Section 7874 provides rules for expatriated entities and their surrogate foreign corporations. An expatriated entity is defined in section 7874(a)(2)(A) as a domestic corporation or partnership with respect to which a foreign corporation is a surrogate foreign corporation, and any U.S. person related (within the meaning of section 267(b) or section 707(b)(1)) to such domestic corporation or partnership. Generally, a foreign corporation is a surrogate foreign corporation under section 7874(a)(2)(B) if, pursuant to a plan or a series of related transactions, certain conditions are met. One such condition depends on the percentage of owner continuity in the foreign corporation after the acquisition. This condition is satisfied if, after the acquisition, at least 60 percent of the stock (by vote or value) of the foreign corporation is held (in the case of an acquisition with respect to a domestic corporation) by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation, or (in the case of an acquisition with respect to a domestic partnership) by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership. See section 7874(a)(2)(B)(ii).

The treatment of expatriated entities and surrogate foreign corporations varies depending on this percentage (ownership fraction). If the ownership fraction is 80 percent or more, the surrogate foreign corporation is treated as a domestic corporation for all purposes of the Code. If the ownership fraction is 60 percent or more (but less than 80 percent), the surrogate foreign corporation is treated as a foreign corporation, but certain income or gain recognized by the expatriated entity generally cannot be offset by net operating losses or credits from the first date properties are acquired pursuant to the plan through the end of the 10-year period following the completion of the acquisition.

Section 7874(c)(2)(A) provides that stock held by members of the “expanded affiliated group” which includes the foreign corporation is not taken into account for purposes of the ownership fraction (affiliate-owned stock rule). Section 7874(c)(1) defines the term expanded affiliated group (EAG) as an affiliated group defined in section 1504(a), but without regard to the exclusion of foreign corporations in section 1504(b)(3) and with a reduction of the 80 percent ownership threshold of section 1504(a) to a more-than-50 percent threshold.

Section 7874(g) provides that “[t]he Secretary shall provide such regulations as are necessary to carry out this section, including regulations providing for such adjustments to the application of this section as are necessary to prevent the avoidance of the purposes of this section, including the avoidance of such purposes through . . . the use of related persons, pass-through or other noncorporate entities, or other intermediaries . . . .” Section 7874(c)(6) provides that “[t]he Secretary shall prescribe such regulations as may be appropriate to determine whether a corporation is a surrogate foreign corporation, including regulations . . . to treat stock as not stock.”

On December 28, 2005, a temporary regulation (T.D. 9238, 2006-1 C.B. 408) was published in the Federal Register (70 FR 76685) that related to the disregard of affiliate-owned stock under section 7874(c)(2)(A). A notice of proposed rulemaking (REG-143244-05, 2006-1 C.B. 419) cross-referencing the temporary regulation was published in the Federal Register for the same day (70 FR 76732). No public hearing was requested or held. Written and electronic comments responding to the notice of proposed rulemaking were received. After consideration of all the comments, the proposed regulation is adopted, as amended by this Treasury decision, as final, and the corresponding temporary regulation is removed. The revisions are discussed below.

Treasury regulation §1.7874-1T provides guidance under the affiliated-owned stock rule. Generally, §1.7874-1T provides that stock owned by members of an EAG is excluded from both the numerator and denominator of the ownership fraction. However, affiliate-owned stock is excluded from the numerator of the ownership fraction, but is included in the denominator of the ownership fraction, in two instances: (1) certain transactions occurring as part of an internal group restructuring involving a domestic entity; and (2) certain acquisitive business transactions between unrelated parties where the former shareholders or partners of the domestic entity have a minority interest in the acquired properties after the acquisition.

With respect to internal group restructurings, the special rule applies where the common parent of the EAG after the acquisition owns directly or indirectly at least 80 percent of the domestic entity before the acquisition, and non-members of the EAG hold, by reason of holding an interest in the domestic entity, no more than 20 percent of the stock (by vote or value) of the foreign corporation after the acquisition. With respect to transactions between unrelated parties, the special rule applies where, after the acquisition, the former owners of the domestic entity do not own, in the aggregate, directly or indirectly, more than 50 percent of the stock (by vote or value) of any member of the EAG.

Section 1.7874-1T also provides guidance regarding the treatment of certain “subsidiary-owned” interests (which include so-called “hook stock”) for purposes of the exceptions to the general application of the ownership fraction. These rules apply to stock or partnership interests owned by an entity in which at least 50 percent of the stock (by vote or value), or at least 50 percent of the capital or profits interest, is owned directly or indirectly by the issuer of such stock or by the partnership in question.

These rules are included in the final regulations, with revisions as noted below.

Both the numerator and denominator of the ownership fraction take into account stock described in section 1504(a)(4) (so-called “plain vanilla preferred stock”). For purposes of determining whether an affiliated group constitutes an EAG, however, such stock is not treated as stock because of the reference to the rules of section 1504(a). See section 7874(c)(1). Commentators have noted the inconsistent treatment of plain vanilla preferred stock in section 7874. In addition, they point out that, due to the debt-like nature of such stock, it should not be treated as stock for any purpose of section 7874, including the ownership fraction.

The Treasury Department and the IRS note that Congress has expressly stated that section 1504(a)(4) preferred stock is not treated as stock in several Code provisions, including certain provisions of section 7874, as noted above. See, for example, sections 243(c)(1), 246A(c)(4), and 355(g)(2)(B)(iv)(III). In contrast, Congress specifically chose not to exclude plain vanilla preferred stock from the ownership fraction. Although section 7874 grants the Treasury Department and the IRS the authority to treat stock as not stock when such treatment would further the purposes of section 7874, the legislative history to section 7874 does not suggest that the treatment of plain vanilla preferred stock in the ownership fraction is inconsistent with the purposes of section 7874. The Treasury Department and the IRS therefore decline to exercise the regulatory authority to exclude plain vanilla preferred stock in the calculation of the ownership fraction. Accordingly, all classes of stock, including plain vanilla preferred stock, are included in the ownership fraction and treated as stock for purposes of section 7874, other than for purposes of determining the EAG.

