Pursuant to the Bylaws, the Joint Board consists of three members appointed by the Secretary of the Treasury and two members appointed by the Secretary of Labor. The Board elects a Chairman and a Secretary from among the Department of the Treasury and the Department of Labor members. The Pension Benefit Guaranty Corporation may designate a non-voting representative to sit with, and participate in, the discussions of the Board. All decisions of the Board are made by simple majority vote.

Approved: February 12, 2016.

Under section 1276(b)(2), a customer may elect to accrue market discount on a constant yield method rather than a ratable method. The election may be made on a debt instrument by debt instrument basis and must be made for the earliest taxable year for which the customer is required to determine accrued market discount. The election may not be revoked once it has been made. In most cases, the use of a constant yield method backloads market discount and is therefore more taxpayer favorable than the use of a ratable method.

In response to comments on the 2013 final basis reporting regulations (which required the broker to assume that the customer had not made a constant yield election), § 1.6045–1T(n)(11)(i)(B) of the 2015 temporary reporting regulations provided that for a debt instrument acquired on or after January 1, 2015, brokers are required to assume that a customer has elected to determine accrued market discount using a constant yield method unless the customer notifies the broker otherwise. A customer that does not want to use a constant yield method to determine accrued market discount must, by the end of the calendar year in which the customer acquired the debt instrument in an account with the broker, notify the broker in writing that the customer wants the broker to use the ratable method to determine accrued market discount.

No comments were received on the substantive rules in § 1.6045–1T(n)(11)(i)(B). Accordingly, the rules in the final regulations in this document are the same as the rules in § 1.6045–1T(n)(11)(i)(B). Several commenters requested permission to apply the default constant yield method to debt instruments acquired on or after January 1, 2014, which was the first date for which a broker was required to report accrued market discount under section 6045, provided that the broker had not reported accrued market discount to a customer for the 2014 calendar year using the ratable method. According to the commenters, the use of a single method to compute market discount accruals for all covered securities with market discount would simplify the calculation of accrued market discount and the reporting of this information to their customers.

The final regulations in this document permit, but do not require, a broker to apply the default constant yield method to a debt instrument acquired on or after January 1, 2014, and before January 1, 2015, provided the broker was not informed that the customer had made a section 1278(b) election (the election to include market discount in income as it accrues rather than upon a disposition or receipt of a partial principal payment), there were no principal payments on the debt instrument during the 2014 calendar year, and the broker therefore had not reported accrued market discount to the customer for the 2014 calendar year using the ratable method.

Under § 1.6045A–1T(e) of the 2015 temporary reporting regulations, a transferring broker is required to provide a transfer statement upon the transfer of a section 1256 option to ensure that the receiving broker has all of the information required for purposes of section 6045. The temporary regulations provide that a transfer statement is required for the transfer of a section 1256 option that occurs on or after January 1, 2016. The temporary regulations also list the data specific to section 1256 options that must be provided.

One commenter asserted that including the fair market value information on a transfer statement for a section 1256 option is unnecessary because the receiving broker can look up the information if it is needed and suggested saving space on the transfer statement by eliminating this data item. After considering the suggestion, the Treasury Department and IRS decline to adopt this suggestion. Providing fair market value information on a transfer statement will help ensure that the receiving broker is reporting an amount of realized but unrecognized gain or loss from the prior year that is consistent with the amount reported in the prior year by the transferring broker, which will minimize the possibility of double counting or omission of gain or loss.

No other comments were received on § 1.6045A–1T of the 2015 temporary reporting regulations. The rules in the final regulations in this document are substantively the same as the rules in the 2015 temporary regulations. However, the rules in § 1.6045A–1T(e) are in § 1.6045A–1(b)(4)(iv) of the final regulations in this document and the rules in § 1.6045A–1T(f) are in § 1.6045A–1(b)(3)(x) of the final regulations in this document.

To coordinate the reporting of OID under section 6049 with the reporting of basis for tax-exempt obligations under section 6045, § 1.6049–10T of the 2015 temporary reporting regulations provides that a payor must report under section 6049 the daily portions of OID on a tax-exempt obligation. The daily portions of OID are determined as if section 1272 and § 1.1272–1 applied to a tax-exempt obligation. A payor must determine whether a tax-exempt obligation was issued with OID and the amount that accrues for each relevant period. In addition, OID on a tax-exempt obligation is determined without regard to the de minimis rule in section 1273(a)(3) and § 1.1273–1(d). Because the temporary regulations require the reporting of OID, payors also must report amortized acquisition premium (which offsets OID) on a tax-exempt obligation. A broker may report either a gross amount for both OID and amortized acquisition premium, or a net amount of OID that reflects the offset of the OID by the amount of amortized acquisition premium allocable to the OID. Section 1.6049–10T of the 2015 temporary reporting regulations applies to a tax-exempt obligation acquired on or after January 1, 2017.

No comments were received on the substantive rules in § 1.6049–10T. Accordingly, the rules in the final regulations in this document are the same as the rules in § 1.6049–10T. However, several commenters requested that, for taxable years beginning after December 31, 2016, a broker be permitted to report on Form 1099–OID the OID and acquisition premium on a tax-exempt obligation that is a covered security acquired before January 1, 2017. According to the commenters, customers might be confused because of the difference between the date that a tax-exempt obligation generally became a covered security (that is, an obligation acquired on or after January 1, 2014), and the date after which a tax-exempt obligation that is a covered security becomes subject to mandatory reporting of OID and acquisition premium (that is, an obligation acquired on or after January 1, 2017). Because a broker is required to track basis for a tax-exempt obligation that is a covered security for purposes of section 6045, the broker is responsible for calculating OID on a tax-exempt obligation acquired on or after January 1, 2014, even if the broker has no obligation to report the obligation’s OID to the customer for purposes of section 6049. To simplify the reporting of OID and acquisition premium and to minimize any customer confusion, the commenters requested that the final regulations permit a broker to report OID and acquisition on all tax-exempt bonds that are covered securities.

After considering the requests, for taxable years beginning after December 31, 2016, the final regulations in this document permit, but do not require, a broker to report OID and acquisition for a tax-exempt obligation that is a covered security acquired before January 1, 2017.

Under § 1.6045–1(n)(3) of the 2013 final basis reporting regulations, certain debt instruments are subject to basis reporting only if the debt instrument is acquired by a customer on or after January 1, 2016. For example, § 1.6045–1(n)(3) applies to a contingent payment debt instrument, a debt instrument that is not issued by a U.S. issuer, and a debt instrument the terms of which are not reasonably available to a broker within 90 days of acquisition of the debt instrument by the customer.

Several commenters on the 2013 final basis reporting regulations requested guidance for a debt instrument the terms of which are not reasonably available to the broker. The commenters stated that they would not have the information necessary to comply with the information reporting rules for these instruments. Several commenters stated that information for a debt instrument issued by a non-U.S. issuer and for a tax-exempt obligation is particularly difficult to obtain. One commenter noted that under SEC Release 34–67908, issued on September 21, 2012 (77 FR 59427), issuers of municipal securities are required to provide certain data to the Electronic Municipal Market Access system set up by the Municipal Securities Rulemaking Board for new issuances, but there is no requirement to file similar information for issuances already outstanding as of the November 1, 2012, effective date of the release.

The Treasury Department and the IRS agree that a broker may not always be able to obtain information for a debt instrument issued by a non-U.S. issuer or for a tax-exempt obligation issued before January 1, 2014. The final regulations in this document therefore provide that a debt instrument issued by a non-U.S. issuer or a tax-exempt obligation issued before January 1, 2014, is treated as a noncovered security (and, therefore, is not subject to basis reporting under section 6045) if the terms of the debt instrument are not reasonably available to the broker within 90 days of the date the debt instrument was acquired by the customer. The Treasury Department and the IRS believe that the information necessary for section 6045 compliance should be available for other debt instruments.

* * * * *

(n) * * *

(4) * * * See paragraph (n)(11) of this section for the treatment of an election described in paragraph (n)(4)(iii) of this section (election to accrue market discount based on a constant yield) and an election described in paragraph (n)(4)(iv) of this section (election to treat all interest as OID).

(iv) * * * However, see paragraph (n)(11)(i)(A) of this section for a debt instrument acquired on or after January 1, 2014.

* * * * *

(5) * * *

(i) * * * However, see paragraph (n)(11) of this section for the treatment of an election described in paragraph (n)(4)(iii) of this section (election to accrue market discount based on a constant yield) and an election described in paragraph (n)(4)(iv) of this section (election to treat all interest as OID).

* * * * *

(6) * * *

(i) * * * See paragraphs (n)(5) and (n)(11)(i)(B) of this section to determine whether the amount reported should take into account a customer election under section 1276(b)(2). * * *

(ii) * * * See paragraphs (n)(5) and (n)(11)(i)(B) of this section to determine whether the amount reported should take into account a customer election under section 1276(b)(2).

(7) * * *

(iii) * * * However, if a broker took into account a customer election under § 1.1272–3 in 2014, the broker must decrease the customer’s basis in the debt instrument by the amount of acquisition premium that is taken into account each year to reduce the amount of the original issue discount that is otherwise includible in the customer’s income for that year in accordance with §§ 1.1272–2(b)(5) and 1.1272–3.

* * * * *

(11) Additional rules for certain holder elections—(i) In general. For purposes of this section, the rules in this paragraph (n)(11) apply notwithstanding any other rule in paragraph (n) of this section.

(A) Election to treat all interest as OID. A broker must report the information required under paragraph (d) of this section without taking into account any election described in paragraph (n)(4)(iv) of this section (the election to treat all interest as OID in § 1.1272–3). As a result, for example, a broker must determine the amount of any acquisition premium taken into account each year for purposes of this section in accordance with § 1.1272–2(b)(4). This paragraph (n)(11)(i)(A) applies to a debt instrument acquired on or after January 1, 2015. A broker, however, may rely on this paragraph (n)(11)(i)(A) for a debt instrument acquired on or after January 1, 2014, and before January 1, 2015.

(B) Election to accrue market discount based on a constant yield. A broker must report the information required under paragraph (d) of this section by assuming that a customer has made the election described in paragraph (n)(4)(iii) of this section (the election to accrue market discount based on a constant yield). However, if a customer notifies a broker in writing that the customer does not want the broker to take into account this election, the broker must report the information required under paragraph (d) of this section without taking into account this election. The customer must provide this notification to the broker by the end of the calendar year in which the customer acquired the debt instrument in an account with the broker. This paragraph (n)(11)(i)(B) applies to a debt instrument acquired on or after January 1, 2015. A broker, however, may rely on this paragraph (n)(11)(i)(B) to report accrued market discount for a debt instrument that is a covered security acquired on or after January 1, 2014, and before January 1, 2015, if the customer had not informed the broker that the customer had made a section 1278(b) election and there were no principal payments on the debt instrument during this period.

(ii) [Reserved].

(12) Certain debt instruments treated as noncovered securities—(i) In general. Notwithstanding paragraph (a)(15) of this section, a debt instrument is treated as a noncovered security for purposes of this section if the terms of the debt instrument are not reasonably available to the broker within 90 days of the date the debt instrument was acquired by the customer and the debt instrument is either—

(A) A debt instrument issued by a non-U.S. issuer; or

(B) A tax-exempt obligation issued before January 1, 2014.

(ii) Effective/applicability date. Paragraph (n)(12)(i) of this section applies to a debt instrument described in paragraph (n)(12)(i)(A) or (B) of this section that is acquired on or after February 18, 2016. However, a broker may rely on paragraph (n)(12)(i) of this section for a debt instrument described in paragraph (n)(12)(i)(A) or (B) of this section acquired before February 18, 2016.

* * * * *

Par. 3. Section 1.6045–1T is amended by revising paragraphs (h) through (p) to read as follows:

* * * * *

(h) through (p) [Reserved]. For further guidance, see § 1.6045–1(h) through (p).

* * * * *

Par. 4. Section 1.6045A–1 is amended by:

1. Removing “and” at the end of paragraph (b)(3)(viii), removing the period at the end of paragraph (b)(3)(ix) and adding “; and” in its place, and adding paragraph (b)(3)(x).

2. Removing “and” at the end of paragraph (b)(4)(ii), removing the period at the end of paragraph (b)(4)(iii) and adding “; and” in its place, and adding paragraph (b)(4)(iv).

3. Removing paragraphs (e) and (f).

The additions read as follows:

* * * * *

(b) * * *

(3) * * *

(x) For a transfer that occurs on or after January 1, 2016, the last date on or before the transfer date that the transferor made an adjustment for a particular item (for example, the last date on or before the transfer date that bond premium was amortized). A broker, however, may rely on this paragraph (b)(3)(x) for a transfer of a covered security that occurs on or after June 30, 2015, and before January 1, 2016.

