with regard to the assets in the trust (but does not waive the right of election with regard to G’s probate estate).

.02 Example 2. G creates the trust in 2006, and is unmarried on the date the trust is created. On May 1, 2007, G marries S. On or before the date that is 6 months after the due date (excluding extensions of time to file actually granted) of the Form 5227 for the trust for calendar year 2007, S irrevocably waives the right of election to receive an elective share with regard to the assets in the trust (but does not waive the right of election with regard to G’s probate estate).

.03 Example 3. G creates the trust in 2008 while married to S. Under applicable state law in effect on the date that G creates the trust, the elective share does not include the assets in the trust. Effective on March 1, 2009, applicable state law is amended to give S the right of election to receive an elective share of the “augmented estate,” which, by definition, includes the assets of the trust. On or before the date that is 6 months after the due date (excluding extensions of time to file actually granted) of the Form 5227 for the trust for calendar year 2009, S irrevocably waives the right of election to receive an elective share with regard to the assets in the trust (but does not waive the right of election with regard to G’s probate estate).

In each of Examples 1 through 3, assuming that S’s timely waiver of the right of election is valid under applicable state law and satisfies the other requirements of this revenue procedure, the existence of the right of election will be disregarded for the purpose of determining whether the trust has qualified continuously since its creation as a CRAT under § 664(d)(1)(B). Further, in each of Examples 1 through 3, the result would be the same if, instead of executing only a partial waiver, S had waived the full right of election with respect to all assets in G’s augmented estate.

.04 Example 4. G creates the trust in 2007 while married to S. Under applicable state law in effect on the date that G creates the trust, the elective share includes the assets in the trust. Later in the same year, applicable state law is amended to provide that the augmented estate does not include the assets of a CRAT or CRUT and the amendment applies retroactively to include the trust created by G. Accordingly, no waiver of the right of election is required with respect to the assets of the trust in order for the trust to continue to qualify as a CRAT.

.05 Example 5. The facts are the same as in Example 2 except that the waiver is contained in, or is signed pursuant to the requirements of, a prenuptial agreement. Unless the agreement as a whole (or only the waiver) is subsequently found to be invalid or unenforceable, the waiver will satisfy the requirements of this revenue procedure.

.06 Example 6. The facts are the same as in Example 1, except that S dies in 2010. In 2012, G marries S2. S2 refuses to waive S2’s right to receive an elective share with regard to the assets in the trust. The existence of S’s right of election will be disregarded for the purpose of determining whether the trust has qualified continuously since its creation up until G’s marriage to S2, as a CRAT under § 664(d)(1)(B). However, because S2 did not timely and irrevocably waive S2’s right to receive an elective share with regard to the assets in the trust, the trust does not qualify as a CRAT under § 664(d)(1)(B).

If, in these examples, G had instead created a CRUT, the results would be the same for purposes of § 664(d)(2)(B).

This revenue procedure is effective as of March 30, 2005.

The collection of information contained in this revenue procedure has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1936.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of information in this revenue procedure is in section 3. This information is required to be collected and retained in order to ensure that a trust meets the requirements of § 664(d)(1) or (d)(2). This information will be used to determine whether the eligibility requirements under those statutes for treatment as a CRAT or CRUT have been met. The collection of information is required to obtain a benefit. The likely respondents are individuals.

The estimated total annual reporting burden is 150,000 hours.

The estimated annual burden per respondent varies from 1 hour to 2 hours, depending on individual circumstances, with an estimated average burden of 1¹/₂ hours to complete the statements required under this revenue procedure. The estimated number of respondents is 100,000.

The estimated annual frequency of responses is on occasion.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any Internal Revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

The principal author of this revenue procedure is Susan H. Levy. For further information regarding this revenue procedure, contact Susan H. Levy at (202) 622-3090 (not a toll-free call) or Bradford R. Poston at (202) 622-3060 (neither a toll-free call).

Internal Revenue Service (IRS), Treasury.

Notice of proposed rulemaking and notice of public hearing.

This document contains amendments to final regulations relating to the withholding of income tax under sections 1441 and 1442 on certain U.S. source income paid to foreign persons and related requirements governing collection, deposit, refunds, and credits of withheld amounts under sections 1461 through 1463. Additionally, this document contains amendments to final regulations under sections 6049 and 6114. These regulations affect persons making payments of U.S. source income to foreign persons.

Written or electronic comments must be received by June 27, 2005. Requests to speak (with outlines of oral comments to be discussed) at the public hearing scheduled for July 20, 2005, at 10:00AM must be received by June 29, 2005.

Send submissions to: CC:PA:LPD:PR (REG-125443-01), room 5203, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions also may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-125443-01), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, or sent electronically, via the IRS internet site www.irs.gov/regs or via the Federal eRulemaking Portal site at www.regulations.gov (IRS and REG-125443-01). The public hearing will be held in the IRS Auditorium, Seventh Floor, Internal Revenue Building, 1111 Constitution Avenue, N.W., Washington, DC.