The Treasury Department and the IRS considered whether the treatment of plain vanilla preferred stock in the EAG definition should be made consistent with the treatment of plain vanilla preferred stock in the ownership fraction. After studying the issue, the Treasury Department and the IRS believe that taking plain vanilla preferred stock into account for purposes of the definition of an EAG may facilitate the avoidance of the rules regarding EAGs. Consequently, the Treasury Department and the IRS also decline to exercise regulatory authority to amend the treatment of plain vanilla preferred stock for purposes of defining an EAG.

The Treasury Department and the IRS will, however, continue to monitor the use of vanilla preferred stock and its treatment under section 7874.

Treasury regulation §1.7874-1T(c)(1) provides that stock held by a member of an EAG is included in the denominator, but not the numerator, of the ownership fraction if two conditions are satisfied. First, the common parent of the EAG must own directly or indirectly at least 80 percent of the stock (by vote or value) or the capital or profits interest in the domestic entity prior to the acquisition. Second, following the acquisition non-members of the EAG, by reason of holding stock or a capital or profits interest in the domestic entity, must not own more than 20 percent of the stock (by vote or value) of the foreign corporation.

One commentator suggested that the requirement should merely look to the stock ownership of the common parent of the EAG both before and after the acquisition. The Treasury Department and the IRS agree with this suggestion. In addition, the Treasury Department and the IRS have determined that the rule should be modified to consider the stock by vote and value held by the common parent of the EAG. Consequently, stock of a member of an EAG is included in the denominator, but not the numerator of the ownership fraction, if the common parent of the EAG held directly or indirectly at least 80 percent of the stock (by vote and value) or the capital and profits interest, as applicable, of the domestic entity before the acquisition, and holds at least 80 percent of the stock (by vote and value) of the foreign acquiring corporation after the acquisition. Corresponding revisions have been made to the examples.

One commentator requested clarification of the wording of §1.7874-1T(d) regarding the treatment of hook stock. In response to this comment, the provision is clarified to exclude hook stock from both the numerator and denominator of the fractions that are used to determine whether the exceptions to the general rule apply (that is, the determination of whether the acquisition resulted in an internal group restructuring or a loss of control of the domestic entity).

The Treasury Department and the IRS understand that taxpayers may be taking the position that a foreign corporation that acquires substantially all of the properties of a domestic corporation in a title 11 or similar case may not be a surrogate foreign corporation because it fails to satisfy the stock ownership requirement described in section 7874(a)(2)(B)(ii). These taxpayers maintain that creditors of the domestic corporation, which typically receive all of the stock of the acquiring foreign corporation issued in the title 11 or similar case, are not considered former shareholders of the domestic corporation for purposes of section 7874(a)(2)(B)(ii). Thus, they take the position that the creditors do not hold the stock of the foreign acquiring corporation received by reason of holding stock in the domestic corporation. Under this position, there often would be little or no continuity of ownership for purposes of section 7874(a)(2)(B)(ii) and, as a result, the foreign corporation would not be a surrogate foreign corporation. Taxpayers take this position even though the creditors, in substance, are the equity owners of the domestic corporation at the time of the title 11 or similar case and acquire the stock issued by the acquiring foreign corporation by reason of their status as creditors of the domestic corporation. Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942).

The Treasury Department and the IRS disagree with this characterization under current law and are considering issuing regulations to clarify the proper application of the rules to such transactions. Section 7874(c)(6) provides that the Secretary shall prescribe such regulations as may be appropriate to determine whether a corporation is a surrogate foreign corporation, including regulations: (i) to treat warrants, options, contracts to acquire stock, convertible debt interests, and other similar interests as stock, and (ii) to treat stock as not stock. These regulations would provide, as appropriate, that for purposes of section 7874(a)(2)(B)(ii), creditors of a domestic corporation emerging from a title 11 or similar case are treated as former shareholders of such corporation. The regulations would further provide, as appropriate, that for this purpose, stock issued by the foreign acquiring corporation to such creditors is held by reason of holding stock in the domestic corporation. Similar rules may apply to acquisitions of substantially all the properties constituting a trade or business of a domestic partnership.

The Treasury Department and the IRS also understand that some taxpayers may be taking the position that, where two or more domestic entities described in section 7874(a)(2)(B)(i) are acquired pursuant to an overall plan, section 7874(a)(2)(B) is applied separately to each such domestic entity. For example, taxpayers may take this position where a foreign corporation is formed to acquire, in exchange for its stock, 100 percent of the stock of two domestic corporations that have approximately the same value. In such a case, after the acquisition the former shareholders of the two domestic corporations, in the aggregate, would hold 100 percent of the stock of the foreign acquiring corporation by reason of holding stock in the domestic corporations. However, the taxpayers may claim that the ownership fraction applies separately to each acquisition such that the ownership fraction would be approximately 50 percent, rather than 100 percent. Under this interpretation, the acquiring foreign corporation would not be a surrogate foreign corporation because the condition described in section 7874(a)(2)(B)(ii) would not be satisfied.

The Treasury Department and the IRS disagree with this interpretation under current law and are considering issuing regulations to clarify the proper application of the rules. These regulations would clarify that the references in section 7874(a)(2)(B) to “a domestic corporation” shall, as appropriate, mean “one or more domestic corporations” where the properties of such corporations are, directly or indirectly, acquired pursuant to the same plan. Similar clarifications will be made with respect to acquisitions involving properties of domestic partnerships.

Finally, the Treasury Department and the IRS understand that some taxpayers may be attempting to avoid the application of section 7874 by structuring acquisitions of domestic entities by foreign corporations through the use of intervening partnerships. For example, a foreign acquiring corporation may issue new shares to a newly formed domestic partnership in exchange for a 99 percent interest in the partnership. The shares transferred to the domestic partnership constitute 70 percent of the outstanding stock of the foreign acquiring corporation. An affiliate of the foreign acquiring corporation would transfer cash or other property to the partnership for the remaining one percent interest. The foreign acquiring corporation then transfers its 99 percent interest in the domestic partnership to the shareholders of a domestic corporation in exchange for 100 percent of the stock of the domestic corporation.

