In General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), the Supreme Court held that corporations generally could distribute appreciated property to their shareholders without the recognition of any corporate level gain (the General Utilities doctrine). Beginning in 1969, Congress enacted a series of exceptions to the General Utilities doctrine, starting with certain non-liquidating distributions of depreciable property. In the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97–248, 96 Stat. 324, Congress enacted current section 311(b) (originally designated as section 311(d)), which required a corporation to recognize gain on appreciated property distributed to a shareholder in redemption of shares. In 1984, Congress enacted legislation that required gain recognition for all non-liquidating distributions. Finally, as part of the Tax Reform Act of 1986, Public Law 99–514, 100 Stat. 2085, (the Act), Congress repealed what remained of the General Utilities doctrine by enacting section 336(a) of the Internal Revenue Code (Code) to apply gain and loss recognition to liquidating distributions. Under current law, sections 311(b) and 336(a) of the Code require a corporation that distributes appreciated property to its shareholders to recognize gain determined as if the property were sold to the shareholders for its fair market value. Additionally, section 631 of the Act added section 337(d) to the Code to permit the Secretary to prescribe regulations that are necessary or appropriate to carry out the purposes of the General Utilities repeal, “including regulations to ensure that [the repeal of the General Utilities doctrine] may not be circumvented through the use of any provision of law or regulations.”

After the enactment of sections 311(b) and 337(d), the Treasury Department and the IRS became aware of transactions in which taxpayers used a partnership to postpone or avoid completely gain generally required to be recognized under section 311(b). In one example of this transaction, a corporation entered into a partnership and contributed appreciated property. The partnership then acquired stock of that corporate partner, and later made a liquidating distribution of this stock to the corporate partner. Under section 731(a), the corporate partner did not recognize gain on the partnership’s distribution of its stock. By means of this transaction, the corporation had disposed of the appreciated property it formerly held and had acquired its own stock, permanently avoiding its gain in the appreciated property. If the corporation had directly exchanged the appreciated property for its own stock, section 311(b) would have required the corporation to recognize gain upon the exchange.

In response to this type of transaction, the Treasury Department and the IRS issued Notice 89–37, 1989–1 CB 679, on March 9, 1989. Notice 89–37 announced that future regulations under section 337(d) would address the use of partnerships to avoid the repeal of the General Utilities doctrine. Specifically, the Treasury Department and the IRS determined that, in certain circumstances, the acquisition (or ownership) by a partnership of stock in one of its corporate partners (or stock of any member of the affiliated group of which the partner is a member) results in avoidance of the repeal of the General Utilities doctrine. Such avoidance occurs to the extent that a corporate partner, in substance, relinquishes an interest in appreciated property in exchange for an interest in its stock (or the stock of an affiliate). The Notice provided that section 311(b), rather than section 731(a), would apply when a partner received a distribution of its own stock, and that the partner would recognize gain whenever a pre-distribution transaction has the economic effect of an exchange of appreciated property for the partner’s own stock.

On December 15, 1992, the Treasury Department and the IRS published a notice of proposed rulemaking under section 337(d) (PS–91–90, REG–208989–90, 1993–1 CB 919) in the Federal Register (57 FR 59324) addressing partnership transactions involving stock of a partner (the 1992 proposed regulations). The 1992 proposed regulations adopted two rules to protect the repeal of the General Utilities doctrine: the deemed redemption rule (the 1992 deemed redemption rule) and the distribution rule (the 1992 distribution rule). The 1992 proposed regulations also provided de minimis and inadvertence exceptions to these two rules.

The 1992 deemed redemption rule addressed pre-distribution transactions involving corporate partner stock owned or acquired by the partnership. The Treasury Department and the IRS believed that certain of these transactions created the economic effect of an exchange of appreciated property for corporate partner stock. The 1992 deemed redemption rule provided that a corporate partner recognizes gain at the time of, and to the extent that, any transaction (or series of transactions) has the economic effect of an exchange by the partner of its interest in appreciated property for an interest in its stock (or the stock of any member of the affiliated group of which such partner is a member) owned, acquired, or distributed by the partnership.

The 1992 distribution rule provided that a partnership’s distribution to a partner of the partner’s stock is treated as a redemption or an exchange of the stock of the partner for a portion of the partner’s partnership interest with a value equal to the distributed stock. Thus, the 1992 distribution rule applied section 311(b) principles to the distribution to trigger gain to the corporate partner, rather than applying section 731, which would not have required gain recognition. The 1992 distribution rule ensured that section 311(b) would apply to any acquisition by the corporate partner of its own stock where the 1992 deemed redemption rule had not applied. The preamble to the 1992 proposed regulations indicated that commenters on the Notice raised concerns that the 1992 distribution rule could duplicate gain recognition and suggested a modified approach. However, the 1992 proposed regulations rejected the modified approach as overly complex.

As noted previously, the 1992 proposed regulations applied to stock of a partner, to stock of a partner’s affiliate, and to other equity interests in the partner or affiliate. The 1992 proposed regulations used a modified affiliation standard to determine whether a partner and another corporation were affiliates. The 1992 proposed regulations treated a corporation as an affiliate of a partner at the time of a deemed redemption or distribution by the partnership if, immediately thereafter, the partner and corporation were members of an affiliated group as defined in section 1504(a) without regard to section 1504(b) (section 337(d) affiliation). On January 19, 1993, the Treasury Department and the IRS issued Notice 93–2, 1993–1 CB 292, which stated that the 1992 proposed regulations would be amended to limit the application of the regulations to transactions in which section 337(d) affiliation existed immediately before the deemed redemption or distribution. The Treasury Department and the IRS indicated that further study was required for cases in which section 337(d) affiliation did not exist prior to a distribution of stock by a partnership to a corporate partner, but resulted from the distribution.

The Treasury Department and the IRS received several written comments in response to Notice 89–37, the 1992 proposed regulations, and Notice 93–2. Commenters largely supported the 1992 deemed redemption rule, though some suggested modifications. Some commenters, however, opposed the 1992 distribution rule, asserting that the rule is overly broad and inconsistent with the deemed redemption rule. These comments are discussed in detail in the Explanation of Provisions section of this preamble.

After considering these comment letters, and taking into account subsequent changes in relevant law as described in part 1 of this preamble, the Treasury Department and the IRS are withdrawing the 1992 proposed regulations and simultaneously issuing temporary and final regulations that also serve as the text of new proposed regulations published in the Proposed Rules section of this issue of the Bulletin.

These regulations apply to certain partnerships that hold stock of a Corporate Partner. For this purpose, a “Corporate Partner” is defined as a person that holds or acquires an interest in a partnership and that is classified as a corporation for federal income tax purposes. The regulations define “Stock of the Corporate Partner” expansively to include the Corporate Partner’s stock, or other equity interests, including options, warrants, and similar interests, in the Corporate Partner or a corporation that controls the Corporate Partner within the meaning of section 304(c), except that section 318(a)(1) and (3) shall not apply (section 304(c) control). Stock of the Corporate Partner also includes interests in any entity to the extent that the value of the interest is attributable to Stock of the Corporate Partner.

These definitions of Corporate Partner and Stock of the Corporate Partner are consistent with those set forth in the 1992 proposed regulations except for two changes. First, these regulations modify the definition of Stock of the Corporate Partner. Based on changes in the law and comments received, the Treasury Department and the IRS have determined that the scope of the definition of “Stock of a Partner” in the 1992 proposed regulations was too narrow in certain instances and too broad in others. These regulations broaden the definition of Stock of a Corporate Partner to include stock or other equity interests of any corporation that possesses section 304(c) control of the Corporate Partner, whereas the 1992 proposed regulations’ definition was limited to stock or other equity interests issued by the Corporate Partner and its section 337(d) affiliates. Section 304(c) control generally exists when there is ownership of stock of a corporation possessing at least 50 percent of the total combined voting power of all classes of the corporation’s stock that is entitled to vote or at least 50 percent of the value of the shares of all classes of stock of the corporation, while control of a corporation under section 1504(a)(2) requires ownership of stock of the corporation possessing at least 80 percent of the total voting power of the stock of the corporation and at least 80 percent of the total value of the stock of the corporation. The Treasury Department and the IRS believe the lower threshold for control set forth in section 304(c) is the more appropriate standard for this purpose because General Utilities repeal could be avoided by acquiring stock of a corporation that owns less than 80 percent of the vote and value of the Corporate Partner’s stock. In addition, these regulations narrow the definition of Stock of a Corporate Partner to exclude stock of any corporation that does not possess section 304(c) control of the Corporate Partner, even if the corporation is a section 337(d) affiliate or a member of the same consolidated group as the Corporate Partner. The enactment of sections 732(f) and 755(c) subsequent to the issuance of the 1992 proposed regulations generally have served to prevent abusive transactions involving partnerships that own stock of lower tier section 337(d) affiliates of the Corporate Partner. Accordingly, these regulations do not apply to a partnership that owns, acquires, or distributes stock of any section 337(d) affiliate of the Corporate Partner unless that affiliate possesses section 304(c) control of the Corporate Partner. The Treasury Department and the IRS continue to study the application of these provisions and plan to issue additional guidance as needed to address further abuses in this area. Comments are requested regarding such guidance.

Second, these regulations add an exception for certain related-party partners. Under this exception, Stock of the Corporate Partner does not include any stock or other equity interest held or acquired by a partnership if all interests in the partnership’s capital and profits are held by members of an affiliated group defined in section 1504(a) that includes the Corporate Partner. Thus, these regulations do not apply if, for example, a domestic corporation and its wholly owned domestic subsidiary (each of which is an includible corporation under section 1504(b)) are the only partners in a partnership and either corporation contributes stock of another affiliate. The Treasury Department and the IRS have determined that this additional exception is appropriate because the purpose of these regulations is not implicated if a partnership is owned entirely by affiliated corporations. The Treasury Department and the IRS invite comments on whether this exception should be extended, for example, to partnerships owned by controlled foreign corporations that are owned entirely by a single affiliated group.

For partnerships that hold Stock of the Corporate Partner, these regulations apply to a transaction (or series of transactions) that is a “Section 337(d) Transaction.” These regulations define a Section 337(d) Transaction as a transaction that has the effect of an exchange by a Corporate Partner of its interest in appreciated property for an interest in Stock of the Corporate Partner owned, acquired, or distributed by a partnership. For example, a Section 337(d) Transaction may occur if: (i) a Corporate Partner contributes appreciated property to a partnership that owns Stock of the Corporate Partner; (ii) a partnership acquires Stock of the Corporate Partner; (iii) a partnership that owns Stock of the Corporate Partner distributes appreciated property to a partner other than the Corporate Partner; (iv) a partnership distributes stock of the Corporate Partner to the Corporate Partner; or (v) a partnership agreement is amended in a manner that increases a Corporate Partner’s interest in the Stock of the Corporate Partner (including in connection with a contribution to, or distribution from, a partnership).

If a partnership engages in a Section 337(d) Transaction, the Corporate Partner must recognize gain. The regulations define a “Gain Percentage” that the partnership uses to quantify the amount of gain recognized. The computation of the Gain Percentage is set forth in part 2 of this preamble.

These regulations largely retain the 1992 deemed redemption rule. If a transaction is a Section 337(d) Transaction described in part 1 of this preamble, a Corporate Partner must recognize gain under the deemed redemption rule. To determine the amount of gain, the Corporate Partner must first determine the amount of appreciated property (other than Stock of the Corporate Partner) effectively exchanged for Stock of the Corporate Partner (by value) and then calculate the amount of taxable gain recognized.

These regulations set forth general principles that apply in determining the amount of appreciated property effectively exchanged for Stock of the Corporate Partner. These general principles require that the Corporate Partner’s economic interest with respect to both Stock of the Corporate Partner and all other appreciated property of the partnership be determined based on all facts and circumstances, including the allocation and distribution rights set forth in the partnership agreement. The deemed redemption rule applies only to the extent that the transaction has the effect of an exchange by the Corporate Partner of its interest in appreciated property for Stock of the Corporate Partner. Thus, these regulations do not apply to the extent a transaction has the effect of an exchange by a Corporate Partner of non-appreciated property for Stock of the Corporate Partner or has the effect of an exchange by a Corporate Partner of appreciated property for property other than Stock of the Corporate Partner.

A Corporate Partner must recognize gain under these regulations even if the Section 337(d) Transaction would not otherwise change the Corporate Partner’s allocable share of gain under section 704(c). For example, if a Corporate Partner contributes appreciated property to a newly-formed partnership and an individual contributes cash that the partnership subsequently uses to purchase Stock of the Corporate Partner, then the purchase of the stock is a Section 337(d) Transaction even though the Corporate Partner’s allocable share of gain in the appreciated property under section 704(c) is the same before and after the purchase. The Treasury Department and the IRS believe that this gain recognition is appropriate because a Section 337(d) Transaction may create an immediate benefit to the Corporate Partner equivalent to the benefit associated with the redemption of corporate stock in exchange for appreciated property. See Example 4 of § 1.337(d)–3T(h) in these regulations.

If the Corporate Partner has an existing interest in the partnership’s Stock of the Corporate Partner prior to the Section 337(d) Transaction, the deemed redemption rule applies only with respect to the Corporate Partner’s incremental increase in the Stock of the Corporate Partner. For example, changing allocations to increase a Corporate Partner’s interest in the Stock of the Corporate Partner from 50 percent to 80 percent and to decrease the Corporate Partner’s interest in other appreciated property from 80 percent to 50 percent would have the effect of an exchange by the Corporate Partner of the 30-percent incremental decrease in its interest in the appreciated property for the 30-percent incremental increase in the Stock of the Corporate Partner. See Example 5 of § 1.337(d)–3T(h) in these regulations.

For purposes of recognizing gain under the deemed redemption rule, the Corporate Partner’s interest in an identified share of Stock of the Corporate Partner will never be less than the Corporate Partner’s largest interest (by value) in that share of Stock of the Corporate Partner that was taken into account when the partnership previously determined whether there had been a Section 337(d) Transaction (regardless of whether the Corporate Partner recognized gain in the earlier transaction). See Example 6 of § 1.337(d)–3T(h) in these regulations. This rule ensures that alternating increases and decreases in a Corporate Partner’s interest in Stock of the Corporate Partner do not cause duplicate gain recognition. This limitation does not apply if any reduction in the Corporate Partner’s interest in the identified share of Stock of the Corporate Partner occurred as part of a plan or arrangement to circumvent the purpose of these regulations. See Example 7 of § 1.337(d)–3T(h) in these regulations.

In certain limited circumstances, a partnership’s acquisition of Stock of the Corporate Partner does not have the effect of an exchange of appreciated property for that stock. For example, as one commenter asserted, if a partnership with an operating business uses the cash generated in that business to purchase Stock of the Corporate Partner, the deemed redemption rule should not apply to the stock purchase because the Corporate Partner’s share in appreciated property has not been reduced, and thus no exchange has occurred. The Treasury Department and the IRS acknowledge that such stock acquisitions would not contravene the purposes of these regulations. Accordingly, these regulations adopt this comment and do not apply to stock purchases or other transactions that do not have the effect of an exchange of appreciated property for Stock of the Corporate Partner.

If a transaction is a Section 337(d) Transaction, the deemed redemption rule requires the Corporate Partner to recognize a percentage of its total gain in partnership appreciated property equal to a fraction, the numerator of which is the Corporate Partner’s interest (by value) in appreciated property effectively exchanged for Stock of the Corporate Partner under the deemed redemption rule, and the denominator of which is the Corporate Partner’s interest (by value) in appreciated property immediately before the Section 337(d) Transaction. This fraction is defined in these regulations as the “Gain Percentage.” The Corporate Partner’s gain under the deemed redemption rule equals the product of (i) the Corporate Partner’s Gain Percentage and (ii) the gain from the appreciated property that is the subject of the exchange that the that the Corporate Partner would recognize if, immediately before the Section 337(d) Transaction, all assets of the partnership and any assets contributed to the partnership in the section 337(d) Transaction were sold in a fully taxable transaction for cash in an amount equal to the fair market value of such property (taking into account section 7701(g)), reduced, but not below zero, by any gain the Corporate Partner is required to recognize with respect to the appreciated property in the Section 337(d) Transaction under any other section of the Code. For example, if a Corporate Partner would be allocated $100x of tax gain on a sale of appreciated partnership property (other than Stock of the Corporate Partner) and the Corporate Partner’s interest in that appreciated partnership property (determined under all facts and circumstances) is $500x, and if the partnership engages in a Section 337(d) Transaction that reduces the Corporate Partner’s interest in appreciated partnership property by $200x and increases the Corporate Partner’s interest in Stock of the Corporate Partner by $200x, then the Corporate Partner’s Gain Percentage equals 40% (200x/500x), and the Corporate Partner’s gain under the deemed redemption rule is $40x (40% of $100x).

The gain from the hypothetical sale used to compute gain under the deemed redemption rule is determined by applying the principles of section 704(c), which generally requires the partnership to take into account variations between the adjusted tax basis and fair market value of partnership property at the time it is contributed to the partnership and upon certain other events that allow or require the value of partnership property to be redetermined under § 1.704–1(b)(2)(iv)(f). See Examples 3 and 5 of § 1.337(d)–3T(h) in these regulations. A partner’s share of gain under section 704(c) for this purpose includes any remedial allocations under § 1.704–3(d) for a partnership that has elected under section 704(c) to report notional items of offsetting tax gain and loss to its partners to eliminate distortions that may arise when the partnership’s total tax gain or loss on the sale of partnership property is less than all partners’ aggregate share of gain or loss from the property.

These regulations also contain two rules related to the effect of the deemed redemption rule on partner and partnership basis. First, these regulations require the Corporate Partner to increase its basis in its partnership interest by an amount equal to the gain that the Corporate Partner recognizes in a Section 337(d) Transaction. This basis increase is necessary to prevent the Corporate Partner from recognizing gain a second time when the partnership liquidates (or, if property is distributed to the Corporate Partner, when that property is sold).

Second, the regulations require the partnership to increase its adjusted tax basis in the appreciated property that is treated as the subject of a Section 337(d) Transaction by the amount of gain that the Corporate Partner recognized with respect to that property as a result of the Section 337(d) Transaction. This basis increase applies regardless of whether the partnership has elected under section 754 to adjust the basis of partnership property. This rule prevents the Corporate Partner from recognizing gain a second time when the partnership sells the property that was effectively exchanged under the deemed redemption rule.

One commenter suggested that when a partnership owns or acquires stock in a Corporate Partner’s subsidiary or a sister of the Corporate Partner and the stock is not issued as part of the transaction, the deemed redemption rule should not apply unless and until a subsequent transaction relating to the stock creates tax consequences that are inconsistent with General Utilities repeal. As discussed in part 1 of this preamble, these regulations only apply to Stock of a Corporate Partner, which under these regulations, does not include stock in a Corporate Partner’s sister corporation or subsidiary unless such corporation possesses section 304(c) control of the Corporate Partner. Such control could exist, if, for example, a Corporate Partner’s subsidiary were to own so-called “hook stock” in the Corporate Partner. If such control of the Corporate Partner does exist, then it is appropriate to treat stock of a Corporate Partner’s subsidiary or sister corporation as Stock of the Corporate Partner because the value of that sister or subsidiary corporation’s stock owned or acquired by the partnership is in part attributable to the Corporate Partner’s stock.

Another commenter suggested that the deemed redemption rule is no longer necessary. The commenter explained that the acquisition of Stock of the Corporate Partner is not the appropriate time to impose tax and that the 1992 distribution rule and changes in the law since 1989 make it more difficult to exit a partnership tax-free. The Treasury Department and the IRS do not adopt this comment because a Section 337(d) Transaction may create an immediate benefit to the Corporate Partner equivalent to the benefit associated with the redemption of corporate stock in exchange for appreciated property. If the deemed redemption rule does not apply at the time of this exchange, the Corporate Partner can defer paying tax on this economic benefit in a manner that is inconsistent with section 311(b).

The 1992 distribution rule required a Corporate Partner to recognize gain when the partnership distributes Stock of the Corporate Partner to the Corporate Partner. Commenters noted a number of concerns with this rule and recommended eliminating it.

Several commenters noted that the rule was overly broad because it could cause the Corporate Partner to recognize gain in an amount that exceeded the appreciation in property effectively exchanged for the stock. For example, the rule could require a Corporate Partner to recognize gain upon a partnership’s distribution of appreciated Stock of the Corporate Partner even though the partnership held no other appreciated property. One commenter stated that the 1992 distribution rule would therefore require the Corporate Partner to recognize gain on appreciation inherent in its partnership interest, even though the distribution does not implicate the repeal of the General Utilities doctrine and even though section 1032 provides for nonrecognition of gain on the distribution. The commenter maintained that the 1992 distribution rule should not apply when a Corporate Partner merely exchanges an indirect interest in its own stock for a direct interest in its own stock.

The Treasury Department and the IRS agree with these comments and adopt new rules governing the tax consequences of a distribution of Stock of the Corporate Partner to that Corporate Partner. Instead of adopting the 1992 distribution rule, these regulations extend the deemed redemption rule to certain distributions to the Corporate Partner of Stock of the Corporate Partner. These new rules governing distributions apply only if the distributed stock has previously been the subject of a Section 337(d) Transaction or becomes the subject of a Section 337(d) Transaction as a result of the distribution (a section 337(d) distribution). Additionally, these regulations do not apply to a distribution to the Corporate Partner of the Stock of the Corporate Partner to which section 732(f) applies at the time of the distribution. If the deemed redemption rule applies to a distribution, these regulations deem the partnership to amend its agreement immediately before the distribution to allocate 100 percent of the distributed stock to the Corporate Partner and to allocate an appropriately reduced interest in other partnership property away from the Corporate Partner. This deemed allocation is solely for purposes of recognizing gain under these regulations, and no inference is intended with regard to the treatment of such allocations generally.

If a distribution is a section 337(d) distribution, then in addition to any gain recognized under the deemed redemption rule upon the distribution of Stock of the Corporate Partner to the Corporate Partner, these regulations also require the Corporate Partner to recognize gain to the extent that the partnership’s basis in the distributed Stock of the Corporate Partner exceeds the Corporate Partner’s basis in its partnership interest (as reduced by any cash distributed in the transaction) immediately before the distribution. Recognition of gain in this circumstance is necessary to prevent the Corporate Partner from shifting basis away from its own stock onto other property of the partnership. The regulations provide an exception to this additional gain recognition rule if the gain recognition or basis reduction rules of section 732(f) apply at the time of the distribution. Although this exception generally ensures that gain recognized as a result of these regulations will not be duplicated as a result of section 732(f), duplication may still result in certain circumstances. For example, if a Corporate Partner recognizes gain under section 337(d) on a partnership distribution and section 732(f) does not apply to the distribution because the section 732(f) control requirement is not satisfied at the time of the distribution, but the control requirement is subsequently satisfied triggering section 732(f), then the Corporate Partner could recognize gain under both provisions. The Treasury Department and the IRS invite comments on how the rules in these regulations should be coordinated with section 732(f).