(4) * * *

(iv) For a transfer of an option described in § 1.6045–1(m)(3) (section 1256 option) that occurs on or after January 1, 2016, the original basis of the option and the fair market value of the option as of the end of the prior calendar year.

* * * * *

(a) In general. For purposes of section 6049, a payor (as defined in § 1.6049–4(a)(2)) of original issue discount (OID) on a tax-exempt obligation (as defined in section 1288(b)(2)) is required to report the daily portions of OID on the obligation as if the daily portions of OID that accrued during a calendar year were paid to the holder (or holders) of the obligation in the calendar year. The amount of the daily portions of OID that accrues during a calendar year is determined as if section 1272 and § 1.1272–1 applied to a tax-exempt obligation. Notwithstanding any other rule in section 6049 and the regulations thereunder, a payor must determine whether a tax-exempt obligation was issued with OID and the amount of OID that accrues for each relevant period. As prescribed by section 1288(b)(1), OID on a tax-exempt obligation is determined without regard to the de minimis rules in section 1273(a)(3) and § 1.1273–1(d).

(b) Acquisition premium. A payor is required to report acquisition premium amortization on a tax-exempt obligation in accordance with the rules in § 1.6049–9(c) as if section 1272 applied to a tax-exempt obligation. See paragraph (a) of this section to determine the amount of OID allocable to an accrual period.

(c) Effective/applicability date. This section applies to a tax-exempt obligation that is a covered security (within the meaning of § 1.6045–1(a)(15) and (n)(12)) acquired on or after January 1, 2017. For a taxable year beginning after December 31, 2016, a broker, however, may rely on this section to report OID and acquisition premium for a tax-exempt obligation that is a covered security acquired before January 1, 2017.

* * * * *

(f) * * *

(2) * * *

(i) * * *

(ii) * * *

(iii) If the disposition occurs on or after December 18, 2015, neither the corporation nor any predecessor of the corporation was a regulated investment company or a real estate investment trust at any time during the shorter of the periods described in section 897(c)(1)(A)(ii).

* * * * *

Par. 3. Section 1.897–3 is amended in each of the paragraphs listed in the first column by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

Par. 4. Section 1.1445–1 is amended as follows:

1. By revising the first sentence and removing the last sentence of paragraph (b)(1).

2. By redesignating paragraphs (b)(2) through (4) as paragraphs (b)(3) through (5) respectively.

3. By adding a new paragraph (b)(2).

4. By revising paragraph (g)(10).

5. By revising the heading and adding two sentences after the first sentence in paragraph (h).

6. In each of the paragraphs listed in the first column by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

The additions and revisions read as follows:

* * * * *

(b) Duty to withhold—(1) In general. Except as provided in paragraph (b)(2) and §§ 1.1445–2 and 1.1445–3, transferees of U.S. real property interests are required to deduct and withhold a tax equal to 15 percent of the amount realized by the transferor if the transferor is a foreign person.* * *

(2) Reduced rate for certain residences. Transferees of U.S. real property interests are required to deduct and withhold a tax equal to 10 percent of the amount realized by the transferor if the transferor is a foreign person and the following requirements are satisfied:

(i) the property is acquired by the transferee for use by the transferee as a residence;

(ii) the amount realized for the property does not exceed $1,000,000; and

(iii) section 1445(b)(5) does not apply to the disposition. See § 1.1445–2(d)(1).

* * * * *

(g) * * *

(10) Address for correspondence. Any written communication to the Internal Revenue Service described in this section is to be mailed to the address specified in the Instructions for Form 8288 under the heading “Where To File.”

(h) Applicability dates. * * * The withholding rates set forth in paragraphs (a), (b)(1), (b)(2), (b)(4)(iii), (c)(2)(i)(A), and (c)(2)(i)(B) of this section apply to dispositions after February 16, 2016. For dispositions on or before February 16, 2016, see paragraphs (a), (b)(1), (b)(3)(iii), (c)(2)(i)(A), and (c)(2)(i)(B) of this section as contained in 26 CFR part 1 revised as of April 1, 2015.

Par. 5. Section 1.1445–2 is amended as follows:

1. By revising the first sentence in the undesignated paragraph following paragraph (b)(2)(i)(C).

2. In paragraph (b)(4)(iv), by adding a sentence after the last sentence.

3. In paragraph (e), by revising the heading and adding two sentences after the first sentence.

4. In each of the paragraphs listed in the first colum by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

The additions and revision read as follows:

* * * * *

(b) * * *

(2) * * *

(i) * * *

(C) * * *

In general, a foreign person is a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, or foreign estate, but not a qualified foreign pension fund (as defined in section 897(l)) or an entity all of the interests of which are held by a qualified foreign pension fund. * * *

(4) * * *

(iv) * * * For dispositions described in § 1.1445–1(b)(2), this paragraph shall be applied by replacing “15 percent” with “10 percent” each time it appears.

* * * * *

(e) Applicability dates. * * * The exclusion of entities described in section 897(l) from the definition of foreign person in paragraph (b)(2)(i) of this section applies to dispositions and distributions after December 18, 2015, and the withholding rates set forth in paragraphs (b)(4)(iv), (c)(3)(iii), and (d)(3)(i) of this section apply to dispositions after February 16, 2016. For dispositions on or before February 16, 2016, see paragraphs (b)(4)(iv), (c)(3)(iii), and (d)(3)(i) of this section as contained in 26 CFR part 1 revised as of April 1, 2015.

Par. 6. Section 1.1445–3 is amended in each of the paragraphs listed in the first column by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

Par. 7. Section 1.1445–4 is amended in each of the paragraphs listed in the first column by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

Par. 8. Section 1.1445–5 is amended as follows:

1. In each of the paragraphs listed in the first column, by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

2. In paragraph (h), by revising the heading and adding two sentences after the first sentence.

The revision and additions read as follows:

* * * * *

(h) Applicability dates. * * * The withholding rates set forth in paragraphs (c)(3)(iv) and (e)(1) of this section apply to distributions after February 16, 2016. For distributions on or before February 16, 2016, see paragraphs (c)(3)(iv) and (e)(1) of this section as contained in 26 CFR part 1 revised as of April 1, 2015.

Par. 9. Section 1.1445–6 is amended in each of the paragraphs listed in the first column by removing the language in the “Remove” column and adding in its place the language in the “Add” column.

Par. 10. Section 1.1445–11T is amended in paragraph (d)(2)(iii) by adding footnote “1” after the last sentence to read as follows:^[1]

* * * * *

(d) * * *

(2) * * *

(iii) * * *

Approved: February 12, 2016.

Proposed §§ 1.6038D–6(b)(1)(i) and 1.6038D–6(c)(1) provide that, in order to be treated as a specified domestic entity, an entity must have an interest in specified foreign financial assets (excluding assets excepted under § 1.6038D–7T) that exceeds the reporting threshold in § 1.6038D–2T(a)(1). Under the proposed regulations, a domestic entity applies the reporting threshold in § 1.6038D–2T(a)(1) to determine whether it is a specified domestic entity. In making this determination, the proposed regulations require a corporation or partnership to take into account the aggregation rules in proposed § 1.6038D–6(b)(4)(i). Proposed §§ 1.6038D–6(b)(1)(i) and 1.6038D–6(c)(1), however, suggested that a specified domestic entity is required to again apply § 1.6038D–2T(a)(1) to determine whether it has a reporting requirement.

The Treasury Department and the IRS did not intend for domestic entities to apply the reporting threshold described in § 1.6038D–2(a)(1) twice in order to determine their section 6038D reporting responsibilities. Therefore, these final regulations eliminate the requirement to apply § 1.6038D–2(a)(1) as part of determining whether an entity is a specified domestic entity. Instead, a domestic entity that meets the definition of a specified domestic entity, which under these final regulations is determined without regard to whether the reporting threshold in § 1.6038D–2(a)(1) is met, applies the reporting threshold under § 1.6038D–2(a)(1) once, as part of determining whether it has a filing obligation. The aggregation rule for corporations and partnerships and the rule excluding assets excepted under § 1.6038D–7 from the reporting threshold have been moved to § 1.6038D–2(a)(6). These changes are organizational and no change is intended to the substantive reporting requirements for a specified domestic entity.

Proposed § 1.6038D–6(b)(1)(iii) provides that a corporation or partnership is treated as formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if either: (1) at least 50 percent of the corporation or partnership’s gross income or assets is passive; or (2) at least 10 percent of the corporation or partnership’s gross income or assets is passive and the corporation or partnership is formed or availed of by a specified individual with a principal purpose of avoiding section 6038D (the principal purpose test). Under proposed § 1.6038D–6(b)(1)(iii), all facts and circumstances are taken into account to determine whether a specified individual has a principal purpose of avoiding section 6038D.

The Treasury Department and the IRS believe that a 50-percent passive assets or income threshold appropriately captures situations in which specified individuals may use a domestic corporation or partnership to circumvent the reporting requirements of section 6038D. Furthermore, the Treasury Department and the IRS have concluded that taxpayers should be able to determine their reporting requirements under section 6038D based on objective requirements rather than a subjective principal purpose test. Therefore, these final regulations eliminate the principal purpose test for determining whether a corporation or partnership is a specified domestic entity. However, the Treasury Department and the IRS will continue to monitor whether domestic corporations and partnerships not required to report under these final regulations are being used inappropriately by specified individuals to avoid reporting under section 6038D. If needed, the Treasury Department and the IRS may expand the definition of a specified domestic entity in future guidance.

Proposed § 1.6038D–6(b)(2) defines “passive income” by listing specific items of income that are treated as passive. Following the issuance of proposed § 1.6038D–6(b)(2), on February 15, 2012, comprehensive regulations (77 FR 9022 (REG–121647–10)) were proposed under sections 1471 through 1474, which were also enacted as part of the HIRE Act that enacted section 6038D. A definition of passive income was included in the proposed regulations under section 1472 for purposes of identifying certain active nonfinancial foreign entities (NFFEs), which are excepted from withholding under section 1472(a) and therefore do not have to report their substantial U.S. owners in order to avoid withholding. The definition of passive income in proposed § 1.1472–1(c)(1)(v) contained a list of items that was similar, although not identical, to the list contained in proposed § 1.6038D–6(b)(2). On January 28, 2013, the proposed regulations under sections 1471 through 1474 were finalized (78 FR 5874, TD 9610). In the final regulations, the Treasury Department and the IRS clarified the scope of the definition of passive income, made modifications in response to comments received, and moved the provision to § 1.1472–1(c)(1)(iv)(A). In addition, exceptions for look-through payments and dealers were added in § 1.1472–1(c)(1)(iv)(B).

The definitions of passive income under sections 1472 and 6038D serve a similar function, which is to identify entities that have a high risk of being used for tax evasion and to reduce compliance burdens for active entities. Therefore, these final regulations in § 1.6038D–6(b)(2) adopt several of the modifications to the term “passive income” that were included in § 1.1472–1(c)(1)(iv)(A). Specifically, these modifications: (1) Clarify that “dividends” includes substitute dividends and expand “interest” to cover income equivalent to interest, including substitute interest, (2) add a new exception for certain active business gains or losses from the sale of commodities, and (3) define notional principal contracts by adding a reference to § 1.446–3(c)(1). In addition, these final regulations add the exception for dealers that is described in § 1.1472–1(c)(1)(iv)(B)(2).

In addition, the proposed regulations under both sections 1472 and 6038D excluded from the definition of passive income rents or royalties derived in the active conduct of a trade or business conducted by employees of the relevant entity. A comment submitted in response to proposed § 1.6038D–6(b)(2)(iii) expressed concern that the exception applies only to rents and royalties derived in an active trade or business conducted exclusively by a corporation’s or partnership’s employees, and noted that it is difficult to find a trade or business that is conducted solely by a business’s employees. These final regulations provide, consistent with § 1.1472–1(c)(1)(iv)(A)(4), that rents and royalties derived in the active conduct of a trade or business conducted “at least in part” by employees of the corporation or partnership will not be considered passive income.

The exception for certain look-through income from related persons in § 1.1472–1(c)(1)(iv)(B)(1) is not adopted in these final regulations because § 1.6038D–6(b)(3)(ii) already eliminates passive income or assets arising from related party transactions for purposes of applying the passive income and asset thresholds to a corporation or partnership with related entities.

Finally, the proposed regulations did not specify how to determine whether 50 percent of a corporation’s or partnership’s assets are passive assets. The Treasury Department and the IRS believe that the weighted average test for active NFFEs in the regulations under section 1472 provides an administrable way to determine the passive asset percentage. Therefore, these final regulations provide that the passive asset percentage is determined based on a weighted average approach similar to the rule in § 1.1472–1(c)(1)(iv). Under this test, corporations or partnerships may use either fair market value or book value (as reflected on the entity’s balance sheet and as determined under either a U.S. or an international financial accounting standard) to determine the value of their assets. Corporations or partnerships may be required to substantiate their determination of the passive asset percentage upon request by the IRS. See section 6001.