The taxpayers take the position that this transaction is not subject to section 7874 even though, in substance, the foreign acquiring corporation acquired 100 percent of the stock of the domestic corporation and the former shareholders of the domestic corporation, through their 99 percent interest in the domestic partnership, hold more than 60 percent of the stock of the foreign acquiring corporation by reason of holding stock in the domestic corporation. Under this interpretation, which relies on treating the partnership as an entity (rather than as an aggregate of its partners), the ownership fraction would be zero because none of the foreign acquiring corporation stock held by the partnership was held by former shareholders of the domestic corporation. Thus, section 7874 would not apply to the transaction.

The Treasury Department and the IRS disagree with this characterization under current law and are considering issuing regulations to clarify the proper application of the rules to these transactions. The regulations would provide, as appropriate, that for purposes of applying section 7874(a)(2)(B)(i) to these structures, the exchange of an interest in a domestic entity for an interest in a partnership shall be treated as an exchange of the interest in the domestic entity for a pro rata share of the assets of the partnership.

The regulations described above, which may be issued in conjunction with the finalization of the §1.7874-2T regulations, may be effective as of May 20, 2008. However, no inference is intended as to the potential applicability of other Code or regulatory provisions, or judicial doctrines (including substance over form) to the transactions described above.

Section 1.7874-1 applies to acquisitions completed on or after May 20, 2008, subject to transition relief for certain acquisitions entered into pursuant to binding commitments. In addition, taxpayers may elect to apply this section to prior acquisitions, but must apply it consistently to all acquisitions within its scope.

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

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 1.7874-1 also issued under 26 U.S.C. 7874(c)(6) and (g).

Par. 2. Section 1.7874-1T is removed.

Par. 3. Section 1.7874-1 is added to read as follows:

Generally, only eligible individuals (as defined in § 223(c)(1)) may contribute to HSAs. Maximum annual HSA contributions are based on an individual’s eligibility, age, and health plan coverage.

A distribution from an IRA under § 408 generally is included in gross income. If an IRA owner made nondeductible contributions to the IRA, those contributions are recovered on a pro-rata basis and the distribution is partly included in and partly excluded from gross income under the rules of § 408(d) and § 72(e)(8).

A nonqualified distribution from a Roth IRA under § 408A is included in gross income only to the extent that earnings are distributed. A qualified Roth IRA distribution (as defined in § 408A(d)) is excluded from gross income.

If a distribution from an IRA or Roth IRA is made before the IRA or Roth IRA account owner attains age 59½, the distribution also is subject to a 10 percent additional tax under § 72(t) unless an exception applies. These exceptions include distributions made on account of death or disability, and distributions made as part of a series of substantially equal periodic payments for the life expectancy of the IRA holder.

Section 408(d)(9) provides, in general, that a qualified HSA funding distribution from an individual’s IRA or Roth IRA to that individual’s HSA is not included in gross income, if the individual is an eligible individual under § 223(c)(1). Moreover, notwithstanding the pro-rata basis recovery rules under § 72, for purposes of determining the basis in any amount remaining in an IRA or Roth IRA following a qualified HSA funding distribution, the qualified HSA funding distribution is treated as included in gross income to the extent that such amount does not exceed the aggregate amount which would have been so included if there were a total distribution from the IRA or Roth IRA owner’s accounts.For example, suppose an individual who has $200 of basis in an IRA with a fair market value of $2,000 makes a qualified HSA funding distribution of $1,500 from the IRA. Immediately after the qualified HSA funding distribution, the individual retains $200 of basis in an IRA that has a fair market value of $500.

If a qualified HSA funding distribution from an individual’s IRA or Roth IRA exceeds the aggregate amount which would have been included in gross income if there were a total distribution from that individual’s IRA or Roth IRA accounts, the individual’s basis in the excess amount (i.e., the amount that would have been excluded from gross income in a distribution to which § 408(d)(9) did not apply) does not carry over to the HSA.

A qualified HSA funding distribution is not subject to the 10 percent additional tax under § 72(t). However, if the qualified HSA funding distribution results in a modification of a series of substantially equal periodic payments that, prior to the modification, qualify for the exception to the 10 percent additional tax under § 72(t)(2)(A)(iv), and such modification results in the imposition of the recapture tax under the rules of § 72(t)(4), the recapture tax applies to the payments made before the date of the qualified HSA funding distribution.

The amount contributed to the HSA through a qualified HSA funding distribution is not allowed as a deduction and counts against the individual’s maximum annual HSA contribution for the taxable year of the distribution. In addition, the taxability of these distributions is subject to the testing period rules in § 408(d)(9)(D), discussed below.

A qualified HSA funding distribution may be made from a traditional IRA under § 408 or a Roth IRA under § 408A, but not from an ongoing SIMPLE IRA under § 408(p) or an ongoing SEP IRA under § 408(k). For this purpose, a SIMPLE IRA or SEP IRA is treated as ongoing if an employer contribution is made for the plan year ending with or within the IRA owner’s taxable year in which the qualified HSA funding distribution would be made.

After the death of an IRA or Roth IRA account owner, a qualified HSA funding distribution may be made from an IRA or Roth IRA maintained for the benefit of an IRA or Roth IRA beneficiary. This distribution will be taken into account in determining whether the required minimum distribution requirements of §§ 408(a)(6), 408(b)(3), and 408A(c)(5) have been satisfied.

For purposes of § 408(d)(9)(C)(i), a qualified HSA funding distribution from the IRA or Roth IRA of an eligible individual to that individual’s HSA must be less than or equal to the IRA or Roth IRA account owner’s maximum annual HSA contribution. The maximum annual HSA contribution is based on (1) the individual’s age as of the end of the taxable year and (2) the individual’s type of high deductible health plan (HDHP) coverage (self-only or family HDHP coverage) at the time of the distribution. For example, in 2008, an IRA owner who is an eligible individual with family HDHP coverage at the time of the distribution and who is age 55 or over by the end of the year is allowed a qualified HSA funding distribution of $5,800, plus the $900 catch-up contribution. An IRA or Roth IRA owner who is an eligible individual with self-only HDHP coverage, and who is under age 55 as of the end of the taxable year, is allowed a qualified HSA funding distribution of $2,900 for 2008.