Concerning the proposed regulations, Ethan Atticks, (202) 622-3840 (not a toll-free number); concerning submissions of comments, the hearing, and/or to be placed on the building access list to attend the hearing, Robin Jones, (202) 622-7180 (not a toll-free number).

Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as follows:

The principal author of the proposed regulations is Ethan Atticks, Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their development.

* * * * *

March 31, 2005

This Announcement is issued pursuant to § 521(b) of Pub. L. 106-170, the Ticket to Work and Work Incentives Improvement Act of 1999, which requires the Secretary of the Treasury to report annually to the public concerning Advance Pricing Agreements (APAs) and the APA Program. The first report covered calendar years 1991 through 1999. Subsequent reports covered calendar years 2000, 2001, 2002, and 2003. This sixth report describes the experience, structure and activities of the APA Program during calendar year 2004. It does not provide guidance regarding the application of the arm’s length standard.

Matthew W. Frank Director, Advance Pricing Agreement Program

Internal Revenue Code (IRC) § 482 provides that the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among two or more commonly controlled businesses if necessary to reflect clearly the income of such businesses. Under the § 482 regulations, the standard to be applied in determining the true taxable income of a controlled business is that of a business dealing at arm’s length with an unrelated business. The arm’s length standard has also been adopted by the international community and is incorporated into the transfer pricing guidelines issued by the Organization for Economic Cooperation and Development (OECD). OECD, TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND TAX ADMINISTRATORS (1995). Transfer pricing issues by their nature are highly factual and have traditionally been one of the largest issues identified by the IRS in its audits of multinational corporations. The APA Program is designed to resolve actual or potential transfer pricing disputes in a principled, cooperative manner, as an alternative to the traditional examination process. An APA is a binding contract between the IRS and a taxpayer by which the IRS agrees not to seek a transfer pricing adjustment under IRC § 482 for a Covered Transaction if the taxpayer files its tax return for a covered year consistent with the agreed transfer pricing method (TPM). In 2004, the IRS and taxpayers executed 65 APAs and amended 4 APAs.

Since 1991, with the issuance of Rev. Proc. 91-22, 1991-1 C.B. 526, the IRS has offered taxpayers, through the APA Program, the opportunity to reach an agreement in advance of filing a tax return on the appropriate TPM to be applied to related party transactions. In 1996, the IRS issued internal procedures for processing APA requests. Chief Counsel Directives Manual (CCDM), ¶¶ 42.10.10 - 42.10.16 (November 15, 1996). Also in 1996, the IRS updated Rev. Proc. 91-22 with the release of Rev. Proc. 96-53, 1996-2 C.B. 375. In 1998, the IRS published Notice 98-65, 1998-2 C.B. 803, which set forth streamlined APA procedures for Small Business Taxpayers.

On July 1, 2004, the IRS updated the procedural rules for obtaining, processing, and administering APAs with the issuance of Rev. Proc. 2004-40, 2004-29 I.R.B. 50 (July 19, 2004). Rev. Proc. 2004-40 supersedes Rev. Proc. 96-53 and Notice 98-65 and is effective for all APA requests (including requests for renewals) filed on or after August 19, 2004. Rev. Proc. 96-53 continues to apply to APA requests filed before August 19, 2004, although a taxpayer with an APA request pending on that date may ask to apply Rev. Proc. 2004-40 to the pending APA.

Also in 2004, the APA Program published IRS Announcement 2004-98, 2004-50 I.R.B. 983 (December 13, 2004), announcing its intention to hold public hearings in early 2005 requesting comments on the state of, and ideas for improving, the APA Program.

An APA generally combines an agreement between a taxpayer and the IRS on an appropriate TPM for the transactions at issue (Covered Transactions) with an agreement between the U.S. and one or more foreign tax authorities (under the authority of the mutual agreement process of our income tax treaties) that the TPM is correct. With such a “bilateral” APA, the taxpayer ordinarily is assured that the income associated with the Covered Transactions will not be subject to double taxation by the IRS and the foreign tax authority. It is the policy of the United States, as reflected in §§ 2.08 and 6 of Rev. Proc. 2004-40, to encourage taxpayers that enter the APA Program to seek bilateral or multilateral APAs when competent authority procedures are available with respect to the foreign country or countries involved. However, the IRS may execute an APA with a taxpayer without reaching a competent authority agreement (a “unilateral” APA).