Proposed § 1.6038D–6(a) provides that whether a domestic partnership is a specified domestic entity is determined annually, and proposed § 1.6038D–6(b)(3)(ii) provides that a partnership is closely held if at least 80 percent of the capital or profits interest in the partnership is held directly, indirectly, or constructively by a specified individual on the last day of the partnership’s taxable year.

A commenter recommended that a partner’s interest in a partnership should be calculated on a year-by-year basis for purposes of determining whether a domestic partnership is a specified domestic entity. The comment noted that it is often difficult to determine the precise capital or profits interest of a partner because it may shift depending on the performance of the partnership.

The requirement to determine a partner’s capital or profits interest on a particular day is present in other provisions of the Internal Revenue Code, Treasury regulations, and published guidance, and the Treasury Department and the IRS believe it is an appropriate measure of an individual’s economic interest in a partnership and, in general, is not overly complex. Accordingly, these final regulations retain the rule in the proposed regulations for determining if a domestic partnership is closely held.

Proposed § 1.6038D–6(b)(4) provides aggregation rules for purposes of applying proposed § 1.6038D–6(b)(1)(i), the § 1.6038D–2(a)(1) reporting threshold, and the passive income and asset thresholds under proposed § 1.6038D–6(b)(1)(iii). The proposed regulations provide that, for purposes of applying proposed § 1.6038D–6(b)(1)(i) and the reporting threshold, all domestic corporations and domestic partnerships that have an interest in specified foreign financial assets and are closely held by the same specified individual are treated as a single entity, and each such related corporation or partnership is treated as owning the specified foreign financial assets held by all such related corporations or partnerships. Similarly, the proposed regulations provide that, for purposes of applying the passive income and asset thresholds, all domestic corporations and domestic partnerships that are closely held by the same specified individual and connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as a single entity, and each member of such a group is treated as owning the combined assets and receiving the combined income of all members of that group.

The Treasury Department and the IRS have determined that it is not necessary both to treat a group as a single entity and to attribute the assets or income of members of the group to an entity. Therefore, these final regulations simplify the aggregation rules by eliminating the reference to treating all domestic corporations and partnerships as a single entity.

Proposed § 1.6038D–6(c) provides that a trust described in section 7701(a)(30)(E) is a specified domestic entity if and only if the trust has one or more specified persons as a current beneficiary. The term current beneficiary means, with respect to the taxable year, any person who at any time during such taxable year is entitled to, or at the discretion of any person may receive, a distribution from the principal or income of the trust (determined without regard to any power of appointment to the extent that such power remains unexercised at the end of the taxable year). The Treasury Department and the IRS intend that a specified domestic entity include a trust whereby a specified person has an immediately exercisable general power of appointment, even if such specified person is not technically a beneficiary. Therefore, these final regulations clarify that the term current beneficiary also includes any holder of a general power of appointment, whether or not exercised, that was exercisable at any time during the taxable year, but does not include any holder of a general power of appointment that is exercisable only on the death of the holder.

Proposed § 1.6038D–6(d) excepts certain entities from being treated as a specified domestic entity. A commenter recommended that the final regulations expand proposed § 1.6038D–6(d) to also except certain domestic trusts that are not required to file a Form 1041, “U.S. Fiduciary Income Tax Return,” or any information returns. The Treasury Department and the IRS do not adopt this comment because the 2014 final regulations already address the commenter’s concerns. The 2014 final regulations provide in § 1.6038D–2(a)(7) that a specified person, including a specified domestic entity, is not required to file Form 8938, “Statement of Specified Foreign Financial Assets,” with respect to a taxable year if the specified person is not required to file an annual return with the IRS with respect to that taxable year. In the case of a specified domestic entity, the term “annual return” means an annual federal income tax return or information return filed with the IRS, including returns required under section 6012. See § 1.6038D–1(a)(11). A Form 1041 is an annual return for purposes of § 1.6038D–1(a)(11) of the final regulations.

A commenter recommended that the final regulations except publicly traded partnerships from being specified domestic entities because they are similar to publicly traded corporations described in section 1473(3), which are excepted from the definition of specified domestic entity under proposed § 1.6038D–6(d)(1). The Treasury Department and the IRS do not adopt this comment. The requirement under proposed § 1.6038D–6(b) that to be a specified domestic entity at least 80 percent of the capital or profits interest in a partnership must be held by a specified individual on the last day of the partnership’s taxable year establishes appropriate general criteria that, as a practical matter, should exempt most publicly traded partnerships from being specified domestic entities.

A commenter recommended that the final regulations except an employer trust established for the benefit of more than a minimum number of employees, such as 50, from being a specified domestic entity even if the employer trust holds stock of a foreign company. The Treasury Department and the IRS believe the exception under proposed § 1.6038D–6(d)(1) for domestic entities that are not “specified United States persons” pursuant to section 1473(3), together with the exception for trusts whose trustees satisfy the supervisory oversight requirements and the income tax and information return filing requirements under proposed § 1.6038D–6(d)(2), are sufficiently broad to except employer trusts that represent a low risk of tax avoidance from characterization as a specified domestic entity. Therefore, this comment is not adopted.

* * * * *

(a) * * *

* * * * *

(12) Specified domestic entity.

* * * * *

(a) * * *

* * * * *

(6) * * *

(i) Specified individual.

(ii) Specified domestic entity.

* * * * *

(a) Specified domestic entity.

(b) Corporations and partnerships.

(1) Formed or availed of.

(2) Closely held.

(i) Domestic corporation.

(ii) Domestic partnership.

(iii) Constructive ownership.

(3) Determination of passive income and assets.

(i) Definition of passive income.

(ii) Exception from passive income treatment for dealers.

(iii) Related entities.

(4) Examples.

(c) Domestic trusts.

(d) Excepted domestic entities.

(1) Certain persons described in section 1473(3).

(2) Certain domestic trusts.

(3) Domestic trusts owned by one or more specified persons.

(e) Effective/applicability dates.

* * * * *

Par. 3. Section 1.6038D–1(a)(12) is revised to read as follows:

(a) * * *

* * * * *

(12) Specified domestic entity. The term specified domestic entity has the meaning set forth in § 1.6038D–6.

* * * * *

Par. 4. Section 1.6038D–2 is amended by:

1. Redesignating the text of paragraph (a)(6) as paragraph (a)(6)(i) and adding a paragraph heading to newly redesignated paragraph (a)(6)(i).

2. Adding paragraph (a)(6)(ii).

3. Revising paragraph (g).

The additions and revision read as follows:

(a) * * *

(6) Aggregate value calculation in case of specified foreign financial asset excluded from reporting—(i) Specified individual. * * *

(ii) Specified domestic entity. The value of any specified foreign financial asset in which a specified domestic entity has an interest and that is excluded from reporting on Form 8938 pursuant to § 1.6038D–7(a) (concerning certain assets reported on another form) is excluded for purposes of determining the aggregate value of specified foreign financial assets. For purposes of determining the aggregate value of specified foreign financial assets, a specified domestic entity that is a corporation or partnership and that has an interest in any specified foreign financial asset is treated as owning all the specified foreign financial assets (excluding specified foreign financial assets excluded from reporting on Form 8938 pursuant to § 1.6038D–7(a)) held by all domestic corporations and domestic partnerships that are closely held by the same specified individual as determined under § 1.6038D–6(b)(2).

* * * * *

(g) Effective/applicability dates. This section, with the exception of § 1.6038D–2(a)(6)(ii), applies to taxable years ending after December 19, 2011. Section 1.6038D–2(a)(6)(ii) applies to taxable years beginning after December 31, 2015. Taxpayers may elect to apply the rules of this section, with the exception of § 1.6038D–2(a)(6)(ii), to taxable years ending on or prior to December 19, 2011.

Par 5. Section 1.6038D–6 is added to read as follows:

(a) Specified domestic entity. A specified domestic entity is a domestic corporation, a domestic partnership, or a trust described in section 7701(a)(30)(E), if such corporation, partnership, or trust is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets. Whether a domestic corporation, a domestic partnership, or a trust described in section 7701(a)(30)(E) is a specified domestic entity is determined annually.

(b) Corporations and partnerships—(1) Formed or availed of. Except as otherwise provided in paragraph (d) of this section, a domestic corporation or a domestic partnership is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if and only if—

(i) The corporation or partnership is closely held by a specified individual as determined under paragraph (b)(2) of this section; and

(ii) At least 50 percent of the corporation’s or partnership’s gross income for the taxable year is passive income or at least 50 percent of the assets held by the corporation or partnership for the taxable year are assets that produce or are held for the production of passive income as determined under paragraph (b)(3) of this section (passive assets). For purposes of this paragraph (b)(1)(ii), the percentage of passive assets held by a corporation or partnership for a taxable year is the weighted average percentage of passive assets (weighted by total assets and measured quarterly), and the value of assets of a corporation or partnership is the fair market value of the assets or the book value of the assets that is reflected on the corporation’s or partnership’s balance sheet (as determined under either a U.S. or an international financial accounting standard).

(2) Closely held—(i) Domestic corporation. A domestic corporation is closely held by a specified individual if at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote, or at least 80 percent of the total value of the stock of the corporation, is owned, directly, indirectly, or constructively, by a specified individual on the last day of the corporation’s taxable year.

(ii) Domestic partnership. A partnership is closely held by a specified individual if at least 80 percent of the capital or profits interest in the partnership is held, directly, indirectly, or constructively, by a specified individual on the last day of the partnership’s taxable year.

(iii) Constructive ownership. For purposes of this paragraph (b)(2), sections 267(c) and (e)(3) apply for the purpose of determining the constructive ownership of a specified individual in a corporation or partnership, except that section 267(c)(4) is applied as if the family of an individual includes the spouses of the individual’s family members.

(3) Determination of passive income and assets—(i) Definition of passive income. Except as provided in paragraph (b)(3)(ii) of this section, for purposes of paragraph (b)(1)(ii) of this section, passive income means the portion of gross income that consists of—

(A) Dividends, including substitute dividends;

(B) Interest;

(C) Income equivalent to interest, including substitute interest;

(D) Rents and royalties, other than rents and royalties derived in the active conduct of a trade or business conducted, at least in part, by employees of the corporation or partnership;

(E) Annuities;

(F) The excess of gains over losses from the sale or exchange of property that gives rise to passive income described in paragraphs (b)(3)(i)(A) through (b)(3)(i)(E) of this section;

(G) The excess of gains over losses from transactions (including futures, forwards, and similar transactions) in any commodity, but not including—

(1) Any commodity hedging transaction described in section 954(c)(5)(A), determined by treating the corporation or partnership as a controlled foreign corporation; or

(2) Active business gains or losses from the sale of commodities, but only if substantially all the corporation or partnership’s commodities are property described in paragraph (1), (2), or (8) of section 1221(a);

(H) The excess of foreign currency gains over foreign currency losses (as defined in section 988(b)) attributable to any section 988 transaction; and

(I) Net income from notional principal contracts as defined in § 1.446–3(c)(1).

(ii) Exception from passive income treatment for dealers. Notwithstanding paragraph (b)(3)(i) of this section, in the case of a corporation or partnership that regularly acts as a dealer in property described in paragraph (b)(3)(i)(F) of this section (referring to the sale or exchange of property that gives rise to passive income), forward contracts, option contracts, or similar financial instruments (including notional principal contracts and all instruments referenced to commodities), the term passive income does not include—

(A) Any item of income or gain (other than any dividends or interest) from any transaction (including hedging transactions and transactions involving physical settlement) entered into in the ordinary course of such dealer’s trade or business as such a dealer; and

(B) If such dealer is a dealer in securities (within the meaning of section 475(c)(2)), any income from any transaction entered into in the ordinary course of such trade or business as a dealer in securities.

(iii) Related entities. For purposes of applying the passive income and asset thresholds of paragraph (b)(1)(ii) of this section, all domestic corporations and domestic partnerships that are closely held by the same specified individual as determined under paragraph (b)(2) of this section and that are connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as owning the combined assets and receiving the combined income of all members of that group. For purposes of the preceding sentence, assets relating to any contract, equity, or debt existing between members of such a group, as well as any items of gross income arising under or from such contract, equity, or debt, are eliminated. A domestic corporation or a domestic partnership is considered connected through stock or partnership interest ownership with a common parent corporation or partnership if stock representing at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote or of the value of such corporation, or partnership interests representing at least 80 percent of the profits interests or capital interests of such partnership, in each case other than stock of or partnership interests in the common parent, is owned by one or more of the other connected corporations, connected partnerships, or the common parent.