Generally, only one qualified HSA funding distribution is allowed during the lifetime of an individual. If, however, the distribution occurs when the individual has self-only HDHP coverage, and later in the same taxable year the individual has family HDHP coverage, the individual is allowed a second qualified HSA funding distribution in that taxable year. Both distributions count against the individual’s maximum HSA contribution for that taxable year. The distributions must be from an IRA or Roth IRA to an HSA owned by the individual who owns the IRA or Roth IRA or, in the case of an inherited IRA, for whom the IRA or Roth IRA is maintained (i.e., a qualified HSA funding distribution cannot be made to an HSA owned by any other person, including the individual’s spouse). IRA or Roth IRA owners are not required to make the maximum qualified HSA funding distribution or to make any qualified HSA funding distribution.

If an individual owns two or more IRAs, and wants to use amounts in multiple IRAs to make a qualified HSA funding distribution, the individual must first make an IRA-to-IRA transfer of the amounts to be distributed into a single IRA, and then make the one-time qualified HSA funding distribution from that IRA.

A qualified HSA funding distribution relates to the taxable year in which the distribution is actually made. The rules in § 223(d)(4)(B) and § 219(f)(3) (contributions made before the deadline for filing the individual’s federal income tax return are deemed to be made on the last day of the preceding taxable year) do not apply to qualified HSA funding distributions.

An individual must be an eligible individual (as defined in § 223(c)(1)) at the time of the qualified HSA funding distribution. The distribution must be a direct transfer from an IRA or Roth IRA to an HSA. For example, if a check from an IRA or Roth IRA is made payable to an HSA trustee or custodian and delivered by the IRA or Roth IRA account owner to the HSA trustee or custodian, the payment to the HSA will be considered a direct payment by the IRA or Roth IRA trustee, custodian or issuer to the HSA for purposes of § 408(d)(9).

If a qualified HSA funding distribution is made from the individual’s IRA or Roth IRA to the individual’s HSA under § 408(d)(9) and the individual remains an eligible individual during the entire testing period, the amount of the qualified HSA funding distribution is excluded from the individual’s gross income and the 10 percent additional tax under § 408(d)(9)(D) does not apply. The testing period begins with the month in which the qualified HSA funding distribution is contributed to the HSA and ends on the last day of the 12^th month following that month. Each qualified HSA funding distribution allowed in § 408(d)(9)(C)(ii)(II) has a separate testing period. For testing period purposes, an eligible individual who changes from family HDHP coverage to self-only HDHP coverage during the testing period remains an eligible individual. If at any time during the testing period the individual ceases to meet all requirements to be an eligible individual, the amount of the qualified HSA funding distribution is included in the individual’s gross income. The qualified HSA funding distribution is included in gross income in the taxable year of the individual in which the individual first fails to be an eligible individual. This amount is subject to the 10 percent additional tax (unless the failure is due to disability, as defined in § 72(m)(7), or death). See § 408(d)(9)(D). Earnings on the amount of the qualified HSA funding distribution are not included in gross income. Amounts included in the IRA or Roth IRA owner’s gross income under § 408(d)(9)(D) are not also included in gross income under §§ 408(d)(1) or (2), nor do the § 72 rules apply (including the additional tax under § 72(t)).

Section 223(b)(8)(B) provides generally that if an individual fails to remain an eligible individual during the § 223(b)(8) testing period, an amount is included in the individual’s gross income (computed by subtracting the sum of the monthly contribution limits that the individual would otherwise have been entitled to under §§ 223(b)(1) and (2) from the amount actually contributed). The testing period rules in § 223(b)(8)(B) do not apply to amounts contributed to an HSA through a qualified HSA funding distribution. Thus, if an individual remains an eligible individual during the entire § 408(d)(9) testing period, then no amount of the qualified HSA funding distribution is included in income and the 10 percent additional tax under § 223(b)(8)(B) does not apply.

If an HSA account beneficiary’s contributions to his or her HSA in a taxable year include both a qualified HSA funding distribution (or distributions) and other contributions subject to § 223(b)(8), the § 408(d)(9)(D) testing period rules apply to the qualified HSA funding distribution (or distributions) and the § 223(b)(8)(B) testing period rules apply to the other contributions. If the individual fails to remain an eligible individual during the § 223(b)(8)(B) testing period, but does remain a qualified individual during the § 408(d)(9)(D) testing period, the amount included in the individual’s gross income is the lesser of:

(1) the amount that would otherwise be included under the § 223(b)(8)(B) rules; or

(2) the amount of contributions to the HSA for the taxable year other than the amount contributed through qualified HSA funding distributions.

An HSA distribution not used for qualified medical expenses (as defined in § 223(d)(2)) is included in gross income under § 223(f)(2) and subject to the 10 percent additional tax under § 223(f)(4) (with certain exceptions), regardless of whether the amount contributed to the HSA under the qualified HSA funding distribution is included in the account beneficiary’s income and subject to the additional tax under § 408(d)(9)(D). See Notice 2007-22, 2007-10 I.R.B. 670, regarding the consequences of distributions from HSAs.

For 2004 through 2006, the maximum annual HSA contribution was the lesser of (1) the annual deductible under the high deductible health plan (HDHP) or (2) the statutory maximum under § 223(b)(2)(B). See Notice 2004-2, 2004-1 C.B. 269, Q&A-12. Section 303 of the Act repeals the limit on annual HSA contributions based on the amount of the deductible under the HDHP. For 2007 and later years, the indexed maximum HSA contribution under § 223(b)(2)(A) (for self-only HDHP coverage) and § 223(b)(2)(B) (for family HDHP coverage) determines the contribution limit, without regard to an individual’s HDHP deductible. Thus, for 2008, the maximum annual HSA contribution is $2,900 for individuals who have self-only HDHP coverage and $5,800 for individuals who have family HDHP coverage.

Section 305 of the Act adds § 223(b)(8), which provides that if an individual is an eligible individual on the first day of the last month of the individual’s taxable year (December 1 for calendar year taxpayers), the individual’s maximum HSA contribution for the year is the greater of the following:

A testing period applies to the full contribution rule (see discussion of the testing period below). If an individual is not an eligible individual on the first day of the last month of the individual’s taxable year (December 1 for calendar year taxpayers), the individual’s maximum HSA contribution for the year is determined under the sum of the monthly contribution limits rule under § 223(b)(2). See Example 6 below.