A unilateral APA is an agreement between a taxpayer and the IRS establishing an approved TPM for U.S. tax purposes. A unilateral APA binds the taxpayer and the IRS, but does not prevent foreign tax administrations from taking different positions on the appropriate TPM for a transaction. As stated in § 6.07 of Rev. Proc. 2004-40, should a transaction covered by a unilateral APA be subject to double taxation as the result of an adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a mutual agreement proceeding, provided there is an applicable income tax treaty in force with the other country.

When a unilateral APA involves taxpayers operating in a country that is a treaty partner, information relevant to the APA (including a copy of the APA and APA annual reports) may be provided to the treaty partner under normal rules and principles governing the exchange of information under income tax treaties.

An IRS team headed by an APA team leader is responsible for the consideration of each APA. As of December 31, 2004, the APA program had 17 team leaders. The team leader is responsible for organizing the IRS APA team. The IRS APA team leader arranges meetings with the taxpayer, secures whatever information is necessary from the taxpayer to analyze the taxpayer’s related party transactions and the available facts under the arm’s length standard of IRC § 482 and the regulations thereunder (Treas. Reg.), and leads the discussions with the taxpayer.

The APA team generally includes an economist, an international examiner, LMSB field counsel, and, in a bilateral case, a U.S. Competent Authority analyst who leads the discussions with the treaty partner. The economist may be from the APA Program or the IRS field organization. As of December 31, 2004, the APA Program had five economists. The APA team may also include an LMSB International Technical Advisor, other LMSB exam personnel, and an Appeals Officer.

The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee as set forth in Rev. Proc. 2004-40, § 4.12. The APA process can be broken into five phases: (1) application; (2) due diligence; (3) analysis; (4) discussion and agreement; and (5) drafting, review, and execution.

Attachment A contains the current versions of the model APA language. As part of its continuing effort to improve its work product, the APA Program has revised the model language to reflect the program’s collective experience with substantive and drafting issues.

In 2004, the APA office consisted of four branches with Branches 1 and 3 staffed with APA team leaders and Branch 2 staffed with economists and a paralegal. Branch 4, the APA West Coast branch, is headquartered in Laguna Niguel, California, with an additional office in San Francisco, and is presently staffed with both team leaders and an economist.

Overall, the APA staff declined in 2004 from 36 to 32. The number of APA team leaders fell from 18 to 17, the number of APA economists fell from seven to five, and a temporary vacancy reduced the number of APA branch chiefs from four to three.

As of December 31, 2004, the APA staff was as follows:

The statistical information required under § 521(b)(2)(C) is contained in Tables 1 and 9 below; the information required under § 521(b)(2)(E) is contained in Tables 2 and 3 below:

The nature of the relationships between the related organizations, trades, or businesses covered by APAs executed in 2004 is set forth in Table 12 below:

The controlled transactions covered by APAs executed in 2004 are set forth in Table 13 and Table 14 below:

The general descriptions of the business functions performed and risks assumed by the organizations, trades, or businesses whose results are tested in the Covered Transactions in the APAs executed in 2004 are set forth in Tables 15 and 16 below:

The related organizations, trades, or businesses whose prices or results are tested to determine compliance with TPMs prescribed in APAs executed in 2004 are set forth in Table 17 below:

The TPMs used in APAs executed in 2004 are set forth in Tables 18-20 below:

Critical Assumptions used in APAs executed in 2004 are described in Table 21 below:

The sources of comparables, selection criteria, and rationale used in determining the selection criteria for APAs executed in 2004 are described in Tables 22 through 24 below. Various formulas for making adjustments to comparables are included as Attachment B.

The types of ranges and adjustment mechanisms used in APAs executed in 2004 are described in Table 26 and 27 below.

The various term lengths for APAs executed in 2004 are set forth in Table 28 below:

APAs executed in 2004 required that taxpayers provide various documents with their annual reports. These documents are described in Table 30 below:

During 2004, there were 48 tested parties that faced financial risks, including interest rate and currency risks. In appropriate cases, APAs may provide specific approaches for dealing with currency risk, such as adjustment mechanisms and/or critical assumptions.

As described in Rev. Proc. 2004-40, § 10.01, APA taxpayers are required to file annual reports to demonstrate compliance with the terms and conditions of the APA. The filing and review of annual reports is a critical part of the APA process. Through annual report review, the APA program monitors taxpayer compliance with the APA on a contemporaneous basis. Annual report review provides current information on the success or problems associated with the various TPMs adopted in the APA process.

All reports received by the APA office are tracked by one designated APA team leader who also has the primary responsibility for annual report review. Other APA team leaders and economists assist in this review, especially when the team leader who negotiated the case is available, since that person will already be familiar with the relevant facts and terms of the agreement. Once received by the APA office, the annual report is sent out to the district personnel with exam jurisdiction over the taxpayer.

The statistics for the review of APA annual reports are reflected in Table 31 below. As of December 31, 2004, there were 337 pending annual reports. In 2004, 143 reports were closed.