These regulations set forth two rules under sections 337 and 732 to coordinate the effects of the rule requiring gain recognition when the Stock of the Corporate Partner is stepped down on a section 337(d) distribution with existing rules for determining the basis of property upon partnership distributions. The first rule applies for purposes of determining the basis of property distributed to the Corporate Partner (other than the basis of the Corporate Partner in its own stock), the basis of the Corporate Partner’s remaining partnership interest, and the partnership’s basis in undistributed Stock of the Corporate Partner, and for purposes of computing gain on the distribution. For these purposes, the basis of Stock of the Corporate Partner distributed to the Corporate Partner equals the greater of: (i) the partnership’s basis of that distributed Stock of the Corporate Partner immediately before the distribution, or (ii) the fair market value of that distributed Stock of the Corporate Partner immediately before the distribution less the Corporate Partner’s allocable share of gain from all of the Stock of the Corporate Partner if the partnership sold all of its assets in a fully taxable transaction for cash in an amount equal to the fair market value of such property (taking into account section 7701(g)) immediately before the distribution. See Examples 2 and 3 of § 1.337(d)–3T(h) in these regulations. This special rule is necessary to prevent basis from shifting away from distributed Stock of the Corporate Partner to other property. This basis shift could occur, for example, upon a distribution of less than all of the partnership’s Stock of the Corporate Partner to the Corporate Partner. The Treasury Department and the IRS request comments on this rule, including comments on whether its objectives would be better achieved through guidance under section 732 providing that on a distribution of a partial interest in partnership property, the basis of the distributed property in the hands of the distributee partner is determined by taking the principles of section 704(c) into account.

A second rule applies when a Corporate Partner receives both Stock of the Corporate Partner and other property in a section 337(d) distribution. Under this rule, the basis to be allocated to the properties distributed under section 732(a) or (b) is allocated first to the Stock of the Corporate Partner before taking into account the distribution of any other property (other than cash). Therefore, before taking into account the distribution of other property, the Corporate Partner will reduce its basis in its partnership interest by the Corporate Partner’s basis in the distributed Stock of the Corporate Partner (but not below zero). The Corporate Partner will determine its basis in other distributed partnership property and in its remaining partnership interest after giving effect to this reduction. This rule, which governs the application of sections 732(a) and 732(b), is being promulgated pursuant to the specific statutory grant of authority in section 337(d)(1) to ensure that the purposes of the repeal of the General Utilities doctrine are not circumvented through the use of any provision of law or regulations.

When a Corporate Partner receives a partnership distribution of its own stock, it is unclear under existing law whether the Corporate Partner has basis in that stock. (See, for example, Rev. Rul. 2006–2, 2006–1 CB 261.) The resolution of this question is beyond the scope of these regulations. However, because the distribution to a Corporate Partner of its own stock affects the Corporate Partner’s basis in other distributed property and any retained partnership interest, these regulations require the partnership and the Corporate Partner to determine the basis of other distributed property and any retained partnership interest by reference to the partnership’s basis in the distributed Stock of the Corporate Partner. That is, the Corporate Partner determines its basis in other distributed property and in any retained partnership interest as though the distributed stock was stock other than Stock of the Corporate Partner. Similarly, the regulations compute any gain recognition on the distribution by comparing the Corporate Partner’s basis in its partnership interest to the basis of that Stock of the Corporate Partner in the hands of the partnership (without regard to whether the Corporate Partner can have basis in the distributed stock). No inference is intended with respect to the question of whether a corporation has or does not have basis in its own stock.

These regulations retain the de minimis and inadvertence exceptions from the 1992 proposed regulations, but make small modifications to the de minimis rule to reduce burden. As set forth in these regulations, the de minimis rule provides that these regulations do not apply to a Corporate Partner if three conditions are satisfied. These conditions are tested upon the occurrence of a Section 337(d) Transaction and upon any subsequent revaluation event described in § 1.704–1(b)(2)(iv)(f).

The first condition requires that both the Corporate Partner and any persons related to the Corporate Partner under section 267(b) or section 707(b) own, in the aggregate, less than five percent of the partnership. The second condition requires that the partnership hold Stock of the Corporate Partner worth less than two percent of the value of the partnership’s gross assets, including Stock of the Corporate Partner. The third condition requires that the partnership has never, at any point in time, held more than $1,000,000 in Stock of the Corporate Partner or more than two percent of any particular class of Stock of the Corporate Partner. The 1992 proposed regulations contained similar conditions, but capped the permissible value of the partnership’s Stock of the Corporate Partner at $250,000.

These regulations provide a special rule that applies if the conditions of the de minimis rule are satisfied at the time of a Section 337(d) Transaction, but are not satisfied at the time of a subsequent Section 337(d) Transaction or revaluation event described in § 1.704–1(b)(2)(iv)(f). This rule provides that, solely for purposes of the deemed redemption rule, a Corporate Partner may determine its gain on the subsequent acquisition or revaluation event as if it had already recognized gain at the previous event. Accordingly, the Corporate Partner would only recognize gain with respect to appreciation arising between the earlier acquisition or revaluation event and the subsequent event. Neither the Corporate Partner nor the partnership increases its basis by the gain the Corporate Partner would have recognized if the de minimis rule did not apply to the prior acquisition or revaluation event.

These regulations also contain an inadvertence exception. The inadvertence exception provides that these regulations do not apply to Section 337(d) Transactions in which the partnership satisfies two requirements. First, the partnership must dispose of, by sale or distribution, the Stock of the Corporate Partner before the due date (including extensions) of its federal income tax return for the taxable year in which the partnership acquired the stock (or in which the Corporate Partner joined the partnership, if applicable). Second, the partnership must not have distributed the Stock of the Corporate Partner to the Corporate Partner or a person possessing section 304(c) control of the Corporate Partner. Other than broadening and narrowing the scope of related distributees as a result of the modified definition of Stock of the Corporate Partner, this inadvertence exception is generally unchanged from the 1992 proposed regulations. However, the Treasury Department and the IRS will consider comments with respect to removing the prohibition against distributions of Stock of the Corporate Partner to the Corporate Partner in light of the enactment of section 737, which requires a partner to recognize gain on property with built-in gain contributed to a partnership when the partnership distributes other property to the partner within seven years of the contribution.

The Treasury Department and the IRS are concerned that taxpayers could use tiered partnerships to circumvent these regulations. Therefore, these regulations require taxpayers to apply these regulations to tiered partnerships in a manner consistent with the regulations’ purpose. See Example 8 of § 1.337(d)–3T(h) in these regulations.

(a) Purpose. The purpose of this section is to prevent corporate taxpayers from using a partnership to circumvent gain required to be recognized under section 311(b) or section 336(a). The rules of this section, including the determination of the amount of gain, must be applied in a manner that is consistent with and that reasonably carries out this purpose.

(b) In general. This section applies when a partnership, either directly or indirectly, owns, acquires, or distributes Stock of the Corporate Partner (within the meaning of paragraph (c)(2) of this section). Under paragraphs (d) or (e) of this section, a Corporate Partner (within the meaning of paragraph (c)(1) of this section) is required to recognize gain when a transaction has the effect of the Corporate Partner acquiring or increasing an interest in its own stock in exchange for appreciated property in a manner that contravenes the purpose of this section as set forth in paragraph (a) of this section. Paragraph (f) of this section sets forth exceptions under which a Corporate Partner does not recognize gain.

(c) Definitions. The following definitions apply for purposes of this section:

(1) Corporate Partner. A Corporate Partner is a person that is classified as a corporation for federal income tax purposes and holds or acquires an interest in a partnership.

(2) Stock of the Corporate Partner—(i) In general. With respect to a Corporate Partner, Stock of the Corporate Partner includes the Corporate Partner’s stock, or other equity interests, including options, warrants, and similar interests, in the Corporate Partner or a corporation that controls the Corporate Partner within the meaning of section 304(c), except that section 318(a)(1) and (3) shall not apply. Stock of the Corporate Partner also includes interests in any entity to the extent that the value of the interest is attributable to Stock of the Corporate Partner.

(ii) Affiliated partner exception. Stock of the Corporate Partner does not include any stock or other equity interests held or acquired by a partnership if all interests in the partnership’s capital and profits are held by members of an affiliated group as defined in section 1504(a) that includes the Corporate Partner.

(3) Section 337(d) Transaction. A Section 337(d) Transaction is a transaction (or series of transactions) that has the effect of an exchange by a Corporate Partner of its interest in appreciated property for an interest in Stock of the Corporate Partner owned, acquired, or distributed by a partnership. For example, a Section 337(d) Transaction may occur when—

(i) A Corporate Partner contributes appreciated property to a partnership that owns Stock of the Corporate Partner;

(ii) A partnership acquires Stock of the Corporate Partner;

(iii) A partnership that owns Stock of the Corporate Partner distributes appreciated property to a partner other than a Corporate Partner;

(iv) A partnership distributes Stock of the Corporate Partner to the Corporate Partner; or

(v) A partnership agreement is amended in a manner that increases a Corporate Partner’s interest in Stock of the Corporate Partner (including in connection with a contribution to, or distribution from, a partnership).

(4) Gain Percentage. A Corporate Partner’s Gain Percentage equals a fraction, the numerator of which is the Corporate Partner’s interest (by value) in appreciated property effectively exchanged for Stock of the Corporate Partner under the test described in paragraphs (d)(1) and (2) of this section, and the denominator of which is the Corporate Partner’s interest (by value) in that appreciated property immediately before the Section 337(d) Transaction. Paragraph (d) of this section requires a partnership to multiply the Gain Percentage by the Corporate Partner’s aggregate gain in appreciated property to determine gain recognized under this section.

(d) Deemed redemption rule—(1) In general. A Corporate Partner in a partnership that engages in a Section 337(d) Transaction recognizes gain at the time, and to the extent, that the Corporate Partner’s interest in appreciated property (other than Stock of the Corporate Partner) is reduced in exchange for an increased interest in Stock of the Corporate Partner, as determined under paragraph (d)(2) of this section. This section does not apply to the extent a transaction has the effect of an exchange by a Corporate Partner of non-appreciated property for Stock of the Corporate Partner or has the effect of an exchange by a Corporate Partner for property other than Stock of the Corporate Partner.

(2) Corporate Partner’s Interest in Partnership Property. The Corporate Partner’s interest with respect to both Stock of the Corporate Partner and the appreciated property that is the subject of the exchange is determined based on all facts and circumstances, including the allocation and distribution rights set forth in the partnership agreement. The Corporate Partner’s interest in an identified share of Stock of the Corporate Partner will never be less than the Corporate Partner’s largest interest (by value) in that share of Stock of the Corporate Partner that was taken into account when the partnership previously determined whether there had been a Section 337(d) Transaction with respect to such share (regardless of whether the Corporate Partner recognized gain in the earlier transaction). See Example 6 of paragraph (h) of this section. However, this limitation will not apply if any reduction in the Corporate Partner’s interest in the identified share of Stock of the Corporate Partner occurred as part of a plan or arrangement to circumvent the purpose of this section. See Example 7 of paragraph (h) of this section.

(3) Amount of gain recognized on the exchange. The amount of gain the Corporate Partner recognizes under paragraph (d)(1) of this section equals the product of the Corporate Partner’s Gain Percentage and the gain from the appreciated property that is the subject of the exchange that the Corporate Partner would recognize if, immediately before the Section 337(d) Transaction, all assets of the partnership and any assets contributed to the partnership in the Section 337(d) Transaction were sold in a fully taxable transaction for cash in an amount equal to the fair market value of such property (taking into account section 7701(g)), reduced, but not below zero, by any gain the Corporate Partner is required to recognize with respect to the appreciated property in the Section 337(d) Transaction under any other provision of this chapter. This gain is computed taking into account allocations of tax items applying the principles of section 704(c), including any remedial allocations under § 1.704–3(d).

(4) Basis adjustments—(i) Corporate Partner’s basis in the partnership interest. The basis of the Corporate Partner’s interest in the partnership is increased by the amount of gain that the Corporate Partner recognizes under this paragraph (d).

(ii) Partnership’s basis in partnership property. The partnership’s adjusted tax basis in the appreciated property that is treated as the subject of the exchange under this paragraph (d) is increased by the amount of gain recognized with respect to that property by the Corporate Partner as a result of that exchange, regardless of whether the partnership has an election in effect under section 754.

(e) Distribution of Stock of the Corporate Partner—(1) In general. This paragraph (e) applies to distributions to the Corporate Partner of Stock of the Corporate Partner to which section 732(f) does not apply and that have previously been the subject of a Section 337(d) Transaction or become the subject of a Section 337(d) Transaction as a result of the distribution. Upon the distribution of Stock of the Corporate Partner to the Corporate Partner, paragraph (d) of this section will apply as though immediately before the distribution the partners amended the partnership agreement to allocate to the Corporate Partner a 100 percent interest in that portion of the Stock of the Corporate Partner that is distributed and to allocate an appropriately reduced interest in other partnership property away from the Corporate Partner.

(2) Basis rules—(i) Basis allocation on distributions of stock and other property. If, as part of the same transaction, a partnership distributes Stock of the Corporate Partner and other property (other than cash) to the Corporate Partner, see § 1.732–1T(c)(1)(iii) for a rule allocating basis first to the Stock of the Corporate Partner before the distribution of the other property.

(ii) Computation of Basis. For purposes of determining the basis of property distributed to the Corporate Partner (other than the basis of the Corporate Partner in its own stock), the basis of the Corporate Partner’s remaining partnership interest, and the partnership’s basis in undistributed Stock of the Corporate Partner, and for purposes of computing gain under paragraph (e)(3) of this section, the partnership’s basis of Stock of the Corporate Partner distributed to the Corporate Partner equals the greater of—

(A) The partnership’s basis of that distributed Stock of the Corporate Partner immediately before the distribution, or

(B) The fair market value of that distributed Stock of the Corporate Partner immediately before the distribution less the Corporate Partner’s allocable share of gain from all of the Stock of the Corporate Partner if the partnership sold all of its assets in a fully taxable transaction for cash in an amount equal to the fair market value of such property (taking into account section 7701(g)) immediately before the distribution.

(3) Gain recognition. The Corporate Partner will recognize gain on a distribution of Stock of the Corporate Partner to the Corporate Partner to the extent that the partnership’s basis in the distributed Stock of the Corporate Partner (as determined under paragraph (e)(2)(ii) of this section) exceeds the Corporate Partner’s basis in its partnership interest (as reduced by any cash distributed in the transaction) immediately before the distribution.

(f) Exceptions—(1) De minimis rule—(i) In general. This section does not apply to a Corporate Partner if at the time that the partnership acquires Stock of the Corporate Partner or at the time of a revaluation event as described in § 1.704–1(b)(2)(iv)(f) (without regard to whether or not the partnership revalues its assets) —

(A) The Corporate Partner and any persons related to the Corporate Partner under section 267(b) or section 707(b) own in the aggregate less than five percent of the partnership;

(B) The partnership holds Stock of the Corporate Partner with a value of less than two percent of the partnership’s gross assets (including the Stock of the Corporate Partner); and

(C) The partnership has never, at any point in time, held in the aggregate—

(1) Stock of the Corporate Partner with a fair market value greater than $1,000,000; or

(2) More than two percent of any particular class of Stock of the Corporate Partner.

(ii) De minimis rule ceases to apply. If a partnership satisfies the conditions of the de minimis rule of paragraph (f)(1) of this section upon an acquisition of Stock of the Corporate Partner or revaluation event as described in § 1.704–1(b)(2)(iv)(f), but later fails to satisfy the conditions of the de minimis rule upon a subsequent acquisition or revaluation event, then solely for purposes of paragraph (d) of this section, the Corporate Partner may compute its gain on the subsequent acquisition or revaluation event as if it had already recognized gain at the previous event. Neither the Corporate Partner nor the partnership increases its basis by the gain the Corporate Partner would have recognized if the de minimis rule of paragraph (f)(1) of this section did not apply to the prior acquisition or revaluation event.

(2) Inadvertence rule. Unless acquired as part of a plan to circumvent the purpose of this section, this section does not apply to Stock of the Corporate Partner that —

(i) Is disposed of (by sale or distribution) by the partnership before the due date (including extensions) of its federal income tax return for the taxable year during which the Stock of the Corporate Partner is acquired (or for the taxable year in which the Corporate Partner becomes a partner, whichever is applicable); and

Is not distributed to the Corporate Partner or a corporation that controls the Corporate Partner within the meaning of section 304(c), except that section 318(a)(1) and (3) shall not apply.

(g) Tiered partnerships. The rules of this section shall apply to tiered partnerships in a manner that is consistent with the purpose set forth in paragraph (a) of this section.

(h) Examples. The following examples illustrate the principles of this section. All amounts in the following examples are reported in millions of dollars:

Example 1. Deemed redemption rule – contribution of Stock of a Corporate Partner. (i) In Year 1, X, a corporation, and A, an individual, form partnership AX as equal partners in all respects. X contributes Asset 1 with a fair market value of $100 and a basis of $20. A contributes X stock, which is Stock of the Corporate Partner, with a basis and fair market value of $100.

(ii) Because A and X are equal partners in AX in all respects, the partnership formation causes X’s interest in X stock to increase from $0 to $50 and its interest in Asset 1 to decrease from $100 to $50. Thus, the partnership formation is a Section 337(d) Transaction because the formation has the effect of an exchange by X of $50 of Asset 1 for $50 of X stock.

(iii) X must recognize gain under paragraph (d) of this section with respect to Asset 1 to prevent the circumvention of section 311(b) principles. X’s gain equals the product of X’s Gain Percentage and the gain from Asset 1 that X would recognize (decreased, but not below zero, by any gain that X recognized with respect to Asset 1 in the Section 337(d) Transaction under any other provision of this chapter) if, immediately before the Section 337(d) Transaction, all assets were sold in a fully taxable transaction for cash in an amount equal to the fair market value of such property. If Asset 1 had been sold in a fully taxable transaction immediately before the formation of partnership AX, X’s allocable share of gain would have been $80. X’s Gain Percentage is 50% (equal to a fraction, the numerator of which is X’s $50 interest in Asset 1 effectively exchanged for X stock, and the denominator of which is X’s $100 interest in Asset 1 immediately before the Section 337(d) Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50%) under the deemed redemption rule in paragraph (d) of this section. Under paragraph (d)(4)(i) of this section, X’s basis in its AX partnership interest increases from $20 to $60. Under paragraph (d)(4)(ii) of this section, AX’s basis in Asset 1 increases from $20 to $60 because Asset 1 is the appreciated property treated as the subject of the exchange.

Example 2. Distribution of Stock of the Corporate Partner – pro rata distribution. (i) The facts are the same as in Example 1(i). AX liquidates in Year 9, when Asset 1 and the X stock each have a fair market value of $200. X and A each receive 50% of Asset 1 and 50% of the X stock in the liquidation. At the time AX liquidates, X’s basis in its AX partnership interest is $60 and A’s basis in its AX partnership interest is $100.

(ii) When AX liquidates, X’s interests in its stock and in Asset 1 do not change. Thus, the liquidation is not a Section 337(d) Transaction because it does not have the effect of an exchange by X of appreciated property for Stock of the Corporate Partner.

(iii) Paragraph (e) of this section applies because the distributed X stock was the subject of a previous Section 337(d) Transaction and because section 732(f) does not apply. Under § 1.732–1T(c)(1)(iii), the distribution to X of X stock is deemed to immediately precede the distribution of 50% of Asset 1 to X for purposes of determining X’s basis in the distributed property. For purposes of determining X’s basis in Asset 1 and X’s gain on distribution, the basis of the distributed X stock is treated as $50, the greater of $50 (50% of the stock’s $100 basis in the hands of the partnership), or $50, the fair market value of that distributed X stock ($100) less X’s allocable share of gain from the distributed X stock if AX had sold all of its assets in a fully taxable transaction for cash in an amount equal to the fair market value of such property immediately before the distribution ($50). Thus, X reduces its basis in its partnership interest by $50 prior to the distribution of Asset 1. Accordingly, X’s basis in the distributed portion of Asset 1 is $10. Because AX’s basis in the distributed X stock immediately before the distribution ($50) does not exceed X’s basis in its AX partnership interest immediately before the distribution ($60), X recognizes no gain under paragraph (e)(3) of this section.

Example 3. Distribution of Stock of the Corporate Partner – non pro rata distribution. (i) The facts are the same as Example 2(i), except that when AX liquidates, X receives 75% of the X stock and 25% of Asset 1 and A receives 25% of the X stock and 75% of Asset 1.

(ii) The liquidation of AX causes X’s interest in X stock to increase from $100 to $150 and its interest in Asset 1 to decrease from $100 to $50. Thus, AX’s liquidating distributions of X stock and Asset 1 to X are a Section 337(d) Transaction because the distributions have the effect of an exchange by X of $50 of Asset 1 for $50 of X stock.

(iii) X must recognize gain with respect to Asset 1 to prevent the circumvention of section 311(b) principles. Under paragraph (e)(1) of this section, paragraph (d) of this section is applied as if X and A amended the AX partnership agreement to allocate to X a 100% interest in the distributed portion of the X stock. X must recognize gain equal to the product of X’s Gain Percentage and the gain from Asset 1 that X would have recognized (decreased, but not below zero, by any gain X recognized with respect to Asset 1 in the Section 337(d) Transaction under any other provision of this chapter) if, immediately before the Section 337(d) Transaction, AX had sold all of its assets in a fully taxable transaction for cash in an amount equal to the fair market value of such property.

(iv) If Asset 1 had been sold in a fully taxable transaction immediately before the amendment of the AX partnership agreement, X’s allocable share of gain would have been $90, or the sum of X’s $40 remaining gain under section 704(c) and $50 of the $100 post-contribution appreciation. X’s Gain Percentage is 50% (equal to a fraction, the numerator of which is X’s $50 interest in Asset 1 effectively exchanged for X stock, and the denominator of which is X’s $100 interest in Asset 1 immediately before the Section 337(d) Transaction). Thus, X recognizes $45 of gain ($90 multiplied by 50%) under the deemed redemption rule in paragraph (d) of this section. Under paragraph (d)(4)(i) of this section, X’s basis in its AX partnership interest increases from $60 to $105. Under paragraph (d)(4)(ii) of this section, AX’s basis in Asset 1 increases from $60 to $105 because Asset 1 is the appreciated property treated as the subject of the exchange.

(v) Paragraph (e) of this section applies because the distributed X stock was the subject of a previous Section 337(d) Transaction and because section 732(f) does not apply. Under § 1.732–1T(c)(1)(iii), AX is treated as first distributing the X stock to X before the distribution of 25% of Asset 1. For purposes of determining X’s basis in Asset 1 and X’s gain on distribution, the basis of the distributed X stock is treated as $100, the greater of $75 (75% of the stock’s $100 basis in the hands of the partnership) or $100, the fair market value of the distributed X stock ($150) less X’s allocable share of gain if the partnership had sold all of the X stock immediately before the distribution for cash in an amount equal to its fair market value ($50). Thus, X will reduce its basis in its partnership interest by $100 prior to the distribution of Asset 1. Accordingly, X’s basis in the distributed portion of Asset 1 is $5. Because AX’s basis in the distributed X stock immediately before the distribution as computed for purposes of this section ($100) does not exceed X’s basis in its AX partnership interest immediately before the distribution ($105), X recognizes no additional gain under paragraph (e)(3) of this section.