Eligible individuals (as defined in § 223(c)(1)) may contribute to HSAs. See Notice 2004-2, Q&A-2; Notice 2004-50, 2004-2 C.B. 196, Q&A-2, 3. Under §§ 223(b)(1) and (2), the maximum annual contribution to an HSA is the sum of the monthly contribution limits determined separately for each month, based on eligibility and health plan coverage on the first day of the month. For this purpose, the monthly limit is 1/12 of the indexed amount provided under § 223(b)(2)(A) for self-only coverage ($2,900 for 2008) and under § 223(b)(2)(B) for family coverage ($5,800 for 2008). In addition, the maximum HSA contribution is increased by an additional contribution amount (catch-up amount) for individuals age 55 or older as of the last day of the calendar year who are not enrolled in Medicare. The catch-up contribution is also computed on a monthly basis. Section 223(b)(2).

New § 223(b)(8)(A) treats an individual who is an eligible individual on the first day of the last month of the taxable year as having been an eligible individual for the entire year and may increase, but not decrease, the contribution limit for such an individual. Thus, in order to make a full contribution for the year under § 223(b)(8), a taxpayer must be an eligible individual on the first day of the last month of his or her taxable year (December 1 for calendar year taxpayers). The eligible individual is also treated as enrolled in the same HDHP coverage (i.e., self-only or family coverage) as he or she has on the first day of the last month of the year. For example, if an individual first becomes HSA-eligible on December 1, 2008, and has family HDHP coverage, he or she is treated as an eligible individual and having family HDHP coverage for all twelve months in 2008. This full contribution rule also applies to catch-up contributions. The full contribution rule applies without regard to whether the individual was an eligible individual for the entire year, had HDHP coverage for the entire year, or had disqualifying non-HDHP coverage for part of the year. However, a testing period applies for purposes of the full contribution rule.

The testing period applies to an individual who is an eligible individual on the first day of the last month of the taxable year. The testing period begins on the first day of the last month of the taxable year and ends on the last day of the 12^th month following that month. Thus, for a calendar year taxpayer, the testing period is from December 1 of the current year to December 31 of the following year. Section 223(b)(8)(B)(iii). For 2008 HSA contributions, the testing period for calendar year taxpayers begins on December 1, 2008 and ends on December 31, 2009.

If an individual who is an eligible individual on the first day of the last month of the taxable year contributes an amount to his or her HSA greater than the sum of the monthly contribution limits under §§ 223(b)(1) and (2), and at any time during the testing period the individual ceases to meet all requirements to be an eligible individual, an amount is included in the individual’s gross income and subject to an additional 10 percent tax, unless the failure is due to disability (as defined in § 72(m)(7)) or death.

The amount that is included in the individual’s gross income is computed by subtracting the sum of the monthly contribution limits that the individual would otherwise have been entitled to under §§ 223(b)(1) and (2) from the amount actually contributed. Section 223(b)(8)(B). It is not necessary to distribute this amount from the HSA, and there may be additional adverse tax consequences from such a distribution. See discussion below on distributions not used for qualified medical expenses. Withdrawing this amount from the HSA will not prevent the inclusion of the amount in income or the additional 10 percent tax. However, earnings on the amount are not included in gross income or subject to the 10 percent additional tax, so long as the earnings remain in the HSA or are used for qualified medical expenses.

Unlike the additional 10 percent tax under § 223(f)(4)(A), the additional 10 percent tax under § 223(b)(8)(B)(i)(II) applies regardless of the age of the account beneficiary (i.e., even after age 65).

To remain an eligible individual during the testing period, an individual is not required to keep the same level of HDHP coverage during the testing period. Thus, changing from family HDHP coverage to single HDHP coverage during the testing period does not result in inclusion of amounts in gross income or an additional 10 percent tax. See Examples 8 and 14 below.

Section 4973 imposes a six percent excise tax for each taxable year on HSA contributions in excess of the maximum contribution limit for the year (excess contributions). If the excess contributions for the year and the net income attributable to such excess contributions are withdrawn from the HSA before the last day (with extensions) for filing the federal income tax return for the taxable year, the amount is not subject to the excise tax for that year. However, an amount included in gross income under § 223(b)(8)(B) because an individual failed to remain an eligible individual during the testing period is not an excess contribution and § 4973 does not apply to this amount. For this reason, the amount cannot be withdrawn under the excess contribution rules.

An HSA distribution not used for qualified medical expenses (as defined in § 223(d)(2)) is included in gross income under § 223(f)(2) and is subject to the additional 10 percent tax under § 223(f)(4) (with certain exceptions), regardless of whether the amount contributed to the HSA under the full contribution rule is included in the account beneficiary’s income and subject to the additional tax under § 223(b)(8)(B)(i). See Notice 2007-22, 2007-10 I.R.B. 670, regarding consequences of distributions from HSAs. See Example 9 below.

An individual may establish an HSA at any time on or after the date the individual becomes HSA-eligible. Contributions for the taxable year can be made in one or more payments, at any time prior to the time (without extensions) for filing the individual’s federal income tax return for the taxable year. An individual who becomes an eligible individual after January 1 may make the maximum contribution to an HSA on the first day he or she is an eligible individual. Notice 2004-2, Q&A-21. In that case, the individual’s contribution is based on the individual’s expected coverage on the first day of the last month of his or her taxable year. But see testing period rules above.

Gift tax is computed by determining a tax on the total of the gifts deemed made by the donor in the year for which the return is filed (the current calendar year) plus the total of that donor’s gifts in prior years (prior taxable gifts). The tax so computed is then reduced by the tax that would have been payable on the prior taxable gifts, had the tax rate for the current taxable year applied to the prior taxable gifts. The result (after taking into account the applicable credit amount under section 2505) is the gift tax on the gifts in the current calendar year. Similarly, the estate tax is computed by determining a tax on the sum of the value of the decedent’s taxable estate and the value of certain taxable gifts (adjusted taxable gifts) made by the decedent prior to death. The tax computed is then reduced by the gift tax that would have been payable on the adjusted taxable gifts, had the estate tax rate applied to the adjusted taxable gifts. The result (after allowing for various credits) is the estate tax on the taxable estate.