(4) Examples. The following examples illustrate the application of this section:

Example 1. Closely held and constructive ownership. (i) Facts. DC1 is a domestic corporation the total value of the stock of which is owned 60% by A, a specified individual, 30% by B, a member of A’s family for purposes of section 267(c)(2) who is not a specified individual, and 10% by FC1, a foreign corporation. DC1 owns 90% of the total value of the stock of DC2, a domestic corporation. FC2, a foreign corporation, owns 10% of DC2. Neither A nor B owns, directly, indirectly, or constructively, any stock in FC1 or FC2.

(ii) Closely held ownership determination. A is considered to own 90% and 81% of the total value of DC1 and DC2, respectively, by application of the rules of section 267(c) and this section. DC1 and DC2 are closely held by A within the meaning of paragraph (b)(2) of this section because A, a specified individual, is considered to own more than 80% of their total value.

Example 2. Application of aggregation rule and reporting threshold. (i) Facts. L is a specified individual. In Year X, L wholly owns DC1, a domestic corporation, and also owns a 90% capital interest in DP, a domestic partnership. DC1 owns 80% of the sole class of stock of DC2, a domestic corporation. DC1 has no assets other than its interest in DC2. DC2’s only assets are assets that produce passive income, with a maximum value in Year X of $40,000 on October 12. DC2’s assets are comprised in relevant part of specified foreign financial assets with a maximum value in Year X of $15,000 on October 12. DP’s only assets are assets that produce passive income and that are specified foreign financial assets with a maximum value of $90,000 in Year X on October 12.

(ii) Specified domestic entity status—(A) DC1 and DC2. DC1 and DC2 are closely held by a specified individual for purposes of paragraph (b)(2) of this section. DC1 and DC2 are considered related entities that are connected through stock ownership with a common parent corporation under paragraph (b)(3)(iii) of this section, because DC1 and DC2 are closely held by L, and DC2 is connected with DC1 through DC1’s ownership of stock of DC2 representing at least 80% of the voting power or value of DC2. As a result, for purposes of applying paragraph (b)(1)(ii) of this section, each of DC1 and DC2 is considered as owning the combined assets, and receiving the combined income, of both DC1 and DC2; however, DC1’s equity interest in DC2 is disregarded for this purpose under paragraph (b)(3)(iii) of this section. Therefore, DC1 and DC2 each satisfies the passive asset threshold of paragraph (b)(1)(ii) of this section, because 100 percent of each company’s assets is passive. DC1 and DC2 are specified domestic entities for Year X.

(B) DP. DP is closely held by a specified individual for purposes of paragraph (b)(2) of this section. DP is not considered a related entity with DC1 and DC2 under paragraph (b)(3)(iii) of this section, because DC1 and DP are not owned by a common parent corporation or partnership. As a result, whether the passive income or passive asset threshold of paragraph (b)(1)(ii) of this section is met with respect to DP is determined solely by reference to DP’s separately earned passive income and separately held passive assets. DP holds only passive assets during Year X and therefore satisfies paragraph (b)(1)(ii) of this section. DP is a specified domestic entity for Year X.

(iii) Reporting requirements—(A) DC1. Under § 1.6038D–2(a)(6)(ii), DC1 is not treated as owning the specified foreign financial assets held by DC2 and DP for purposes of applying the reporting threshold of § 1.6038D–2(a)(1), because DC1 does not have an interest in any specified foreign financial assets. DC1 is not required to file Form 8938 because DC1 does not satisfy the reporting threshold of § 1.6038D–2(a)(1).

(B) DC2 and DP. Under § 1.6038D–3, DC2 and DP each has an interest in specified foreign financial assets. For purposes of applying the reporting threshold of § 1.6038D–2(a)(1), § 1.6038D–2(a)(6)(ii) provides that DC2 is treated as owning in addition to its own assets the assets of DP, and DP is treated as owning in addition to its own assets the assets of DC2. As a result, DC2 and DP each satisfies the reporting threshold of § 1.6038D–2(a)(1), because the value of the specified foreign financial assets each is considered as owning for purposes of § 1.6038D–2(a)(1) is $105,000 on October 12, Year X, which exceeds DC2’s and DP’s $75,000 reporting threshold. DC2 and DP must each file Form 8938 for Year X to report their respective specified foreign financial assets in which they have an interest and disclose their maximum values as provided in § 1.6038D–4 ($15,000 in the case of DC2 and $90,000 in the case of DP).

Example 3. Application of aggregation rule and entity with an active trade or business. (i) Facts. The facts are the same as in Example 2, except that DC2 also owns an active business. The assets attributable to the business are not passive assets and constitute at least 60% of the value of DC2’s assets at all times during Year X. The income from the business is not passive income and constitutes at least 60% of the gross income generated by DC2 in Year X.

(ii) Specified domestic entity status—(A) DC1 and DC2. DC1 and DC2 are considered related entities that are connected through stock ownership with a common parent corporation under paragraph (b)(3)(iii) of this section because DC1 and DC2 are closely held by L, and DC2 is connected with DC1 though DC1’s ownership of stock of DC2 representing at least 80% of the voting power or value of DC2. As a result, for purposes of applying paragraph (b)(1)(ii) of this section, each of DC1 and DC2 is treated as owning the combined assets, and receiving the combined income, of both DC1 and DC2; however, DC1’s equity interest in DC2 is disregarded for this purpose under paragraph (b)(3)(iii) of this section. As a result, no more than 40 percent of the value of DC1’s and DC2’s assets at all times during Year X are passive and no more than 40 percent of DC1’s and DC2’s gross income for Year X is passive. DC1 and DC2 do not satisfy the passive income or passive asset threshold in paragraph (b)(1)(ii) of this section for Year X. DC1 and DC2 are not specified domestic entities for Year X.

(B) DP. For the reasons described in paragraph (ii)(B) of Example 2, DP is a specified domestic entity for Year X.

(iii) Reporting requirements—(A) DC1 and DC2. DC1 and DC2 are not specified domestic entities for Year X, and are not required to file Form 8938.

(B) DP. Under § 1.6038D–3, DP has an interest in specified foreign financial assets. Under § 1.6038D–2(a)(6)(ii), DP is treated as owning in addition to its own assets the assets of DC2. As a result, DP satisfies the reporting threshold of § 1.6038D–2(a)(1) because the value of the specified foreign financial assets it is considered to own for purposes of § 1.6038D–2(a)(1) is $105,000 on October 12, Year X, which exceeds DP’s $75,000 reporting threshold. DP must file Form 8938 for Year X to report the specified foreign financial assets in which it has an interest and disclose their maximum values as provided in § 1.6038D–4, which is $90,000.

(c) Domestic trusts. Except as otherwise provided in paragraph (d) of this section, a trust described in section 7701(a)(30)(E) is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if and only if the trust has one or more specified persons as a current beneficiary. The term current beneficiary means, with respect to the taxable year, any person who at any time during such taxable year is entitled to, or at the discretion of any person may receive, a distribution from the principal or income of the trust (determined without regard to any power of appointment to the extent that such power remains unexercised at the end of the taxable year). The term current beneficiary also includes any holder of a general power of appointment, whether or not exercised, that was exercisable at any time during the taxable year, but does not include any holder of a general power of appointment that is exercisable only on the death of the holder.

(d) Excepted domestic entities. An entity is not considered to be a specified domestic entity if the entity is—

(1) Certain persons described in section 1473(3). An entity, except for a trust that is exempt from tax under section 664(c), that is excepted from the definition of the term “specified United States person” under section 1473(3) and the regulations issued under that section;

(2) Certain domestic trusts. A trust described in section 7701(a)(30)(E) provided that the trustee of the trust—

(i) Has supervisory authority over or fiduciary obligations with regard to the specified foreign financial assets held by the trust;

(ii) Timely files (including any applicable extensions) annual returns and information returns on behalf of the trust; and

(iii) Is —

(A) A bank that is examined by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, or the National Credit Union Administration;

(B) A financial institution that is registered with and regulated or examined by the Securities and Exchange Commission; or

(C) A domestic corporation described in section 1473(3)(A) or (B), and the regulations issued with respect to those provisions.

(3) Domestic trusts owned by one or more specified persons. A trust described in section 7701(a)(30)(E) to the extent such trust or any portion thereof is treated as owned by one or more specified persons under sections 671 through 678 and the regulations issued under those sections.

(e) Effective/applicability dates. This section applies to taxable years beginning after December 31, 2015.

Approved: January 19, 2016.

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) regarding organizations described in section 509(a)(3) of the Internal Revenue Code (Code). An organization described in section 501(c)(3) is classified as either a private foundation or a public charity. To be classified as a public charity, an organization must be described in section 509(a)(1), (2), or (3). Organizations described in section 509(a)(3) are known as “supporting organizations.” Supporting organizations achieve their public charity status by providing support to one or more organizations described in section 509(a)(1) or (2), which in this context are referred to as “supported organizations.”

To be described in section 509(a)(3), an organization must satisfy (1) an organizational test, (2) an operational test, (3) a relationship test, and (4) a disqualified person control test. The organizational and operational tests require that a supporting organization be organized and at all times thereafter operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more supported organizations. The relationship test requires a supporting organization to establish one of three types of relationships with one or more supported organizations. A supporting organization that is operated, supervised or controlled by one or more supported organizations is known as a “Type I” supporting organization. The relationship of a Type I supporting organization with its supported organization(s) is comparable to that of a corporate parent-subsidiary relationship. A supporting organization that is supervised or controlled in connection with one or more supported organizations is known as a “Type II” supporting organization. The relationship of a Type II supporting organization with its supported organization(s) involves common supervision or control by the persons supervising or controlling both the supporting organization and the supported organization(s). A supporting organization that is operated in connection with one or more supported organizations is known as a “Type III” supporting organization and is discussed further in the remainder of this preamble. Finally, the disqualified person control test requires that a supporting organization not be controlled directly or indirectly by certain disqualified persons.

These proposed regulations focus primarily on the relationship test for Type III supporting organizations. Specifically, the proposed regulations reflect statutory changes enacted by sections 1241 through 1243 of the Pension Protection Act of 2006, Public Law 109–280 (120 Stat. 780) (2006) (PPA)), which made the following five changes to the requirements an organization must satisfy to qualify as a Type III supporting organization:

(1) Removed the ability of a charitable trust to rely on the special rule under § 1.509(a)–4(i)(2)(iii) of the regulations then in effect;

(2) Directed the Secretary of the Treasury to promulgate regulations under section 509 that establish a new distribution requirement for Type III supporting organizations that are not “functionally integrated” (a non-functionally integrated (NFI) Type III supporting organization) to ensure that a “significant amount” is paid to supported organizations (for this purpose the term “functionally integrated” means a Type III supporting organization that is not required under Treasury regulations to make payments to supported organizations, because the supporting organization engages in activities that relate to performing the functions of, or carrying out the purposes of, its supported organization(s));

(3) Required a Type III supporting organization to provide annually to each of its supported organizations the information required by the Treasury Department and the IRS to ensure that the supporting organization is responsive to the needs or demands of its supported organization(s);

(4) Prohibited a Type III supporting organization from supporting any supported organization not organized in the United States; and

(5) Prohibited a Type I or Type III supporting organization from accepting a gift or contribution from a person who, alone or together with certain related persons, directly or indirectly controls the governing body of a supported organization of the Type I or Type III supporting organization.

These proposed regulations set forth additional rules on the requirements for Type III supporting organizations, including additional requirements to meet the responsiveness test for all Type III supporting organizations; additional rules regarding the qualification of an organization as a functionally integrated Type III supporting organization under § 1.509(a)–4(i)(4), including provisions for supporting organizations that support governmental entities; and additional rules regarding the required annual distributions under § 1.509(a)–4(i)(5) by a NFI Type III supporting organization. The proposed regulations also define the term “control” for purposes of section 509(f)(2), which prohibits a Type I supporting organization or a Type III supporting organization from accepting contributions from persons who control the governing body of its supported organization(s).

On August 2, 2007, the Treasury Department and the IRS published in the Federal Register (72 FR 42335) an advanced notice of proposed rulemaking (ANPRM) (REG–155929–06) in response to the PPA. The ANPRM described proposed rules to implement the changes made by the PPA to the Type III supporting organization requirements and solicited comments regarding those proposed rules.

On September 24, 2009, the Treasury Department and the IRS published in the Federal Register (74 FR 48672) a notice of proposed rulemaking (the 2009 NPRM) (REG–155929–06). The 2009 NPRM contained proposed regulations (the 2009 proposed regulations) setting forth the requirements to qualify as a Type III supporting organization under the PPA.

On December 28, 2012, the Treasury Department and the IRS published in the Federal Register (77 FR 76382) a Treasury decision (TD 9605) containing final and temporary regulations (the 2012 TD) regarding the requirements to qualify as a Type III supporting organization. Based on the comments received, the 2012 TD made certain changes to the rules proposed in the 2009 NPRM, included in the temporary regulations significant changes to the distribution requirement, and reserved certain topics for further consideration. Also on December 28, 2012, the Treasury Department and the IRS published in the Federal Register (77 FR 76426) a notice of proposed rulemaking (the 2012 NPRM) (REG–155929–06) that incorporated the text of the temporary regulations in the 2012 TD by cross-reference. The 2012 TD provided transition relief for Type III supporting organizations in existence on December 28, 2012, that met and continued to meet the test under former § 1.509(a)–4(i)(3)(ii), as in effect prior to December 28, 2012, treating them as functionally integrated until the first day of their second taxable years beginning after December 28, 2012. The preamble to the 2012 TD also identified issues for possible future rulemaking and requested comments. The IRS received three comments on these issues. The comments were considered in developing these proposed regulations and are available for public inspection at www.regulations.gov or upon request. No public hearing was requested.

The Treasury Department and the IRS published Notice 2014–4, 2014–2 I.R.B. 274, to provide additional transition relief for any Type III supporting organization that (1) supports at least one governmental supported organization to which the supporting organization is responsive within the meaning of § 1.509(a)–4(i)(3) and (2) engages in activities for or on behalf of the governmental supported organization that perform the functions of, or carry out the purposes of, the governmental supported organization and that, but for the involvement of the supporting organization, would normally be engaged in by the governmental supported organization itself. Notice 2014–4 provides that such an organization will be treated as a functionally integrated Type III supporting organization until the earlier of the date final regulations are published under § 1.509(a)–4(i)(4)(iv) in the Federal Register or the first day of the organization’s third taxable year beginning after December 31, 2013.

On December 23, 2015, the Treasury Department and the IRS published in the Federal Register (80 FR 79684) a Treasury Decision (TD 9746) containing final regulations (the 2015 TD) regarding the distribution requirement for NFI Type III supporting organizations. The preamble of those regulations provided that supporting organizations supporting a governmental supported organization could continue to rely on Notice 2014–4 until the date of publication of the notice of proposed rulemaking prescribing the new proposed regulations under § 1.509(a)–4(i)(4)(iv). The IRS received three comments in response to Notice 2014–4, which the Treasury Department and the IRS considered in developing these proposed regulations.

Type I and Type III supporting organizations are prohibited from accepting a gift or contribution from a person who, alone or together with certain related persons, directly or indirectly controls the governing body of a supported organization of the Type I or Type III supporting organization, or from persons related to a person possessing such control. Section 509(f)(2) and § 1.509(a)–4(f)(5). For this purpose, related persons include family members and 35-percent controlled entities within the meaning of section 4958(f). Although the 2012 TD reserved § 1.509(a)–4(f)(5)(ii), “Meaning of control,” the preamble to the 2012 TD indicated that the Treasury Department and the IRS intended to issue proposed regulations that would provide such a definition.

These proposed regulations define “control” for this purpose consistently with § 1.509(a)–4(j), which relates to control by disqualified persons for purposes of the disqualified person control test. In general, under the proposed regulations, the governing body of a supported organization is considered “controlled” by a person if that person, alone or by aggregating his or her votes or positions of authority with certain related persons, as described in section 509(f)(2)(B)(ii) and (iii), may require the governing body of the supported organization to perform any act that significantly affects its operations or may prevent the governing body of the supported organization from performing any such act.

Section 1.509(a)–4(i)(1) provides that for each taxable year, a Type III supporting organization must satisfy (i) a notification requirement, (ii) a responsiveness test, and (iii) an integral part test provided in the regulations. These proposed regulations provide additional rules regarding each of these requirements.

Section 509(f)(1)(A) provides that an organization shall not be considered a Type III supporting organization unless the organization provides to each supported organization, for each taxable year, such information as the Secretary may require to ensure that the organization is responsive to the needs or demands of the supported organizations.

To satisfy this notification requirement, § 1.509(a)–4(i)(2) requires a Type III supporting organization to provide to each of its supported organizations for each taxable year: (1) A written notice addressed to a principal officer of the supported organization describing the type and amount of all of the support it provided to the supported organization during the supporting organization’s preceding taxable year; (2) a copy of the supporting organization’s most recently filed Form 990, “Return of Organization Exempt from Income Tax,” or other annual information return required to be filed under section 6033; and (3) a copy of the supporting organization’s governing documents, including any amendments (unless previously provided and not subsequently amended). For NFI Type III supporting organizations, the description of support in the written notice includes all of the distributions described in § 1.509(a)–4(i)(6) to the supported organization.

The proposed regulations amend § 1.509(a)–4(i)(2) to clarify that a supporting organization must deliver the required documents to each of its supported organizations by the last day of the fifth month of the taxable year after the taxable year in which the supporting organization provided the support it is reporting. This proposed change is intended to reduce confusion, but does not substantively change the due date or the content of the required notification. Date of delivery is determined applying the general principles of section 7502.

Section 1.509(a)–4(i)(3)(i) provides that a supporting organization meets the responsiveness test if it is “responsive to the needs or demands of a supported organization.” To meet this responsiveness test, an organization must satisfy: (1) A relationship test described in § 1.509(a)–4(i)(3)(ii) under which the officers, directors, or trustees of the organization have a specified relationship with the officers, directors, or trustees (and in some cases the members) of the supported organization; and (2) a significant voice test described in § 1.509(a)–4(i)(3)(iii) under which the officers, directors, or trustees of the supported organization, by reason of this relationship, have a significant voice in the investment policies of the supporting organization, the timing of grants, the manner of making grants, and the selection of grant recipients by the supporting organization, and in otherwise directing the use of the income or assets of the supporting organization. The preamble to the 2012 TD stated that, in determining the appropriate distribution amount for NFI Type III supporting organizations, the Treasury Department and the IRS considered the required relationship between a supporting organization and its supported organizations, and that the Treasury Department and the IRS intended to issue proposed regulations in the future that would amend the responsiveness test by requiring a Type III supporting organization to be responsive to all of its supported organizations.

In response to this proposal in the preamble to the 2012 TD, one commenter stated that a supporting organization should not be required to be responsive to all of its supported organizations because the resulting administrative burden would effectively limit the total number of organizations a supporting organization could support. The commenter suggested alternatives under which a supporting organization would be responsive to only a subset of its supported organizations that would vary from year to year.

The Treasury Department and the IRS note that the distinguishing characteristic of Type III supporting organizations, and the basis for their public charity classification, is that they are responsive to and significantly involved in the operations of their publicly supported organizations. See § 1.509(a)–4(f)(4). The Treasury Department and the IRS believe that, unless a Type III supporting organization is responsive to each of its supported organizations, the supported organizations cannot exercise the requisite level of oversight of and engagement with the supporting organization. Limiting the responsiveness requirement to fewer than all of the supported organizations may result in the necessary oversight and accountability being present for less than all of a supporting organization’s operations. Therefore, the proposed regulations revise § 1.509(a)–4(i)(3)(i) to require a supporting organization to be responsive to the needs and demands of each of its supported organizations in order to meet the responsiveness test.

To illustrate how concerns about potential administrative burdens may be addressed consistent with the responsiveness test, the proposed regulations include a new example. The proposed example is intended to demonstrate one way in which a Type III supporting organization that supports multiple organizations may satisfy the responsiveness test in a manner that can be cost-effective. The example shows that a supporting organization can, with respect to each of its supported organizations, meet a different subset of the required relationships with the supporting organization’s officers, directors, or trustees listed in § 1.509(a)–4(i)(3)(ii). It also shows how a supporting organization can organize and hold regular meetings, provide information, and encourage communication to help ensure that the supported organizations have a significant voice in the operations of the supporting organization.

Another commenter requested additional guidance regarding the ability of trusts to satisfy the significant voice requirement of the responsiveness test. The new Example 3 provides further illustration of how Type III supporting organizations, including charitable trusts, might satisfy the significant voice requirement of the responsiveness test. The Treasury Department and the IRS note that although the examples in the regulations relating to the responsiveness test may involve a Type III supporting organization that is organized as either a corporation or a trust, the applicable law and relevant regulatory provisions, as modified by the proposed regulations, are applicable to all Type III supporting organizations in the same manner, whether organized as a corporation or a trust. The Treasury Department and the IRS anticipate that Type III supporting organizations may be able to demonstrate they satisfy the responsiveness test in a variety of ways, and that the determination will be based on all the facts and circumstances.

As a result of the proposed changes to the responsiveness test, the proposed regulations also include conforming changes to examples and other regulatory provisions.

Section 1.509(a)–4(i)(1) provides that, for each taxable year, a Type III supporting organization must satisfy the integral part test. The integral part test is satisfied under § 1.509(a)–4(i)(1)(iii) by maintaining significant involvement in the operations of one or more supported organizations and providing support on which the supported organizations are dependent. To satisfy this test, a Type III supporting organization must meet the requirements either for a functionally integrated Type III supporting organization or for an NFI Type III supporting organization, as set forth in § 1.509(a)–4(i)(4) or (5), respectively.

A Type III organization is functionally integrated under § 1.509(a)–4(i)(4) if (1) it engages in activities substantially all of which directly further the exempt purposes of one or more supported organizations and otherwise meets the requirements described in paragraph (i)(4)(ii) of that section, (2) it is the parent of each of its supported organizations as described in paragraph (i)(4)(iii) of that section, or (3) it supports a governmental supported organization and otherwise meets the requirements of paragraph (i)(4)(iv) of that section. The direct furtherance test is not addressed by these regulations.

Under the current regulations, a supporting organization is the parent of a supported organization if the supporting organization exercises a substantial degree of direction over the policies, programs, and activities of the supported organization and a majority of the officers, directors, or trustees of the supported organization is appointed or elected, directly or indirectly, by the governing body, members of the governing body, or officers (acting in their official capacities) of the supporting organization. See § 1.509(a)–4(i)(4)(iii). This definition was adopted by the 2012 TD; however, the preamble to the 2012 TD stated that the Treasury Department and the IRS had determined that the definition of parent was insufficiently specific. It further stated that the Treasury Department and the IRS intended to issue proposed regulations that would provide a new definition of parent.

As noted in the preamble to the 2009 NPRM, the classification of a parent organization as functionally integrated was intended to “apply to supporting organizations that oversee or facilitate the operation of an integrated system, such as hospital systems.” To more fully accomplish this purpose, the proposed regulations amend § 1.509(a)–4(i)(4)(iii) to clarify that in order for a supporting organization to qualify as the parent of each of its supported organizations, the supporting organization and its supported organizations must be part of an integrated system (such as a hospital system), and the supporting organization must engage in activities typical of the parent of an integrated system. Examples of these activities include (but are not limited to) coordinating the activities of the supported organizations and engaging in overall planning, policy development, budgeting, and resource allocation for the supported organizations. The Treasury Department and the IRS request comments on what activities are typical of the parent of an integrated system, and whether additional activities should be explicitly listed as examples.

The proposed regulations retain the requirement that the governing body, members of the governing body, or officers of the supporting organization must appoint or elect a majority of the officers, directors, or trustees of the supported organization. The Treasury Department and the IRS intend, as stated in the 2009 NPRM, the use of the phrase “appointed or elected, directly or indirectly” to mean the supporting organization could qualify as a parent of a second-tier (or lower) subsidiary. Thus, for example, if the directors of supporting organization A appoint a majority of the directors of supported organization B, which in turn appoints a majority of the directors of supported organization C, the directors of supporting organization A will be treated as appointing the majority of the directors of both supported organization B and supported organization C.

The preamble to the 2012 TD stated that the Treasury Department and the IRS intended that the new definition of parent would specifically address the power to remove and replace officers, directors, or trustees of the supported organization. The Treasury Department and the IRS interpret the existing requirement under § 1.509(a)–4(i)(4)(iii) that the parent organization have the power to appoint or elect a majority of the officers, directors, or trustees of each supported organization to include the requirement that the parent organization also have the power to remove and replace such officers, directors, or trustees, or otherwise have an ongoing power to appoint or elect with reasonable frequency. The Treasury Department and the IRS request comments on whether § 1.509(a)–4(i)(4)(iii) should be amended to provide further clarification on this issue.

The 2009 NPRM proposed an exception to the general rules for qualifying as a functionally integrated Type III supporting organization if the supporting organization supported only one governmental entity, which was defined as an entity the assets of which are subject to the appropriations process of a federal, state, local, or Indian tribal government. The 2009 NPRM also provided that in order to be considered functionally integrated, a substantial part of the supporting organization’s total activities had to directly further the exempt purpose(s) of its supported organization, and that exempt purposes are not directly furthered by fundraising, grantmaking, or investing and managing non-exempt-use assets. The Treasury Department and IRS received multiple comments regarding this proposal. The 2012 TD stated the Treasury Department and the IRS were continuing to consider the public comments on the 2009 NPRM regarding this governmental entity exception and reserved § 1.509(a)–4(i)(4)(iv) for future guidance on how a Type III supporting organization can qualify as functionally integrated by supporting a governmental entity.

These proposed regulations take the prior comments into consideration and provide rules to qualify as functionally integrated both for new and existing Type III supporting organizations that support governmental supported organizations. These proposed rules also define the term “governmental supported organization.”

One commenter stated that the definition of a governmental supported organization in the 2009 NPRM was too complicated and difficult to understand and administer. This commenter proposed using the existing definition of a governmental unit in section 170(b)(1)(A)(v) and (c)(1).

The Treasury Department and the IRS agree with the commenter that for simplicity and administrability the term “governmental supported organization” should be defined by using an existing Code definition of a governmental unit. The proposed regulations define a governmental supported organization as a governmental unit described in section 170(c)(1), or an organization described in section 170(c)(2) and (b)(1)(A) (other than in clauses (vii) and (viii)) that is an instrumentality of one or more governmental units described in section 170(c)(1). The Treasury Department and the IRS further note that a governmental unit described in section 170(c)(1) includes all of the agencies, departments, and divisions of the governmental unit, and all such agencies, departments, and divisions will be treated as one governmental supported organization for purposes of § 1.509(a)–4(i)(4)(iv). The Treasury Department and the IRS specifically request comments on the proposed definition of governmental supported organization.

Two commenters said that the 2009 NPRM’s limit of only one governmental supported organization was too strict and instead recommended allowing a supporting organization to qualify for this exception if it supports at least one governmental supported organization, as Notice 2014–4 provides. One commenter noted that the 2009 NPRM’s limit of only one governmental supported organization would adversely affect existing supporting organizations that support an additional supported organization that is not itself a governmental entity, but that has a substantial operational connection with the governmental supported organization. Another commenter said that the test in Notice 2014–4 was not sufficient because it did not cover activities, such as fundraising and grant making, that the governmental supported organization could not otherwise perform.

In response to these comments, the Treasury Department and the IRS propose a new test for Type III supporting organizations that support only governmental supported organizations to qualify as functionally integrated. The Treasury Department and the IRS agree it would be appropriate to treat a Type III supporting organization that supports two or more governmental supported organizations as functionally integrated, provided that the governmental supported organizations are themselves connected geographically or operationally, which will help ensure that the supported organizations provide sufficient input to and oversight of the supporting organization. Thus, the proposed regulations provide that a supporting organization that supports more than one governmental supported organization may be considered functionally integrated if all of its governmental supported organizations either: (1) Operate within the same geographic region (defined as a city, county, or metropolitan area); or (2) work in close coordination or collaboration with one another to conduct a service, program, or activity that the supporting organization supports. To satisfy the close cooperation or coordination requirement, the proposed regulations require a supporting organization to maintain on file a letter from each of the governmental supported organizations (or a joint letter from all of them) describing their collaborative or cooperative efforts with respect to the particular service, program, or activity. In addition, the proposed regulations incorporate the 2009 NPRM proposed requirement that a substantial part of the supporting organization’s total activities must directly further the exempt purposes of its governmental supported organization(s). The Treasury Department and the IRS believe that using a substantial part requirement, instead of the substantially all requirement in § 1.509(a)–4(i)(4)(iv)(A), is appropriate when supporting organizations support only governmental supported organizations operating in the same geographic region or working in close collaboration because the input from and oversight by the governmental supported organizations minimize the potential for abuse.

Two commenters stated that activities such as fundraising, grant-making, and managing non-exempt-use assets should be considered activities that directly further the exempt purposes of a governmental supported organization. The Treasury Department and the IRS note that the integral part test’s definition of “directly further” in § 1.509(a)–4(i)(4)(ii)(C) generally excludes fundraising, making grants, and investing and managing non-exempt-use assets. The Treasury Department and the IRS excluded these items because they determined that a Type III supporting organization should qualify as functionally integrated only if the supporting organization itself conducts activities that perform the functions of or carry out the purposes of the supported organization (as distinguished from providing financial support for the activities carried out by the supported organization). The Treasury Department and the IRS do not believe a different definition of “directly further” should apply to supporting organizations that support governmental supported organizations. Accordingly, the proposed regulations do not adopt this comment. However, under the proposed rules, these types of organizations would be considered functionally integrated if a substantial part, but not substantially all, of their total activities directly further the exempt purposes of their governmental supported organization(s). Accordingly, these proposed regulations allow these organizations to conduct more fundraising and other financial activities, if certain requirements are met, than is permitted under the substantially all test of § 1.509(a)–4(i)(4)(ii).

In response to comments, the proposed regulations also provide a special rule for existing Type III supporting organizations, provided that they support no more than one additional supported organization that is not a governmental supported organization. A Type III supporting organization in existence on or before February 19, 2016 is treated as functionally integrated if: (1) It supports one or more governmental supported organizations and no more than one supported organization that is not a governmental supported organization; (2) it designated each of its supported organizations as provided in § 1.509(a)–4(d)(4) on or before February 19, 2016; and (3) a substantial part of its total activities directly furthers the exempt purposes of its governmental supported organization(s).

The proposed regulations also further extend the transition relief provided in Notice 2014–4 and extended by the 2015 TD. Under the proposed regulations, a Type III supporting organization in existence on or before February 19, 2016 that continues to meet the requirements of Notice 2014–4 is treated as functionally integrated until the earlier of the first day of the organization’s first taxable year beginning after the date final regulations under § 1.509(a)–4(i)(4)(iv) are published or the first day of the organization’s second taxable year beginning after February 19, 2016.

D. Integral Part Test – Non-Functionally Integrated Type III Supporting Organizations

Section 1.509(a)–4(i)(5) generally provides that an NFI Type III supporting organization meets the integral part test if it satisfies the distribution requirement of paragraph (i)(5)(ii) of that section and the attentiveness requirement of paragraph (i)(5)(iii) of that section. Section 1.509(a)–4(i)(5)(ii) provides that, with respect to each taxable year, a supporting organization must distribute to or for the use of one or more supported organizations an amount equaling or exceeding its “distributable amount”. Section 1.509(a)–4(i)(6) provides the amount of a distribution made to a supported organization is the amount of cash or the fair market value of the property distributed.

For clarity and consistency, the proposed regulations revise § 1.509(a)–4(i)(5)(ii) to state that a supporting organization must make distributions as described in § 1.509(a)–4(i)(6) to satisfy the distribution requirement, and revise section 1.509(a)–4(i)(6) to describe in detail what distributions count towards the distribution requirement.

Section 1.509(a)–4(i)(5)(ii)(B) provides that the distributable amount is equal to the greater of 85 percent of an organization’s adjusted net income for the immediately preceding taxable year (as determined by applying the principles of section 4942(f) and § 53.4942(a)–2(d)) or its minimum asset amount for the immediately preceding taxable year, reduced by the amount of taxes imposed on the supporting organization under subtitle A of the Code during the immediately preceding taxable year. See § 1.509(a)–4(i)(5)(ii)(B).

The Treasury Department and the IRS believe that, because the taxes under subtitle A of the Code are imposed on a supporting organization’s unrelated business taxable income (pursuant to section 511) and the activity that produces the unrelated business taxable income does not further the supported organization’s exempt purposes, these taxes should not be treated as an amount distributed to a supported organization. Therefore, the proposed regulations remove the provision in § 1.509(a)–4(i)(5)(ii)(B) that reduces the distributable amount by the amount of taxes subtitle A of the Code imposed on a supporting organization during the immediately preceding taxable year.

As noted above, § 1.509(a)–4(i)(6) provides details on the distributions by a supporting organization that count toward satisfying the distribution requirement imposed in § 1.509(a)–4(i)(5)(ii). The current regulations provide that distributions include but are not limited to: (1) Any amount paid to a supported organization to accomplish the supported organization’s exempt purposes; (2) any amount paid by the supporting organization to perform an activity that directly furthers the exempt purposes of the supported organization within the meaning of § 1.509(a)–4(i)(4)(ii), but only to the extent such amount exceeds any income derived by the supporting organization from the activity; (3) any reasonable and necessary administrative expenses paid to accomplish the exempt purposes of the supported organization(s), which do not include expenses incurred in the production of investment income; (4) any amount paid to acquire an exempt-use asset described in § 1.509(a)–4(i)(8)(ii); and (5) any amount set aside for a specific project that accomplishes the exempt purposes of a supported organization to which the supporting organization is responsive.

The preamble to the 2012 TD stated that the list in § 1.509(a)–4(i)(6) is not exhaustive and other distributions may count toward the distribution requirement. The preamble further stated the Treasury Department and the IRS intended to propose regulations that more fully describe the expenditures (including expenditures for administrative and additional charitable activities) that do and do not count toward the distribution requirement.

The Treasury Department and the IRS believe that the non-exclusive list in the current regulations creates uncertainty for supporting organizations and the IRS about what counts toward the distribution requirement. Therefore, the proposed regulations revise and clarify the list in § 1.509(a)–4(i)(6) of what counts toward the distribution requirement and make it an exclusive list.

The 2012 TD clarified that reasonable and necessary administrative expenses paid to accomplish the exempt purposes of supported organizations, and not expenses incurred in the production of investment income, count toward the distribution requirement. For example, if a supporting organization conducts exempt activities that are for the benefit of, perform the functions of, or carry out the purposes of its supported organization(s) and also conducts nonexempt activities (such as investment activities or unrelated business activities), then the supporting organization’s administrative expenses (such as salaries, rent, utilities and other overhead expenses) must be allocated between the exempt and nonexempt activities on a reasonable and consistently-applied basis. The administrative expenses attributable to the exempt activities are treated as distributions to its supported organization(s) if such expenses are reasonable and necessary. The administrative expenses and operating costs attributable to the nonexempt activities are not treated as distributions to the supported organization(s). The proposed regulations retain this provision, but also provide additional guidance on fundraising expenses.

The 2012 TD did not specifically address whether fundraising expenses count toward the distribution requirement. The proposed regulations specify that reasonable and necessary administrative expenses paid to accomplish the exempt purposes of a supported organization generally do not include fundraising expenses the supporting organization incurs. However, under the proposed regulations, reasonable and necessary expenses incurred by the supporting organization to solicit contributions that a supported organization receives directly from donors count toward the distribution requirement, but only to the extent that the amount of such expenses does not exceed the amount of contributions actually received by the supported organization as a result of the solicitation activities of the supporting organization. The Treasury Department and the IRS believe this rule would provide greater consistency with the treatment of contributions that supporting organizations receive directly and then distribute to their supported organizations (net of the supporting organizations’ solicitation expenses). To ensure that a supporting organization has the information it needs to calculate the allowable expenses, the proposed regulations require the supporting organization to obtain written substantiation from the supported organization of the amount of contributions the supported organization actually received as a result of the supporting organization’s solicitations.

One commenter requested that program related investments (PRIs) count toward the distribution requirement. The preamble to the 2012 TD stated the 2012 final and temporary regulations did not specifically address whether or not PRIs may count toward the distribution requirement or are excluded in calculating a supporting organization’s distributable amount for a taxable year. The Treasury Department and the IRS recognize that private foundations may use PRIs in a variety of ways to accomplish their exempt purposes and that PRIs thus are treated as qualifying distributions under section 4942. However, because supporting organizations must be operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of their supported organizations, they differ from private foundations. For purposes of meeting the integral part test, the Treasury Department and the IRS do not believe that PRIs should be treated as distributions to supported organizations. The Treasury Department and the IRS believe that other provisions relating to the distribution requirement, such as the availability of set asides and the potential for carry-forwards of excess distributions, provide significant flexibility for supporting organizations to meet the current and future needs of their supported organizations. For these reasons, the proposed regulations do not adopt this comment.

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(f) * * *

(5) * * *

(ii) Meaning of control. For purposes of paragraph (f)(5)(i) of this section, the governing body of a supported organization will be considered controlled by a person described in paragraph (f)(5)(i)(A) of this section if that person, alone or by aggregating the person’s votes or positions of authority with persons described in paragraph (f)(5)(i)(B) or (C) of this section, may require the governing body of the supported organization to perform any act that significantly affects its operations or may prevent the governing body of the supported organization from performing any such act. The governing body of a supported organization will generally be considered to be controlled directly or indirectly by one or more persons described in paragraph (f)(5)(i)(A), (B), or (C) of this section if the voting power of such persons is 50 percent or more of the total voting power of such governing body or if one or more of such persons have the right to exercise veto power over the actions of the governing body of the supported organization. However, all pertinent facts and circumstances will be taken into consideration in determining whether one or more persons do in fact directly or indirectly control the governing body of a supported organization.

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(i) * * *

(2) * * *(i) Annual notification. 6For each taxable year (the Reporting Year), a Type III supporting organization must provide the following documents to each of its supported organizations:

(A) A written notice addressed to a principal officer of the supported organization describing the type and amount of all of the support (including all of the distributions described in paragraph (i)(6) of this section if applicable) the supporting organization provided to the supported organization during the supporting organization’s taxable year immediately preceding the Reporting Year (and during any other taxable year of the supporting organization ending after December 28, 2012, for which such support information has not previously been provided);

* * * * *

(iii) Due date. The notification documents required by this paragraph (i)(2) shall be delivered or electronically transmitted by the last day of the fifth calendar month of the Reporting Year.

* * * * *

(3) * * *(i) General rule. A supporting organization meets the responsiveness test only if it is responsive to the needs or demands of each of its supported organizations. Except as provided in paragraph (i)(3)(v) of this section, in order to meet this test, a supporting organization must satisfy the requirements of paragraphs (i)(3)(ii) and (iii) of this section with respect to each of its supported organizations.

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(iv) * * *

Example 3. Z is described in section 501(c)(3). Z’s organizational documents provide that it supports ten different organizations, each of which is described in section 509(a)(1). One of the directors of S (one of the supported organizations) is a voting member of Z’s board of directors and participates in Z’s regular board meetings. Officers of Z hold regular face-to-face or telephonic meetings during the year to which officers of all the supported organizations are invited. Z’s meetings with the supported organizations may be held jointly or separately. Prior to the meetings, Z makes available to the supported organizations (including by email) up-to-date information about its activities including its assets and liabilities, receipts and distributions, and investment policies and returns. In the meetings, officers of each of the supported organizations have an opportunity to ask questions and discuss with officers of Z the projected needs of their organizations, as well as Z’s investment and grant making policies and practices. In addition to holding these meetings with the supported organizations, Z provides the contact information of one of its officers to each of the supported organizations and encourages them to contact that officer if they have questions, or if they wish to schedule additional meetings to discuss the projected needs of their organization and how Z should distribute its income and invest its assets. Z provides the information required under paragraph (i)(2) of this section and a copy of its annual audited financial statements to the principal officers of the supported organizations. Z meets the relationship test of paragraph (i)(3)(ii)(B) or (C) of this section with respect to each of its supported organizations. Based on these facts, Z also satisfies the significant voice requirement of paragraph (i)(3)(iii) of this section, and therefore meets the responsiveness test of this paragraph (i)(3) with respect to each of its ten supported organizations.

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(4) * * *

(ii) * * *

(A) * * *

(1) Directly further the exempt purposes of one or more supported organizations by performing the functions of, or carrying out the purposes of, such supported organization(s); and

* * * * *

(B) Meaning of substantially all. For purposes of paragraph (i)(4)(ii)(A) of this section, in determining whether substantially all of a supporting organization’s activities directly further the exempt purposes of one or more supported organization(s), all pertinent facts and circumstances will be taken into consideration.

* * * * *

(iii) Parent of supported organization(s). For purposes of paragraph (i)(4)(i)(B) of this section, in order for a supporting organization to qualify as the parent of each of its supported organizations, the supporting organization and its supported organizations must be part of an integrated system (such as a hospital system), the supporting organization must engage in activities typical of the parent of an integrated system, and a majority of the officers, directors, or trustees of each supported organization must be appointed or elected, directly or indirectly, by the governing body, members of the governing body, or officers (acting in their official capacities) of the supporting organization. For purposes of this paragraph (i)(4)(iii), examples of activities typical of the parent of an integrated system of supported organizations include (but are not limited to) coordinating the activities of the supported organizations and engaging in overall planning, policy development, budgeting, and resource allocation for the supported organizations.

(iv) Supporting a governmental supported organization—(A) In general. A supporting organization satisfies the requirements of this paragraph (i)(4)(iv) if—

(1) The supporting organization supports only governmental supported organizations, and, if the supporting organization supports more than one governmental supported organization, all of the governmental supported organizations either—

(i) Operate within the same geographic region; or

(ii) Work in close coordination or collaboration with one another to conduct a service, program, or activity that the supporting organization supports; and

(2) A substantial part of the supporting organization’s total activities are activities that directly further, as defined by paragraph (i)(4)(ii)(C) of this section, the exempt purposes of its governmental supported organization(s).

(B) Governmental supported organization defined. For purposes of paragraph (i)(4)(iv)(A) of this section, the term governmental supported organization means a supported organization that is–

(1) A governmental unit described in section 170(c)(1); or

(2) An organization described in section 170(c)(2) and (b)(1)(A) (other than in clauses (vii) and (viii)) that is an instrumentality of one or more governmental units described in section 170(c)(1).

(C) Geographic region defined. For purposes of paragraph (i)(4)(iv)(A)(1) of this section, the term geographic region means a city, county, or metropolitan area.

(D) Close cooperation or coordination. To satisfy the close cooperation or coordination requirement of paragraph (i)(4)(iv)(A)(1) of this section, the supporting organization shall maintain on file a letter from each of the governmental supported organizations (or a joint letter from all of them) describing their collaborative or cooperative efforts with respect to the particular service, program, or activity.

(E) Exception for organizations supporting a governmental supported organization on or before February 19, 2016. A Type III supporting organization in existence on or before February 19, 2016 will be treated as meeting the requirements of this paragraph (i)(4)(iv) if it met and continues to meet the following requirements—

(1) It supports one or more governmental supported organizations described in paragraph (i)(4)(iv)(B) of this section and does not support more than one supported organization that is not a governmental supported organization;

(2) Each of the supported organizations is designated by the supporting organization as provided in paragraph (d)(4) of this section on or before February 19, 2016; and

(3) A substantial part of the supporting organization’s total activities are activities that directly further, as defined by paragraph (i)(4)(ii)(C) of this section, the exempt purposes of its governmental supported organization(s).

(F) Transition rule for supporting organizations in existence on or before February 19, 2016. Until the earlier of the first day of the organization’s first taxable year beginning after the date final regulations are published in the Federal Register under this paragraph (i)(4)(iv) or the first day of the organization’s second taxable year beginning after February 19, 2016, a Type III supporting organization in existence on or before February 19, 2016 will be treated as meeting the requirements of this paragraph (i)(4)(iv) if it met and continues to meet the following requirements—

(1) It supports at least one supported organization that is a governmental entity to which the supporting organization is responsive within the meaning of paragraph (i)(3) of this section; and

(2) It engages in activities for or on behalf of the governmental supported organization described in paragraph (i)(4)(iv)(F)(1) of this section that perform the functions of, or carry out the purposes of, that governmental supported organization and that, but for the involvement of the supporting organization, would normally be engaged in by the governmental supported organization itself.

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(5) * * *

(ii) * * *(A) Annual distribution. With respect to each taxable year, a supporting organization must make distributions described in paragraph (i)(6) of this section in a total amount equaling or exceeding the supporting organization’s distributable amount for the taxable year, as defined in paragraph (i)(5)(ii)(B) of this section, on or before the last day of the taxable year.

(B) Distributable amount. Except as provided in paragraphs (i)(5)(ii)(D) and (E) of this section, the distributable amount for a taxable year is an amount equal to the greater of 85 percent of the supporting organization’s adjusted net income (as determined by applying the principles of section 4942(f) and § 53.4942(a)–2(d) of this chapter) for the taxable year immediately preceding the taxable year of the required distribution (immediately preceding taxable year) or its minimum asset amount (as defined in paragraph (i)(5)(ii)(C) of this section) for the immediately preceding taxable year.

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(iii) * * *(A) General rule. With respect to each taxable year, a non-functionally integrated Type III supporting organization must distribute one-third or more of its distributable amount to one or more supported organizations that are attentive to the operations of the supporting organization (within the meaning of paragraph (i)(5)(iii)(B) of this section).

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(D) * * *

Example 4. O is an organization described in section 501(c)(3). O is organized to support five private universities, V, W, X, Y, and Z, each of which is described in section 509(a)(1). O meets the responsiveness test described in paragraph (i)(3) of this section with respect to each of its supported organizations. Each year, O distributes an aggregate amount that equals its distributable amount described in paragraph (i)(5)(ii)(B) of this section and distributes an equal amount to each of the five universities. O distributes annually to each of V and W an amount that equals more than 10 percent of each university’s total annual support received in its most recently completed taxable year. Based on these facts, O meets the requirements of paragraph (i)(5)(iii) of this section because it distributes two-fifths (more than the required one-third) of its distributable amount to supported organizations that are attentive to O.

(6) Distributions that count toward distribution requirement. * * * Distributions by the supporting organization that count toward the distribution requirement imposed in paragraph (i)(5)(ii) of this section are limited to the following—

* * * * *

(iii) Any reasonable and necessary—

(A) Administrative expenses paid to accomplish the exempt purposes of the supported organization, which do not include expenses incurred in the production of investment income or the conduct of fundraising activities, except as provided in paragraph (i)(6)(iii)(B) of this section; and

(B) Expenses incurred to solicit contributions that are received directly by a supported organization, but only to the extent the amount of such expenses does not exceed the amount of contributions actually received by the supported organization as a result of the solicitation, as substantiated in writing by the supported organization;

* * * * *

(v) Any amount set aside for a specific project that accomplishes the exempt purposes of a supported organization, with such set-aside counting toward the distribution requirement for the taxable year in which the amount is set aside but not in the year in which it is actually paid, if at the time of the set-aside, the supporting organization—

* * * * *

(l) Effective/applicability dates. (1) Paragraphs (a)(6), (f)(5), and (i) of this section are effective on December 28, 2012, except—

(i) Paragraphs (i)(4)(ii)(C), (i)(5)(ii)(C) and (D), (i)(6)(iv), (i)(7)(ii), and (i)(8) of this section are applicable on December 21, 2015; and

(ii) Paragraphs (f)(5)(ii), (i)(2)(i) and (iii), (i)(3)(i), (i)(4)(ii)(A)(1), (i)(4)(ii)(B), (i)(4)(iii) and (iv), (i)(5)(ii)(A) and (B), (i)(5)(iii)(A), (i)(6)(i), (iii) and (v) of this section, Example 3 of paragraph (i)(3)(iv) of this section, and Example 4 of paragraph (i)(5)(iii)(D) of this section are effective on the date the Treasury decision adopting these rules as final or temporary regulations is published in the Federal Register.

(2) See paragraphs (i)(5)(ii)(B) and (C) and (i)(8) of § 1.509(a)–4T contained in 26 CFR part 1, revised as of April 1, 2015, for certain rules regarding non-functionally integrated Type III supporting organizations effective before December 21, 2015. See paragraphs (i)(5)(ii)(A) and (B) and (i)(5)(iii)(D) of § 1.509(a)–4 (as effective December 21, 2015), for certain rules regarding non-functionally integrated Type III supporting organizations effective before the date the Treasury decision adopting these rules as final or temporary regulations is published in the Federal Register.

The Proposed Regulations clarify and further develop the eligibility requirements for a political subdivision. To qualify as a political subdivision under the Proposed Regulations, an entity must meet three requirements, taking into account all of the facts and circumstances: sovereign powers, governmental purpose, and governmental control. The Proposed Regulations also authorize the Commissioner to set forth in future guidance to be published in the Internal Revenue Bulletin additional circumstances in which an entity qualifies as a political subdivision.

The Proposed Regulations continue, without substantive change, the longstanding requirement that a political subdivision be empowered to exercise at least one of the generally recognized sovereign powers. The three sovereign powers recognized for this purpose are eminent domain, police power, and taxing power. See Comm'r of Internal Revenue v. Shamberg's Estate, 144 F.2d 998 (2d Cir. 1944). The entity must be able to exercise a substantial amount of at least one of these powers. See, e.g., Rev. Rul. 77–164 (1977–1 CB 20); Rev. Rul. 77–165 (1977–1 CB 21).

In determining whether an entity is a political subdivision, the case law and administrative guidance interpreting the definition of political subdivision in the Existing Regulations commonly consider whether the entity serves a public purpose. Historically, the determination of whether an entity serves a public purpose has focused on the purpose for which the entity was created, usually as set forth in the legislation authorizing creation of the entity, rather than on the entity's conduct after its creation. See, e.g., Shamberg's Estate, 144 F.2d at 1004. The Proposed Regulations require that a political subdivision serve a governmental purpose. A governmental purpose requires, among other things, that the purpose for which the entity was created, as set out in its enabling legislation, be a public purpose and that the entity actually serve that purpose. It also requires that the entity operate in a manner that provides a significant public benefit with no more than incidental benefit to private persons. Cf., Rev. Rul. 90–74 (1990–2 CB 34) (applying an “incidental private benefit” standard for purposes of determining whether income is included in gross income under section 115(1)).

The Proposed Regulations provide that a political subdivision must be governmentally controlled. The Proposed Regulations provide rules for determining both what constitutes control and which parties must possess that control.

The Proposed Regulations define control to mean ongoing rights or powers to direct significant actions of the entity. Rights or powers to direct the entity's actions only at a particular point in time are not ongoing and, therefore, do not constitute control. For example, the right to approve an entity's plan of operation as a condition of the entity's formation is not an ongoing right. To constitute control, a collection of rights and powers must enable its holder to direct the significant actions of the entity.

The Proposed Regulations provide three non-exclusive benchmarks of rights or powers that constitute control: (1) the right or power both to approve and to remove a majority of an entity's governing body; (2) the right or power to elect a majority of the governing body of the entity in periodic elections of reasonable frequency; or (3) the right or power to approve or direct the significant uses of funds or assets of the entity in advance of that use. Aside from these three arrangements, the determination of whether a collection of rights and powers constitutes control will depend on the facts and circumstances. Neither the right to dissolve an entity nor procedures designed to ensure the integrity of the entity but not to direct significant actions of the entity are control. Cf., Rev. Rul. 69–453 (1969–2 CB 182) (addressing procedures that do not constitute control in the context of instrumentalities).

Control by a small faction of private individuals, business corporations, trusts, partnerships, or other persons is fundamentally not governmental control. Therefore, the Proposed Regulations generally require that control be vested in either a general purpose State or local governmental unit or in an electorate established under an applicable State or local law of general application. If, however, a small faction of private persons controls an electorate, that electorate's control of the entity does not constitute governmental control of the entity. Accordingly, the Proposed Regulations provide that an entity controlled by an electorate is not governmentally controlled when the outcome of the exercise of control is determined solely by the votes of an unreasonably small number of private persons.

The determination of whether the number of private persons controlling an electorate is unreasonably small generally depends on all of the facts and circumstances. To provide certainty, the Proposed Regulations limit application of this facts and circumstances test to situations that fall between two quantitative measures of concentration in voting power. The number of private persons controlling an electorate is always unreasonably small if the combined votes of the three voters with the largest shares of votes in the electorate will determine the outcome of the relevant election, regardless of how the other voters vote. The number of private persons controlling an electorate is never unreasonably small if determining the outcome of the relevant election requires the combined votes of more voters than the 10 voters with the largest shares of votes in the electorate. For example, control can always be vested in any electorate comprised of 20 or more voters that each have the right to cast one vote in the relevant election without giving rise to a private faction. For purposes of applying these measures of concentration in voting power, related parties are treated as a single voter and the votes of the related parties are aggregated.

Some observers have suggested that, despite private control, development districts should be political subdivisions during an initial development period in which one or two private developers elect the district's governing body and no other governmental control exists. The Treasury Department and IRS recognize that the governmental control requirement may present challenges for such development districts. In these circumstances, the Treasury Department and IRS are concerned about the potential for excessive private control by individual developers, the attendant impact of excessive issuance of tax-exempt bonds, and inappropriate private benefits from this Federal subsidy. The Treasury Department and IRS seek public comment on whether it is necessary or appropriate to permit such districts to be political subdivisions during an initial development period; how such relief might be structured; what specific safeguards might be included in the recommended relief to protect against potential abuse; and whether the proposed prospective effective dates and transition periods in §1.103–1(d) of the Proposed Regulations provide sufficient relief.

In addition to amending the definition of political subdivision, paragraphs (a) and (b) of the Proposed Regulations update the references in the general provisions of the Existing Regulations to reflect changes to the Code made in the Tax Reform Act of 1986, Public Law 99–514, 100 Stat. 2085, and other laws and regulations since the promulgation of the longstanding Existing Regulations. The Proposed Regulations also streamline these provisions. In general, the Treasury Department and the IRS intend that these proposed amendments not change the meaning of the Existing Regulations. The last sentence of §1.103–1(a) of the Proposed Regulations, however, clarifies that the continued tax-exemption of an issue of bonds depends on its issuer's continued status as a qualifying issuer of tax-exempt bonds. The Treasury Department and IRS seek comments on the need for remedial action provisions in the event the entity ceases to qualify as a political subdivision and on the substance of any such provisions.

Subject to certain transition rules, the Proposed Regulations generally would apply to all entities for all purposes of the tax-exempt bond provisions of sections 103 and 141 to 150 beginning 90 days after the Proposed Regulations are finalized. In order to ease hardship that may arise from the new definition of political subdivision, under proposed transition rules, that definition would not apply for purposes of determining whether outstanding bonds and refunding bonds in which the weighted average maturity is not extended continue to be obligations of a political subdivision. While these transition rules for outstanding bonds and refunding bonds would apply for the purpose of determining whether these bonds continue to be obligations of a political subdivision, the new proposed definition of political subdivision would apply for other purposes under sections 103 and 141 to 150, such as whether a new entity that subsequently became a user of a project financed with such bonds qualified as a State or local governmental unit for purposes of section 141. Furthermore, under another proposed transition rule that would apply to entities in existence prior to 30 days after the Proposed Regulations are published, the proposed definition of political subdivision would not apply for any purpose until three years and ninety days after the Proposed Regulations are finalized. This three-year transition period provides existing entities an opportunity to restructure as necessary to satisfy the new definition of political subdivision and allows existing entities to continue to issue new bonds during the transition period. To enhance certainty, an issuer also may choose to apply the definition of political subdivision in §1.103–1(c) in the final regulations in circumstances in which that definition otherwise would not apply under the transition rules.

In addition, prior to the applicability date of the final regulations, issuers may elect to apply the definition of political subdivision in §1.103–1(c) of the Proposed Regulations in whole, but not in part, for any purpose of sections 103 and 141 through 150, provided such use is applied consistently for all purposes of sections 103 and 141 through 150 to any given entity.

(a) Interest on State or local bonds. Under section 103(a), except as otherwise provided in section 103(b), gross income does not include interest on any State or local bond. Under section 103(c), the term State or local bond means any obligation (as defined in § 1.150–1(b)) of a State (including for this purpose the District of Columbia or any possession of the United States) or a political subdivision thereof (a State or local governmental unit). Obligations issued by or on behalf of any State or local governmental unit by a constituted authority empowered to issue such obligations are the obligations of such a unit. An obligation qualifies as a State or local bond so long as the issuer of that obligation remains a State or local governmental unit or a constituted authority.

(b) Certain limitations on interest exclusion. Under section 103(b), the interest exclusion in section 103(a) is inapplicable to a private activity bond under section 141(a) (unless the bond is a qualified bond under section 141(e)), an arbitrage bond under section 148, or a bond which does not meet the applicable requirements of section 149.

(c) Definition of political subdivision—(1) In general. The term political subdivision means an entity that meets each of the requirements of paragraphs (c)(2) (sovereign powers), (c)(3) (governmental purpose), and (c)(4) (governmental control) of this section, taking into account all of the facts and circumstances, or that is described in published guidance issued pursuant to paragraph (c)(5) of this section. Entities that may qualify as political subdivisions include, among others, general purpose governmental entities, such as cities and counties (whether or not incorporated as municipal corporations), and special purpose governmental entities, such as special assessment districts that provide for roads, water, sewer, gas, light, reclamation, drainage, irrigation, levee, school, harbor, port improvements, and other governmental purposes for a State or local governmental unit.

(2) Sovereign powers. Pursuant to a State or local law of general application, the entity has a delegated right to exercise a substantial amount of at least one of the following recognized sovereign powers of a State or local governmental unit: the power of taxation, the power of eminent domain, and police power.

(3) Governmental purpose. The entity serves a governmental purpose. The determination of whether an entity serves a governmental purpose is based on, among other things, whether the entity carries out the public purposes that are set forth in the entity's enabling legislation and whether the entity operates in a manner that provides a significant public benefit with no more than incidental private benefit.

(4) Governmental control. A State or local governmental unit exercises control over the entity. For this purpose, control is defined in paragraph (c)(4)(i) of this section and a State or local governmental unit exercises such control only if the control is vested in persons described in paragraph (c)(4)(ii) of this section.

(i) Definition of control. Control means an ongoing right or power to direct significant actions of the entity. Rights or powers may establish control either individually or in the aggregate. Among rights or powers that may establish control, an ongoing ability to exercise one or more of the following significant rights or powers, on a discretionary and non-ministerial basis, constitutes control: the right or power both to approve and to remove a majority of the governing body of the entity; the right or power to elect a majority of the governing body of the entity in periodic elections of reasonable frequency; or the right or power to approve or direct the significant uses of funds or assets of the entity in advance of that use. Procedures designed to ensure the integrity of the entity but not to direct significant actions of the entity are insufficient to constitute control of an entity. Examples of such procedures include requirements for submission of audited financial statements of the entity to a higher level State or local governmental unit, open meeting requirements, and conflicts of interest limitations.

(ii) Control vested in a State or local governmental unit or an electorate. Control is vested in persons described in paragraphs (c)(4)(ii)(A) or (c)(4)(ii)(B) of this section or a combination thereof:

(A) A State or local governmental unit possessing a substantial amount of each of the sovereign powers and acting through its governing body or through its duly authorized elected or appointed officials in their official capacities; or

(B) An electorate established under applicable State or local law of general application, provided the electorate is not a private faction (as defined in paragraph (c)(4)(iii) of this section).

(iii) Definition of private faction—(A) In general. A private faction is any electorate if the outcome of the exercise of control described in paragraph (c)(4)(i) of this section is determined solely by the votes of an unreasonably small number of private persons. The determination of whether a number of such private persons is unreasonably small depends on all of the facts and circumstances, including, without limitation, the entity's governmental purpose, the number of members in the electorate, the relationships of the members of the electorate to one another, the manner of apportionment of votes within the electorate, and the extent to which the members of the electorate adequately represent the interests of persons reasonably affected by the entity's actions. For purposes of this definition, the special rules in paragraphs (c)(4)(iii)(B) through (D) of this section apply.

(B) Treatment of certain limited electorates as private factions. An electorate is a private faction if any three private persons that are members of the electorate possess, in the aggregate, a majority of the votes necessary to determine the outcome of the relevant exercise of control.

(C) Safe harbor—voting power dispersed among more than 10 persons. An electorate is not a private faction if the smallest number of private persons who can combine votes to establish a majority of the votes necessary to determine the outcome of the relevant exercise of control is greater than 10 persons. For example, if an electorate consists of 20 private persons with equal, five-percent shares of the total votes, that electorate is not a private faction because a minimum of 11 members of that electorate is necessary to have a majority of the votes. By contrast, for example, if an electorate consists of 20 private persons with unequal voting shares in which some combination of 10 or fewer members has a majority of the votes, then that electorate does not qualify for the safe harbor from treatment as a private faction under this paragraph (c)(4)(iii)(C).

(D) Operating rules. The following rules apply for purposes of determining numbers of voters and voting control in paragraphs (c)(4)(iii)(B) and (C) of this section: (1) Related parties (as defined in §1.150–1(b)) are treated as a single person; and

(2) In computing the number of votes necessary to determine the outcome of the relevant exercise of control, all voters entitled to vote in an election are assumed to cast all votes to which they are entitled.

(5) Authority of the Commissioner. In guidance published in the Internal Revenue Bulletin, the Commissioner may set forth additional circumstances in which an entity qualifies as a political subdivision of a State or local governmental unit. See § 601.601(d)(2)(ii) of this chapter.

(d) Applicability dates—(1) In general. Except as otherwise provided in paragraphs (d)(2) through (4) of this section, this section applies to all entities for all purposes of sections 103 and 141 through 150 beginning on the date 90 days after the publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

(2) Applicability date of the definition of political subdivision for outstanding bonds. For purposes of determining whether outstanding bonds of an entity are obligations of a political subdivision under section 103, the definition of political subdivision in paragraph (c) of this section does not apply to that entity with respect to its outstanding bonds that are issued before the general applicability date under paragraph (d)(1) of this section.

(3) Applicability date of the definition of political subdivision for refunding bonds. For purposes of determining whether refunding bonds of an entity are obligations of a political subdivision under section 103, the definition of political subdivision in paragraph (c) of this section does not apply to that entity with respect to its refunding bonds that are issued on or after the general applicability date under paragraph (d)(1) of this section to refund bonds with respect to which paragraph (c) of this section otherwise does not apply, provided that the weighted average maturity of the refunding bonds is no longer than the remaining weighted average maturity of the refunded bonds.

(4) Applicability date of the definition of political subdivision for existing entities. For existing entities that are created or organized before May 21, 2016, the definition of political subdivision in paragraph (c) of this section does not apply for any purpose of sections 103 and 141 to 150 during the three-year period beginning on the general applicability date under paragraph (d)(1) of this section.

(5) Elective application of definition of political subdivision. An issuer may choose to apply the definition of political subdivision in paragraph (c) of this section to an issue of bonds in circumstances in which that section otherwise would not apply to that issue under paragraph (d)(2) or (3) of this section, provided that choice is applied consistently to the issue. An entity may choose to apply the definition of political subdivision in paragraph (c) of this section to an entity in circumstances in which that section otherwise would not apply to that entity under paragraph (d)(4) of this section, provided that choice is applied consistently to the entity.