Example 4. Deemed redemption rule – subsequent purchase of Stock of the Corporate Partner. The facts are the same as Example 1(i), except that A contributes cash of $100 instead of X stock. In a later year, when the value of Asset 1 has not changed, AX uses the contributed cash to purchase X stock for $100. AX’s purchase of X stock has the effect of an exchange by X of appreciated property for X stock, and thus, is a Section 337(d) Transaction. X must recognize gain at the time, and to the extent, that X’s share of appreciated property (other than X stock) is reduced in exchange for X stock. Thus, the consequences of the partnership’s purchase of X stock are the same as those described in Example 1(ii) and (iii), resulting in X recognizing $40 of gain.

Example 5. Change in allocation ratios – amendment of partnership agreement. (i) The facts are the same as Example 2(i), except that in Year 9, AX does not liquidate, and the AX partnership agreement is amended to allocate to X 80% of the income, gain, loss, and deduction from the X stock and to allocate to A 80% of the income, gain, loss, and deduction from Asset 1. If AX had sold the partnership assets immediately before the change to the partnership agreement, X would have been allocated $90 of gain from Asset 1 and $50 of gain from the X stock.

(ii) The amendment to the AX partnership agreement causes X’s interest in its stock to increase from $100 (50% of the stock value immediately before the amendment of the agreement) to $160 (80% of stock value immediately following amendment of agreement) and its interest in Asset 1 to decrease from $100 to $40. Thus, the amendment of the partnership agreement is a Section 337(d) Transaction because the amendment has the effect of an exchange by X of $60 of Asset 1 for $60 of its stock.

(iii) X must recognize gain equal to the product of X’s Gain Percentage and the gain from Asset 1 that X would have recognized (decreased, but not below zero, by any gain X recognized with respect to Asset 1 in the Section 337(d) Transaction under any other provision of this chapter ) if, immediately before the Section 337(d) Transaction, AX had sold all of its assets in a fully taxable transaction for cash in an amount equal to the fair market value of such property. If Asset 1 had been sold in a fully taxable transaction immediately before the amendment of the AX partnership agreement, X’s allocable share of gain would have been $90, or the sum of X’s $40 remaining gain under section 704(c) and 50% of the $100 post-contribution appreciation. X’s Gain Percentage is 60% (equal to a fraction, the numerator of which is X’s $60 interest in Asset 1 effectively exchanged for X stock, and the denominator of which is X’s $100 interest in Asset 1 immediately before the Section 337(d) Transaction). Thus, X recognizes $54 of gain ($90 multiplied by 60%) under the deemed redemption rule in paragraph (d) of this section. Under paragraph (d)(4)(i) of this section, X’s basis in its AX partnership interest increases from $60 to $114. Under paragraph (d)(4)(ii) of this section, AX’s basis in Asset 1 increases from $60 to $114 because Asset 1 is the appreciated property treated as the subject of the exchange.

Example 6. Change in allocation ratios – admission and exit of a partner. (i) The facts are the same as Example 1(i). In addition, in Year 2, when the values of Asset 1 and the X stock have not changed, B contributes $100 of cash to AX in exchange for a one-third interest in the partnership. Upon the admission of B as a partner, X’s interest in Asset 1 decreases from $50 to $33.33, and its interest in B’s contributed cash increases. B’s admission is not a Section 337(d) Transaction because it does not have the effect of an exchange by X of its interest in Asset 1 for X stock. Accordingly, X does not recognize gain under paragraph (d) of this section.

(ii) In Year 9, when the values of Asset 1 and the X stock have not changed, the partnership distributes $50 of cash and 50% of Asset 1 (valued at $50) to B in liquidation of B’s interest. X and A are equal partners in all respects after the distribution. Upon the liquidation of B’s interest, X’s interest in Asset 1 decreases from $33.33 to $25, and its interest in X stock increases from $33.33 to $50. AX’s liquidation of B’s interest has the effect of an exchange by X of appreciated property for X stock, and thus, is a Section 337(d) Transaction.

(iii) Pursuant to paragraph (d)(2) of this section, X’s interest in X stock and other appreciated property held by the partnership is determined based on all facts and circumstances, including allocation and distribution rights in the partnership agreement. However, paragraph (d)(2) of this section also requires that X’s interest in its stock for purposes of paragraph (d) will never be less than the Corporate Partner’s largest interest (by value) in those shares of Stock of the Corporate Partner taken into account when the partnership previously determined whether there had been a Section 337(d) Transaction (regardless of whether the Corporate Partner recognized gain in the earlier transaction). Although X’s interest in X stock increases to $50 upon AX’s liquidation of B’s interest, X’s largest interest previously taken into account under paragraph (d)(1) of this section was $50. Thus, X’s interest in its stock is not considered to be increased, and X therefore recognizes no gain under paragraph (d) of this section, provided that the transactions did not occur as part of a plan or arrangement to circumvent the purpose of this section.

Example 7. Change in allocation ratios – plan to circumvent purpose of this section. (i) In Year 1, X, a corporation, and A, an individual, contribute a small amount of capital to newly-formed partnership AX, with X receiving a 99% interest in AX and A receiving a 1% interest in AX. AX borrows $100 from a third-party lender and uses the proceeds to purchase X stock, which is Stock of the Corporate Partner. Later, as part of a plan or arrangement to circumvent the purposes of this section, A contributes $100 of cash, which AX uses to repay the loan, and X contributes Asset 1 with a fair market value of $100 and basis of $20. After these contributions, A and X are equal partners in AX in all respects.

(ii) Pursuant to paragraph (d)(2) of this section, X’s interest in X stock and other appreciated property held by the partnership is determined based on all facts and circumstances, including allocation and distribution rights in the partnership agreement. Generally pursuant to paragraph (d)(2) of this section, X’s interest in X stock for purposes of paragraph (d) will never be less than the Corporate Partner’s largest interest (by value) in those shares of Stock of the Corporate Partner taken into account when the partnership previously determined whether there had been a Section 337(d) Transaction (regardless of whether the Corporate Partner recognized gain in the earlier transaction). This limitation does not apply, however, if the reduction in X’s interest in X’s stock occurred as part of a plan or arrangement to circumvent the purpose of this section. Because the transactions described in this example are part of a plan or arrangement to circumvent the purpose of this section, the limitation in paragraph (d)(2) of this section does not apply. Accordingly, the deemed redemption rule under paragraph (d) of this section applies to the transactions with the consequences described in Example 1(iii) of this section, resulting in X recognizing $40 of gain.

Example 8. Tiered partnership. (i) In Year 1, X, a corporation, and A, an individual, form partnership UTP. X contributes Asset 1 with a fair market value of $80 and a basis of $0 in exchange for an 80% interest in UTP. A contributes $20 of cash in exchange for a 20% interest in UTP. UTP and B, an individual, form partnership LTP as equal partners. UTP contributes Asset 1 and $20 of cash. B contributes X stock, which is Stock of the Corporate Partner, with a basis and fair market value of $100.

(ii) Pursuant to paragraph (g) of this section, the rules of this section shall apply to tiered partnerships in a manner that is consistent with the purpose set forth in paragraph (a) of this section. Pursuant to paragraph (d)(1) of this section, if X is in a partnership that engages in a Section 337(d) Transaction, X must recognize gain at the time, and to the extent, that X’s share of appreciated property is reduced in exchange for X stock. The formation of LTP causes X’s interest in X stock to increase from $0 to $40 and its interest in Asset 1 to decrease from $64 to $32. Thus, LTP’s formation is a Section 337(d) Transaction because the formation has the effect of an exchange by X of $32 of Asset 1 for $32 of X stock.

(iii) X must recognize gain with respect to Asset 1 to prevent the circumvention of section 311(b) principles. X must recognize gain equal to the product of X’s Gain Percentage and the gain from Asset 1 (decreased, but not below zero, by any gain X recognized with respect to Asset 1 in the Section 337(d) Transaction under any other provision of this chapter) that X would recognize if, immediately before the Section 337(d) Transaction, all assets were sold in a fully taxable transaction for cash in an amount equal to the fair market value of such property. If Asset 1 had been sold in a fully taxable transaction immediately before LTP’s formation, X’s allocable share of gain would have been $80 pursuant to section 704(c). X’s Gain Percentage is 50% (equal to a fraction, the numerator of which is X’s $32 interest in Asset 1 effectively exchanged for X stock, and the denominator of which is X’s $64 interest in Asset 1 immediately before the Section 337(d) Transaction). Thus, X recognizes $40 of gain ($80 multiplied by 50%) under the deemed redemption rule in paragraph (d) of this section. Under paragraphs (d)(4)(i) and (d)(4)(ii) of this section, X’s basis in its UTP partnership interest increases from $0 to $40, UTP’s basis in its LTP partnership interest increases from $20 to $60, and LTP’s basis in Asset 1 increases from $0 to $40 pursuant to paragraph (g) of this section.

(i) Effective/applicability date. This section applies to transactions occurring on or after June 12, 2015.

(j) Expiration date. This section expires on June 11, 2018.

Par. 3. Section 1.732–1 is amended by revising paragraphs (c)(1) and (5) to read as follows:

* * * * *

(c) * * * (1) [Reserved]. For further guidance, see § 1.732–1T(c)(1).

* * * * *

(5) Effective/applicability date—(i) In general. This paragraph (c) applies to distributions of property from a partnership that occur on or after December 15, 1999.

(ii) [Reserved]. For further guidance, see § 1.732–1T(c)(5)(ii).

* * * * *

Par. 4. Section 1.732–1T is added to read as follows:

(a) and (b) [Reserved]. For further guidance, see § 1.732–1(a) and (b).

(c) Allocation of basis among properties distributed to a partner—(1) General rule—(i) Unrealized receivables and inventory items. Except as provided in paragraph (c)(1)(iii) of this section, the basis to be allocated to properties distributed to a partner under section 732(a)(2) or (b) is allocated first to any unrealized receivables (as defined in section 751(c)) and inventory items (as defined in section 751(d)(2)) in an amount equal to the adjusted basis of each such property to the partnership immediately before the distribution. If the basis to be allocated is less than the sum of the adjusted bases to the partnership of the distributed unrealized receivables and inventory items, the adjusted basis of the distributed property must be decreased in the manner provided in § 1.732–1(c)(2)(i). See § 1.460–4(k)(2)(iv)(D) for a rule determining the partnership’s basis in long-term contract accounted for under a long-term contract method of accounting.

(ii) Other distributed property. Any basis not allocated to unrealized receivables or inventory items under paragraph (c)(1)(i) of this section or to stock of persons that control the corporate partner or to the corporate partner’s stock under paragraph (c)(1)(iii) of this section is allocated to any other property distributed to the partner in the same transaction by assigning to each distributed property an amount equal to the adjusted basis of the property to the partnership immediately before the distribution. However, if the sum of the adjusted bases to the partnership of such other distributed property does not equal the basis to be allocated among the distributed property, any increase or decrease required to make the amounts equal is allocated among the distributed property as provided in § 1.732–1(c)(2).

(iii) Stock distributed to the corporate partner. If a partnership makes a distribution described in § 1.337(d)–3T(e)(1), then for purposes of this section, the basis to be allocated to properties distributed under section 732(a)(2) or (b) is allocated first to the Stock of the Corporate Partner, as defined in § 1.337(d)–3T(c)(2), before the distribution of any other property (other than cash). The amount allocated to the Stock of the Corporate Partner is as provided in § 1.337(d)–3T(e)(2).

(2) through (5)(i) [Reserved]. For further guidance, see § 1.732–1(c)(2) through (c)(5)(i).

(ii) Exception. Notwithstanding paragraph (c)(5)(i), the first sentence of each of paragraphs (c)(1)(i) and (c)(1)(ii) of this section, and paragraph (c)(1)(iii) of this section in its entirety, apply to distributions of Stock of the Corporate Partner, as defined in § 1.337(d)–3T(c)(2), that occur on or after June 12, 2015.

(d) and (e) [Reserved]. For further guidance, see § 1.732–1(d) and (e).

(f) Expiration date. This section expires on June 11, 2018.

Approved June 1, 2015

Under paragraph (a)(1)(i) of the 2012 final regulations, a health insurance issuer offering group health insurance coverage must provide an SBC to a group health plan (or its sponsor) upon an application by the plan for health coverage. The issuer must provide the SBC as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application. The Departments proposed to add language to clarify that, under the 2012 final regulations, a health insurance issuer offering group health insurance coverage (or plan, if applicable, under paragraph (a)(1)(ii), as discussed below) is not required to automatically provide the SBC again if the issuer already provided the SBC before application to any entity or individual, provided there is no change in the information required to be in the SBC.

The comments the Departments received on this clarification generally supported the proposed language and, accordingly, these final regulations finalize the language of the proposed regulations without change. Therefore, these final regulations include language clarifying that, if the issuer provides the SBC upon request before application for coverage, the requirement to provide an SBC upon application is deemed satisfied, and the issuer is not required to automatically provide another SBC upon application to the same entity or individual, provided there is no change to the information required to be in the SBC. However, if there has been a change in the information required to be included in the SBC, a new SBC that includes the changed information must be provided upon application (that is, as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application).

Under paragraph (a)(i)(B) of the 2012 final regulations, if there is any change in the information required to be in the SBC that was provided upon application and before the first day of coverage, the issuer must update and provide a current SBC to the plan (or its sponsor) no later than the first day of coverage. If the information is unchanged, the issuer does not need to provide the SBC again in connection with coverage for that plan year, except upon request. The December 2014 proposed regulations stated that if the plan sponsor is negotiating coverage terms after an application has been filed and the information required to be in the SBC changes, an updated SBC is not required to be provided to the plan or its sponsor (unless an updated SBC is requested) until the first day of coverage. The updated SBC should reflect the final coverage terms under the policy, certificate, or contract of insurance that was purchased.

Some commenters supported the clarification and stated that if there is a change in the information required, a new SBC that includes the changed information must be provided upon application. Other commenters stated that enrollees in both the group and individual markets need to know of pending plan changes during open and special enrollment periods so that they can make informed decisions about their plan options.

These final regulations finalize the language of the proposed regulations without change. Therefore, if the plan sponsor is negotiating coverage terms after an application has been filed and the information required to be in the SBC changes, an updated SBC is not required to be provided to the plan or its sponsor (unless an updated SBC is requested) until the first day of coverage. The updated SBC is required to reflect the final coverage terms under the policy, certificate, or contract of insurance that was purchased.

Under paragraph (a)(1)(ii) of 2012 final regulations, a group health plan (including the plan administrator), and a health insurance issuer offering group health insurance coverage, must provide an SBC to a participant or beneficiary^[10] with respect to each benefit package offered by the plan or issuer for which the participant or beneficiary is eligible.^[11] The December 2014 proposed regulations clarified that if the plan or issuer provides the SBC prior to application for coverage, the plan or issuer is not required to automatically provide another SBC upon application, if there is no change to the information required to be in the SBC. If there is any change to the information required to be in the SBC by the time the application is filed, the plan or issuer must update and provide a current SBC as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application.

The comments the Departments received on this proposal generally supported adopting the language of the proposed regulations, which incorporates this clarification of the 2012 final regulations. Therefore, these final regulations provide that if an SBC was provided upon request before application, the requirement to provide the SBC upon application is deemed satisfied, provided there is no change to the information required to be in the SBC. However, if there has been a change in the information required to be in the SBC, a new SBC that includes the updated information must be provided as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application.

Under the 2012 final regulations, if there is any change to the information required to be in the SBC that was provided upon application and before the first day of coverage, the plan or issuer must update and provide a current SBC to a participant or beneficiary no later than the first day of coverage. The December 2014 proposed regulations addressed how to satisfy the requirement to provide an SBC when the terms of coverage are not finalized. Those proposed regulations proposed that if the plan sponsor is negotiating coverage terms after an application has been filed and the information required to be in the SBC changes, the plan or issuer is not required to provide an updated SBC (unless an updated SBC is requested) until the first day of coverage. The updated SBC would be required to reflect the final coverage terms under the policy, certificate, or contract of insurance that was purchased. The Departments did not receive comments relating to this provision, and, therefore, these final regulations finalize the language of the proposed regulations without change.

Under the 2012 final regulations, the plan or issuer must also provide the SBC to individuals enrolling through a special enrollment period, also called special enrollees.^[12] Special enrollees must be provided with an SBC no later than when a summary plan description is required to be provided under the timeframe set forth in ERISA section 104(b)(1)(A) and its implementing regulations, which is 90 days from enrollment.

The December 2014 proposed regulations followed the approach of the 2012 final rules with respect to this requirement and did not include a proposed change. The proposed regulations provided that, to the extent individuals who are eligible for special enrollment would like to receive SBCs earlier than this timeframe, they may request an SBC with respect to any particular plan, policy, or benefit package and the SBC is required to be provided as soon as practicable, but in no event later than seven business days following receipt of the request. The Departments received several comments relating to the timeframe. While some commenters supported the existing requirement, other commenters stated that the Departments should require plans and issuers to provide the SBC to special enrollees upon enrollment or by the first day of coverage. Some commenters stated that rules should require plans and issuers to treat special enrollees the same as applicants for coverage, which would require provision of the SBC as soon as practicable following receipt of an application, but in no event later than seven business days following receipt of the application.

The Departments recognize the importance of special enrollees having information about a plan, policy, or benefit package for which they are eligible; however, special enrollees have the opportunity to obtain this information by requesting the SBC. Accordingly, these regulations retain the provision of the proposed regulations regarding special enrollees without change. To the extent that individuals who are eligible for special enrollment and are contemplating their coverage options would like to receive SBCs earlier, they may always request an SBC with respect to any particular plan, policy, or benefit package, and the SBC is required to be provided as soon as practicable, but in no event later than seven business days following receipt of the request. Therefore, these final regulations continue to provide that the plan or issuer must provide the SBC to individuals enrolling through a special enrollment period, also called special enrollees, no later than when a summary plan description is required to be provided under the timeframe set forth in ERISA section 104(b)(1)(A) and its implementing regulations, which is 90 days from enrollment.

Paragraph (a)(1)(iii) of the 2012 final regulations sets forth three special rules to streamline provision of the SBC and avoid unnecessary duplication with respect to group health coverage. In addition to retaining these three existing special rules, the Departments proposed adding two additional provisions, and codifying an enforcement safe harbor set forth in a previous FAQ,^[13] to ensure participants and beneficiaries receive information while preventing unnecessary duplication. The first proposed provision sought to address circumstances where an entity required to provide an SBC with respect to an individual has entered into a binding contract with another party to provide the SBC to the individual. In such a case, the proposed regulations stated that the entity would be considered to satisfy the requirement to provide the SBC with respect to the individual if specified conditions are met:

(1) The entity monitors performance under the contract;^[14]

(2) If the entity has knowledge that the SBC is not being provided in a manner that satisfies the requirements of this section and the entity has all information necessary to correct the noncompliance, the entity corrects the noncompliance as soon as practicable; and

(3) If the entity has knowledge the SBC is not being provided in a manner that satisfies the requirements of this section and the entity does not have all information necessary to correct the noncompliance, the entity communicates with participants and beneficiaries who are affected by the noncompliance regarding the noncompliance, and begins taking significant steps as soon as practicable to avoid future violations.

In response to this proposal, some commenters expressed concern that the proposed approach would permit circumstances where a group health plan that contracts with a third party administrator is deemed compliant with the requirements, although certain participants and beneficiaries under the plan have not received an SBC. On the other hand, the Departments received comments recommending the final regulations eliminate the requirement to monitor the performance of contractors, arguing that it is unnecessary and unduly burdensome.

In light of all the comments received, the Departments finalize the proposed approach without change. The approach set forth by the Departments works to achieve the goals of preventing unnecessary duplication for plans and issuers, while incorporating safeguards to ensure that participants and beneficiaries receive the requisite information. The Departments believe that the requirement to monitor the performance under the contract is necessary to ensure that participants and beneficiaries receive the information to which they are entitled. The Departments may provide additional guidance if the Departments become aware of situations where participants and beneficiaries are not being provided SBCs in accordance with these final regulations.

The second provision proposed by the Departments addressed unnecessary duplication with respect to a group health plan that uses two or more insurance products provided by separate issuers to insure benefits under the plan. The Departments recognize that a plan sponsor may purchase an insurance product for certain coverage from a particular issuer and purchase a separate insurance product or self-insure with respect to other coverage (such as outpatient prescription drug coverage). In these circumstances, the first issuer may or may not know of the existence of other coverage, or whether the plan sponsor has arranged the two benefit packages as a single plan or two separate plans.

To address these arrangements, the December 2014 proposed regulations proposed that, with respect to a group health plan that uses two or more insurance products provided by separate issuers, the group health plan administrator is responsible for providing complete SBCs with respect to the plan. The group health plan administrator may contract with one of its issuers (or other service providers) to perform that function. Absent a contract to perform the function, an issuer has no obligation to provide coverage information for benefits that it does not insure. The comments the Departments received on this proposed provision generally supported the approach, and therefore these regulations also finalize this rule without change.

To address concerns regarding unnecessary duplication in situations where plans may have benefits provided by more than one issuer, the Departments set forth an enforcement safe harbor in an FAQ on May 11, 2012,^[15] which permitted the provision of multiple partial SBCs if certain conditions were satisfied. The Departments extended this enforcement safe harbor for one year on April 23, 2013,^[16] and indefinitely on May 2, 2014.^[17] The Departments requested comment on whether to codify this policy in the final regulations.

Some commenters supported the policy in the enforcement safe harbor and either requested the Departments extend the enforcement safe harbor or codify it in regulations. Other commenters requested that the Departments require plan administrators to synthesize the information into a single SBC in order to meet the SBC content requirements when two or more insurance products are provided by separate issuers with respect to a single group health plan.

These final regulations codify this enforcement safe harbor, which permits a group health plan administrator to synthesize the information into a single SBC or provide multiple partial SBCs that, together, provide all the relevant information to meet the SBC content requirements.

Paragraph (a)(1)(iv) of the HHS 2012 final regulations sets forth standards applicable to individual health insurance coverage, under which the provision of the SBC by an issuer offering individual market coverage largely parallels the group market requirements described above, with only those changes necessary to reflect the differences between the two markets. The rules provide that a health insurance issuer offering individual health insurance coverage must provide an SBC to an individual or dependent upon receiving an application for any health insurance policy as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application.^[18] If there is any change in the information required to be in the SBC that was provided upon application and before the first day of coverage, the issuer must update and provide a current SBC to an individual or dependent no later than the first day of coverage.

The December 2014 proposed regulations proposed to clarify when the issuer must provide the SBC again if the issuer already provided the SBC prior to application. HHS proposed that if the issuer provides the SBC prior to application for coverage, the issuer is not required to automatically provide another SBC upon application, if there is no change to the information required to be in the SBC. If there is any change to the information required to be in the SBC that was provided prior to application for coverage by the time the application is filed, the issuer must update and provide a current SBC to the same individual or dependent as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application.

The comments received on this proposal generally supported adopting the language of the proposed regulation. Therefore, these final regulations provide that if an SBC was provided upon request before application, the requirement to provide the SBC upon application is deemed satisfied, provided there is no change to the information required to be in the SBC. However, if there has been a change in the information that is required to be in the SBC, a new SBC that includes the changed information must be provided as soon as practicable following receipt of the application, but in no event later than seven business days following receipt of the application.

HHS also proposed to address situations where an issuer offering individual market insurance coverage, consistent with applicable Federal and State law, automatically reenrolls an individual and any dependents into a different plan or product than the plan in which these individuals were previously enrolled. If the issuer automatically re-enrolls an individual covered under a policy, certificate, or contract of insurance (including every dependent) into a policy, certificate, or contract of insurance under a different plan or product, HHS proposed that the issuer would be required to provide an SBC with respect to the coverage in which the individual (including every dependent) will be enrolled, consistent with the timing requirements that apply when the policy is renewed or reissued. The comments received regarding this proposal supported this proposed approach. Therefore, these final regulations finalize the proposed approach without change.

Student health insurance coverage is a type of individual health insurance coverage provided pursuant to a written agreement between an institution of higher education and a health insurance issuer to students enrolled in that institution of higher education, and their dependents, that meet certain specified conditions.^[19] The December 2014 proposed regulations proposed to extend an anti-duplication rule similar to that provided with respect to group health coverage to student health insurance coverage. HHS proposed that the requirement to provide an SBC with respect to an individual would be considered satisfied for an entity (such as an institution of higher education) if another party (such as a health insurance issuer) provides a timely and complete SBC to the individual. HHS solicited comments on whether or not a requirement to monitor the provisioning of the SBC in this circumstance should be added.

The comments received generally supported this proposal. Most of the commenters supported requiring the entity that is contracting the provisioning of the SBC to a different entity to monitor the contract to ensure individuals receive an SBC. However, a few commenters stated that such a requirement would be unnecessary and unduly burdensome.

Considering the comments received, these final regulations adopt an anti-duplication provision with respect to providing SBCs for student health insurance coverage, with the addition of a duty to monitor that parallels the duty to monitor that is being finalized with respect to the anti-duplication rule for group health plans. HHS believes that the requirement to monitor the performance under the contract is necessary to ensure that individuals receive the information to which they are entitled. HHS may provide additional guidance if the Departments become aware of situations where individuals are not being provided SBCs in accordance with these final regulations.

PHS Act section 2715(b)(3) generally provides that the SBC must include nine statutory content elements. The 2012 final regulations added three content elements: (1) for plans and issuers that maintain one or more networks of providers, an Internet address (or similar contact information) for obtaining a list of the network providers; (2) for plans and issuers that use a formulary in providing prescription drug coverage, an Internet address (or similar contact information) for obtaining information on prescription drug coverage under the plan or coverage; and (3) an Internet address for obtaining the uniform glossary, as well as a contact phone number to obtain a paper copy of the uniform glossary, and a disclosure that paper copies of the uniform glossary are available.

One of the statutory content elements is a statement of whether the plan or coverage provides minimum essential coverage (MEC) as defined under section 5000A(f) of the Code, and whether the plan’s or coverage’s share of the total allowed costs of benefits provided under the plan or coverage is not less than 60% of those costs. In April 2013, the Departments issued an updated SBC template (and sample completed SBC) with the addition of statements regarding whether the plan or coverage provides MEC (as defined under section 5000A(f) of the Code) and whether the plan or coverage meets the minimum value (MV) requirements.^[20] In Affordable Care Act Implementation FAQs Part XIV, issued contemporaneously with the updated SBC template in April 2013, the Departments stated that this language is required to be included in SBCs provided with respect to coverage beginning on or after January 1, 2014.^[21]

The Departments also stated in Affordable Care Act Implementation FAQs Part XIV that if a plan or issuer was unable to modify the SBC template for these disclosures, the Departments would not take any enforcement action against a plan or issuer for using the original template authorized at the time the 2012 final regulations were issued, provided that the SBC was furnished with a cover letter or similar disclosure stating whether the plan or coverage does or does not provide MEC and whether the plan’s or coverage’s share of the total allowed costs of benefits provided under the plan or coverage does or does not meet the MV standard under the Affordable Care Act.^[22] As stated in the FAQ issued on March 30, 2015, the Departments anticipate finalizing the new template and associated documents by January 2016. Therefore, until the new template and associated documents are finalized and applicable, plans and issuers may continue to rely on the flexibility provided in Affordable Care Act Implementation FAQs Part XIV ^[23] and the Departments will not take enforcement action against a plan or issuer that provides an SBC with a cover letter or similar disclosure with the required MEC and MV statements.^[24]

Under section 1303(b)(3)(A) of the Affordable Care Act and implementing regulations at 45 CFR 156.280(f), a Qualified Health Plan (QHP) issuer that elects to offer a QHP that provides coverage of abortion services for which federal funding is prohibited (non-excepted abortion services) must provide a notice to enrollees, as part of the SBC provided at the time of enrollment, of coverage of such services.

The December 2014 proposed regulations proposed to require issuers of QHPs sold through an individual market Exchange to disclose on the SBC these QHPs whether abortion services are covered or excluded, and whether coverage is limited to services for which federal funding is allowed (excepted abortion services). Several commenters supported this proposal. Some commenters recommended that the requirement to disclose coverage or exclusion of abortion services be expanded to all plans and issuers offering coverage in all markets, not only issuers of QHPs in the individual market. Finally, some commenters recommended limiting the required disclosure to only a QHP issuer that offers a QHP providing coverage of non-excepted abortion services.

After consideration of all the comments regarding this proposal, these final regulations adopt the proposed approach without change. These final regulations require that QHP issuers must disclose on the SBC for QHPs sold through an individual market Exchange whether abortion services are covered or excluded, and whether coverage is limited to excepted abortion services. HHS feels that this level of transparency is important to facilitate comparisons across individual market QHPs, and to avoid confusion regarding which abortion services are or are not covered.

The December 2014 proposed regulations were published contemporaneously with proposed updates to the SBC template, instructions, and associated documents. The proposed updates to the SBC template instructions and associated documents included guidance for QHP issuers regarding the wording and placement of the abortion disclosure requirement on the SBC. We received numerous comments regarding the proposed language for the disclosure, as well as the placement of the disclosure on the SBC template. As previously stated, the Departments anticipate finalizing the new template and associated documents, separately from this final rule, by January 2016. HHS will consider and address the comments regarding the wording and placement of the disclosure in finalizing the new template and associated documents. HHS acknowledges that QHP issuers will not have final guidance regarding the specific wording and placement of this disclosure until the template, instructions, and associated documents are finalized. Therefore, until the new template and associated documents are finalized and applicable, individual market QHP issuers may adopt any reasonable wording and placement of the disclosure on the SBC. Individual market QHP issuers may also provide the disclosure in a cover letter or other similar disclosure provided with the SBC. Consistent with the effective dates described in section K of this final rule, this requirement is applicable for individual market QHP issuers for SBCs issued in connection with coverage that begins on or after January 1, 2016.

For Multi-State Plan issuers, the Office of Personnel Management will issue guidance about the wording and placement of the abortion disclosure requirement on the SBC.

The statute provides that the SBC must include “a contact number for the consumer to call with additional questions and an Internet web address where a copy of the actual individual coverage policy or group certificate of coverage can be reviewed and obtained.” The 2012 final regulations state that the SBC must include “contact information for questions and obtaining a copy of the plan document or the insurance policy, certificate, or contract of insurance (such as a telephone number for customer service and an Internet address for obtaining a copy of the plan document or the insurance policy, certificate, or contract of insurance).” These final regulations clarify that all plans and issuers must include on the SBC contact information for questions.

Questions have arisen as to whether PHS Act section 2715(b)(3)(i) (which requires that an SBC include “. . . an Internet web address where a copy of the actual individual coverage policy or group certificate of coverage can be reviewed and obtained”) and associated regulations require that all plans and issuers must post underlying plan documents automatically on an Internet website. Some commenters stated that plans and issuers should be required to post actual policy and underlying plan documents as well as direct links to the plan’s prescription drug formulary. Other commenters stated that the Departments should permit plan sponsors to decide whether the underlying plan documents are posted online. Others stated that mandating self-insured group health plans to post underlying plan information online is redundant and burdensome.

The statutory language regarding this requirement refers specifically to an “individual coverage policy” and “group certificate of coverage.” This statutory provision does not reference group health plan coverage that provides benefits on a self-insured basis. While the Departments recognize that such information may be useful to consumers, based on the statutory language, the Departments may only require issuers to post the underlying individual coverage policy or group certificate of coverage to an Internet address. Accordingly, these final regulations provide that issuers must also include an Internet web address where a copy of the actual individual coverage policy or group certificate of coverage can be reviewed and obtained. The Departments note that these final regulations require these documents to be easily available to individuals, plan sponsors, and participants and beneficiaries shopping for coverage prior to submitting an application for coverage. For the group market only, because the actual “certificate of coverage” is not available until after the plan sponsor has negotiated the terms of coverage with the issuer, an issuer is permitted to satisfy this requirement with respect to plan sponsors that are shopping for coverage by posting a sample group certificate of coverage for each applicable product. After the actual certificate of coverage is executed, it must be easily available to plan sponsors and participants and beneficiaries via an Internet web address.

The Departments note that nothing in this section prohibits issuers and group health plan sponsors from making additional underlying group health plan or policy documents more readily available to participants and beneficiaries, including by posting them on the internet. HHS encourages issuers to make all relevant policy documents easily accessible to individuals shopping for, and enrolled in, coverage to facilitate comparison of policy options and understanding of benefits available under a particular plan or policy.

The Departments also note that, separate from the SBC requirement, provisions of other applicable laws require disclosure of plan documents and other instruments governing the plan. For example, ERISA section 104 and the Department of Labor’s implementing regulations^[25] provide that, for plans subject to ERISA, the plan documents and other instruments under which the plan is established or operated must generally be furnished by the plan administrator to plan participants^[26] upon request. In addition, the Department of Labor’s claims procedure regulations (applicable to ERISA plans), as well as the Departments’ claims and appeals regulations under the Affordable Care Act (applicable to all non-grandfathered group health plans and health insurance issuers in the group and individual markets),^[27] set forth rules regarding claims and appeals, including the right of claimants (or their authorized representatives) upon appeal of an adverse benefit determination (or a final internal adverse benefit determination) to be provided by the plan or issuer, upon request and free of charge, reasonable access to and copies of all documents, records, and other information relevant to the claimant’s claim for benefits. Plans and issuers must continue to comply with these provisions and any other applicable laws.

PHS Act section 2715 sets forth standards related to the appearance and language of the SBC. Specifically, the SBC is to be presented in a culturally and linguistically appropriate manner utilizing terminology understandable by the average plan enrollee, in a uniform format that does not exceed four double-sided pages in length, and does not include print smaller than 12-point font. Plans and issuers have informed the Departments that they are concerned about including all of the required information in the SBC while also satisfying the limitation on the length of the document of four double-sided pages. Comments were invited on potential ways to reconcile the statutory page limit with the statutory content, appearance, and format requirements, particularly the need for the summary to present information in an understandable, accurate, and meaningful way that facilitates comparisons of health options, including those that have disparate and comparatively complex features. Specifically, the Departments invited comments on the sorts of plans that have difficulty meeting the statutory limit, and what other sorts of accommodations may be appropriate for those plans.

Some commenters expressed concern regarding the difficulty of complying with the statutory page limit. One commenter stated that it is difficult to provide customers with clear and accurate information while describing the benefits provided under certain complex plan designs. As discussed above, the statute requires that the SBC not exceed four pages, and these final regulations retain the interpretation set forth in the 2012 final regulations that the SBC can be four double-sided pages. The Departments will address specific issues related to completing the four-page template, as well as the issues plans and issuers encounter meeting these requirements with the finalization of the new template and associated documents, separate from this final rule.

To facilitate faster and less burdensome disclosure of the SBC and to be consistent with PHS Act section 2715(d)(2), which permits disclosure in either paper or electronic form, the 2012 final regulations set forth rules to permit greater use of electronic transmittal of the SBC. For SBCs provided electronically by a plan or issuer to participants and beneficiaries, the 2012 final regulations make a distinction between a participant or beneficiary who is already covered under the group health plan and a participant or beneficiary who is eligible for coverage but not enrolled in a group health plan. For participants and beneficiaries who are already covered under the group health plan, the 2012 final regulations permit provision of the SBC electronically, if the requirements of the Department of Labor’s regulations at 29 CFR 2520.104b–1 are met. Paragraph (c) of those regulations includes an electronic disclosure safe harbor.^[28] For participants and beneficiaries who are eligible for but not enrolled in coverage, the 2012 final regulations permit the SBC to be provided electronically, if the format is readily accessible^[29] and a paper copy is provided free of charge upon request. Additionally, to reduce paper copies that may be unnecessary, if the electronic form is an Internet posting, the plan or issuer must timely advise the individual in paper form (such as a postcard) or email that the documents are available on the Internet, provide the Internet address, and notify the individual that the documents are available in paper form upon request. The Departments note that the rules for participants and beneficiaries who are eligible for but not enrolled in coverage are substantially similar to the requirements for an issuer providing an electronic SBC to a group health plan (or its sponsor) under paragraph (a)(4)(i) of the regulations. Finally, plans, and participants and beneficiaries (both those covered and those eligible but not enrolled), have the right to receive an SBC in paper form, free of charge, upon request.

In Affordable Care Act Implementation FAQs Part IX, question 1, the Departments adopted an additional safe harbor related to electronic delivery of SBCs.^[30] In the December 2014 proposed regulations, the Departments proposed to codify this safe harbor through rulemaking. Commenters generally supported permitting electronic delivery of SBCs. Some commenters requested the Departments adopt the safe harbor outlined in the FAQ. Other commenters recommended adopting the safe harbor standard for all individuals receiving the SBC without making any distinction as to whether the individual is already enrolled in the plan.

These final regulations adopt the safe harbor for electronic delivery set forth in the FAQ without expanding the application of the safe harbor to all individuals entitled to receive the SBC. The Departments note that these rules provide a mechanism by which all SBCs may be provided electronically. The Departments believe that the approach set forth in the FAQ achieves an appropriate balance between ensuring participants and beneficiaries receive the necessary information, while allowing plans and issuers to provide such information electronically. Thus, SBCs may be provided electronically to participants and beneficiaries in connection with their online enrollment or online renewal of coverage under the plan. SBCs also may be provided electronically to participants and beneficiaries who request an SBC online. In either case, the individual must have the option to receive a paper copy upon request.

The HHS 2012 final regulations established a provision under paragraph (a)(4)(iii)(C) that deems health insurance issuers in the individual market to be in compliance with the requirement to provide the SBC to an individual requesting summary information about a health insurance product prior to submitting an application for coverage if the issuer provides the content required under paragraph (a)(2) of the regulations to the federal health reform Web portal described in 45 CFR 159.120. Issuers must submit all of the content required under paragraph (a)(2), as specified in guidance by the Secretary, to be deemed compliant with the requirement to provide an SBC to an individual requesting summary information prior to submitting an application for coverage. HHS intends to continue to facilitate the operation of this deemed compliance option for individual market issuers. An issuer must provide all SBCs other than the ‘‘shopper’' SBC contemplated in the deemed compliance provision as required under the 2012 final regulations (and any future final regulations), including providing the SBC at the time of application and renewal.

The Departments note that, consistent with the 2012 final regulations, an issuer in the individual market must provide the SBC in a manner that can reasonably be expected to provide actual notice regardless of the format. An issuer in the individual market satisfies the form requirements set forth in the 2012 final regulations if it does at least one of the following: (1) Hand-delivers a paper copy of the SBC to the individual or dependent; (2) mails a paper copy of the SBC to the mailing address provided to the issuer by the individual or dependent; (3) provides the SBC by email after obtaining the individual’s or dependent’s agreement to receive the SBC or other electronic disclosures by email; (4) posts the SBC on the Internet and advises the individual or dependent in paper or electronic form, in a manner compliant with 45 CFR 147.200(a)(4)(iii)(A)(1) through (3), that the SBC is available on the Internet and includes the applicable Internet address; or (5) provides the SBC by any other method that can reasonably be expected to provide actual notice.

The 2012 final regulations also provide that the obligation to provide an SBC cannot be satisfied electronically in the individual market unless: the format is readily accessible; the SBC is displayed in a location that is prominent and readily accessible; the SBC is provided in an electronic form that can be electronically retained and printed; the SBC is consistent with the appearance, content, and language requirements; and the issuer notifies the individual that a paper SBC is available upon request without charge.^[31]

The December 2014 proposed regulations proposed to clarify the form and manner for SBCs provided by a self-insured non-Federal governmental plan. Under the proposal, such SBCs could be provided in paper form. Alternatively, such SBCs could be provided electronically if the plan conforms to either the substance of the provisions applicable to ERISA plans (in paragraph (a)(4)(ii) of the regulations) or to individual health insurance coverage (in paragraph (a)(4)(iii) of the regulations).

The Departments did not receive any comments regarding this proposal. Therefore, the Departments are finalizing the proposal without change, to allow for self-insured non-Federal governmental plans to provide an SBC in either paper form, or electronically if the plan conforms to either the substance of the provisions applicable to ERISA plans (in paragraph (a)(4)(ii) of the regulations) or to individual health insurance coverage (in paragraph (a)(4)(iii) of the regulations).

PHS Act section 2715(b)(2) provides that standards shall ensure that the SBC “is presented in a culturally and linguistically appropriate manner.” The 2012 final regulations provide that a plan or issuer for this purpose is considered to provide the SBC in a culturally and linguistically appropriate manner if the thresholds and standards of 45 CFR 147.136(e), implementing standards for the form and manner of notices related to internal claims appeals and external review, are met as applied to the SBC.^[32]

To help plans and issuers meet the language requirements of paragraph (a)(5) of the 2012 final regulations, as requested by commenters, HHS provided written translations of the SBC template, sample language, and the uniform glossary in Chinese, Navajo, Spanish, and Tagalog (the four languages with populations meeting the thresholds outlined in 45 CFR 147.136(e)).^[33] HHS may also make these materials available in other languages to facilitate voluntary distribution of SBCs to other individuals with limited English proficiency. The Departments requested comment on this standard, and on other potential standards that could facilitate consistency across the Departments’ programs.

Some commenters requested an additional standard that would require the translation of the SBC into any language spoken by 500 individuals or 5 percent of individuals in the plan’s service area or an employer’s workforce, whichever is less, and to include taglines in at least 15 languages on all SBCs that indicate the availability of translated SBCs and oral language services. Some commenters were concerned that the 10 percent standard for language and translation services is insufficient to present the SBC in a culturally and linguistically appropriate manner and cited different Federal standards for other disclosures. Other commenters supported the existing requirement from the 2012 final regulations or stated that the prevalence of speakers of a language in a particular state is the best criteria for identifying which language services should be provided.

The Departments believe that it is important to provide SBCs in a culturally and linguistically appropriate manner to ensure that individuals get the important information needed to properly evaluate coverage options. The standard established under the 2012 final regulations addresses the need to provide language services to ensure that consumers receive SBCs in an understandable format while balancing that need with the goal of keeping administrative costs down. Additionally, a rule based on a particular number or percentage of a plan’s population, rather than a county’s population, may increase administrative costs and make it difficult for plans and issuers to provide SBCs that comply with the page limitations. Therefore, these final rules continue to provide that a plan or issuer is considered to provide the SBC in a culturally and linguistically appropriate manner if the thresholds and standards of 45 CFR 147.136(e), implementing standards for the form and manner of notices related to internal claims appeals and external review, are met as applied to the SBC.^[34][35]

In general, PHS Act section 2715(f) provides that a group health plan (including its administrator), and a health insurance issuer offering group or individual health insurance coverage, that willfully fails to provide the information required under this section are subject to a fine. In the December 2014 proposed regulations, the Department of Labor proposed that it will use the same process and procedures for assessment of the civil fine as used for failure to file an annual report under 29 CFR 2560.502c–2 and 29 CFR part 2570, subpart C. In accordance with ERISA section 502(b)(3), 29 U.S.C. 1132(b)(3), the Secretary of Labor is not authorized to assess this fine against a health insurance issuer. Moreover, the IRS proposed to clarify that the IRS will enforce this section using a process and procedure consistent with section 4980D of the Code. The Departments did not receive comments on this proposal to utilize existing processes and procedures under ERISA and the Code and therefore finalize these proposals without change.

In August 2012, the Departments issued FAQs^[36] that provided a temporary nonenforcement policy with respect to group health plans providing Medicare Advantage benefits, which are Medicare benefits financed by the Medicare Trust Funds, for which the benefits are set by Congress and regulated by the Centers for Medicare & Medicaid Services. The December 2014 proposed regulations proposed to add language to codify this temporary relief and exempt from the SBC requirements a group health plan benefit package that provides Medicare Advantage benefits. Medicare Advantage benefits are not health insurance coverage, and Medicare Advantage organizations are not required to provide an SBC with respect to such benefits. Additionally, there are separately required disclosures required to be provided by Medicare Advantage organizations to ensure that enrollees in these plans receive the necessary information about their coverage and benefits.

The Departments did not receive comments opposing the proposal to exempt group health plans providing Medicare Advantage benefits from the SBC requirements. Therefore, these final regulations finalize without change the proposal to codify the relief and exempt from the SBC requirements a group health plan benefit package that provides Medicare Advantage benefits.

In May 2012, the Departments issued FAQs addressing insurance products that are no longer being offered for purchase (“closed blocks of business”). The Departments had provided temporary enforcement relief through an FAQ provided that certain conditions were met: (1) The insurance product is no longer being actively marketed; (2) the health insurance issuer stopped actively marketing the product prior to September 23, 2012, when the requirement to provide an SBC was first applicable to health insurance issuers; and (3) the health insurance issuer has never provided an SBC with respect to such product.^[37] The Departments reiterated that relief in the December 2014 proposed regulations, and we do so again in these final regulations. But, we again note that if an insurance product was actively marketed for business on or after September 23, 2012, and is no longer being actively marketed for business, or if the plan or issuer ever provided an SBC in connection with the product, the plan and issuer must provide the SBC with respect to such coverage, as required by PHS Act section 2715 and these final regulations.

The December 2014 proposed regulations proposed that these rules, if finalized, would apply for disclosures with respect to participants and beneficiaries who enroll or re-enroll in group health coverage through an open enrollment period (including re-enrollees and late enrollees) beginning on the first day of the first open enrollment period that begins on or after September 1, 2015. With respect to disclosures to participants and beneficiaries who enroll in group health coverage other than through an open enrollment period (including individuals who are newly eligible for coverage and special enrollees), the requirements were proposed to apply beginning on the first day of the first plan year that begins on or after September 1, 2015. For disclosures to plans, and to individuals and dependents in the individual market, these requirements were proposed to apply to health insurance issuers beginning on September 1, 2015. Comments received generally supported these applicability dates, except that a number of commenters suggested that the requirements apply with respect to the individual market for coverage beginning on or after January 1, 2016. These final regulations adopt the applicability dates as proposed, except that for disclosures to individuals and dependents in the individual market, the requirements apply to health insurance issuers with respect to SBCs issued for coverage that begins on or after January 1, 2016. Until these final regulations become applicable, plans and issuers must continue to comply with the 2012 final regulations, as applicable.

Executive Orders 12866 and 13563 direct agencies to assess all costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects; distributive impacts; and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. This rule has been designated a “significant regulatory action” under section 3(f) of Executive Order 12866. Accordingly, the rule has been reviewed by the Office of Management and Budget.

A regulatory impact analysis (RIA) must be prepared for major rules with economically significant effects ($100 million or more in any one year). As discussed below, the Departments have concluded that these final regulations would not have economic impacts of $100 million or more in any one year or otherwise meet the definition of an “economically significant rule” under Executive Order 12866. Nonetheless, consistent with Executive Orders 12866 and 13563, the Departments have provided an assessment of the potential benefits and the costs associated with these final regulations.

These final regulations are expected to have only small benefits and costs as they primarily provide clarifications of the previous 2012 final regulations and also incorporate into regulations previous guidance issued by the Departments that has taken the form of responses to frequently asked questions or enforcement safe harbors.^[38] The Departments have not been able to quantify these costs and benefits, but they are qualitatively discussed below.

The clarifications would help lower costs as they establish that duplicate SBCs do not have to be provided upon application if a previous SBC was provided and there have been no changes to the required information. The clarification also prevents unnecessary duplications for plans and issuers, while incorporating safeguards to ensure that participants and beneficiaries (and covered individuals and dependents) receive the required information. These final regulations also provide flexibility in providing SBCs for the situation where a plan has multiple issuers and also adopt the safe harbor for electronic delivery previously set forth in an FAQ, thereby reducing the cost of delivery.

These final regulations also require an issuer to provide an internet web address where a copy of the actual individual coverage policy or group certificate of coverage can be reviewed and obtained. The costs associated with this requirement are discussed in the Paperwork Reduction Act section below.

These final rules are not subject to the requirements of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et seq.), because these final regulations make no changes to the existing collection of information as defined in 44 U.S.C. 3502(3).

Please note that the proposed regulations included an ICR related to the revision of the SBC template that has been omitted in these final regulations as the Departments intend to utilize consumer testing and offer an opportunity for public comment before finalizing revisions to the SBC template. An analysis under the PRA will be conducted when the SBC template is finalized.

These final regulations require health insurance issuers offering group and individual health insurance coverage must include in the SBC an Internet web address where a copy of the actual individual coverage policy or group certificate of coverage can be reviewed and obtained. These documents are required to be easily available to individuals, plan sponsors, and participants and beneficiaries shopping for coverage prior to submitting an application for coverage. With respect to group health coverage, because the actual “certificate of coverage” is not available until after the plan sponsor has negotiated the terms of coverage with the issuer, an issuer is permitted to satisfy this requirement with respect to plan sponsors that are shopping for coverage by posting a sample group certificate of coverage for each applicable product. After the actual certificate of coverage is executed, it must be easily available to plan sponsors and participants and beneficiaries via an Internet web address.

Some commenters stated that requiring the individual coverage policy documents and group certificates of coverage be made available by posting to an Internet web address would be unduly burdensome because of the requirement to make the documents available to individuals and plan sponsors shopping for coverage, but not yet enrolled in coverage. The December 2014 proposed regulations estimated the burden for this requirement to be de minimis because the documents already exist and issuers already have web addresses where the materials can be made available. Additionally, HHS understands that issuers already frequently make these materials available online to individuals, plan sponsors, and participants and beneficiaries after enrollment in coverage. These final regulations clarify that these documents must be made available online to those shopping for coverage prior to enrollment as well. It is not expected that group health insurance issuers will be providing access to group certificates of coverage prior to execution of the final group certificate of coverage. Instead, HHS anticipates and expects that the sample group certificate of coverage that underlies the product being marketed and sold, and that have been filed with and approved by a state Department of Insurance, are what will be provided prior to the execution of the actual group certificate of coverage. Based on this HHS still believes that the requirement to make these documents available via an Internet web address will result in only a de minimis burden on issuers.

These final regulations make no other revisions to the existing collection of information. The December 2014 proposed regulations included an ICR related to the revision of the SBC template that has been omitted in these final regulations as the Departments intend to utilize consumer testing and offer an opportunity for public comment before finalizing revisions to the SBC template. An analysis under the PRA will be conducted when the SBC template is finalized.

The Department notes that persons are not required to respond to, and generally are not subject to any penalty for failing to comply with, an ICR unless the ICR has a valid OMB control number.

The 2015–2017 paperwork burden estimates are summarized as follows:

Type of Review: Revision.

Agency: Department of Health and Human Services.

Title: Summary of Benefits and Coverage Uniform Glossary

CMS Identifier (OMB Control Number): CMS-10407 (0938-1146).

Affected Public: Private sector.

Total Respondents: 126,500

Total Responses: 41,153,858

Frequency of Response: On-going.

Estimated Total Annual Burden Hours (three year average): 322,411 hours.

Estimated Total Annual Cost Burden (three year average): $7,207,361

The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes certain requirements with respect to Federal rules that are subject to the notice and comment requirements of section 553(b) of the Administrative Procedure Act (5 U.S.C. 551 et seq.) and which are likely to have a significant economic impact on a substantial number of small entities. Unless the head of an agency certifies that a proposed rule is not likely to have a significant economic impact on a substantial number of small entities, section 603 of the RFA requires that the agency present an initial regulatory flexibility analysis (IRFA) describing the rule’s impact on small entities and explaining how the agency made its decisions with respect to the application of the rule to small entities.

The RFA generally defines a ‘‘small entity’' as (1) a proprietary firm meeting the size standards of the Small Business Administration (SBA) (13 CFR 121.201) pursuant to the Small Business Act (15 U.S.C. 631 et seq.), (2) a nonprofit organization that is not dominant in its field, or (3) a small government jurisdiction with a population of less than 50,000. (States and individuals are not included in the definition of “small entity.”)

There are several different types of small entities affected by these final regulations. For issuers and third party administrators, the Departments use as their measure of significant economic impact on a substantial number of small entities a change in revenues of more than 3 to 5 percent. For plans, the Departments continue to consider a small plan to be an employee benefit plan with fewer than 100 participants.^[39] Further, while some large employers may have small plans, in general small employers maintain most small plans. Thus, the Departments believe that assessing the impact of this final rule on small plans is an appropriate substitute for evaluating the effect on small entities. The definition of small entity considered appropriate for this purpose differs, however, from a definition of small business that is based on size standards promulgated by the Small Business Administration (SBA) (13 CFR 121.201) pursuant to the Small Business Act (15 U.S.C. 631 et seq.).

The Departments carefully considered the likely impact of these final rules on small entities in connection with their assessment under Executive Order 12866. The incremental changes of these final regulations impose minimal additional costs, but also serve to reduce the costs of compliance by providing help to plans and service providers by providing clarifications. These final regulations also incorporate into regulations previous guidance from the Departments that has taken the form of responses to frequently asked questions or enforcement safe harbors. Accordingly, pursuant to section 605(b) of the RFA, the Departments hereby certify that these final regulations will not have a significant economic impact on a substantial number of small entities.

Section 202 of the Unfunded Mandates Reform Act (UMRA) of 1995 requires that agencies assess anticipated costs and benefits before issuing any final rule that includes a Federal mandate that could result in expenditure in any one year by State, local or Tribal governments, in the aggregate, or by the private sector, of $100 million in 1995 dollars updated annually for inflation. In 2015, that threshold level is approximately $144 million. These final regulations include no mandates on State, local, or Tribal governments. These final regulations propose requirements regarding standardized consumer disclosures that would affect private sector firms (for example, health insurance issuers offering coverage in the individual and group markets, and third-party administrators providing administrative services to group health plans), but we conclude that these costs would not exceed the $144 million threshold. Thus, the Departments of Labor and HHS conclude that these final regulations would not impose an unfunded mandate on State, local or Tribal governments or the private sector. Regardless, consistent with policy embodied in UMRA, the final requirements described in this notice of final rulemaking has been designed to be the least burdensome alternative for State, local and Tribal governments, and the private sector while achieving the objectives of the Affordable Care Act.

Executive Order 13132 outlines fundamental principles of federalism, and requires the adherence to specific criteria by Federal agencies in the process of their formulation and implementation of policies that have “substantial direct effects” on the States, the relationship between the national government and States, or on the distribution of power and responsibilities among the various levels of government. Federal agencies promulgating regulations that have federalism implications must consult with State and local officials and describe the extent of their consultation and the nature of the concerns of State and local officials in the preamble to the regulation.

In the Departments of Labor’s and HHS’ view, these final regulations have federalism implications because they would have direct effects on the States, the relationship between the national government and the States, or on the distribution of power and responsibilities among various levels of government relating to the disclosure of health insurance coverage information to consumers. Under these final regulations, all group health plans and health insurance issuers offering group or individual health insurance coverage, including self-funded non-federal governmental plans as defined in section 2791 of the PHS Act, would be required to follow uniform standards for compiling and providing a summary of benefits and coverage to consumers. Such Federal standards developed under PHS Act section 2715(a) would preempt any related State standards that require a summary of benefits and coverage that provides less information to consumers than that required to be provided under PHS Act section 2715(a).

In general, through section 514, ERISA supersedes State laws to the extent that they relate to any covered employee benefit plan, and preserves State laws that regulate insurance, banking, or securities. While ERISA prohibits States from regulating a plan as an insurance or investment company or bank, the preemption provisions of section 731 of ERISA and section 2724 of the PHS Act (implemented in 29 CFR 2590.731(a) and 45 CFR 146.143(a)) apply so that the requirements in title XXVII of the PHS Act (including those added by the Affordable Care Act) are not to be construed to supersede any provision of State law which establishes, implements, or continues in effect any standard or requirement solely relating to health insurance issuers in connection with individual or group health insurance coverage except to the extent that such standard or requirement prevents the application of a requirement of a Federal standard. The conference report accompanying HIPAA indicates that this is intended to be the “narrowest” preemption of State laws (See House Conf. Rep. No. 104–736, at 205, reprinted in 1996 U.S. Code Cong. & Admin. News 2018).

States may continue to apply State law requirements except to the extent that such requirements prevent the application of the Affordable Care Act requirements that are the subject of this rulemaking. Accordingly, States have significant latitude to impose requirements on health insurance issuers that are more restrictive than the Federal law. However, under these final rules, a State would not be allowed to impose a requirement that modifies the summary of benefits and coverage required to be provided under PHS Act section 2715(a), because it would prevent the application of these final rules’ uniform disclosure requirements.

In compliance with the requirement of Executive Order 13132 that agencies examine closely any policies that may have federalism implications or limit the policy making discretion of the States, the Departments of Labor and HHS have engaged in efforts to consult with and work cooperatively with affected States, including consulting with, and attending conferences of, the National Association of Insurance Commissioners and consulting with State insurance officials on an individual basis. It is expected that the Departments of Labor and HHS will act in a similar fashion in enforcing the Affordable Care Act, including the provisions of section 2715 of the PHS Act. Throughout the process of developing these final regulations, to the extent feasible within the applicable preemption provisions, the Departments of Labor and HHS have attempted to balance the States’ interests in regulating health insurance issuers, and Congress’ intent to provide uniform minimum protections to consumers in every State. By doing so, it is the Departments of Labor’s and HHS’ view that they have complied with the requirements of Executive Order 13132.

Pursuant to the requirements set forth in section 8(a) of Executive Order 13132, and by the signatures affixed to this final rule, the Departments certify that the Employee Benefits Security Administration and the Centers for Medicare & Medicaid Services have complied with the requirements of Executive Order 13132 for the attached final rules in a meaningful and timely manner.

For purposes of the Department of the Treasury it has been determined that this notice of final rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these final regulations. For a discussion of the impact of this final rule on small entities, please see section V.C. of this preamble. Pursuant to section 7805(f) of the Code, this notice of final rulemaking has been submitted to the Small Business Administration for comment on its impact on small business.

These final regulations are subject to the Congressional Review Act provisions of the Small Business Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. 801 et seq.), which specifies that before a rule can take effect, the Federal agency promulgating the rule shall submit to each House of the Congress and to the Comptroller General a report containing a copy of the rule along with other specified information, and has been transmitted to Congress and the Comptroller General for review.

Section 2010(c) of the Code allows the estate of a decedent who is survived by a spouse to make a portability election, which generally allows the surviving spouse to apply the decedent’s deceased spousal unused exclusion (DSUE) amount to the surviving spouse’s own transfers during life and at death. Under section 2010(c)(5)(A), a portability election is effective only if made on an estate tax return filed by the executor of the decedent’s estate within the time prescribed by law for filing such return. Section 20.2010–2T(a)(1) of the 2012 temporary regulations requires every estate electing portability of a decedent’s DSUE amount to file an estate tax return within nine months of the decedent’s date of death, unless an extension of time for filing has been granted.

A commenter requested that the final regulations address the availability of an extension of time under §§ 301.9100–2 and 301.9100–3 of the Procedure and Administration Regulations to elect portability under section 2010(c)(5)(A) of the Code. Section 301.9100–2(b) provides an automatic six-month extension of time for making certain statutory and regulatory elections if the return is timely filed. Because the portability election is deemed to be made by the timely filing of a complete and properly prepared estate tax return, this relief provision will not be helpful with regard to the portability election unless the return that was timely filed was not complete or properly prepared and that insufficiency is corrected within six months from the unextended due date of the return.

Section 301.9100–3 allows the grant of an extension of time for making regulatory elections that do not meet the requirements for an automatic extension of time under § 301.9100–2. An extension under § 301.9100–3 to elect portability is not available to estates that are required to file an estate tax return based on the applicable amount in section 6018(a) because, in such a case, the due date for the portability election is prescribed by statute and § 301.9100–3 applies only to an election whose due date is prescribed by regulation. See sections 2010(c)(5)(A), 6075(a), and 6018(a); § 301.9100–1(b). However, an extension of time under § 301.9100–3 to elect portability may be available to estates that are under the value threshold described in section 6018 for being required to file an estate tax return. In such a case, the due date for the portability election is prescribed by regulation, not by statute. See Rev. Proc. 2014–18, 2014–7 IRB 513, section 2.03.

The Treasury Department and the IRS believe that clarifying the availability of an extension of time under § 301.9100–3 to elect portability will assist taxpayers in understanding and meeting their tax responsibilities. Accordingly, the final regulations provide that an extension of time to elect portability will not be granted under § 301.9100–3 to any estate that is required to file an estate tax return because the value of the gross estate equals or exceeds the threshold amount described in section 6018, but may be granted under the rules set forth in § 301.9100–3 to estates with a gross estate value below that threshold amount and thus not otherwise required to file an estate tax return.

As transitional relief in the wake of TRUIRJCA and ATRA, the Treasury Department and the IRS have published guidance regarding the availability of an automatic extension of time for executors of certain estates under the filing threshold of section 6018(a) to file an estate tax return to elect portability of an unused exclusion amount. See Notice 2012–21, 2012–10 IRB 450; Rev. Proc. 2014–18. The Treasury Department and the IRS continue to receive, and are continuing to consider, requests for permanent extensions of this type of relief. However, such relief is not included in the final regulations.

Section 20.2010–2T(a)(2) of the 2012 temporary regulations provides that upon the timely filing of a complete and properly prepared estate tax return, an executor of the estate of a decedent survived by a spouse will have elected portability of the decedent’s DSUE amount, unless the executor validly opts out of making the portability election. The inclusion of a computation of the DSUE amount is an essential requirement of a complete and properly prepared estate tax return intended to make the portability election. See section 2010(c)(5)(A) and § 20.2010–2T(b)(1). Section 20.2010–3T(c) provides that the portability election applies (and generally is available to the surviving spouse) upon the decedent’s death, but, to the extent the DSUE amount subsequently is reduced or cannot be substantiated, the DSUE amount will not be available to the surviving spouse.

A commenter requested that the final regulations address whether an estate can make a “protective” election if a DSUE amount is not reflected on an otherwise complete and properly prepared estate tax return at the time of its timely filing, but subsequent adjustments to amounts on the estate tax return would result in unused exclusion of that decedent. The following example illustrates such a scenario. An executor files a complete and properly prepared estate tax return that shows a DSUE amount equal to zero at the time of the return’s timely filing and does not follow the instructions set forth in the instructions for opting out of portability. At the same time, the executor also files a protective claim for refund attributable to a claim against the estate. Subsequently, the estate becomes entitled to a deduction under section 2053 for a payment made in satisfaction of the claim against the estate which reduces the estate tax and results in unused exemption.

In this example, the Treasury Department and the IRS believe that the executor has elected portability in accordance with § 20.2010–2T(a)(2) and that the recomputed DSUE amount will be available to the decedent’s surviving spouse. The final regulations clarify this intended result by providing in § 20.2010–2(b) that the computation requirement in section 2010(c)(5)(A) will be satisfied if the estate tax return is prepared in accordance with the requirements of § 20.2010–2(a)(7). Accordingly, there is no need for a protective election.

Several commenters requested that the final regulations allow a surviving spouse who is not an executor as defined in section 2203 of the Code to file an estate tax return and make the portability election in several different circumstances. A few of the circumstances described include those in which the spouse is given the right to file the estate tax return in a prenuptial or marital agreement, or the spouse has petitioned the appropriate local court for the spouse’s appointment as an executor solely for the limited purpose of filing the estate tax return and the executor does not make the portability election. The Treasury Department and the IRS recognize the possibility that an executor may exercise the executor’s discretion to not make the portability election, thus causing the estate to forfeit the opportunity to elect portability, but note that section 2010(c)(5) of the Code permits only the executor of the decedent’s estate to file the estate tax return and make the portability election. The 2012 temporary regulations address the circumstances in which an appointed executor or a non-appointed executor may file the estate tax return and decide whether or not to elect portability. The Treasury Department and the IRS believe that any consideration of what, if any, state law action might bring the surviving spouse within the definition of executor under section 2203 is outside of the scope of this regulation. Accordingly, the final regulations adopt the applicable rules in the 2012 temporary regulations without change.

Section 20.2010–2T(a)(2) provides that the estate of a decedent survived by a spouse makes the portability election by timely filing a complete and properly prepared estate tax return for the decedent’s estate. Section 20.2010–2T(a)(7)(i) provides that an estate tax return prepared in accordance with all applicable requirements is considered a “complete and properly prepared” estate tax return. Section 20.2010–2T(a)(7)(ii)(A), however, provides a special rule applicable to estates that are not otherwise required to file an estate tax return under section 6018. For these estates, the executor does not need to report the value of certain property that qualifies for the marital or charitable deduction. The 2012 temporary regulations also included exceptions to the application of the special rule by providing specific circumstances under which the special rule will not apply.

A commenter suggested that the final regulations elaborate on the circumstances under which a timely filed estate tax return may be considered so deficient as to render the estate tax return incomplete for purposes of electing portability. The Treasury Department and the IRS acknowledge that, as with all tax returns, some errors or omissions made with respect to an estate tax return will be considered minor and correctible. However, the Treasury Department and the IRS consider the issue of whether an estate tax return is complete and properly prepared to be determined most appropriately on a case-by-case basis by applying standards as prescribed in current law. Therefore, this suggestion has not been adopted.

A commenter recommended that the final regulations modify the special rule in § 20.2010–2T(a)(7)(ii)(A) to narrow the exceptions to the application of the special rule, thus allowing more estates to avoid the expense of a potentially-complicated appraisal to value assets includible in the gross estate. Specifically, the commenter recommended that the special rule in § 20.2010–2T(a)(7)(ii)(A) should apply to certain property, the value of which qualifies for the marital deduction or charitable deduction (marital deduction property or charitable deduction property), when: (i) the marital deduction property or charitable deduction property is a stated number of shares of stock and a stated number of shares of the same stock are includible in the gross estate but are not marital deduction property or charitable deduction property; (ii) the property represents the balance of the value of shares remaining after a non-marital or non-charitable bequest of shares based on a specific value; and (iii) the property represents the marital or charitable portion of a fractional division of property, whether by bequest, spousal election, or disclaimer. In the first two instances, the value of the marital deduction property or charitable deduction property may be relevant to assessing the accuracy of the valuation of the nondeductible interest and whether any valuation premium or discount is warranted. In the last instance, because any beneficiary’s share of the estate usually can be satisfied in a manner other than with that beneficiary’s proportional share of each individual asset, it will be necessary to know the total value in order to verify the non-deductible portion of the estate. Therefore, the Treasury Department and the IRS continue to believe that § 20.2010–2T(a)(7)(ii)(A) appropriately excludes the described circumstances from application of the special rule. While the final regulations do not adopt the commenter’s suggestion to narrow the exceptions to the application of the special rule, the final regulations provide flexibility to refine the rules in subregulatory guidance at any time in the future when the IRS may determine that additional guidance would be appropriate with regard to the application of the special rule to particular types of transfers.

The same commenter suggested that the exception in § 20.2010–2T(a)(7)(ii)(A)(2) is made unnecessarily broad by its reference to “another provision of the Code.” The commenter was concerned that, because the fair market value of a bequeathed asset determines the basis of that asset in the hands of the legatee, the value of all estate assets would have an impact on section 1014, and, thus, all assets would have to be valued. In referring to value needed to determine an estate’s eligibility under other Code sections such as sections 2032 and 2032A, the Treasury Department and the IRS did not intend to include a basis determination under section 1014. Accordingly, the language of § 20.2010–2T(a)(7)(ii)(A)(2) has been clarified.

Finally, a commenter repeated a suggestion (first made in response to a request for comments in Notice 2011–82, 2011–42 IRB 516) that the IRS prepare a shorter version of the estate tax return to be used by estates that are not otherwise required to file an estate tax return but do so only to elect portability. The Treasury Department and the IRS have reconsidered this suggestion, taking into account several factors including: the information needed by the IRS to compute and verify the DSUE amount; how such an abbreviated return would differ from a return qualifying for the special rule regarding valuations under § 20.2010–2(a)(7)(ii); the past experience of the IRS regarding the accuracy of abbreviated returns; the administrative issues in creating and maintaining alternate return forms; and the reasons provided by commenters. The Treasury Department and the IRS have concluded that, on balance, a timely filed, complete, and properly prepared estate tax return affords the most efficient and administrable method of obtaining the information necessary to compute and verify the DSUE amount, and the alleged benefits to taxpayers from an abbreviated form is far outweighed by the anticipated administrative difficulties in administering the estate tax. In addition, the “Technical Explanation of the Revenue Provisions Contained in the ‘Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010’ Scheduled for Consideration by the United States Senate,” J. Comm. on Tax’n, 111^th Cong., JCX–55–10 (December 10, 2010), suggests that estates electing portability that are not otherwise required to file an estate tax return under section 6018(a) are intended to be subject to the same filing requirements applicable to estates required to file an estate tax return under section 6018(a). For these reasons, this suggestion is not adopted.

The preamble to the 2012 regulations discussed comments and proposals the Treasury Department and the IRS had received on the proper application of the portability rules to qualified domestic trusts (QDOTs) created for spouses who are not U.S. citizens. The preamble noted that each of the proposals raised issues of fairness, complexity, and administrability.

The QDOT rules in the 2012 temporary regulations provide that the executor of a decedent’s estate claiming a marital deduction for property passing to a QDOT shall compute the decedent’s DSUE amount on the decedent’s estate tax return for the purpose of electing portability in the same way the DSUE amount is computed for any other decedent. However, because the estate tax payments made from the QDOT after the decedent’s death are part of the decedent’s estate tax liability, the decedent’s DSUE amount must be redetermined upon the final distribution or other taxable event on which estate tax under section 2056A is imposed (generally, this occurs upon the termination of all QDOTs created by or funded with assets passing from the decedent or upon the death of the surviving spouse). See § 20.2010–2T(c)(4). The QDOT rules in the 2012 temporary regulations further provide that the earliest date such a decedent’s DSUE amount may be included in determining the applicable exclusion amount available to the surviving spouse or the surviving spouse’s estate is the date of the event that triggers the final estate tax liability of the decedent under section 2056A. See § 20.2010–3T(c)(2). The preamble to the 2012 temporary regulations requested further comments on the QDOT issue.

A commenter challenged this delay in the surviving spouse’s ability to use the decedent’s DSUE amount if the surviving spouse becomes a United States citizen after the decedent’s estate tax return is filed and after property passes to a QDOT for the benefit of that surviving spouse.

Under section 2056A(b)(12), the estate tax imposed under section 2056A(b)(1) will cease to apply to property held in a QDOT if the surviving spouse becomes a United States citizen (a fact to be certified to the IRS under § 20.2056A–10(a)(2)) and either of the following requirements are met: (A) the spouse was a resident of the United States at all times after the death of the decedent and before the spouse becomes a citizen of the United States, or (B) no tax was imposed by section 2056A(b)(1)(A) with respect to any distribution before the spouse becomes a citizen. If the spouse becomes a U.S. citizen, but does not satisfy either of these two requirements, section 2056A(b)(12)(C) provides that the section 2056A(b)(1) estate tax will cease to apply to the QDOT if the spouse elects (i) to treat any distribution on which tax was imposed by section 2056A(b)(1)(A) as a taxable gift made by the spouse during the year in which the spouse becomes a U.S. citizen or in any subsequent year, and thereby including each such distribution in the spouse’s own adjusted taxable gifts for both estate and gift tax purposes, and (ii) to treat any reduction in the tax imposed by section 2056A(b)(1)(A) by reason of the credit allowable under section 2010 with respect to the decedent as a credit allowable to such surviving spouse under section 2505 for purposes of determining the amount of the credit allowable under section 2505 with respect to taxable gifts made by the surviving spouse during the year in which the spouse becomes a U.S. citizen or any subsequent year.

The Treasury Department and the IRS conclude that, if the surviving spouse of the decedent becomes a citizen of the United States and the requirements under section 2056A(b)(12) and the corresponding regulations are satisfied so that the tax imposed by section 2056A(b)(1) no longer applies, then the decedent’s DSUE amount is no longer subject to adjustment and will become available for transfers by the surviving spouse as of the date the surviving spouse becomes a citizen of the United States. Accordingly, the final regulations make clarifying changes in §§ 20.2010–2(c)(4), 20.2010–3(c)(3), and 25.2505–2(d)(3).

A commenter also requested clarification of the rules in §§ 20.2010–3T(b), 25.2505–2T(b) and 25.2505–2T(c) as they apply to a QDOT. Section 25.2505–2T(b) provides that, in the case of a surviving spouse making a gift, the surviving spouse will be considered to apply any available DSUE amount to the taxable gift before the surviving spouse’s own basic exclusion amount. Sections 20.2010–3T(b) and 25.2505–2T(c) address how to compute the DSUE amount included in the applicable exclusion amount of a surviving spouse who previously has applied a DSUE amount of one or more deceased spouses. These rules are applicable to all surviving spouses but can be applied only after the surviving spouse determines the spouse’s available DSUE amount, if any. Sections 20.2010–3T(c)(2) and 25.2505–2T(d)(2) provide rules governing the date DSUE can be taken into consideration by the surviving spouse or the surviving spouse’s estate when property passes from a decedent for the benefit of a surviving spouse in one or more QDOTs and the decedent elects portability. The Treasury Department and the IRS believe that the impact of these rules in the context of QDOTs is sufficiently clear. Thus, the final regulations adopt these rules without change, except that the rule in § 25.2505–2T(d)(2) is now provided in § 25.2505–2(d)(3).

Section 2010(c)(5)(B) grants the IRS the authority to examine returns of each deceased spouse of the surviving spouse to determine the DSUE amount allowed to be included in the applicable exclusion amount of the surviving spouse, even if the period of limitations under section 6501 has expired for assessing gift or estate tax with respect to the returns of the deceased spouse. The Treasury Department and the IRS received several comments and recommendations related to this examination authority.

First, a commenter requested that the final regulations provide that, during an examination to determine the allowable DSUE amount, the examination authority of the IRS be limited to issues of the reporting and valuation of assets, and not extend to other legal issues that may impact the availability of the DSUE amount to the surviving spouse. The Treasury Department and the IRS note that section 2010(c)(5)(B) grants broad statutory authority to the IRS to examine the correctness of any return, without regard to the period of limitations on assessment, “to make determinations with respect to [the allowable DSUE] amount for purposes of carrying out [section 2010(c) of the Code].” Thus, the Treasury Department and the IRS conclude that limiting such authority is inconsistent with the statute. Accordingly, this suggestion is not adopted.

Second, a commenter requested confirmation that, in the examination of a return for the purpose of determining the allowable DSUE amount that takes place after the expiration of the period of limitations on assessment of tax, the valuation of assets may be adjusted upward or downward with a possible result that the allowable DSUE amount may decrease or increase. The accurate valuation of assets reported on an estate or gift tax return, regardless of whether the valuation is higher or lower than the reported value, is fundamental to the examination of such a return and fundamental to the accurate determination of the DSUE amount available to the surviving spouse. The Treasury Department and the IRS accordingly conclude no clarifying change is necessary on this issue.

Third, a commenter suggested the final regulations consider whether, in the examination of a return for the purpose of determining the allowable DSUE amount that takes place after the expiration of the period of limitations on assessment of tax, an adjustment to the value of an asset reported on the return affects the basis of that asset under section 1014. Section 1014 generally provides that the basis of property acquired from a decedent is the fair market value of such property on the decedent’s date of death. The Treasury Department and the IRS believe that a change to the date-of-death value of an asset included in the estate of a decedent survived by a spouse, made pursuant to an examination of a return of that decedent after the expiration of the period of limitations on the assessment of tax on that return, does not necessarily result in a change to the basis of that asset under section 1014. Rather, the basis of property acquired from a decedent is determined in accordance with the existing principles of section 1014. The Treasury Department and the IRS conclude that the scope of the examination authority granted in section 2010(c)(5)(B) is sufficiently clear and, therefore, make no change in the final regulations.

Fourth, a commenter suggested that the final regulations clarify the deductibility of administrative expenses associated with the examination to determine the allowable DSUE amount. The Treasury Department and the IRS conclude that any expenses associated with an examination to determine the DSUE amount to be included in the applicable exclusion amount of the surviving spouse should be treated as any other expense associated with the preparation of the surviving spouse’s return. Thus, in the case of an examination arising with respect to a gift tax return of the surviving spouse, such expenses are not deductible and, in the case of an examination arising with respect to an estate tax return of the surviving spouse, such expenses may be deductible if such expenses meet all of the applicable requirements for deductibility under section 2053. The Treasury Department and the IRS believe that the standards for deducting expenses for estate and gift tax purposes are sufficiently clear so that no change to the 2012 temporary regulations is necessary.

Finally, a commenter suggested clarifying who may participate in the examination to determine the DSUE amount to be included in the applicable exclusion amount of the surviving spouse. In general, pursuant to the current rules, each taxpayer has the authority to participate in the resolution of the issues raised in the audit of his or her return. However, the Treasury Department and the IRS believe addressing this issue is outside the scope of this final regulation and, therefore, make no change in the final regulation.

A commenter requested further guidance on the rules in §§ 20.2010–3T(e) and 25.2505–2T(f), which prohibit a noncitizen, nonresident surviving spouse, or the estate of such a surviving spouse, from taking into account the DSUE amount of any deceased spouse except to the extent allowed under any treaty obligation of the United States. First, the commenter suggested the final regulations clarify the specificity a treaty must employ in referencing portability or the DSUE amount for the exception to apply. The Treasury Department and the IRS consider this question regarding the interpretation of treaty language to be outside the scope of these final regulations and, thus, decline to make this change.

Next, the commenter requested that the final regulations allow a surviving spouse who becomes a U.S. citizen after the death of the deceased spouse to take into account the DSUE amount of such deceased spouse. Because a surviving spouse who becomes a U.S. citizen is subject to the estate and gift tax rules of chapter 11 and 12 that apply to U.S. citizens and residents, the Treasury Department and the IRS believe it is appropriate that such a surviving spouse be permitted to take into account the DSUE amount available from any deceased spouse as of the date such surviving spouse becomes a U.S. citizen, provided the deceased spouse’s executor has made the portability election. Accordingly, the final regulations include such a rule in §§ 20.2010–3 and 25.2505–2.

Multiple commenters have requested guidance on the application of Rev. Proc. 2001–38, 2001–24 IRB 1335, when an estate makes a portability election under section 2010(c)(5)(A) as well as an election under section 2056(b)(7) to treat qualified terminable interest property (QTIP) as passing to the surviving spouse for purposes of the marital deduction.

Rev. Proc. 2001–38 provides a procedure by which the IRS will disregard and treat as a nullity for Federal estate, gift, and generation-skipping transfer tax purposes a QTIP election made under section 2056(b)(7) in cases where the election was not necessary to reduce the estate tax liability to zero. The commenter notes that, with the introduction of portability of a deceased spouse’s unused exclusion amount, an executor may purposefully elect both portability and QTIP treatment and the rationale for the rule voiding the election in Rev. Proc. 2001–38 (that the election was of no benefit to the taxpayer) is no longer applicable. The Treasury Department and the IRS intend to provide guidance, by publication in the Internal Revenue Bulletin, to clarify whether a QTIP election made under section 2056(b)(7) may be disregarded and treated as null and void when an executor has elected portability of the DSUE amount under section 2010(c)(5)(A).

A commenter noted that §§ 20.2010–3T and 25.2505–2T include an incorrect basic exclusion amount for the applicable year in the examples. The final regulations correct this mistake.

The NPRM requested comments on, and reserved § 20.2010–2(c)(3) to provide guidance on, the impact of the credits in sections 2012 through 2015 on computing the DSUE amount. One comment was received, and advocated for a rule in computing the DSUE amount that the tentative tax is equal to the net estate tax after the application of all available credits. The commenter stated that a deceased spouse’s applicable credit amount should not be applied to the extent one or more of the estate tax credits are available to reduce the decedent’s estate tax.

The amount of the allowable credit in sections 2012 through 2015 can be determined only after subtracting from the tax imposed by section 2001 the applicable credit amount determined under section 2010. Accordingly, to the extent the applicable credit amount is applied to reduce the tax imposed by section 2001 to zero, the credits in sections 2012 through 2015 are not available. The rule in section 2010(c)(4) for computing the DSUE amount does not take into account any unused credits arising under sections 2012 through 2015. Based on these considerations, the Treasury Department and the IRS conclude that no adjustment to the computation of the DSUE amount to account for any unused credits is warranted. Accordingly, § 20.2010–2(c)(3) of the final regulations clarifies that eligibility for credits against the tax imposed by section 2001 does not factor into the computation of the DSUE amount.

(a) General rule. Notwithstanding § 20.2001–1(b), §§ 20.2010–2(d) and 20.2010–3(d) provide additional rules regarding the authority of the Internal Revenue Service to examine any gift or other tax return(s), even if the time within which a tax may be assessed under section 6501 has expired, for the purpose of determining the deceased spousal unused exclusion amount available under section 2010(c) of the Internal Revenue Code.

(b) Effective/applicability date. Paragraph (a) of this section applies to the estates of decedents dying on or after June 12, 2015. See 26 CFR 20.2001–2T(a), as contained in 26 CFR part 20, revised as of April 1, 2015, for the rules applicable to estates of decedents dying on or after January 1, 2011, and before June 12, 2015.

This section lists the table of contents for §§ 20.2010–1 through 20.2010–3.

(a) General rule.

(b) Special rule in case of certain gifts made before 1977.

(c) Credit limitation.

(d) Explanation of terms.

(1) Applicable credit amount.

(2) Applicable exclusion amount.

(3) Basic exclusion amount.

(4) Deceased spousal unused exclusion (DSUE) amount.

(5) Last deceased spouse.

(e) Effective/applicability date.

(a) Election required for portability.

(1) Timely filing required.

(2) Portability election upon filing of estate tax return.

(3) Portability election not made; requirements for election not to apply.

(4) Election irrevocable.

(5) Estates eligible to make the election.

(6) Persons permitted to make the election.

(7) Requirements of return.

(b) Requirement for DSUE computation on estate tax return.

(c) Computation of the DSUE amount.

(1) General rule.

(2) Special rule to consider gift taxes paid by decedent.

(3) Impact of applicable credits.

(4) Special rule in case of property passing to qualified domestic trust.

(5) Examples.

(d) Authority to examine returns of decedent.

(e) Effective/applicability date.

(a) Surviving spouse’s estate limited to DSUE amount of last deceased spouse.

(1) In general.

(2) No DSUE amount available from last deceased spouse.

(3) Identity of last deceased spouse unchanged by subsequent marriage or divorce.

(b) Special rule in case of multiple deceased spouses and previously-applied DSUE amount.

(1) In general.

(2) Example.

(c) Date DSUE amount taken into consideration by surviving spouse’s estate.

(1) General rule.

(2) Exception when surviving spouse not a U.S. citizen on date of deceased spouse’s death.

(3) Special rule when property passes to surviving spouse in a qualified domestic trust.

(d) Authority to examine returns of deceased spouses.

(e) Availability of DSUE amount for estates of nonresidents who are not citizens.

(f) Effective/applicability date.

(a) General rule. Section 2010(a) allows the estate of every decedent a credit against the estate tax imposed by section 2001. The allowable credit is the applicable credit amount. See paragraph (d)(1) of this section for an explanation of the term applicable credit amount.

(b) Special rule in case of certain gifts made before 1977. The applicable credit amount allowable under paragraph (a) of this section must be reduced by an amount equal to 20 percent of the aggregate amount allowed as a specific exemption under section 2521 (as in effect before its repeal by the Tax Reform Act of 1976) for gifts made by the decedent after September 8, 1976, and before January 1, 1977.

(c) Credit limitation. The applicable credit amount allowed under paragraph (a) of this section cannot exceed the amount of the estate tax imposed by section 2001.

(d) Explanation of terms. The explanation of terms in this section applies to this section and to §§ 20.2010–2 and 20.2010–3.

(1) Applicable credit amount. The term applicable credit amount refers to the allowable credit against estate tax imposed by section 2001 and gift tax imposed by section 2501. The applicable credit amount equals the amount of the tentative tax that would be determined under section 2001(c) if the amount on which such tentative tax is to be computed were equal to the applicable exclusion amount. The applicable credit amount is determined by applying the unified rate schedule in section 2001(c) to the applicable exclusion amount.

(2) Applicable exclusion amount. The applicable exclusion amount equals the sum of the basic exclusion amount and, in the case of a surviving spouse, the deceased spousal unused exclusion (DSUE) amount.

(3) Basic exclusion amount. The basic exclusion amount is the sum of—

(i) For any decedent dying in calendar year 2011, $5,000,000; and

(ii) For any decedent dying after calendar year 2011, $5,000,000 multiplied by the cost-of-living adjustment determined under section 1(f)(3) for that calendar year by substituting “calendar year 2010” for “calendar year 1992” in section 1(f)(3)(B) and by rounding to the nearest multiple of $10,000.

(4) Deceased spousal unused exclusion (DSUE) amount. The term DSUE amount refers, generally, to the unused portion of a decedent’s applicable exclusion amount to the extent this amount does not exceed the basic exclusion amount in effect in the year of the decedent’s death. For the rules on computing the DSUE amount, see §§ 20.2010–2(c) and 20.2010–3(b).

(5) Last deceased spouse. The term last deceased spouse means the most recently deceased individual who, at that individual’s death after December 31, 2010, was married to the surviving spouse. See §§ 20.2010–3(a) and 25.2505–2(a) for additional rules pertaining to the identity of the last deceased spouse for purposes of determining the applicable exclusion amount of the surviving spouse.

(e) Effective/applicability date. This section applies to the estates of decedents dying on or after June 12, 2015. See 26 CFR 20.2010–1T, as contained in 26 CFR part 20, revised as of April 1, 2015, for the rules applicable to estates of decedents dying on or after January 1, 2011, and Jun e 12, 2015.

(a) Election required for portability. To allow a decedent’s surviving spouse to take into account that decedent’s deceased spousal unused exclusion (DSUE) amount, the executor of the decedent’s estate must elect portability of the DSUE amount on a timely filed Form 706, “United States Estate (and Generation-Skipping Transfer) Tax Return” (estate tax return). This election is referred to in this section and in § 20.2010–3 as the portability election.

(1) Timely filing required. An estate that elects portability will be considered, for purposes of subtitle B and subtitle F of the Internal Revenue Code (Code), to be required to file a return under section 6018(a). Accordingly, the due date of an estate tax return required to elect portability is nine months after the decedent’s date of death or the last day of the period covered by an extension (if an extension of time for filing has been obtained). See §§ 20.6075–1 and 20.6081–1 for additional rules relating to the time for filing estate tax returns. An extension of time to elect portability under this paragraph (a) will not be granted under § 301.9100–3 of this chapter to an estate that is required to file an estate tax return under section 6018(a), as determined without regard to this paragraph (a). Such an extension, however, may be available under the procedures applicable under §§ 301.9100–1 and 301.9100–3 of this chapter to an estate that is not required to file a return under section 6018(a), as determined without regard to this paragraph (a).

(2) Portability election upon filing of estate tax return. Upon the timely filing of a complete and properly prepared estate tax return, an executor of an estate of a decedent survived by a spouse will have elected portability of the decedent’s DSUE amount unless the executor chooses not to elect portability and satisfies the requirement in paragraph (a)(3)(i) of this section. See paragraph (a)(7) of this section for the return requirements related to the portability election.

(3) Portability election not made; requirements for election not to apply. The executor of the estate of a decedent survived by a spouse will not make or be considered to make the portability election if either of the following applies:

(i) The executor states affirmatively on a timely filed estate tax return, or in an attachment to that estate tax return, that the estate is not electing portability under section 2010(c)(5). The manner in which the executor may make this affirmative statement on the estate tax return is as set forth in the instructions issued with respect to such form (“Instructions for Form 706”).

(ii) The executor does not timely file an estate tax return in accordance with paragraph (a)(1) of this section.

(4) Election irrevocable. An executor of the estate of a decedent survived by a spouse who timely files an estate tax return may make or may supersede a portability election previously made, provided that the estate tax return reporting the election or the superseding election is filed on or before the due date of the return, including extensions actually granted. However, see paragraph (a)(6) of this section when contrary elections are made by more than one person permitted to make the election. The portability election, once made, becomes irrevocable once the due date of the estate tax return, including extensions actually granted, has passed.

(5) Estates eligible to make the election. An executor may elect portability on behalf of the estate of a decedent survived by a spouse if the decedent dies on or after January 1, 2011. However, an executor of the estate of a nonresident decedent who was not a citizen of the United States at the time of death may not elect portability on behalf of that decedent, and the timely filing of such a decedent’s estate tax return will not constitute the making of a portability election.

(6) Persons permitted to make the election—(i) Appointed executor. An executor or administrator of the estate of a decedent survived by a spouse that is appointed, qualified, and acting within the United States, within the meaning of section 2203 (an appointed executor), may timely file the estate tax return on behalf of the estate of the decedent and, in so doing, elect portability of the decedent’s DSUE amount. An appointed executor also may elect not to have portability apply pursuant to paragraph (a)(3) of this section.

(ii) Non-appointed executor. If there is no appointed executor, any person in actual or constructive possession of any property of the decedent (a non-appointed executor) may timely file the estate tax return on behalf of the estate of the decedent and, in so doing, elect portability of the decedent’s DSUE amount, or, by complying with paragraph (a)(3) of this section, may elect not to have portability apply. A portability election made by a non-appointed executor when there is no appointed executor for that decedent’s estate can be superseded by a subsequent contrary election made by an appointed executor of that same decedent’s estate on an estate tax return filed on or before the due date of the return, including extensions actually granted. An election to allow portability made by a non-appointed executor cannot be superseded by a contrary election to have portability not apply made by another non-appointed executor of that same decedent’s estate (unless such other non-appointed executor is the successor of the non-appointed executor who made the election). See § 20.6018–2 for additional rules relating to persons permitted to file the estate tax return.

(7) Requirements of return—(i) General rule. An estate tax return will be considered complete and properly prepared for purposes of this section if it is prepared in accordance with the instructions issued for the estate tax return (Instructions for Form 706) and if the requirements of §§ 20.6018–2, 20.6018–3, and 20.6018–4 are satisfied. However, see paragraph (a)(7)(ii) of this section for reduced requirements applicable to certain property of certain estates.

(ii) Reporting of value not required for certain property—(A) In general. A special rule applies with respect to certain property of estates in which the executor is not required to file an estate tax return under section 6018(a), as determined without regard to paragraph (a)(1) of this section. With respect to such an estate, for bequests, devises, or transfers of property included in the gross estate, the value of which is deductible under section 2056 or 2056A (marital deduction property) or under section 2055(a) (charitable deduction property), an executor is not required to report a value for such property on the estate tax return (except to the extent provided in this paragraph (a)(7)(ii)(A)) and will be required to report only the description, ownership, and/or beneficiary of such property, along with all other information necessary to establish the right of the estate to the deduction in accordance with §§ 20.2056(a)–1(b)(i) through (iii) and 20.2055–1(c), as applicable. However, this rule does not apply in certain circumstances as provided in this paragraph (a) and as may be further described in guidance issued from time to time by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter). In particular, this rule does not apply to marital deduction property or charitable deduction property if—

(1) The value of such property relates to, affects, or is needed to determine, the value passing from the decedent to a recipient other than the recipient of the marital or charitable deduction property;

(2) The value of such property is needed to determine the estate’s eligibility for the provisions of sections 2032, 2032A, or another estate or generation-skipping transfer tax provision of the Code for which the value of such property or the value of the gross estate or adjusted gross estate must be known (not including section 1014 of the Code);

(3) Less than the entire value of an interest in property includible in the decedent’s gross estate is marital deduction property or charitable deduction property; or

(4) A partial disclaimer or partial qualified terminable interest property (QTIP) election is made with respect to a bequest, devise, or transfer of property includible in the gross estate, part of which is marital deduction property or charitable deduction property.

(B) Return requirements when reporting of value not required for certain property. Paragraph (a)(7)(ii)(A) of this section applies only if the executor exercises due diligence to estimate the fair market value of the gross estate, including the property described in paragraph (a)(7)(ii)(A) of this section. Using the executor’s best estimate of the value of properties to which paragraph (a)(7)(ii)(A) of this section applies, the executor must report on the estate tax return, under penalties of perjury, the amount corresponding to the particular range within which falls the executor’s best estimate of the total gross estate, in accordance with the Instructions for Form 706.

(C) Examples. The following examples illustrate the application of paragraph (a)(7)(ii) of this section. In each example, assume that Husband (H) dies in 2015, survived by his wife (W), that both H and W are U.S. citizens, that H’s gross estate does not exceed the excess of the applicable exclusion amount for the year of his death over the total amount of H’s adjusted taxable gifts and any specific exemption under section 2521, and that H’s executor (E) timely files Form 706 solely to make the portability election.

Example 1. (i) Facts. The assets includible in H’s gross estate consist of a parcel of real property and bank accounts held jointly with W with rights of survivorship, a life insurance policy payable to W, and a survivor annuity payable to W for her life. H made no taxable gifts during his lifetime.

(ii) Application. E files an estate tax return on which these assets are identified on the proper schedule, but E provides no information on the return with regard to the date of death value of these assets in accordance with paragraph (a)(7)(ii)(A) of this section. To establish the estate’s entitlement to the marital deduction in accordance with § 20.2056(a)–1(b) (except with regard to establishing the value of the property) and the instructions for the estate tax return, E includes with the estate tax return evidence to verify the title of each jointly held asset, to confirm that W is the sole beneficiary of both the life insurance policy and the survivor annuity, and to verify that the annuity is exclusively for W’s life. Finally, E reports on the estate return E’s best estimate, determined by exercising due diligence, of the fair market value of the gross estate in accordance with paragraph (a)(7)(ii)(B) of this section. The estate tax return is considered complete and properly prepared and E has elected portability.

Example 2. (i) Facts. H’s will, duly admitted to probate and not subject to any proceeding to challenge its validity, provides that H’s entire estate is to be distributed outright to W. The non-probate assets includible in H’s gross estate consist of a life insurance policy payable to H’s children from a prior marriage, and H’s individual retirement account (IRA) payable to W. H made no taxable gifts during his lifetime.

(ii) Application. E files an estate tax return on which all of the assets includible in the gross estate are identified on the proper schedule. In the case of the probate assets and the IRA, no information is provided with regard to date of death value in accordance with paragraph (a)(7)(ii)(A) of this section. However, E attaches a copy of H’s will and describes each such asset and its ownership to establish the estate’s entitlement to the marital deduction in accordance with the instructions for the estate tax return and § 20.2056(a)–1(b) (except with regard to establishing the value of the property). In the case of the life insurance policy payable to H’s children, all of the regular return requirements, including reporting and establishing the fair market value of such asset, apply. Finally, E reports on the estate return E’s best estimate, determined by exercising due diligence, of the fair market value of the gross estate in accordance with paragraph (a)(7)(ii)(B) of this section. The estate tax return is considered complete and properly prepared and E has elected portability.

Example 3. (i) Facts. H’s will, duly admitted to probate and not subject to any proceeding to challenge its validity, provides that 50 percent of the property passing under the terms of H’s will is to be paid to a marital trust for W and 50 percent is to be paid to a trust for W and their descendants.

(ii) Application. The amount passing to the non-marital trust cannot be verified without knowledge of the full value of the property passing under the will. Therefore, the value of the property of the marital trust relates to or affects the value passing to the trust for W and the descendants of H and W. Accordingly, the general return requirements apply to all of the property includible in the gross estate and the provisions of paragraph (a)(7)(ii) of this section do not apply.

(b) Requirement for DSUE computation on estate tax return. Section 2010(c)(5)(A) requires an executor of a decedent’s estate to include a computation of the DSUE amount on the estate tax return to elect portability and thereby allow the decedent’s surviving spouse to take into account that decedent’s DSUE amount. This requirement is satisfied by the timely filing of a complete and properly prepared estate tax return, as long as the executor has not elected out of portability as described in paragraph(a)(3)(i) of this section. See paragraph (a)(7) of this section for the requirements for a return to be considered complete and properly prepared.

(c) Computation of the DSUE amount—(1) General rule. Subject to paragraphs (c)(2) through (4) of this section, the DSUE amount of a decedent with a surviving spouse is the lesser of the following amounts—

(i) The basic exclusion amount in effect in the year of the death of the decedent; or

(ii) The excess of—

(A) The decedent’s applicable exclusion amount; over

(B) The sum of the amount of the taxable estate and the amount of the adjusted taxable gifts of the decedent, which together is the amount on which the tentative tax on the decedent’s estate is determined under section 2001(b)(1).

(2) Special rule to consider gift taxes paid by decedent. Solely for purposes of computing the decedent’s DSUE amount, the amount of the adjusted taxable gifts of the decedent referred to in paragraph (c)(1)(ii)(B) of this section is reduced by the amount, if any, on which gift taxes were paid for the calendar year of the gift(s).

(3) Impact of applicable credits. An estate’s eligibility under sections 2012 through 2015 for credits against the tax imposed by section 2001 does not impact the computation of the DSUE amount.

(4) Special rule in case of property passing to qualified domestic trust—(i) In general. When property passes for the benefit of a surviving spouse in a qualified domestic trust (QDOT) as defined in section 2056A(a), the DSUE amount of the decedent is computed on the decedent’s estate tax return for the purpose of electing portability in the same manner as this amount is computed under paragraph (c)(1) of this section, but this DSUE amount is subject to subsequent adjustments. The DSUE amount of the decedent must be redetermined upon the occurrence of the final distribution or other event (generally, the termination of all QDOTs created by or funded with assets passing from the decedent or the death of the surviving spouse) on which estate tax is imposed under section 2056A. See § 20.2056A–6 for the rules on determining the estate tax under section 2056A. See § 20.2010–3(c)(3) regarding the timing of the availability of the decedent’s DSUE amount to the surviving spouse.

(ii) Surviving spouse becomes a U.S. citizen. If the surviving spouse becomes a U.S. citizen and if the requirements of section 2056A(b)(12) and the corresponding regulations are satisfied, the estate tax imposed under section 2056A(b)(1) ceases to apply. Accordingly, no estate tax will be imposed under section 2056A either on subsequent QDOT distributions or on the property remaining in the QDOT on the surviving spouse’s death and the decedent’s DSUE amount is no longer subject to adjustment.

(5) Examples. The following examples illustrate the application of this paragraph (c):

Example 1. Computation of DSUE amount. (i) Facts. In 2002, having made no prior taxable gift, Husband (H) makes a taxable gift valued at $1,000,000 and reports the gift on a timely filed gift tax return. Because the amount of the gift is equal to the applicable exclusion amount for that year ($1,000,000), $345,800 is allowed as a credit against the tax, reducing the gift tax liability to zero. H dies in 2015, survived by Wife (W). H and W are U.S. citizens and neither has any prior marriage. H’s taxable estate is $1,000,000. The executor of H’s estate timely files H’s estate tax return and elects portability, thereby allowing W to benefit from H’s DSUE amount.

(ii) Application. The executor of H’s estate computes H’s DSUE amount to be $3,430,000 (the lesser of the $5,430,000 basic exclusion amount in 2015, or the excess of H’s $5,430,000 applicable exclusion amount over the sum of the $1,000,000 taxable estate and the $1,000,000 amount of adjusted taxable gifts).

Example 2. Computation of DSUE amount when gift tax paid. (i) Facts. The facts are the same as in Example 1 of this paragraph (c)(5) except that the value of H’s taxable gift in 2002 is $2,000,000. After application of the applicable credit amount, H owes gift tax on $1,000,000, the amount of the gift in excess of the applicable exclusion amount for that year. H pays the gift tax owed on the 2002 transfer.

(ii) Application. On H’s death, the executor of H’s estate computes the DSUE amount to be $3,430,000 (the lesser of the $5,430,000 basic exclusion amount in 2015, or the excess of H’s $5,430,000 applicable exclusion amount over the sum of the $1,000,000 taxable estate and $1,000,000 of adjusted taxable gifts sheltered from tax by H’s applicable credit amount). H’s adjusted taxable gifts of $2,000,000 were reduced for purposes of this computation by $1,000,000, the amount of taxable gifts on which gift taxes were paid.

Example 3. Computation of DSUE amount when QDOT created. (i) Facts. Husband (H), a U.S. citizen, makes his first taxable gift in 2002, valued at $1,000,000, and reports the gift on a timely filed gift tax return. No gift tax is due because the applicable exclusion amount for that year ($1,000,000) equals the fair market value of the gift. H dies in 2015 with a gross estate of $2,000,000. H’s surviving spouse (W) is a resident, but not a citizen, of the United States and, under H’s will, a pecuniary bequest of $1,500,000 passes to a QDOT for the benefit of W. H’s executor timely files an estate tax return and makes the QDOT election for the property passing to the QDOT, and H’s estate is allowed a marital deduction of $1,500,000 under section 2056(d) for the value of that property. H’s taxable estate is $500,000. On H’s estate tax return, H’s executor computes H’s preliminary DSUE amount to be $3,930,000 (the lesser of the $5,430,000 basic exclusion amount in 2015, or the excess of H’s $5,430,000 applicable exclusion amount over the sum of the $500,000 taxable estate and the $1,000,000 adjusted taxable gifts). No taxable events within the meaning of section 2056A occur during W’s lifetime with respect to the QDOT, and W makes no taxable gifts. At all times since H’s death, W has been a U.S. resident. In 2017, W dies and the value of the assets of the QDOT is $1,800,000.

(ii) Application. H’s DSUE amount is redetermined to be $2,130,000 (the lesser of the $5,430,000 basic exclusion amount in 2015, or the excess of H’s $5,430,000 applicable exclusion amount over $3,300,000 (the sum of the $500,000 taxable estate augmented by the $1,800,000 of QDOT assets and the $1,000,000 adjusted taxable gifts)).

Example 4. Computation of DSUE amount when surviving spouse with QDOT becomes a U.S. citizen. (i) Facts. The facts are the same as in Example 3 of this paragraph (c)(5) except that W becomes a U.S. citizen in 2016 and dies in 2018. The U.S. Trustee of the QDOT notifies the IRS that W has become a U.S. citizen by timely filing a final estate tax return (Form 706–QDT). Pursuant to section 2056A(b)(12), the estate tax under section 2056A no longer applies to the QDOT property.

(ii) Application. Because H’s DSUE amount no longer is subject to adjustment once W becomes a citizen of the United States, H’s DSUE amount is $3,930,000, as it was preliminarily determined as of H’s death. Upon W’s death in 2018, the value of the QDOT property is includible in W’s gross estate.

(d) Authority to examine returns of decedent. The IRS may examine returns of a decedent in determining the decedent’s DSUE amount, regardless of whether the period of limitations on assessment has expired for that return. See § 20.2010–3(d) for additional rules relating to the IRS’s authority to examine returns. See also section 7602 for the IRS’s authority, when ascertaining the correctness of any return, to examine any returns that may be relevant or material to such inquiry.

(e) Effective/applicability date. This section applies to the estates of decedents dying on or after June 12, 2015. See 26 CFR 20.2010–2T, as contained in 26 CFR part 20, revised as of April 1, 2015, for the rule applicable to estates of decedents dying on or after January 1, 2011, and before June 12, 2015.

(a) Surviving spouse’s estate limited to DSUE amount of last deceased spouse—(1) In general. The deceased spousal unused exclusion (DSUE) amount of a decedent, computed under § 20.2010–2(c), is included in determining the surviving spouse’s applicable exclusion amount under section 2010(c)(2), provided—

(i) Such decedent is the last deceased spouse of such surviving spouse within the meaning of § 20.2010–1(d)(5) on the date of the death of the surviving spouse; and

(ii) The executor of the decedent’s estate elected portability (see § 20.2010–2(a) and (b) for applicable requirements).

(2) No DSUE amount available from last deceased spouse. If the last deceased spouse of such surviving spouse had no DSUE amount, or if the executor of such a decedent’s estate did not make a portability election, the surviving spouse’s estate has no DSUE amount (except as provided in paragraph (b)(1)(ii) of this section) to be included in determining the applicable exclusion amount, even if the surviving spouse previously had a DSUE amount available from another decedent who, prior to the death of the last deceased spouse, was the last deceased spouse of such surviving spouse. See paragraph (b) of this section for a special rule in the case of multiple deceased spouses and a previously applied DSUE amount.

(3) Identity of last deceased spouse unchanged by subsequent marriage or divorce. A decedent is the last deceased spouse (as defined in § 20.2010–1(d)(5)) of a surviving spouse even if, on the date of the death of the surviving spouse, the surviving spouse is married to another (then-living) individual. If a surviving spouse marries again and that marriage ends in divorce or an annulment, the subsequent death of the divorced spouse does not end the status of the prior deceased spouse as the last deceased spouse of the surviving spouse. The divorced spouse, not being married to the surviving spouse at death, is not the last deceased spouse as that term is defined in § 20.2010–1(d)(5).

(b) Special rule in case of multiple deceased spouses and previously-applied DSUE amount—(1) In general. A special rule applies to compute the DSUE amount included in the applicable exclusion amount of a surviving spouse who previously has applied the DSUE amount of one or more deceased spouses to taxable gifts in accordance with § 25.2505–2(b) and (c). If a surviving spouse has applied the DSUE amount of one or more (successive) last deceased spouses to the surviving spouse’s transfers during life, and if any of those last deceased spouses is different from the surviving spouse’s last deceased spouse as defined in § 20.2010–1(d)(5) at the time of the surviving spouse’s death, then the DSUE amount to be included in determining the applicable exclusion amount of the surviving spouse at the time of the surviving spouse’s death is the sum of—

(i) The DSUE amount of the surviving spouse’s last deceased spouse as described in paragraph (a)(1) of this section; and

(ii) The DSUE amount of each other deceased spouse of the surviving spouse, to the extent that such amount was applied to one or more taxable gifts of the surviving spouse.

(2) Example. The following example, in which all described individuals are U.S. citizens, illustrates the application of this paragraph (b):

Example. (i) Facts. Husband 1 (H1) dies in 2011, survived by Wife (W). Neither has made any taxable gifts during H1’s lifetime. H1’s executor elects portability of H1’s DSUE amount. The DSUE amount of H1 as computed on the estate tax return filed on behalf of H1’s estate is $5,000,000. In 2012, W makes taxable gifts to her children valued at $2,000,000. W reports the gifts on a timely filed gift tax return. W is considered to have applied $2,000,000 of H1’s DSUE amount to the amount of taxable gifts, in accordance with § 25.2505–2(c), and, therefore, W owes no gift tax. W has an applicable exclusion amount remaining in the amount of $8,120,000 ($3,000,000 of H1’s remaining DSUE amount plus W’s own $5,120,000 basic exclusion amount). W marries Husband 2 (H2) in 2013. H2 dies in 2014. H2’s executor elects portability of H2’s DSUE amount, which is properly computed on H2’s estate tax return to be $2,000,000. W dies in 2015.

(ii) Application. The DSUE amount to be included in determining the applicable exclusion amount available to W’s estate is $4,000,000, determined by adding the $2,000,000 DSUE amount of H2 and the $2,000,000 DSUE amount of H1 that was applied by W to W’s 2012 taxable gifts. The $4,000,000 DSUE amount added to W’s $5,430,000 basic exclusion amount (for 2015), causes W’s applicable exclusion amount to be $9,430,000.

(c) Date DSUE amount taken into consideration by surviving spouse’s estate—(1) General rule. A portability election made by an executor of a decedent’s estate (see § 20.2010–2(a) and (b) for applicable requirements) generally applies as of the date of the decedent’s death. Thus, such decedent’s DSUE amount is included in the applicable exclusion amount of the decedent’s surviving spouse under section 2010(c)(2) and will be applicable to transfers made by the surviving spouse after the decedent’s death (subject to the limitations in paragraph (a) of this section). However, such decedent’s DSUE amount will not be included in the applicable exclusion amount of the surviving spouse, even if the surviving spouse had made a transfer in reliance on the availability or computation of the decedent’s DSUE amount:

(i) If the executor of the decedent’s estate supersedes the portability election by filing a subsequent estate tax return in accordance with § 20.2010–2(a)(4);

(ii) To the extent that the DSUE amount subsequently is reduced by a valuation adjustment or the correction of an error in calculation; or

(iii) To the extent that the surviving spouse cannot substantiate the DSUE amount claimed on the surviving spouse’s return.

(2) Exception when surviving spouse not a U.S. citizen on date of deceased spouse’s death. If a surviving spouse becomes a citizen of the United States after the death of the surviving spouse’s last deceased spouse, the DSUE amount of the surviving spouse’s last deceased spouse becomes available to the surviving spouse on the date the surviving spouse becomes a citizen of the United States (subject to the limitations in paragraph (a) of this section). However, when the special rule regarding qualified domestic trusts in paragraph (c)(3) of this section applies, the earliest date on which a decedent’s DSUE amount may be included in the applicable exclusion amount of such decedent’s surviving spouse who becomes a U.S. citizen is as provided in paragraph (c)(3) of this section.

(3) Special rule when property passes to surviving spouse in a qualified domestic trust—(i) In general. When property passes from a decedent for the benefit of the decedent’s surviving spouse in one or more qualified domestic trusts (QDOT) as defined in section 2056A(a) and the decedent’s executor elects portability, the DSUE amount available to be included in the applicable exclusion amount of the surviving spouse under section 2010(c)(2) is the DSUE amount of the decedent as redetermined in accordance with § 20.2010–2(c)(4) (subject to the limitations in paragraph (a) of this section). The earliest date on which such decedent’s DSUE amount may be included in the applicable exclusion amount of the surviving spouse under section 2010(c)(2) is the date of the occurrence of the final QDOT distribution or final other event (generally, the termination of all QDOTs created by or funded with assets passing from the decedent or the death of the surviving spouse) on which tax under section 2056A is imposed. However, the decedent’s DSUE amount as redetermined in accordance with § 20.2010–2(c)(4) may be applied to certain taxable gifts of the surviving spouse. See § 25.2505–2(d)(3)(i).

(ii) Surviving spouse becomes a U.S. citizen. If a surviving spouse for whom property has passed from a decedent in one or more QDOTs becomes a citizen of the United States and the requirements in section 2056A(b)(12) and the corresponding regulations are satisfied, then the date on which such decedent’s DSUE amount may be included in the applicable exclusion amount of the surviving spouse under section 2010(c)(2) (subject the limitations in paragraph (a) of this section) is the date on which the surviving spouse becomes a citizen of the United States. See § 20.2010–2(c)(4) for the rules for computing the decedent’s DSUE amount in the case of a qualified domestic trust.

(d) Authority to examine returns of deceased spouses. For the purpose of determining the DSUE amount to be included in the applicable exclusion amount of a surviving spouse, the Internal Revenue Service (IRS) may examine returns of each of the surviving spouse’s deceased spouses whose DSUE amount is claimed to be included in the surviving spouse’s applicable exclusion amount, regardless of whether the period of limitations on assessment has expired for any such return. The IRS’s authority to examine returns of a deceased spouse applies with respect to each transfer by the surviving spouse to which a DSUE amount is or has been applied. Upon examination, the IRS may adjust or eliminate the DSUE amount reported on such a return of a deceased spouse; however, the IRS may assess additional tax on that return only if that tax is assessed within the period of limitations on assessment under section 6501 applicable to the tax shown on that return. See also section 7602 for the IRS’s authority, when ascertaining the correctness of any return, to examine any returns that may be relevant or material to such inquiry. For purposes of these examinations to determine the DSUE amount, the surviving spouse is considered to have a material interest that is affected by the return information of the deceased spouse within the meaning of section 6103(e)(3).

(e) Availability of DSUE amount for estates of nonresidents who are not citizens. The estate of a nonresident surviving spouse who is not a citizen of the United States at the time of such surviving spouse’s death shall not take into account the DSUE amount of any deceased spouse of such surviving spouse within the meaning of § 20.2010–1(d)(5) except to the extent allowed under any applicable treaty obligation of the United States. See section 2102(b)(3).

(f) Effective/applicability date. This section applies to the estates of decedents dying on or after June 12, 2015. See 26 CFR 20.2010–3T, as contained in 26 CFR part 20, revised as of April 1, 2015, for the rules applicable to estates of decedents dying on or after January 1, 2011, and before June 12, 2015.

This section lists the table of contents for §§ 25.2505–1 and 25.2505–2.

(a) General rule.

(b) Applicable rate of tax.

(c) Special rule in case of certain gifts made before 1977.

(d) Credit limitation.

(e) Effective/applicability date.

(a) Donor who is surviving spouse is limited to DSUE amount of last deceased spouse.

(1) In general.

(2) No DSUE amount available from last deceased spouse.

(3) Identity of last deceased spouse unchanged by subsequent marriage or divorce.

(b) Manner in which DSUE amount is applied.

(c) Special rule in case of multiple deceased spouses and previously-applied DSUE amount.

(1) In general.

(2) Example.

(d) Date DSUE amount taken into consideration by donor who is a surviving spouse.

(1) General rule.

(2) Exception when surviving spouse not a U.S. citizen on date of deceased spouse’s death.

(3) Special rule when property passes to surviving spouse in a qualified domestic trust.

(e) Authority to examine returns of deceased spouses.

(f) Availability of DSUE amount for nonresidents who are not citizens.

(g) Effective/applicability date.

(a) General rule. Section 2505(a) allows a citizen or resident of the United States a credit against the tax imposed by section 2501 for each calendar year. The allowable credit is the applicable credit amount in effect under section 2010(c) that would apply if the donor died as of the end of the calendar year, reduced by the sum of the amounts allowable as a credit against the gift tax due for all preceding calendar periods. See §§ 25.2505–2, 20.2010–1, and 20.2010–2 for additional rules and definitions related to determining the applicable credit amount in effect under section 2010(c).

(b) Applicable rate of tax. In determining the amounts allowable as a credit against the gift tax due for all preceding calendar periods, the unified rate schedule under section 2001(c) in effect for such calendar year applies instead of the rates of tax actually in effect for preceding calendar periods. See sections 2505(a) and 2502(a)(2).

(c) Special rule in case of certain gifts made before 1977. The applicable credit amount allowable under paragraph (a) of this section must be reduced by an amount equal to 20 percent of the aggregate amount allowed as a specific exemption under section 2521 (as in effect before its repeal by the Tax Reform Act of 1976) for gifts made by the decedent after September 8, 1976, and before January 1, 1977.

(d) Credit limitation. The applicable credit amount allowed under paragraph (a) of this section for any calendar year shall not exceed the amount of the tax imposed by section 2501 for such calendar year.

(e) Effective/applicability date. This section applies to gifts made on or after June 12, 2015. See 26 CFR 25.2505–1T, as contained in 26 CFR part 25, revised as of April 1, 2015, for the rules applicable to gifts made on or after January 1, 2011, and before June 12, 2015Insert.

(a) Donor who is surviving spouse is limited to DSUE amount of last deceased spouse—(1) In general. In computing a surviving spouse’s gift tax liability with regard to a transfer subject to the tax imposed by section 2501 (taxable gift), a deceased spousal unused exclusion (DSUE) amount of a decedent, computed under § 20.2010–2(c), is included in determining the surviving spouse’s applicable exclusion amount under section 2010(c)(2), provided:

(i) Such decedent is the last deceased spouse of such surviving spouse within the meaning of § 20.2010–1(d)(5) at the time of the surviving spouse’s taxable gift; and

(ii) The executor of the decedent’s estate elected portability (see § 20.2010–2(a) and (b) for applicable requirements).

(2) No DSUE amount available from last deceased spouse. If on the date of the surviving spouse’s taxable gift the last deceased spouse of such surviving spouse had no DSUE amount or if the executor of the estate of such last deceased spouse did not elect portability, the surviving spouse has no DSUE amount (except as and to the extent provided in paragraph (c)(1)(ii) of this section) to be included in determining his or her applicable exclusion amount, even if the surviving spouse previously had a DSUE amount available from another decedent who, prior to the death of the last deceased spouse, was the last deceased spouse of such surviving spouse. See paragraph (c) of this section for a special rule in the case of multiple deceased spouses.

(3) Identity of last deceased spouse unchanged by subsequent marriage or divorce. A decedent is the last deceased spouse (as defined in § 20.2010–1(d)(5)) of a surviving spouse even if, on the date of the surviving spouse’s taxable gift, the surviving spouse is married to another (then-living) individual. If a surviving spouse marries again and that marriage ends in divorce or an annulment, the subsequent death of the divorced spouse does not end the status of the prior deceased spouse as the last deceased spouse of the surviving spouse. The divorced spouse, not being married to the surviving spouse at death, is not the last deceased spouse as that term is defined in § 20.2010–1(d)(5).

(b) Manner in which DSUE amount is applied. If a donor who is a surviving spouse makes a taxable gift and a DSUE amount is included in determining the surviving spouse’s applicable exclusion amount under section 2010(c)(2), such surviving spouse will be considered to apply such DSUE amount to the taxable gift before the surviving spouse’s own basic exclusion amount.

(c) Special rule in case of multiple deceased spouses and previously-applied DSUE amount—(1) In general. A special rule applies to compute the DSUE amount included in the applicable exclusion amount of a surviving spouse who previously has applied the DSUE amount of one or more deceased spouses. If a surviving spouse applied the DSUE amount of one or more (successive) last deceased spouses to the surviving spouse’s previous lifetime transfers, and if any of those last deceased spouses is different from the surviving spouse’s last deceased spouse as defined in § 20.2010–1(d)(5) at the time of the current taxable gift by the surviving spouse, then the DSUE amount to be included in determining the applicable exclusion amount of the surviving spouse that will be applicable at the time of the current taxable gift is the sum of—

(i) The DSUE amount of the surviving spouse’s last deceased spouse as described in paragraph (a)(1) of this section; and

(ii) The DSUE amount of each other deceased spouse of the surviving spouse to the extent that such amount was applied to one or more previous taxable gifts of the surviving spouse.

(2) Example. The following example, in which all described individuals are U.S. citizens, illustrates the application of this paragraph (c):

Example. (i) Facts. Husband 1 (H1) dies in 2011, survived by Wife (W). Neither has made any taxable gifts during H1’s lifetime. H1’s executor elects portability of H1’s deceased spousal unused exclusion (DSUE) amount. The DSUE amount of H1 as computed on the estate tax return filed on behalf of H1’s estate is $5,000,000. In 2012, W makes taxable gifts to her children valued at $2,000,000. W reports the gifts on a timely filed gift tax return. W is considered to have applied $2,000,000 of H1’s DSUE amount to the 2012 taxable gifts, in accordance with paragraph (b) of this section, and, therefore, W owes no gift tax. W is considered to have an applicable exclusion amount remaining in the amount of $8,120,000 ($3,000,000 of H1’s remaining DSUE amount plus W’s own $5,120,000 basic exclusion amount). In 2013, W marries Husband 2 (H2). H2 dies on June 30, 2015. H2’s executor elects portability of H2’s DSUE amount, which is properly computed on H2’s estate tax return to be $2,000,000.

(ii) Application. The DSUE amount to be included in determining the applicable exclusion amount available to W for gifts during the second half of 2015 is $4,000,000, determined by adding the $2,000,000 DSUE amount of H2 and the $2,000,000 DSUE amount of H1 that was applied by W to W’s 2012 taxable gifts. Thus, W’s applicable exclusion amount during the balance of 2015 is $9,430,000 ($4,000,000 DSUE plus $5,430,000 basic exclusion amount for 2015).

(d) Date DSUE amount taken into consideration by donor who is a surviving spouse—(1) General rule. A portability election made by an executor of a decedent’s estate (see § 20.2010–2(a) and (b) for applicable requirements) generally applies as of the date of such decedent’s death. Thus, the decedent’s DSUE amount is included in the applicable exclusion amount of the decedent’s surviving spouse under section 2010(c)(2) and will be applicable to transfers made by the surviving spouse after the decedent’s death (subject to the limitations in paragraph (a) of this section). However, such decedent’s DSUE amount will not be included in the applicable exclusion amount of the surviving spouse, even if the surviving spouse had made a taxable gift in reliance on the availability or computation of the decedent’s DSUE amount:

(i) If the executor of the decedent’s estate supersedes the portability election by filing a subsequent estate tax return in accordance with § 20.2010–2(a)(4);

(ii) To the extent that the DSUE amount subsequently is reduced by a valuation adjustment or the correction of an error in calculation; or

(iii) To the extent that the DSUE amount claimed on the decedent’s return cannot be determined.

(2) Exception when surviving spouse not a U.S. citizen on date of deceased spouse’s death. If a surviving spouse becomes a citizen of the United States after the death of the surviving spouse’s last deceased spouse, the DSUE amount of the surviving spouse’s last deceased spouse becomes available to the surviving spouse on the date the surviving spouse becomes a citizen of the United States (subject to the limitations in paragraph (a) of this section). However, when the special rule regarding qualified domestic trusts in paragraph (d)(3) of this section applies, the earliest date on which a decedent’s DSUE amount may be included in the applicable exclusion amount of such decedent’s surviving spouse who becomes a U.S. citizen is as provided in paragraph (d)(3) of this section.

(3) Special rule when property passes to surviving spouse in a qualified domestic trust—(i) In general. When property passes from a decedent for the benefit of the decedent’s surviving spouse in one or more qualified domestic trusts (QDOT) as defined in section 2056A(a) and the decedent’s executor elects portability, the DSUE amount available to be included in the applicable exclusion amount of the surviving spouse under section 2010(c)(2) is the DSUE amount of the decedent as redetermined in accordance with § 20.2010–2(c)(4) (subject to the limitations in paragraph (a) of this section). The earliest date on which such decedent’s DSUE amount may be included in the applicable exclusion amount of the surviving spouse under section 2010(c)(2) is the date of the occurrence of the final QDOT distribution or final other event (generally, the termination of all QDOTs created by or funded with assets passing from the decedent or the death of the surviving spouse) on which tax under section 2056A is imposed. However, the decedent’s DSUE amount as redetermined in accordance with § 20.2010–2(c)(4) may be applied to the surviving spouse’s taxable gifts made in the year of the surviving spouse’s death or, if the terminating event occurs prior to the surviving spouse’s death, then in the year of that terminating event and/or in any subsequent year during the surviving spouse’s life.

(ii) Surviving spouse becomes a U.S. citizen. If a surviving spouse for whom property has passed from a decedent in one or more QDOTs becomes a citizen of the United States and the requirements in section 2056A(b)(12) and the corresponding regulations are satisfied, then the date on which such decedent’s DSUE amount may be included in the applicable exclusion amount of the surviving spouse under section 2010(c)(2) (subject to the limitations in paragraph (a) of this section) is the date on which the surviving spouse becomes a citizen of the United States. See § 20.2010–2(c)(4) for the rules for computing the decedent’s DSUE amount in the case of a qualified domestic trust.

(iii) Example. The following example illustrates the application of this paragraph (d)(3):

Example. (i) Facts. Husband (H), a U.S. citizen, dies in 2011 having made no taxable gifts during his lifetime. H’s gross estate is $3,000,000. H’s wife (W) is not a citizen of the United States and, under H’s will, a pecuniary bequest of $2,000,000 passes to a QDOT for the benefit of W. H’s executor timely files an estate tax return and makes the QDOT election for the property passing to the QDOT, and H’s estate is allowed a marital deduction of $2,000,000 under section 2056(d) for the value of that property. H’s taxable estate is $1,000,000. On H’s estate tax return, H’s executor computes H’s preliminary DSUE amount to be $4,000,000. No taxable events within the meaning of section 2056A occur during W’s lifetime with respect to the QDOT, and W resides in the United States at all times after H’s death. W makes a taxable gift of $1,000,000 to X in 2012 and a taxable gift of $1,000,000 to Y in January 2015, in each case from W’s own assets rather than from the QDOT. W dies in September 2015, not having married again, when the value of the assets of the QDOT is $2,200,000.

(ii) Application. H’s DSUE amount is redetermined to be $1,800,000 (the lesser of the $5,000,000 basic exclusion amount for 2011, or the excess of H’s $5,000,000 applicable exclusion amount over $3,200,000 (the sum of the $1,000,000 taxable estate augmented by the $2,200,000 of QDOT assets)). On W’s gift tax return filed for 2012, W cannot apply any DSUE amount to the gift made to X. However, because W’s gift to Y was made in the year that W died, W’s executor will apply $1,000,000 of H’s redetermined DSUE amount to the gift on W’s gift tax return filed for 2015. The remaining $800,000 of H’s redetermined DSUE amount is included in W’s applicable exclusion amount to be used in computing W’s estate tax liability.

(e) Authority to examine returns of deceased spouses. For the purpose of determining the DSUE amount to be included in the applicable exclusion amount of a surviving spouse, the Internal Revenue Service (IRS) may examine returns of each of the surviving spouse’s deceased spouses whose DSUE amount is claimed to be included in the surviving spouse’s applicable exclusion amount, regardless of whether the period of limitations on assessment has expired for any such return. The IRS’s authority to examine returns of a deceased spouse applies with respect to each transfer by the surviving spouse to which a DSUE amount is or has been applied. Upon examination, the IRS may adjust or eliminate the DSUE amount reported on such a return of a deceased spouse; however, the IRS may assess additional tax on that return only if that tax is assessed within the period of limitations on assessment under section 6501 applicable to the tax shown on that return. See also section 7602 for the IRS’s authority, when ascertaining the correctness of any return, to examine any returns that may be relevant or material to such inquiry.

(f) Availability of DSUE amount for nonresidents who are not citizens. A nonresident surviving spouse who was not a citizen of the United States at the time of making a transfer subject to tax under chapter 12 of the Internal Revenue Code shall not take into account the DSUE amount of any deceased spouse except to the extent allowed under any applicable treaty obligation of the United States. See section 2102(b)(3).

(g) Effective/applicability date. This section applies to gifts made on or after June 12, 2015. See 26 CFR 25.2505–2T, as contained in 26 CFR part 25, revised as of April 1, 2015, for the rules applicable to gifts made on or after January 1, 2011, and before June 12, 2015.

* * * * *

(b) * * *

Approved June 8, 2015.

The purpose of this revenue procedure to set forth the 2015 requirements for:

This revenue procedure contains specifications for these information returns:

For purposes of this revenue procedure, a substitute form or statement is one that is not published by the IRS. For a substitute form or statement to be acceptable to the IRS, it must conform to the official form or the specifications outlined in this revenue procedure. Do not submit any substitute forms or statements listed above to the IRS for approval. Privately published forms may not state, “This is an IRS approved form.”

Filers making payments to certain recipients during a calendar year are required by the Internal Revenue Code (the Code) to file information returns with the IRS for these payments. These filers must also provide this information to their recipients. In some cases, this also applies to payments received. See Part 4 for specifications that apply to recipient statements (generally Copy B).

In general, section 6011 of the Code contains requirements for filers of information returns. A filer must file information returns electronically or on paper. A filer who is required to file 250 or more information returns of any one type during a calendar year must file those returns electronically.

Caution. Beginning January 1, 2014, financial institutions that are required to report payments made under chapters 3 or 4 must file Forms 1042–S electronically, regardless of the number of forms to file.

Note. If you file electronically, do not file the same returns on paper.

Although not required, small volume filers (fewer than 250 returns during a calendar year) may file the forms electronically. See the requirements for filing information returns (and providing a copy to a payee) in the 2015

General Instructions for Certain Information Returns and the 2015 Instructions for Form 1042–S. In addition, see the current revision of Publication 1220, Specifications for Electronic Filing of Forms 1097, 1098, 1099, 3921, 3922, 5498, and W–2G, for electronic filing through the IRS FIRE system.

The IRS prints and provides the forms on which various payments must be reported. See Section 5.3, later, for ordering forms and instructions. Alternatively, filers may prepare substitute copies of these IRS forms and use such forms to report payments to the IRS.

Note. IRS/IRB does not process information returns which are filed on paper forms. See Publication 1220, Specifications for Electronic Filing of Forms 1097–BTC, 1098, 1099, 3921, 3922, 5498, and W–2G, for information on waivers and extensions of time.

Note. Further information impacting Publication 1179, such as issues arising after its final release, will be posted on IRS.gov at www.irs.gov/pub1179.

The following changes have been made to this year’s revenue procedure.

FATCA filing requirements of certain foreign financial institutions (FFIs). An FFI with a chapter 4 requirement to report a U.S. account maintained by the FFI that is held by a specified U.S. person may satisfy this requirement by reporting on Form(s) 1099 (listed below) under the election described in Regulations section 1.1471–4(d)(5)(i)(A) or (B). Additionally, a U.S. payer may satisfy its chapter 4 requirement to report such a U.S. account by reporting on Form(s) 1099. See Regulations section 1.1471–4(d)(2)(iii)(A).

Information for these FFIs has been added to the General Instructions for Certain Information Returns.

Truncating taxpayer identifying numbers on payee statements. Final regulations have been issued that allow issuers to truncate payee identifying numbers on all payee statements covered by these instructions, except for Form W2–G. See Recipient Information under Instructions for Preparing Paper Forms That Will Be Filed With the IRS, later.

Substitute forms for Form 1042–S. As of 2015 paper substitutes for Form 1042–S may no longer contain multiple income types for the same recipient (except Copy E retained by the withholding agent). Copies B, C, and D must be identical to the IRS form. See Part 5, later.

New Form 1098–Q. New Form 1098–Q, Qualifying Longevity Annuity Contract Information, is used to report the status of longevity annuity contracts held by defined contribution plans, IRAs, and eligible governmental plans, to participants. See Form 1098–Q and its instructions for more information available at www.irs.gov/form1098q.

Editorial changes. We made editorial changes throughout, including updated references. Redundancies were eliminated as much as possible.

Form recipient means the person to whom you are required by law to furnish a copy of the official form or information statement. The form recipient may be referred to by different names on various Forms 1099 and related forms (“ beneficiary,” “borrower,” “debtor,” “donor,” “employee,” “homeowner”, “insured,” “participant,” “payee,” “payer/borrower,” “policyholder,” “shareholder,” “student,” “transferor,” or, in the case of Form W–2G, the “winner”). See Section 1.3.4.

Filer means the person or organization required by law to file with the IRS a form listed in Section 1.1.2 with the IRS. As outlined earlier, a filer may be a payer, creditor, payment settlement entity, recipient of mortgage or student loan interest payments, educational institution, broker, barter exchange, person reporting real estate transactions; trustee or issuer of any educational savings account, individual retirement arrangement or medical savings account; lender who acquires an interest in secured property or who has reason to know that the property has been abandoned, corporation reporting a change in control and capital structure or transfer of stock to an employee, or certain donees of motor vehicles, boats, and airplanes.

Substitute form means a paper substitute of Copy A of an official form listed in Section 1.1.2 that totally conforms to the provisions in this revenue procedure.

Substitute form recipient statement means a paper statement of the information reported on a form listed in Section 1.1.2. This statement must be furnished to a person (form recipient), as defined under the applicable provisions of the Code and the applicable regulations.

Composite substitute statement means one in which two or more required statements (for example, Forms 1099–INT and 1099–DIV) are furnished to the recipient on one document. However, each statement must be designated separately and must contain all the requisite Form 1099 information except as provided under Section 4.2. A composite statement may not be filed with the IRS.

Paper substitutes for Form 1096 and Copy A of Forms 1097–BTC, 1098, 1099, 3921, 3922, 5498, W–2G, and 1042–S that totally conform to the specifications listed in this revenue procedure may be privately printed and filed as returns with the IRS. The reference to the Department of the Treasury–Internal Revenue Service should be included on all such forms.

If you are uncertain of any specification and want it clarified, you may submit a letter citing the specification, stating your understanding and interpretation of the specification, and enclosing an example of the form (if appropriate) to:

Internal Revenue Service

Attn: Substitute Forms Program

SE:W:CAR:MP:P:TP

5000 Ellin Road, C6–440

Lanham, MD 20706

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

You may also contact the Substitute Forms Program via e-mail at

substituteforms@irs.gov. Please enter “Substitute Forms” on the Subject Line.

Forms 1096, 1097–BTC, 1098, 1099, 3921, 3922, 5498, W–2G, and 1042–S are subject to annual review and possible change. Therefore, filers are cautioned against overstocking supplies of privately printed substitutes.

Some Forms 1097–BTC, 1098, 1099, 3921, 3922, 5498, W–2G, and 1042–S that include logos, slogans and advertisements may not be recognized as important tax documents. A payee may not recognize the importance of the payee copy for tax reporting purposes due to the use of logos, slogans, and advertisements. Thus, the IRS has determined that logos, slogans and advertising will not be allowed on Forms 1096 or Copy A of Forms 1097–BTC, 1098, 1099, 3921, 3922, 5498, W–2G, 1042–S, or any payee copies, with the following exceptions:

The IRS e-file logo on the IRS official payee copies may be included, but it is not required, on any of the substitute form copies.

The information return and payee copies must clearly identify the payer’s name associated with its employer identification number.

Logos and slogans, may be used on permissible enclosures, such as a check or account statement, other than information returns and payee copies.

As indicated in Sections 1.3.1 and 5.1.3, of this revenue procedure, Forms 1096, 1097–BTC, 1098, 1099, 3921, 3922, 5498, W–2G, and 1042–S are subject to annual review and possible change. If you have comments about the restrictions on including logos, slogans, and advertising on information returns and payee copies, send or email your comments to: Internal Revenue Service, Attn: Substitute Forms Program, SE:W:CAR:MP:P:TP, 5000 Ellin Road, C6–440, Lanham, MD 20706 or substituteforms@irs.gov.

Proposed substitutes of Copy A must be exact replicas of the official IRS form with respect to layout and content. Proposed substitutes for Copy A that do not conform to the specifications in this revenue procedure are not acceptable. Further, if you file such forms with the IRS, you may be subject to a penalty for failure to file a correct information return under section 6721 of the Code. The amount of the penalty is based on when you file the correct information return. The penalty is:

Copy B and Copy C of the following forms must contain the information in Part 4 to be considered a “statement” or “official form” under the applicable provisions of the Code. The format of this information is at the discretion of the filer with the exception of the location of the tax year, form number, form name, and the information for composite Form 1099 statements as outlined under Section 4.2.

Copy B, of the forms below, are for the following recipients.

Copy C of the following forms are:

Note. On Copy C, Form 1099–LTC, you may reverse the locations of the policyholder’s and the insured’s name, street address, city, state, and ZIP code for easier mailing.

Form identifying numbers (for example, 9191 for Form 1099–DIV) must be printed in nonreflective black carbon-based ink in print positions 15 through 19 using an OCR A font. The check boxes to the right of the form identifying numbers must be 10-point boxes. The “VOID” checkbox is in print position 25 (1.9” from left vertical line of the form). The “CORRECTED” check box is in print position 33 (2.7” from left vertical line of the form). Measurements are generally from the left edge of the paper, not including the perforated strip.

The substitute form Copy A must be an exact replica of the official IRS form with respect to layout and content. To determine the correct form measurements, see Exhibits A through EE at the end of this publication.

Hot wax and cold carbon spots are not permitted on any of the internal form plies. These spots are permitted on the back of a mailer top envelope ply.

Use of chemical transfer paper for Copy A is acceptable.

The Government Printing Office (GPO) symbol must be deleted.

Color and paper quality for Copy A (cut sheets and continuous pinfeed forms) as specified by JCP Code 0–25, dated November 29, 1978, must be white 100% bleached chemical wood, optical character recognition (OCR) bond produced in accordance with the following specifications.

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

Chemical transfer paper is permitted for Copy A only if the following standards are met:

All copies must be clearly legible. Fading must be minimized to assure legibility.

All print on Copy A of Forms 1097–BTC, 1098, 1099, 3921, 3922, 5498, and the print on Form 1096 above the statements, “Return this entire page to the Internal Revenue Service. Photocopies are not acceptable.” must be in Flint J–6983 red OCR dropout ink or an exact match. However, the four-digit form identifying number must be in nonreflective carbon-based black ink in OCR A font.

The shaded areas of any substitute form should generally correspond to the format of the official form.

The printing for the Form 1096 statement and the following text may be in any shade or tone of black ink. Black ink should only appear on the lower part of the reverse side of Form 1096, where it will not bleed through and interfere with scanning.

Note. The instructions on the front and back of Form 1096, which include filing addresses, must be printed.

Separation between fields must be 0.1 inch.

Other printing requirements are discussed below.

You must initiate or have a quality control program to assure OCR ink density. Readings will be made when printed on approved 20 lb. white OCR bond with a reflectance of not less than 80%. Black ink must not have a reflectance greater than 15%. These readings are based on requirements of the “Scan-Optics Series 9000” Optical Scanner using Flint J–6983 red OCR dropout ink or an exact match.

The following testers and ranges are acceptable:

Important information: The forms produced under these specifications must be guaranteed to function properly when processed through High Speed Scan-Optics 9000 mm scanners. Forms require precision spacing, printing, and trimming.

Density readings on the solid J–6983 (red) must be between the ranges of 0.95 to 0.90. The optimal scanning range is 0.93. Density readings on the solid black must be between the ranges of 112 to 108. The optimal scanning range is 110.

Note. The readings are taken using an Ex-Rite 500 series densitometer, in Status T with Obsolute or – paper setting under an Illuminate 5000 Kelvin Watt Light. You must maintain print contrast specification of ink and densitometer reflectivity reading throughout entire production run.

Type must be substantially identical in size and shape to the official form. All rules are either ½-point or ¾-point. Rules must be identical to those on the official IRS form.

Note. The form identifying number must be nonreflective carbon-based black ink in OCR A font.