The Taxpayer Relief Act of 1997 (TRA) (Public Law 105-34, 111 Stat. 855), the Internal Revenue Service Restructuring and Reform Act of 1998 (Public Law 105-206, 112 Stat. 685), and the Tax and Trade Relief Extension Act of 1998 (Public Law 105-277, 112 Stat. 2681-909), (collectively, the 1998 Acts), enacted or amended sections 2001(f), 2504(c), 6501(c)(9), and 7477, effective in the case of gifts made after August 5, 1997, to provide a degree of finality regarding the valuation of lifetime gifts for gift and estate tax purposes. Congress was concerned that the prior regime resulted in the resolution of controversies based on stale evidence, and necessitated the retention of records for unduly long periods of time. H.R. Rep. No. 105-148 at 359 (1997).

Under sections 6501(a) and (c)(9) as amended by TRA and the 1998 Acts, and the applicable regulations, if a transfer of property is adequately disclosed on a gift tax return, then the period of limitations for assessment of gift tax with regard to that transfer will commence to run on the date the return is filed. Once the time for assessment of gift tax has expired for a transfer made after August 5, 1997, the value of the gift as “finally determined” for gift tax purposes, as defined in section 2001(f), is the value to be used for purposes of determining prior taxable gifts in computing the gift tax liability in subsequent years under section 2504(c), and for purposes of determining adjusted taxable gifts in computing the estate tax liability under section 2001(f). Under §§20.2001-1(b) and 25.2504-2(b), this finality rule applies with respect to all issues that might be raised with respect to the transfer, including valuation issues and legal issues. The amount of a gift is finally determined if: (1) the amount is shown on a gift tax return and the IRS does not contest the amount before the period for assessing gift tax expires; (2) before the period for assessing gift tax expires, the amount is adjusted by the IRS and the taxpayer does not contest the adjusted amount; or, (3) the amount is determined by a court or pursuant to a settlement agreement between the taxpayer and the IRS.

Section 7477 was enacted as part of TRA in conjunction with these other provisions to provide a declaratory judgment procedure pursuant to which taxpayers may contest in the United States Tax Court an IRS determination regarding the value of a gift. See H.R. CONF. REP. NO. 105-220, at 407-408 (1997). In the absence of section 7477, without an actual gift tax deficiency, a taxpayer would be unable to petition the Tax Court to contest the determination or, without an overpayment of tax, file a claim for refund or bring suit for refund in Federal court. This could occur, for example, if an increase in gift tax determined under section 2502 is offset by the taxpayer’s applicable credit amount under section 2505(a), so that no additional tax would be assessed as a result of the valuation increase. Thus, without section 7477, such a taxpayer would be left without any way to challenge the IRS determination, even though, upon the expiration of the statute of limitations, that determination would become binding for purposes of calculating the cumulative gift tax on all future gifts of that taxpayer, as well as the taxpayer’s estate tax liability.

Under section 7477(a), the donor may contest an IRS determination of the amount of a gift. Specifically, the donor may petition the Tax Court for a declaratory judgment, provided that certain requirements are met. Section 7477(a) applies in the case of an actual controversy involving a determination by the IRS regarding the value of a gift that is shown on the gift tax return or disclosed on the gift tax return or in a statement attached to that return.

These proposed regulations provide a procedure for pursuing a declaratory judgment in the Tax Court pursuant to section 7477 in situations where, prior to the enactment of that section, the taxpayer would have had no remedy to challenge the IRS determination. Specifically, the procedure provided by these proposed regulations applies only in those situations where an adjustment by the IRS does not result in a gift tax deficiency or refund. In situations where the IRS adjustment results in a proposed tax deficiency or a potential refund, taxpayers should not follow the procedures in these proposed regulations but should continue to follow the procedures already in place to dispute a deficiency or claim a refund. These procedures more efficiently address and resolve disputes involving a deficiency or refund.

The first requirement for eligibility for relief under section 7477 is that the transfer must be shown or disclosed “on the return of tax imposed by chapter 12,” that is, a Federal gift tax return, or on a statement attached to the return. Under the proposed regulations, the return of tax imposed by chapter 12 is defined as the last gift tax return for the calendar year filed on or before the due date of the return, including extensions granted (if any), or if a timely return is not filed, the first gift tax return for the calendar year filed after the due date.

If the transfer is not shown or disclosed on the gift tax return, or on a statement attached to the return, a declaratory judgment under section 7477 is not available. If, however, a transfer is disclosed on the return or on a statement attached to the return, this eligibility requirement for the section 7477 procedure is satisfied, even if the transfer is disclosed in a manner that does not satisfy the requirements of section 6501(c)(9) and §301.6501(c)-1(e) or (f) pertaining to adequate disclosure sufficient to commence the running of the period of limitations on assessment. There may be no compelling reason for the IRS to examine a transaction that is disclosed on the return but not in a manner sufficient to trigger the running of the statute of limitations, because the time period for adjusting the value of the gift is not limited by the statute of limitations for assessments. The Treasury Department and the IRS, however, recognize that in many cases the IRS may prefer to contemporaneously resolve the transfer tax treatment of that transaction, even though the standards for adequate disclosure with regard to that transaction have not been satisfied by the donor. Thus, the IRS in its discretion may make a determination regarding the transfer and place the transfer in controversy by mailing a notice of determination of value used in unagreed cases (Letter 3569) with regard to that transfer. The ability to place a transfer that is not adequately disclosed in controversy is consistent with the Congressional purpose in enacting the TRA provisions, noted previously, to promote the early resolution of gift tax controversies based on contemporaneous evidence. The IRS and Treasury Department emphasize that the issuance of a Letter 3569 with regard to such a transfer does not constitute a determination by the IRS that the transfer was adequately disclosed or otherwise cause the period of limitations on assessment to commence to run with respect to that transfer.

Alternatively, the IRS may in its discretion decide not to put a transfer in controversy at that time (whether or not any other transfer reported on a gift tax return is then put into controversy). If the IRS decides not to put the transfer into controversy at that time, the IRS will not issue a Letter 3569 (described in this preamble) (or the Letter 3569 issued will not address that transfer), the declaratory judgment procedure will not be available for that transfer, and the limitations period applicable to that transfer will remain open.

Section 7477 also requires an actual controversy with respect to a determination by the IRS of the value of the disclosed transfer. Thus, the donor is not permitted to bypass the examination process and unilaterally seek a declaratory judgment. Generally, the IRS must propose adjustments with which the donor disagrees. Accordingly, the proposed regulations provide that, in order for the section 7477 declaratory judgment procedure to be available to a donor, the IRS must first make a determination regarding the gift tax treatment of the transfer that results in an actual controversy in a situation where the adjustments do not result in a gift tax deficiency or refund. This IRS determination is deemed to be made by the mailing of a Letter 3569 to notify the taxpayer of the adjustments proposed by the IRS. The mailing of this letter to the donor is the prerequisite for filing a petition with the Tax Court requesting a declaratory judgment under section 7477.

Section 7477 also requires that the donor’s pleading seeking a declaratory judgment under section 7477 must be filed with the Tax Court before the 91^st day after the mailing of the Letter 3569 by the IRS. The pleading must be in the form of a petition subject to Tax Court Rule 211(d).

Finally, section 7477(b)(2) provides that the Tax Court may not issue a declaratory judgment under section 7477 unless it first determines that the donor has exhausted all administrative remedies available to the donor within the IRS with respect to the controversy. Tax Court Rule 211(d) requires that the petition in an action under section 7477 must contain a statement that the petitioner has exhausted all administrative remedies within the IRS. See also Tax Court Rule 210(c)(4). Accordingly, the proposed regulations set forth the administrative remedies available to the donor with respect to a determination by the IRS of the amount of a gift, and the circumstances in which the IRS will not contest the donor’s allegation that administrative remedies have been exhausted. The administrative remedies are intended to parallel those applicable in the case of an asserted gift tax deficiency.

Specifically, the proposed regulations provide that the IRS will not contest the donor’s allegation that the donor’s administrative remedies have been exhausted if: (1) the donor requests Appeals consideration in writing within 30 calendar days after the mailing date of a notice of preliminary determination of value (Preliminary Determination Letter) from the IRS, or by such later date for responding to the Preliminary Determination Letter as determined pursuant to IRS procedures; (2) the donor participates fully in the Appeals consideration process, including without limitation timely submitting all additional information related to the amount of the gift that is requested by the IRS in connection with (or as a follow-up to) the Appeals consideration process; and (3) the IRS mails to the donor the Letter 3569, which will notify the donor of the proposed adjustments and of the donor’s right to contest the determination by filing a petition for declaratory judgment with the Tax Court before the 91^st day after the date of mailing the Letter 3569. The Letter 3569 usually will be issued by the Appeals office. However, because section 7477 requires that the Tax Court, rather than the IRS, determine whether the donor has exhausted all administrative remedies, the donor generally will be sent a Letter 3569 in those situations where the donor does not respond to the Preliminary Determination Letter, or expressly declines to participate in the Appeals process. If a donor does not respond to a Preliminary Determination Letter, or if a donor does not participate in the Appeals process, the IRS will consider the donor to have failed to exhaust administrative remedies. In such cases, the IRS may challenge any allegation in the donor’s petition for a section 7477 declaratory judgment that the donor has exhausted all administrative remedies.

The proposed regulations also provide that the IRS will not contest the donor’s allegation that all administrative remedies have been exhausted in certain circumstances where the above-described process is not followed by the IRS. (For example, the IRS might mail a Letter 3569 to the donor in the absence of these other preliminary steps where, because of the imminent expiration of the applicable statute of limitations, the IRS believes there is not sufficient time to issue a Preliminary Determination Letter to allow Appeals consideration). If the IRS’s decision not to issue a Preliminary Determination Letter is not due to the donor’s actions or failure to act, the IRS will not contend that the donor failed to exhaust all administrative remedies, provided that the donor fully participates in the Appeals consideration process offered by the IRS during the pendancy of the Tax Court proceeding. In this regard, the IRS and Treasury Department do not view the reference to section 7477 contained in §601.106(a)(2)(iv) of the Statement of Procedural Rules as currently in effect and Rev. Proc. 87-24, 1987-1 C.B. 720, as prohibiting Appeals’ jurisdiction to consider docketed cases under current section 7477. The version of section 7477 referenced in those items was repealed prior to the enactment of the current section 7477 as part of the TRA.

The proposed regulations confirm that the donor is not required to consent to an extension of the time within which gift tax with respect to the transfer at issue may be assessed in order to exhaust the donor’s administrative remedies, and that the failure to consent to such an extension will not be taken into account for this purpose. See section 7430(b)(1) and Minahan v. Commissioner, 88 T.C. 492 (1987), considering this issue in the context of section 7430(b)(1) prior to amendment by Public Law 104-168 (110 Stat. 1452).

Under the proposed regulations, a donor may petition for a declaratory judgment with respect to disputes regarding valuation and/or other related issues. This is consistent with §§20.2001-1(b) and 25.2504-2(b) providing that, once the gift tax statute of limitations has expired with respect to a transfer, the IRS is precluded from making any adjustments with respect to that transfer for purposes of determining prior taxable gifts or adjusted taxable gifts, regardless of whether the adjustment involves a valuation issue or a legal issue pertaining to the proper interpretation of the gift tax law. See also §301.6501(c)-1(f)(5) providing a similar rule regarding transfers that are incomplete gifts but are reported as completed gifts. Accordingly, even if a gift tax adjustment does not generate any additional gift tax liability, the IRS nevertheless is required to propose the adjustment (and to take all other necessary steps) in order to challenge the return as filed within the statutory limitations period, regardless of the nature of the issue presented. Sections 2001(f), 2504(c), 6501(c)(9) and 7477, as enacted or amended by TRA and the 1998 Acts, provide an integrated statutory regime pursuant to which taxpayers are accorded finality with respect to adequately disclosed transfers (except for transfers that are reported as incomplete gifts), while the IRS is afforded the reasonable opportunity to identify in a timely manner returns that present issues that merit further examination. The section 7477 declaratory judgment procedure is a necessary part of this regime because it provides a mechanism to finally resolve any disputed adjustments in circumstances where there is no tax assessment and thus the donor would otherwise be unable to satisfy the jurisdictional requirements for any judicial resolution. The IRS and Treasury Department believe it is appropriate for the declaratory judgment mechanism under section 7477, when available in circumstances where there is no deficiency or refund, to be available for all adjustments regardless of whether the basis for those adjustments is factual, legal, or both.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. 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 these regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this regulation has been submitted to the Small Business Administration for comment on their 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 IRS and the Treasury Department request comments on the clarity of the proposed regulations and how they may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for October 16, 2008 at 10:00 a.m. in the auditorium of the Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. 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 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit comments by September 8, 2008, and submit an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by September 11, 2008.

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 301 continues to read in part as follows:

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

Par. 2. Section 301.7477-1 is revised to read as follows:

This document contains proposed Income Tax Regulations under section 274(i) added by section 2(b) of Public Law 99-44 (May 24, 1985), which provides a definition of qualified nonpersonal use vehicle. Temporary Regulation §1.274-5T(k), identifying categories of qualified nonpersonal use vehicles, was issued in T.D. 8061, 1985-2 C.B. 93 (1985). A notice of proposed rulemaking (LR-145-84, 1985-2 C.B. 809) was issued by cross-reference to Temporary Regulation §1.274-5T(k) (50 FR 46088, 1985-2 C.B. 809 (1985)). These proposed regulations incorporate the text of §1.274-5T(k) and add clearly marked public safety officer vehicles as a new type of qualified nonpersonal use vehicle, listed along with clearly marked police and fire vehicles at §1.274-5(k)(2)(ii)(A). Clearly marked public safety officer vehicles are added to the definition of clearly marked police and fire vehicles at §1.274-5(k)(3), and an example is added at §1.274-5(k)(8). (See §601.601(d)(2)(ii)(b).)

Section 274(d) provides that a taxpayer is not allowed a deduction or credit for certain expenses unless the expense is substantiated. These substantiation requirements apply to expenses incurred in the use of any listed property (defined in section 280F(d)(4)), which includes any passenger automobile and any other property used as a means of transportation. Section 274(d) does not apply to any qualified nonpersonal use vehicle as defined in section 274(i).

Section 274(i) provides that a qualified nonpersonal use vehicle is any vehicle which by reason of its nature is not likely to be used more than a de minimis amount for personal uses. The legislative history to section 274(i) provided a list of qualified nonpersonal use vehicles and identified a number of examples of qualified nonpersonal use vehicles such as school buses, qualified specialized utility repair trucks, and qualified moving vans. The legislative history indicated that Congress wanted the Commissioner to expand the list to include other vehicles appropriate for listing because by their nature it is highly unlikely that they will be used more than a very minimal amount for personal purposes. H.R. Rep. No. 99-34, at 11 (1985).

Passenger automobiles such as sedans and sport utility vehicles are generally not exempt from taxation as qualified nonpersonal use vehicles because by design they can easily be used for personal purposes. However, unmarked law enforcement vehicles and clearly marked police and fire vehicles are included in the list of qualified nonpersonal use vehicles set forth in the legislative history to section 274(i) and incorporated into the proposed and temporary regulations.

The IRS and the Treasury Department have become aware of a need for an additional category of vehicles to be included in the list of qualified nonpersonal use vehicles. Clearly marked vehicles provided to Federal, state and local government workers who respond to emergency situations do not satisfy the current regulations governing qualified nonpersonal use vehicles if the individual workers are not employed by either the fire department or police department. Accordingly, the proposed regulations add clearly marked public safety officer vehicles to the list of qualified nonpersonal use vehicles so that emergency responders receive the same treatment whether they work for the police department, fire department or another department of state or local government.

A clearly marked public safety officer vehicle is a vehicle owned or leased by a governmental unit or any agency or instrumentality thereof, that is required to be used for commuting by a public safety officer as defined in section 402(l)(4)(C) who, when not on a regular shift, is on call at all times, provided that any personal use (other than commuting) of the vehicle outside the limit of the public safety officer’s obligation to respond to an emergency is prohibited by such governmental unit. A public safety officer vehicle is clearly marked if, through painted insignia or words, it is readily apparent that the vehicle is a public safety officer vehicle.

Section 402(l)(4)(C) provides that the term “public safety officer” shall have the same meaning given such term by the Omnibus Crime Control and Safe Streets Act of 1968, as codified at 42 U.S.C. section 3796b(9)(A). 42 U.S.C. Section 3796b(9)(A) defines public safety officer as “an individual serving a public agency in an official capacity, with or without compensation, as a law enforcement officer, a firefighter, a chaplain, or as a member of a rescue squad or ambulance crew.”

Proposed §1.274-5(k) and (l) provide a list of qualified nonpersonal use vehicles and related definitions. Section 1.274-5(k) and (l) were originally proposed in 1985 (LR-145-84, 50 FR 46088, November 6, 1985) and simultaneously issued as a temporary regulation (T.D. 8061, 50 FR 46006, November 6, 1985). Paragraph (k) of LR-145-84 is being re-proposed, with amendments, as part of these proposed regulations. Paragraph (l) provides definitions of the terms “automobile,” “vehicle,” “employer,” “employee,” and “personal use.” Paragraph (l) is being re-proposed, with no changes, as part of these proposed regulations. The corresponding provisions of the proposed regulations in LR-145-84 are withdrawn upon publication of this notice. The corresponding provisions of the temporary regulations in T.D. 8061 will be withdrawn once these proposed regulations are published as final regulations in the Federal Register.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that these regulations do not require a collection of information and do not impose any new or different requirements on small entities. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking has been submitted to the Chief Council for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed amendments are adopted, consideration will be given to any written comments that are submitted to CC:PA:LPD:PR (REG-106897-08). All comments will be available for public inspection and copying. A public hearing will be scheduled and held upon written request by any person who submits written comments on the proposed regulation. Notice of the time and place for the 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 1.132-5 paragraph (h) is amended to read as follows: