These proposed regulations would amend the current final regulations under section 417(e) to permit plans to simplify the treatment of certain optional forms of benefit that are paid partly in the form of an annuity that is excepted from the minimum present value requirements of section 417(e)(3) pursuant to §1.417(e)-1(d)(6) and partly in a more accelerated form. Where a defined benefit plan offers a single-sum distribution or other form of accelerated distribution as an optional form of benefit in addition to the required qualified joint and survivor annuity, many participants have been reluctant to elect lifetime payments to insure against unexpected longevity, choosing instead an accelerated distribution form in order to maximize their liquidity. However, participants who elect a single sum or other accelerated form of distribution may face a greater challenge in protecting themselves against the risk of outliving their retirement savings.

The IRS and the Treasury Department believe that many participants would be better served by having the opportunity to elect to receive a portion of their retirement benefits in annuity form (which provides financial protection against unexpected longevity) while receiving accelerated payments for the remainder of the benefit to provide increased liquidity during retirement. Under current regulations, both portions of such a distribution option are subject to the minimum present value requirements of section 417(e)(3).

The proposed regulations would provide an exception to this rule in the case of a plan with a bifurcated accrued benefit as defined in the proposed regulations. Under this exception, such a plan is permitted to provide that, if a participant selects two different distribution options with respect to separate portions of the bifurcated accrued benefit, then the two different distribution options are treated as two separate optional forms of benefit for purposes of applying the requirements of section 417(e)(3). Thus, if this rule applies to treat two separate distribution options selected with respect to separate portions of a bifurcated accrued benefit as two separate optional forms of benefit, and one of those separate optional forms of benefit is exempt from the requirement to use the section 417(e)(3) assumptions, then that exemption would apply to that separate optional form of benefit. In such a case, the plan would have to apply the section 417(e)(3) assumptions only to the separate optional form of benefit that is not so exempted (rather than apply those assumptions to the entire optional form of benefit).

The primary impact of this proposed change would be to make it simpler and easier for a plan to offer an optional form of benefit that is a combination of a single-sum payment and an annuity. Allowing a plan to apply a bifurcated approach would permit the plan to use the section 417(e)(3) assumptions for the single-sum portion of the optional form and its usual annuity equivalence factors for the annuity portion (rather than being required to make a special calculation of the annuity portion using the section 417(e)(3) assumptions). Not only would this be simpler administratively, it would also yield a more intuitive result.

One type of plan with a bifurcated accrued benefit that would be eligible for this treatment is a plan that provides for two separate portions of the accrued benefit that are determined without regard to any election of optional form of benefit and permits a participant to choose different forms of benefit with respect to each of those portions of the accrued benefit. An example of such a plan is a plan that has been amended to accrue benefits under a different plan formula, where a participant’s benefit is the sum of the participant’s accrued benefit for years of service before the amendment date, determined under the pre-amendment plan terms, plus the participant’s accrued benefit for years of service after the amendment date, determined under the post-amendment plan terms, with no interaction between the two formulas, and the plan permits a participant to make separate elections of optional forms of benefit with respect to each of those portions of the accrued benefit.

A second type of plan with a bifurcated accrued benefit that would be eligible for this treatment is a plan that provides for a participant to apply different distribution elections to different portions of the accrued benefit so that the amount of the distribution, with respect to the distribution election applied to its respective portion of the accrued benefit, is the pro rata portion of the amount of the distribution that would be determined if that distribution election had been applied to the entire accrued benefit. An example of such a plan is a plan that provides both a single-sum option and a joint and survivor option for the entire benefit, but allows a participant to select an optional form which is 25 percent of the full lump sum and 75 percent of the full joint and survivor annuity.

A third type of plan with a bifurcated accrued benefit that would be eligible for this treatment is a plan that provides a single-sum distribution option with respect to only a portion of the benefit and provides a separate benefit election for the remainder of the distribution. In order to satisfy the requirements to be this type of plan with a bifurcated accrued benefit, the amount of the distribution that is not paid in a single sum must be no less than the amount that would be payable under the rules described in the prior paragraph had a single sum election been available with respect to the entire accrued benefit, where the single sum is determined as the present value of the accrued benefit payable at normal retirement age (or the immediate annuity if the participant is older than normal retirement age) determined using the applicable interest rates and the applicable mortality table. An example of such a plan is a plan that provides that a participant can elect to receive in a single sum an amount equal to the employee contributions, accumulated with interest, with the remainder of the accrued benefit paid under one of the annuity optional forms of benefit available under the plan in an amount sufficient to satisfy the requirements under the proposed regulations.

As previously discussed, the proposed regulations would make the bifurcation of benefits for purposes of section 417(e)(3) conditional on the existence of plan terms that explicitly provide that, if a participant selects two different distribution options with respect to separate portions of the bifurcated accrued benefit, then the two different distribution options are treated as two separate optional forms of benefit for purposes of applying the requirements of section 417(e)(3). To provide for such bifurcated treatment, a plan sponsor would be required to amend its plan to provide for use of the plan factors that generally apply to annuity distributions instead of the section 417(e)(3) assumptions in these circumstances. Any plan amendment must comply with the requirements of section 411(d)(6). See the discussion in this preamble under the heading “Effective/Applicability Date.”

The Treasury Department and the IRS recognize that additional modifications to the regulations under section 417(e)(3) are needed in light of the enactment of PPA ’06. It is expected that additional proposed amendments to the regulations under section 417(e)(3) will be issued to reflect statutory changes and to make other clarifications.

These regulations are proposed to be effective on the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

The changes under the proposed regulations are proposed to apply to distributions with annuity starting dates in plan years beginning after the publication date of final regulations. If the regulations are finalized as proposed and a plan that previously provided for a partial single-sum distribution together with a specified annuity distribution is amended to treat that distribution form as a bifurcated accrued benefit (and applies less favorable actuarial factors to the portion of the benefit that is not subject to section 417(e)(3)), then the plan must comply with the requirements of section 411(d)(6). This can be done by providing that, after the applicable amendment date under §1.411(d)-3(g)(4), the amount of each portion of a distribution is not less than the amount that would have been payable under the plan provisions in effect before the amendment applied to the participant’s accrued benefit as of the applicable amendment date.

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(d) Present value requirement—(1) General rule—(i) Defined benefit plans. * * *

(ii) Defined contribution plans. Because the accrued benefit under a defined contribution plan equals the account balance, a defined contribution plan is not subject to the requirements of this paragraph (d), regardless of whether the requirements of section 401(a)(11) apply to the plan.

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(7) Permitted bifurcation of certain optional forms of benefit—(i) General rule. A plan with a bifurcated accrued benefit (as described in paragraph (d)(7)(ii) of this section) is permitted to provide that, if a participant selects two different distribution options with respect to separate portions of the bifurcated accrued benefit, then the two different distribution options are treated as two separate optional forms of benefit for purposes of applying the requirements of section 417(e)(3) and this paragraph (d). Thus, if this paragraph (d)(7) applies to treat two separate distribution options selected with respect to separate portions of a bifurcated accrued benefit as two separate optional forms of benefit, and the exception from the application of paragraph (d) of this section that is contained in paragraph (d)(6) of this section applies to one of those optional forms of benefit, then this paragraph (d) applies only to the optional form of benefit to which the exception under paragraph (d)(6) of this section does not apply.

(ii) Bifurcated accrued benefit—(A) In general. A plan provides a bifurcated accrued benefit within the meaning of this paragraph (d)(7)(ii) if the plan satisfies the requirements of paragraph (d)(7)(iii) of this section (relating to separately determined benefits), (d)(7)(iv) of this section (relating to separate distribution options for proportionate benefits), or (d)(7)(v) of this section (relating to single sum with separate distribution option for remainder).

(B) Rules of operation. If a plan provides a bifurcated accrued benefit within the meaning of this paragraph (d)(7)(ii), and one portion of the benefits under the plan would itself be a bifurcated accrued benefit if it were the entire accrued benefit, then the rules of paragraph (d)(7)(i) of this section may be re-applied to such portion.

(iii) Separately determined benefits. A plan satisfies the requirements of this paragraph (d)(7)(iii) if the plan provides for two separate portions of the accrued benefit that are determined without regard to any election of optional form of benefit and permits a participant to select different distribution options with respect to each of those portions of the accrued benefit.

(iv) Separate elections for proportionate benefits. A plan satisfies the requirements of this paragraph (d)(7)(iv) if—

(A) The plan provides for a participant to select one distribution option with respect to a portion of the accrued benefit and a different distribution option with respect to the remaining portion of the accrued benefit;

(B) The distribution option selected with respect to each of the separate portions of the accrued benefit is available with respect to the entire accrued benefit; and

(C) The amount of the distribution with respect to each distribution option applied to its respective portion of the accrued benefit is the pro rata portion of the amount of the distribution that would be determined if that distribution option had been applied to the entire accrued benefit.

(v) Single sum with separate election for remainder. A plan satisfies the requirements of this paragraph (d)(7)(v) if—

(A) The plan provides for a specified amount to be distributed in a single sum, with the remainder distributed as another distribution option payable under the plan;

(B) A single-sum distribution is not available with respect to the participant’s entire accrued benefit; and

(C) The amount of the distribution that is not paid in a single sum is not less than the amount that would be payable if—

(1) A single sum election were available with respect to the entire accrued benefit, where the single sum is the present value of the accrued benefit payable at normal retirement age (or the immediate annuity if the participant is older than normal retirement age) determined using the applicable interest rates and the applicable mortality table;

(2) The participant elected to receive the specified amount in a single sum; and

(3) The rules of paragraph (d)(7)(iv) of this section were applied to determine the amount of the distribution that is not paid in a single sum.

(vi) Examples. The following examples illustrate the rules of this paragraph (d)(7). Unless otherwise indicated, these examples are based on the following assumptions: each plan is a single-employer defined benefit plan with a calendar-year plan year, a one-year stability period coinciding with the calendar year, and a one-month lookback used for determining the applicable interest rate. The normal retirement age is 65, and all participant elections are made with proper spousal consent. In addition, these examples reflect the amendments to sections 417 and 411 that were made in the Pension Protection Act of 2006, Public Law 109-280, 120 Stat. 780 (2006).

Example 1. (i) Plan B offers a number of optional forms of payment, including a qualified joint and survivor annuity and a single-sum payment. The single-sum payment is equal to the present value of the participant’s immediate benefit (but no less than the present value of the participant’s accrued benefit) using the applicable interest and mortality rates under section 417(e)(3). The amount of the joint and survivor annuity is determined using plan factors that are not based on the applicable interest and mortality rates under section 417(e)(3). Plan B permits a participant to elect to receive a percentage of the accrued benefit chosen by the participant as a single sum and the remainder in any annuity form provided under the plan, with both portions of the payment determined by multiplying the amount that would be payable if the entire benefit were paid in that form by the percentage that applies to that distribution option. Plan B provides that, with respect to a distribution that is paid partly in the form of a single sum and partly in the form of an annuity, the single sum and the annuity are treated as two separate optional forms of benefit for purposes of applying the provisions of the plan implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Assume that the December 2012 segment rates are 3.21%, 5.19% and 5.67% for purposes of this example.

(ii) Participant S retires at age 62 in 2013, with an accrued benefit of $1,000 per month payable as a straight life annuity at normal retirement age. Participant S is eligible for an unreduced early retirement benefit and can therefore collect a straight life annuity benefit of $1,000 per month beginning immediately. Alternatively, Participant S can elect to receive the benefit in other forms, including a single-sum payment of $153,852 (based on the applicable interest rate and mortality table under section 417(e), which are the 2013 applicable mortality table and the December 2012 segment rates), or a 100% joint and survivor annuity of $850 per month (based on the plan’s annuity conversion factors). Participant S elects to receive 25% of the benefit in the form of a single-sum payment and the balance as a 100% joint and survivor annuity.

(iii) In accordance with paragraph (d)(7)(iv) of this section, Plan B provides for a bifurcated accrued benefit because Plan B provides for a participant to select a single-sum distribution with respect to a portion of the accrued benefit and an annuity distribution option with respect to the remaining portion of the accrued benefit. Each distribution option is available with respect to the entire accrued benefit, and the amount of the distribution with respect to each distribution option applied to its respective portion of the accrued benefit is the pro rata portion of the amount of the distribution that would be determined if that distribution option had been applied to the entire accrued benefit. Furthermore, Plan B provides that the two different distribution options selected with respect to each of those portions of the accrued benefit are treated as two separate optional forms of benefit for purposes of applying the provisions of Plan B implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Accordingly, Participant S receives a single sum payment equal to 25% of the full single sum amount, or $38,463. In addition, Participant S receives a 100% joint and survivor annuity in the amount of $637.50 per month, equal to 75% of the full joint and survivor benefit of $850 per month otherwise payable. The joint and survivor benefit is not subject to the minimum present value requirements of section 417(e)(3) because it is treated as a separate optional form of benefit under paragraph (d)(7)(i) of this section.

Example 2. (i) Plan C permits participants to elect a partial single sum equal to employee contributions, accumulated with interest. Any other amounts must be paid in the form of an annuity. Under the terms of Plan C, if a participant elects to receive this partial single sum, the annuity benefit payable to the participant is at least as great as the minimum amount determined pursuant to paragraph (d)(7)(v)(C) of this section. Plan C provides that, with respect to a distribution that is paid partly in the form of a single sum and partly in the form of an annuity, the single sum and the annuity are treated as two separate optional forms of benefit for purposes of applying the provisions of the plan implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Participant T retires at age 60 in 2013 with an accrued benefit of $1,500 per month payable as a straight life annuity payable at normal retirement age. Based on the plan’s early retirement and optional form factors (which are not based on the applicable interest and mortality rates under section 417(e)(3)), Participant T’s benefit commencing at age 60 in the form of a 10-year certain and continuous annuity would be $925 per month. Participant T elects to receive a single sum payment of $32,000 equal to T’s accumulated contributions with interest, and the remainder as a 10-year certain and continuous annuity. Assume that the December 2012 segment rates are the same as those assumed in Example 1. Based on the applicable mortality table for 2013 and the December 2012 segment rates, the deferred annuity factor at age 60 for lifetime payments commencing at age 65 is 8.769.

(ii) In accordance with paragraph (d)(7)(v) of this section, Plan C provides for a bifurcated accrued benefit because Plan C provides for a specified amount to be distributed in a single sum, with the remainder distributed as another distribution option payable under the plan, a single-sum distribution is not available with respect to a participant’s entire accrued benefit, and the amount of the distribution that is not paid in a single sum meets the requirements of paragraph (d)(7)(v)(C) of this section. Furthermore, Plan C provides that, with respect to a distribution that is paid partly in the form of a single sum and partly in the form of an annuity, the single sum and the annuity are treated as two separate optional forms of benefit for purposes of applying the provisions of the plan implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Accordingly, the rule for proportional benefits under paragraph (d)(7)(iv) of this section is applied to determine the minimum amount of Participant T’s annuity as if a single sum payment were available, equal to the present value of T’s full accrued benefit. If Plan C had offered a single sum payment option with respect to Participant T’s full accrued benefit of $1,500 per month, the minimum present value based on the applicable mortality table for 2013 and the assumed December 2012 segment rates would have been $1,500 x 12 x the deferred annuity factor of 8.769, or $157,842. The single sum payment actually available to Participant T under the provisions of Plan C is the amount of accumulated contributions with interest, or $32,000 which represents 20.27% of the single sum value of Participant T’s full accrued benefit ($32,000 ÷ $157,842 = 20.27%).

(iii) Therefore, the portion of T’s accrued benefit not payable as a single sum must be at least as great as the amount based on the remaining 79.73% of T’s benefit multiplied by the accrued benefit of $1,500 per month, or $1,195.95 per month payable at normal retirement age. Based on Plan C’s early retirement and optional form factors, the annuity benefit payable to Participant T in the form of a 10-year certain and continuous annuity beginning at age 60 cannot be less than $925 times 79.73% or $737.50 per month. Participant T receives this in addition to the single sum payment of $32,000. The 10-year certain and continuous benefit is not subject to the minimum present value requirements of section 417(e)(3) because it is treated as a separate optional form of benefit under paragraph (d)(7)(i) of this section.

Example 3. (i) Plan D permits participants to elect a single-sum payment of up to $10,000 with the remaining benefit payable in the form of an annuity. Under the terms of Plan D, if a participant elects to receive this partial single sum, the annuity benefit payable to the participant is at least as great as the minimum amount determined pursuant to paragraph (d)(7)(v)(C) of this section. Plan D provides that, with respect to a distribution that is paid partly in the form of a single sum and partly in the form of an annuity, the single sum and the annuity are treated as two separate optional forms of benefit for purposes of applying the provisions of the plan implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Participant W retires in 2013 at age 55 with an accrued benefit of $1,000 per month payable at normal retirement age. Participant W is eligible for an unreduced early retirement benefit of $1,000 per month payable as a straight life annuity. Alternatively, based on Plan D’s definition of actuarial equivalence (which is not based on the applicable interest and mortality rates under section 417(e)(3)), Participant W can receive an immediate benefit in the form of a 100% joint-and-survivor annuity of $800 per month. Participant W elects to receive a single sum payment of $10,000, with the balance of the benefit payable as a 100% joint-and-survivor annuity beginning at age 55. Assume that the December 2012 segment rates are the same as those assumed in Example 1. Based on the applicable mortality table for 2013 and the December 2012 segment rates, the deferred annuity factor at age 55 for lifetime payments commencing at age 65 is 6.558.

(ii) In accordance with paragraph (d)(7)(v) of this section, Plan D provides for a bifurcated accrued benefit because Plan D provides for a specified amount to be distributed in a single sum, with the remainder distributed as another distribution option payable under the plan, a single-sum distribution is not available with respect to a participant’s entire accrued benefit, and the amount of the distribution that is not paid in a single sum meets the requirements of paragraph (d)(7)(v)(C) of this section.

Furthermore, Plan D provides that, with respect to a distribution that is paid partly in the form of a single sum and partly in the form of an annuity, the single sum and the annuity are treated as two separate optional forms of benefit for purposes of applying the provisions of the plan implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Accordingly, the rule for proportional benefits under paragraph (d)(7)(iv) of this section is applied to determine the minimum amount of Participant W’s annuity as if a single sum payment were available, equal to the present value of W’s full accrued benefit.

(iii) If Plan D had offered a single sum payment option with respect to Participant W’s full accrued benefit of $1,000 per month, the minimum present value based on the applicable mortality table for 2013 and the assumed December 2012 segment rates would have been $1,000 x 12 x the deferred annuity factor of 6.558, or $78,696. The single sum payment actually available to Participant W under the provisions of Plan D is $10,000, which represents 12.71% of the single sum value of W’s full accrued benefit ($10,000 ÷ $78,696 = 12.71%).

(iv) Therefore, the portion of Participant W’s accrued benefit not payable as a single sum must be at least as great as the amount based on the remaining 87.29% of W’s benefit multiplied by the accrued benefit of $1,000 per month, or $872.90 per month payable at normal retirement age. Based on Plan D’s early retirement and optional form factors, the annuity benefit payable to Participant W in the form of a 100% joint-and-survivor annuity beginning at age 55 is no less than 87.29% x $800, or $698.32 per month. Participant W receives this in addition to the single sum payment of $10,000. The joint and survivor annuity benefit is not subject to the minimum present value requirements of section 417(e)(3) because it is treated as a separate optional form of benefit under paragraph (d)(7)(i) of this section.

Example 4. (i) Plan E was amended to freeze benefits under the traditional plan formula as of December 31, 2012, and to provide benefits under a cash balance formula beginning January 1, 2013. The plan provides that participants may elect separate distribution options for the portion of the benefit accrued under the traditional formula as of December 31, 2012, and the portion of the benefit earned under the cash balance formula. Furthermore, the plan provides that a participant may elect to receive a single-sum payment only with respect to the portion of the benefit earned under the cash balance formula. Plan E provides that the two distribution options selected with respect to the portion of the benefit accrued under the traditional formula as of December 31, 2012, and the portion of the benefit earned under the cash balance formula are treated as two separate optional forms of benefit for purposes of applying the provisions of Plan E implementing the requirements of section 417(e)(3) and §1.417(e)-1(d).

(ii) In accordance with paragraph (d)(7)(iii) of this section, Plan E provides for a bifurcated accrued benefit because the portion of the accrued benefit determined under the traditional formula and the portion of the accrued benefit determined under the cash balance formula are determined separately without regard to any election of optional form of benefit and Plan E permits a participant to select different distribution options with respect to both of those portions of the accrued benefit. Furthermore, as permitted by paragraph (d)(7)(i) of this section, Plan E provides that the two different distribution options selected with respect to each of those portions of the accrued benefit are treated as two separate optional forms of benefit for purposes of applying the provisions of Plan E implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Therefore, whether a participant elects to receive a single sum payment of the portion of the benefit earned under the cash balance formula does not affect whether the distribution elected with respect to the portion of the benefit earned as of December 31, 2012, is subject to the minimum present value requirements of section 417(e)(3).

Example 5. (i) The facts are the same as in Example 4, except that Plan E also permits a participant to elect, with respect to the cash balance portion of the benefit, to receive a percentage of the accrued benefit chosen by the participant as a single sum and the remainder in any annuity form provided under the plan, with both portions of the payment determined by multiplying the amount that would be payable if the entire benefit were paid in that form by the percentage that applies to that distribution option. Plan E provides that, with respect to such a distribution that is paid partly in the form of a single sum and partly in the form of an annuity, the single sum and the annuity are treated as two separate optional forms of benefit for purposes of applying the provisions of the plan implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Participant X retires at age 65, with an accrued benefit under the traditional formula of $500 per month (earned as of December 31, 2012), and a cash balance hypothetical account of $45,000. Based on Plan E’s actuarial equivalence factors, Participant X’s accrued benefit derived from the cash balance hypothetical account is $320 per month, payable as a life annuity at normal retirement. Participant X elects to receive $15,000 of the current hypothetical account balance in the form of a single sum and to receive the remainder of the total accrued benefit as a life annuity.

(ii) Under the analysis set forth in Example 4, Plan E provides for a bifurcated accrued benefit in accordance with paragraph (d)(7)(iv)(C) of this section with respect to the portion of the accrued benefit attributable to the benefit accrued as of December 31, 2012, and the portion of the accrued benefit attributable to the benefit earned under the cash balance formula.

Furthermore, Plan E provides that the two different distribution options selected with respect to each of those portions of the accrued benefit are treated as two separate optional forms of benefit for purposes of applying the provisions of Plan E implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Thus, a separate distribution option may be chosen for each of these two portions, and section 417(e)(3) applies separately to each portion.

(iii) In accordance with paragraphs (d)(7)(ii)(B) and (d)(7)(iv) of this section, the portion of the accrued benefit under Plan E earned under the cash balance formula is also a bifurcated accrued benefit because Plan E provides for a participant to select a single-sum distribution with respect to a portion of the cash balance formula accrued benefit and an annuity distribution option with respect to the remaining portion of the cash balance formula accrued benefit, each distribution option is available with respect to the entire cash balance formula accrued benefit, and the amount of the distribution with respect to each distribution option applied to its respective portion of the cash balance formula accrued benefit is the pro rata portion of the amount of the distribution that would be determined if that distribution option had been applied to the entire cash balance formula accrued benefit. Furthermore, Plan E provides that the two different distribution options selected with respect to each of those portions of the cash balance formula accrued benefit are treated as two separate optional forms of benefit for purposes of applying the provisions of Plan E implementing the requirements of section 417(e)(3) and §1.417(e)-1(d). Thus, under paragraph (d)(7)(iv) of this section, 1/3 of the cash balance hypothetical account is paid as a single sum (that is, $15,000 ÷ $45,000), and the remaining 2/3 of the cash balance hypothetical account, or $30,000, is converted to an annuity benefit of 2/3 x $320, or $213.33 per month.

(iv) Participant X therefore receives a single sum payment of $15,000, representing the portion of the current hypothetical account balance that X elected to receive as a single sum. In addition, Participant X receives a monthly life annuity of $713.33 per month (equal to the $500 benefit attributable to the benefit earned as of December 31, 2012, plus the $213.33 portion of the cash balance benefit paid as an annuity). Participant X’s election to receive a single sum payment of part of the benefit earned under the cash balance formula does not affect whether the remainder of Participant X’s distribution is subject to the minimum present value requirements of section 417(e)(3).

(8) Effective/applicability date—(i) In general. Except as otherwise provided in this paragraph (d)(8), this paragraph (d) applies to distributions with annuity starting dates in plan years beginning on or after January 1, 1995.

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(v) Paragraph (d)(7) of this section applies to distributions with annuity starting dates in plan years beginning on or after the date final regulations that finalize these proposed regulations are published in the Federal Register.

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This document contains proposed regulations that provide guidance on the excise tax imposed on the sale of certain medical devices under section 4191 of the Internal Revenue Code (Code), enacted by section 1405 of the Health Care and Education Reconciliation Act of 2010, Public Law 111-152 (124 Stat. 1029 (2010)), in conjunction with the Patient Protection and Affordable Care Act, Public Law 111-148 (124 Stat. 119 (2010)) (jointly, the ACA).

Section 4191 imposes an excise tax on the sale of certain medical devices by the manufacturer, producer, or importer of the device in an amount equal to 2.3 percent of the sale price. Section 4191 applies to sales of taxable medical devices after December 31, 2012.

Section 4191(b)(1) provides that, in general, a “taxable medical device” is any device, as defined in section 201(h) of the Federal Food, Drug & Cosmetic Act (FFDCA), (codified as amended at 21 U.S.C. 301 et seq. (2006)), that is intended for humans. Section 201(h) of the FFDCA provides generally that the term “device” means an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component, part, or accessory, that is recognized in the official National Formulary, or the United States Pharmacopeia, or any supplement to them; intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease; or intended to affect the structure or any function of the body, and that does not achieve its primary intended purposes through chemical action within or on the body and that is not dependent upon being metabolized for the achievement of its primary intended purposes.

Section 4191(b)(2) provides that the term “taxable medical device” does not include eyeglasses, contact lenses, hearing aids, and any other medical device determined by the Secretary to be of a type that is generally purchased by the general public at retail for individual use.

In addition, the ACA amended section 4221(a) to limit tax-free sales of taxable medical devices to sales (i) for use by the purchaser for further manufacture, or for resale by the purchaser to a second purchaser for use by such second purchaser in further manufacture, and (ii) for export, or for resale by the purchaser to a second purchaser for export. The ACA makes a corresponding amendment to section 6416(b)(2) with regard to claims for refund.

The ACA added section 4191 to chapter 32, subtitle D of the Code, which relates to taxes imposed upon the sales of taxable articles by manufacturers, producers, and importers (commonly referred to as “manufacturers excise taxes”). Therefore, the existing rules governing chapter 32 apply to section 4191. The substantive regulations relating to manufacturers excise taxes are contained in part 48 (Manufacturers and Retailers Excise Tax Regulations) of Title 26 of the Code of Federal Regulations (CFR). The procedural regulations governing manufacturers excise taxes are contained in part 40 (Excise Tax Procedural Regulations) of 26 CFR.

The manufacturers excise tax rules are discussed in Part VII under “Explanation of Provisions,” in this preamble. For additional information on the manufacturers excise tax rules generally, see chapter 5 of IRS Publication 510, “Excise Taxes,” available at http://www.irs.gov/publications/p510/ch05.html.

On December 27, 2010, the IRS published Notice 2010-89, 2010-52 I.R.B. 908, to request comments on the implementation and administration of the new tax under section 4191. The IRS and the Treasury Department received numerous comments in response to the notice and considered all comments in the drafting of the proposed regulations. The comments are discussed in more detail in this preamble. The IRS and the Treasury Department also consulted with the Food and Drug Administration (FDA) and the Centers for Medicare and Medicaid Services (CMS) in developing these regulations.

Section 4191(b)(1) links the definition of “taxable medical device” to the definition of “device” in section 201(h) of the FFDCA. The FDA generally administers the provisions of the FFDCA, including section 201(h) and other provisions relating to medical devices.

The FDA generally requires owners or operators of places of business (also called establishments) that are located in the United States, or in foreign countries that export devices to the United States, and that manufacture, prepare, propagate, compound, assemble, process, repackage, or relabel medical devices intended for human use to register their establishments and list their devices upon first entering into operation, and to update this information on an annual basis with the FDA. See sections 510(a)-(d), (i), and (j) of the FFDCA, 21 CFR 807.20, and 21 CFR 807.21.

Various commentators observed that the statutory definition of “taxable medical device” leaves uncertainty as to which devices are included in the definition. The proposed regulations address this concern by providing that for purposes of the medical device excise tax, a device defined in section 201(h) of the FFDCA that is intended for humans means a device that is listed as a device with the FDA under section 510(j) of the FFDCA and 21 CFR Part 807, pursuant to FDA requirements. The FDA listing requirements are longstanding. Further, device manufacturers must comply with these requirements as part of the FDA’s device regulation process. Therefore, device manufacturers can be expected to know which devices fall within the definition.

The FDA has promulgated classification regulations for approximately 1,700 different generic types of devices. Each classification regulation includes one or more product codes that describe a subcategory of the device type described in the regulation. Currently, manufacturers may, in certain circumstances, list multiple different devices that fall within the same product code under a single listing. Therefore, all devices that are listed under a single product code listing in conjunction with the FDA’s device listing requirement are “taxable medical devices” unless they fall within an exemption under section 4191(b)(2).

The proposed regulations also provide that if a device is not listed with the FDA but the FDA later determines that the device should have been listed as a device, the device will be deemed to have been listed as a device with the FDA as of the date the FDA notifies the manufacturer or importer in writing that corrective action with respect to listing is required.

Section 4191(b)(2) provides that the term “taxable medical device” does not include eyeglasses, contact lenses, hearing aids, and any other medical device determined by the Secretary to be of a type that is generally purchased by the general public at retail for individual use (the retail exemption).

The FDA has grouped each of the 1,700 classification regulations into 16 medical specialties (21 CFR, Parts 862-892). Each of these generic types of devices is assigned to one (or sometimes more than one) of three regulatory classes based on the level of control necessary to assure the safety and effectiveness of the device. The three classes of FDA devices are Class I (general controls), Class II (special controls), and Class III (pre-market approval). A number of device types that predate the enactment of the Medical Device Amendments to the Food, Drug, and Cosmetic Act of 1976 remain unclassified.

With regard to the retail exemption, section 4191 makes no reference to the three regulatory classes. Further, the Joint Committee on Taxation’s Technical Explanation of the ACA makes clear that the FDA regulatory classes do not, by themselves, determine whether a device falls within the retail exemption. Specifically, the Technical Explanation states, “The exemption for such items is not limited by device class as defined in section 513 of the Federal Food, Drug, and Cosmetic Act.” Rather, the Technical Explanation notes that the exemption could cover “Class I items such as certain bandages and tipped applicators, Class II items such as certain pregnancy test kits and diabetes testing supplies, and Class III items such as certain denture adhesives and snake bite kits.” The Technical Explanation also emphasizes that “items would only be exempt if they are generally designed and sold for individual use.” Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 111th Congress (JCS-2-11), March 2011, at 366.

The proposed regulations provide a facts and circumstances approach to evaluating whether a taxable medical device is of a type that is generally purchased by the general public at retail for individual use. Under the proposed regulations, a device is considered to be of a type generally purchased by the general public at retail for individual use if (i) the device is regularly available for purchase and use by individual consumers who are not medical professionals, and (ii) the device’s design demonstrates that it is not primarily intended for use in a medical institution or office, or by medical professionals. The proposed regulations provide a set of non-exclusive factors for use in evaluating whether a taxable medical device is of a type that is generally purchased by the general public at retail for individual use. The proposed regulations also include a safe harbor provision.

The proposed regulations provide a non-exclusive list of factors to be considered in determining whether a device is regularly available for purchase and use by individual consumers who are not medical professionals. Those factors are (i) whether consumers who are not medical professionals can purchase the device through retail businesses that also sell items other than medical devices, including drug stores, supermarkets, and similar vendors; (ii) whether consumers who are not medical professionals can safely and effectively use the device for its intended medical purpose with minimal or no training from a medical professional; and (iii) whether the device is classified by the FDA under Subpart D of 21 CFR Part 890 (Physical Medicine Devices).

The proposed regulations also provide a non-exclusive list of factors to be considered in determining whether the design of a device demonstrates that it is primarily intended for use in a medical institution or office, or by medical professionals, and therefore not intended for purchase and use by individual consumers. Those factors are (i) whether the device generally must be implanted, inserted, operated, or otherwise administered by a medical professional; (ii) whether the cost to acquire, maintain, and/or use the device requires a large initial investment and/or ongoing expenditure that is not affordable for the average consumer; (iii) whether the device is a Class III device under the FDA system of classification; (iv) whether the device is classified by the FDA under certain parts or subparts of 21 CFR; and (v) whether the device qualifies as durable medical equipment, prosthetics, orthotics, and supplies (DMEPOS) for which payment is available exclusively on a rental basis under the Medicare Part B payment rules and is an “item requiring frequent and substantial servicing” as defined in 42 CFR 414.222. With regard to the regulatory classifications incorporated into the fourth factor described in this preamble, the IRS and the Treasury Department have determined, based on all the facts and circumstances, that the overwhelming majority of product codes that fall within these regulatory categories do not include devices that are of a type generally purchased by the general public at retail for individual use.

Whether a device is of a type generally purchased by the general public at retail for individual use is determined based on all relevant facts and circumstances. Thus, there may be relevant facts and circumstances in addition to the factors specifically identified in the proposed regulations.

To provide greater certainty, the proposed regulations also include a safe harbor provision that identifies certain categories of taxable medical devices that the IRS and the Treasury Department have determined fall within the retail exemption. The safe harbor includes (i) devices that are identified in the FDA’s IVD Home Use Lab Tests (Over-the-Counter Tests) database, available at http://www.accessdata.fda.gov/scripts/cdrh/cfdocs/cfIVD/Search.cfm; (ii) devices described as “OTC” or “over the counter” devices in the relevant FDA classification regulation heading; (iii) devices that are described as “OTC” or “over the counter” devices in the FDA’s product code name, the FDA’s device classification name, or the “classification name” field in the FDA’s device registration and listing database, available at http://www.accessdata.fda.gov/scripts/cdrh/cfdocs/cfrl/rl.cfm; and (iv) certain devices that qualify as DMEPOS for which payment is available on a purchase basis under Medicare Part B payment rules in accordance with the fee schedule published by CMS.

The IRS and the Treasury Department recognize the challenges involved in applying a facts and circumstances test to the wide array of devices that are potentially subject to the medical device excise tax, including for smaller manufacturers or importers for which the application of the retail exemption may determine whether they are subject to the tax at all. The IRS and the Treasury Department intend through the rulemaking process to continue their efforts to find ways to make the test easier to apply to particular cases and to provide certainty with respect to a substantial majority of devices. To that end, comments are requested on additional factors, examples, or safe harbors that could be added to provide greater certainty for a larger number of devices. Comments are particularly requested on how to provide greater clarity with respect to taxable medical devices that are sold primarily or exclusively through specialty medical retailers that sell medical devices and related materials. Comments are also requested on whether the packaging and labeling of a taxable medical device, the terms and conditions of the manufacturer’s warranty with respect to a device, and substantial sales of a device over the internet would be meaningful factors for use in establishing whether a device qualifies for the retail exception, and if so, how any such factor should be described and applied. Comments are also requested on other types of DMEPOS that should be considered for safe harbor treatment and how those items can be consistently and specifically identified. For example, “inexpensive equipment,” as defined in 42 CFR 414.220(a)(1), appears to describe items that may meet the retail exception under an application of the facts and circumstances test. However, comments are requested on how devices that fall under the definition would be identified given that the CMS fee schedule categorizes “inexpensive equipment” together with other medical devices that appear not to fall within the retail exception.

The IRS and the Treasury Department received numerous comments suggesting that it is not feasible to base the retail exception on quantitative data that compares the relative number of sales of a certain taxable medical device at retail to the number of sales of the device to doctors’ offices, hospitals, and other medical and health care providers and institutions. Several commentators stated that for a given device, numerical data on the proportion of sales to retail purchasers and to non-retail purchasers is often not available to the manufacturers and importers of the device, even with respect to the devices that they manufacture or import. Further, the commentators noted that even if the data is available, a rule that looks to industry-wide data regarding the percentage of retail and non-retail sales of a device would require an ongoing, resource-intensive effort to collect industry-wide sales information, and would not provide certainty to stakeholders because the data may change from year to year. In light of these difficulties, the proposed regulations do not adopt a market data approach to the retail exception.

One commentator suggested that the IRS and the Treasury Department provide a retail exception safe harbor based on a manufacturer’s or importer’s proportion of sales of a particular device at retail, compared to that manufacturer’s or importer’s overall sales of the device. Under this suggestion, if the retail sales of a particular device by a manufacturer or importer met or exceeded a certain ratio or percentage, as compared to overall sales by the manufacturer or importer of that device, then all sales of the device would be exempt from tax. The proposed regulations do not adopt this approach to the retail exception because the suggested safe harbor could result in inconsistent treatment of different manufacturers of the same device. The language of section 4191 applies the retail exception to types of devices, not to manufacturers and importers based on the nature of their distributions or sales.

Some commentators suggested that if the manufacturer or importer is able to determine that a particular taxable medical device is sold to consumers at retail, no tax should be imposed on any sale of that device, even if the device is not of a type that is generally purchased by the general public at retail for individual use. Such an approach would be contrary to the language of the statute. Therefore, the proposed regulations do not adopt this approach.

The definition of “device” in section 201(h) of the FFDCA includes devices used in veterinary medicine. However, the definition of “taxable medical device” under section 4191 limits taxable medical devices to devices described in section 201(h) of the FFDCA that are “intended for humans.” The proposed regulations further limit the definition of “taxable medical device” to devices that are listed with the FDA. Under existing FDA regulations, a device intended for use exclusively in veterinary medicine must be labeled as such and is not subject to several pre-market and post-market provisions of the FFDCA, including the listing requirement. Therefore, under the proposed regulations, devices intended for use exclusively in veterinary medicine are not “taxable medical devices.”

A commentator has noted, however, that many medical devices used in veterinary practices are also used in human medicine. The commentator suggested that if the manufacturer can demonstrate that a device is sold for use in veterinary medicine, the excise tax should not be imposed on that sale. The proposed regulations do not adopt this suggestion because the statutory language does not limit the definition of “taxable medical device” to devices intended exclusively for humans. Therefore, a device that is intended for humans but that is also intended for use or used in veterinary medicine is a “taxable medical device” if it is listed as a device with the FDA pursuant to FDA requirements, and does not fall within an exemption under section 4191(b)(2), such as the retail exemption.

Many commentators expressed concern over the potential taxation of devices that have both medical and non-medical uses, such as latex gloves, and requested that the excise tax not be imposed on the sale of devices for non-medical uses.

Section 4191 imposes a tax upon the sale of a taxable medical device by the manufacturer, unless the sale is for export or further manufacture. In most instances, the manufacturer does not sell directly to the end user of the device. Therefore, the manufacturer does not typically know the identity of the end user at the time of sale. Further, commentators suggest that manufacturers would have difficulty tracking their products through the supply chain and determining the ultimate destination of their products once they are sold to a distributor. Commentators also stated that, in some cases, after the manufacturer sells a device to a distributor, the distributor may package and label the device for sale for non-medical uses.

Under the proposed regulations, the definition of “taxable medical device” is tied to the FDA’s listing requirements for devices. Therefore, a device that is listed with the FDA pursuant to FDA requirements is a “taxable medical device,” unless it falls within an exemption under section 4191(b)(2), such as the retail exemption.

Several commentators stated that they manufacture devices that are used in clinical medicine to diagnose disease in humans, as well as in industrial laboratory work and laboratory research. Those commentators further stated that when sold for non-medical purposes, such devices are labeled “Research Use Only.” The comments suggest that, although the devices labeled “Research Use Only” are physically suitable for clinical use, FDA regulations prohibit the use of devices with this label in a clinical setting for human medical purposes. The commentators requested that sales of devices that are labeled “Research Use Only” be exempt from the medical device excise tax because of the intended use of such devices.

The proposed regulations define “taxable medical device” as any device that is listed as a device with the FDA pursuant to FDA requirements. Under 21 CFR 807.65(f) of the FDA regulations, persons that “manufacture, prepare, propagate, compound, or process devices solely for use in research, teaching, or analysis and do not introduce such devices into commercial distribution” are exempt from the FDA’s registration and listing requirements. See section 510(g) of the FFDCA. Accordingly, a device that is sold for use in research that is not listed because it satisfies the requirements of 21 CFR 807.65(f) is not a “taxable medical device” under the proposed regulations. In contrast, a device that is sold for use in research that is listed with the FDA pursuant to FDA requirements, such as a device not solely used in research or one that is introduced into commercial distribution, is a “taxable medical device” under the proposed regulations, unless it falls within an exemption under section 4191(b)(2), such as the retail exemption.

Several commentators requested an exemption for devices that are subject to an Investigational Device Exemption (IDE). The FDA permits the distribution of certain devices that the FDA has not yet approved for marketing under an IDE. See 21 CFR Part 812 for the FDA’s regulatory provisions regarding the IDE. Devices under an IDE are exempt from the FDA’s listing requirements. Accordingly, a device subject to an IDE is not a “taxable medical device” under the proposed regulations.

A commentator requested that the proposed regulations provide a blanket exclusion for dental instruments and equipment. The proposed regulations do not adopt this suggestion. There is no statutory basis for treating dental devices differently from other taxable medical devices. Many dental instruments and equipment items are subject to the FDA’s listing requirement. Accordingly, those devices that are listed as devices with the FDA pursuant to FDA requirements are “taxable medical devices” under the proposed regulations, unless they fall within an exemption under section 4191(b)(2), such as the retail exemption.

The ACA added section 4191 to chapter 32; therefore, the existing rules governing chapter 32 apply to the medical device excise tax. Those rules are longstanding. They are contained in statutory and regulatory provisions, and have been developed further through revenue rulings, other published guidance, and case law.

Several commentators requested clarification on the existing manufacturers excise tax rules. This section provides an overview of the rules and addresses some of the manufacturers excise tax issues raised by commentators.

In general, the manufacturer or importer of a taxable article is liable for the tax upon the sale of the article. Under chapter 32, the lease or use of a taxable article by the manufacturer is generally treated as a sale.

The term “manufacturer” means any person who produces a taxable article from scrap, salvage, or junk material, or from new or raw material, by processing, manipulating, or changing the form of an article or by combining or assembling two or more articles. A manufacturer that sells a taxable article in knockdown (that is, unassembled) condition is considered the manufacturer and is liable for tax on the sale of the article. For chapter 32 purposes, the term “manufacturer” also includes an “importer.” The importer of a taxable article is any person who brings the article into the United States from a source outside the United States, or withdraws an article from a customs bonded warehouse for sale or use in the United States. See §48.0-2(a)(4) for the definitions of the terms “manufacturer” and “importer.”

If more than one person is involved in the manufacture or importation of an item, such as a contract manufacturing arrangement, the determination of which person is the manufacturer or the importer is based on the facts and circumstances of the arrangement. The substance rather than the form of the transaction is determinative. See Rev. Rul. 58-134, 1958-1 C.B. 395, Rev. Rul. 60-42, 1960-1 C.B. 474, and Polaroid v. U.S., 235 F2d. 276 (1st Cir. 1956), for rules regarding the determination of which party is the manufacturer for chapter 32 purposes. See Rev. Rul. 68-197, 1968-1 C.B. 455, and Rev. Rul. 82-40, 1982-1 C.B. 175, for rules regarding the determination of which party is the importer for chapter 32 purposes.

Some commentators suggested that, in determining who is liable for the tax, the IRS and the Treasury Department should apply either the section 954 contract manufacturing rules or the FDA’s registration and listing rules under 21 CFR Part 807. The proposed regulations do not adopt these suggestions. As noted above, the existing chapter 32 framework includes definitions of “manufacturer” and “importer.” Section 4191 does not provide alternate definitions for those terms. Accordingly, the definitions of “manufacturer” and “importer” under chapter 32 apply to section 4191.

Generally, the manufacturers excise tax attaches when the title to the taxable article passes from the manufacturer to a purchaser. When title passes is dependent upon the intention of the parties as gathered from the contract of sale and the attendant circumstances. In the case of a sale on credit, the tax attaches whether or not the purchase price is actually paid. In the case of conditional or installment sales of a taxable article, the tax attaches to each partial payment. See §48.0-2(b) for the general rules regarding the attachment of tax.

Section 4218 imposes tax on certain uses of an article by the article’s manufacturer. The tax attaches at the time the use begins. Under §48.4218-1(b), generally, if the manufacturer of a taxable article uses the article for any purpose other than in the manufacture of another taxable article, then the manufacturer is liable for tax on the article as if the manufacturer had sold it. However, if a manufacturer uses a taxable article in the testing of another article of its own manufacture, the use of the taxable article by the manufacturer is not a taxable use. See Rev. Rul. 76-119, 1976-1 C.B. 345. Section 48.4218-5 provides rules on how to calculate the price on which the tax is imposed in cases of the taxable use of an article by the manufacturer.

Several commentators requested guidance on whether taxable medical devices that are used as demonstration products are subject to the medical device excise tax. The provision or use of a taxable medical device as a demonstration product may constitute a taxable sale or use, depending on the facts and circumstances of the arrangement. For example, Rev. Rul. 72-563, 1972-2 C.B. 568, holds that a manufacturer has sold an article when it provides the article “free of charge” to another person for promotional purposes. In addition, Rev. Rul. 60-290, 1960-2 C.B. 331, holds that the use of a taxable article by its manufacturer for demonstration purposes is a taxable use for purposes of section 4218.

Under section 4217(a), the lease of a taxable article by the manufacturer is considered a sale. If, at the time of making the lease, the manufacturer is in the business of selling the same type and model of article in arm’s length transactions, the tax attaches to each lease payment until the cumulative total of the tax payments equals the total tax. If, however, at the time of making the lease, the manufacturer is not engaged in the business of selling the same type and model of article in arm’s length transactions, the tax attaches to each lease payment if the article is leased by the manufacturer. See section 4216(c), section 4217(b), §48.4216(c)-1, and §48.4217-2 for the rules regarding the attachment and payment of tax in the context of leases.

Under §48.4217-1, the term “lease” means a contract or agreement, written or verbal, that gives the lessee an exclusive, continuous right to the possession or use of a particular article for a period of time. The term includes any renewal or extension of a lease, or any subsequent lease of the article.

The tax imposed under section 4191 is based on the price for which a taxable medical device is sold. Under section 48.4216(a)-1(a), the price for which a taxable article is sold includes the total consideration paid for the device, whether that consideration is in the form of money, services, or other things.

The taxable sale price of a taxable article also includes, among other things, any charge for coverings or containers (regardless of their nature), and any charge incident to placing the article in a condition to be packed and ready for shipment. However, the taxable sale price excludes (i) the manufacturers excise tax, whether or not it is stated as a separate charge; (ii) the actual cost of transportation, delivery, insurance, installation, and other expenses incurred by the manufacturer or importer in placing the article in the hands of the purchaser pursuant to a bona fide sale (the costs of transportation of goods to a warehouse before their bona fide sale are not excludable); (iii) discounts, rebates, and similar allowances actually granted to the purchaser; (iv) local advertising charges; and (v) charges for warranty paid at the purchaser’s option. See section 4216(a) and §48.4216(a)-1 for the rules regarding the charges included in sale price. See sections 4216(a) and (e), §48.4216(a)-2, §48.4216(e)-1, §48.4216(e)-2, and §48.4216(e)-3 for the rules regarding exclusions from sale price.

The basic sale price rules assume that the manufacturer sells the taxable article in an arm’s length transaction (that is, in a transaction between two unrelated parties) to a wholesale distributor that then sells the taxable article to a retailer that resells to consumers. However, if a manufacturer sells a taxable article other than to a wholesale distributor or at less than a fair market arm’s length price, the taxable sale price is determined on a constructive sale price rather than the actual sale price. The constructive sale price rules are set forth in section 4216(b), in §48.4216(b)-1, §48.4216(b)-2, §48.4216(b)-3, and §48.4216(b)-4 of the regulations, and in numerous revenue rulings.

If a purchaser of a taxable article returns the article to the manufacturer under a warranty as to its quality or service and the manufacturer replaces the article with a new taxable article free of charge or at a reduced price, the tax on the new article is computed on the actual amount, if any, paid to the manufacturer for the new article. See §48.4216(a)-3(b) for the rules regarding replacements under warranty.

Several commentators requested clarification on how the sale price rules work in the context of taxable medical devices, particularly with regard to “bonus” goods and rebates. These commentators indicated that rebates are a common practice in the medical device industry. Under existing manufacturers tax rules, if a manufacturer sells taxable articles at the regular price and includes some of the same articles as a bonus, the tax imposed under section 4191 applies to the total price charged for the entire order. With regard to rebates, §48.4216(a)-3(c) provides that the tax must be based on the original price of the taxable article, unless the rebate has been made prior to the close of the period for which the tax is returned. However, if a manufacturer subsequently allows a rebate for taxable articles on which tax has been paid, the manufacturer is entitled to a credit or refund for that portion of the tax that is proportionate to the part of the price that is rebated. See Rev. Rul. 68-659, 1968-2 C.B. 511, and Rev. Rul. 69-73, 1969-1 C.B. 284, for applications of the rules regarding bonus goods, free goods, and rebates. See §48.4216(a)-3(c) for rules regarding readjustments in sale price for discounts, rebates, and bonuses.

If title to, or ownership of, a taxable article passes from the manufacturer to a transferee by operation of law (such as through an inheritance or as part of the sale of a business) or as a result of any transaction not taxable under chapter 32, tax attaches to the sale of the article by the transferee to the same extent and in the same manner as if the transferee were the manufacturer of the article. See section 4219 and §48.4219-1 for the rules regarding transfers of title to taxable articles by operation of law.

Under section 4221(a), the tax imposed by section 4191 does not apply to the sale of taxable medical devices for use by the purchaser for further manufacture (or for resale by the purchaser to a second purchaser for further manufacture) or for export (or for resale for export).

Under §48.4221-2(b), an article is sold for use in further manufacture if the article is sold for use by the purchaser as material in the production of, or as a component part of, another article taxable under chapter 32. Section 48.4221-2 sets forth rules governing tax-free sales of articles to be used or resold for further manufacture.

Under §48.0-2(a)(10), an article is exported if the article is severed from the mass of things belonging within the United States with the intention of uniting it with the mass of things belonging within some foreign country or within a possession of the United States. Section 48.4221-3 sets forth rules regarding tax-free sales of articles for export.

To make a tax-free sale for further manufacture or export, the manufacturer, the first purchaser, and in some cases the second purchaser must be registered by the IRS. A manufacturer or purchaser applies for registration by filing a Form 637, “Application for Registration (For Certain Excise Tax Activities),” in accordance with the instructions on the form. See §48.4222(a)-1 for the registration requirements for tax-free sales. Foreign purchasers of articles sold or resold for export are exempt from the registration requirement. See §48.4222(b)-1(b).

Generally, the purchaser of a taxable article must provide the purchaser’s registration number to the manufacturer and certify the exempt purpose for which the article will be used. The information must be in writing and may be noted on the purchase order or other document furnished by the purchaser to the manufacturer in connection with the sale. See §48.4221-1(c).

A credit or refund of the manufacturers excise tax may be available if a tax-paid article is exported or used for an exempt purpose, such as further manufacture. See 6416 and the corresponding regulations for the conditions to allowance of a claim for credit or refund of tax and for the documentation required to support a claim for credit or refund.

Part 40 of 26 CFR contains the procedural rules applicable to manufacturers excise taxes with regard to returns, deposits, and payments.

Subtitle F of the Code contains the procedural rules applicable to “internal revenue taxes” (including manufacturers excise taxes) with regard to assessment, collection, penalties, overpayments, refunds, and statutes of limitations.

Several commentators requested clarification on the taxation of kits, often referred to as “convenience kits.” In general, a convenience kit is two or more different medical devices, or a combination of medical devices and other items, packaged together for the convenience of the user.

According to commentators, a number of different types of businesses, including device manufacturers and distributors, engage in the practice of creating such convenience kits. A manufacturer may assemble a kit containing a combination of items that it manufactures and items that it purchases from other manufacturers, importers, or distributors. A kit may also be assembled by a distributor that purchases the items contained in the kit from one or more manufacturers or importers. Some kits are designed to be used by medical or health care professionals for the performance of a particular medical procedure. Other kits are available to the general public at retail, such as first aid kits and home pregnancy test kits.

Several commentators expressed concern over the potential for double taxation when one or more taxable medical devices are included in a kit. Some commentators suggested that tax should not be imposed on both the taxable medical devices used as components of the kit and the kit itself. Other commentators recommended imposing tax on the taxable medical devices included in the kit, but not on the assembled kit. Other commentators suggested that the assembly of a kit does not constitute manufacture because the items included in the kit are not transformed.

Under the proposed regulations, a kit is a “taxable medical device” if the kit is listed as a device with the FDA pursuant to FDA requirements. The proposed regulations define “kit” as a set of two or more articles packaged in a single bag, tray, or box for the convenience of the end user.

Moreover, the existing manufacturers excise tax rules apply to kits in determining who is liable for the tax and which sale is subject to tax. Under these existing rules, if a manufacturer sells a taxable medical device to a distributor that uses the device to produce a kit that is a distinct taxable medical device, the distributor’s assembly of the kit constitutes further manufacture because the distributor has created a new taxable article. The proposed regulations clarify that if a kit is a taxable medical device, then the use of other taxable medical devices in the assembly of the kit constitutes further manufacture by the person who assembles the kit.

In some circumstances, the manufacturer may make a tax-free sale of a taxable medical device to the distributor for use in the production or assembly of a kit; tax will attach, however, upon the sale of the kit by the distributor. If the manufacturer sells a taxable medical device to the distributor for use in the production or assembly of a kit at a tax-included price, the distributor may be eligible to claim a credit or refund for the overpayment of tax pursuant to section 6416(b)(3). The rules regarding tax-free sales for further manufacture and the credit and refund provisions of section 6416(b)(3) provide a mechanism for avoiding double taxation when a taxable medical device is included in a kit that is also a taxable medical device. See §48.4221-2(b) for the circumstances under which a taxable article is sold for use in further manufacture. See section 4221 and §48.4221-1, §48.4221-2, §48.4222(a)-1, and §48.4223-1 for the rules regarding tax-free sales for further manufacture.

Generally, under §48.4216(a)-1(e), if a taxable and nontaxable article are sold by the manufacturer as a unit, the tax attaches to that portion of the unit that is properly allocable to the taxable article. In the case of a kit that is a separate taxable medical device, the taxable and nontaxable articles used in the kit’s production or assembly have lost their identity as separate articles. Accordingly, the proposed regulations clarify that the provisions of §48.4216(a)-1(e) do not apply to the sale of kits that are separate taxable medical devices. The proposed regulations further clarify that under such circumstances, the entire sale price of the kit is subject to tax under section 4191.

Several commentators requested clarification on the tax treatment of an associated or secondary device that is sold with a primary device, such as a monitor that is sold as part of an x-ray system. Commentators also requested information on the tax treatment of components of a device.

Under the proposed regulations, the definition of “taxable medical device” is tied to the FDA’s listing requirements for devices. Therefore, associated devices or components that are listed as devices with the FDA pursuant to FDA requirements are “taxable medical devices” for purposes of section 4191, unless they fall within an exemption under section 4191(b)(2), such as the retail exemption. However, if a manufacturer uses an associated device or component in creating a new device that must be listed with the FDA, then the rules under section 4221 and the corresponding regulations regarding further manufacture apply.

Combination products are therapeutic and diagnostic products that combine drugs, devices, and/or biological products. See 21 CFR 3.2(e). The IRS and the Treasury Department received a comment regarding combination products consisting of a device component and a drug component, such as prefilled syringes and inhalers. The commentator suggested that the sale of a combination product should not be subject to the medical device tax if its drug component is taken into account in computing the branded prescription drug (BPD) fee enacted under section 9008 of the ACA. The commentator suggested that the combination product be subject to either the BPD fee or the medical device tax, but not both, based on the FDA’s determination of a combination product’s primary mode of action.

The ACA enacted both the medical device excise tax and the BPD fee, but provided no coordination between the provisions. Under the proposed regulations, the definition of “taxable medical device” is tied to the FDA’s listing requirements for devices. In general, the annual BPD fee is allocated among covered entities engaged in the business of manufacturing or importing branded prescription drugs with aggregate branded prescription drug sales of over $5 million to specified government programs. See section 9008 of the ACA and 26 CFR Part 51. For this purpose, each branded prescription drug is identified based on its National Drug Code (NDC). Based on consultation with the FDA, the IRS and the Treasury Department anticipate that few, if any, combination products will be subject to both the medical device excise tax and the BPD fee. The IRS and the Treasury Department request comments on the extent to which combination products may be subject to the medical device excise tax and taken into account in computing the BPD fee, and the mechanisms by which any such impact could be avoided.

A commentator requested transition relief for sales contracts for medical software and IT systems. According to the commentator, sellers of software and IT systems frequently provide medical devices, such as medical device data systems, under long-term, multi-year contracts. Under these contracts, the manufacturer often delivers software and IT systems in stages, with partial payments due at various times during the contract term. The commentator requested that contracts, leases, and other agreements entered into before January 1, 2013, not be subject to the medical device excise tax, even if payments on the contract are received after December 31, 2012.

The proposed regulations apply the existing manufacturers excise tax rules for sales contracts. Under section 4216 and §48.4216(c)-1(b), generally, when a taxable article is sold under an installment payment contract with title reserved in the seller, or under another arrangement that creates a security interest and under which payments are to be made in installments, tax is computed and paid on each payment made by the purchaser. The tax payable with each payment is a percentage of each payment based on the rate of the tax, if any, in effect on the date the payment is due.

The proposed regulations do not adopt the request for transition relief. The statute was enacted on March 30, 2010, with an effective date of January 1, 2013. The statute did not provide an exception or special rule for sales pursuant to contracts in existence prior to the effective date of the tax. The proposed regulations track the statute.

(a) Imposition of tax. Under section 4191(a), tax is imposed on the sale of any taxable medical device by the manufacturer, producer, or importer of the device. For the definition of the term taxable medical device, see §48.4191-2.

(b) Rate of tax. Tax is imposed on the sale of a taxable medical device at the rate of 2.3 percent of the price for which the device is sold. For the definition of the term price, see section 4216 and §§48.4216(a)-1 through 48.4216(e)-3.

(c) Liability for tax. The manufacturer, producer, or importer making the sale of a taxable medical device is liable for the tax imposed by section 4191(a). For rules relating to the determination of who the manufacturer, producer, or importer is for purposes of section 4191, see §48.0-2(a)(4). For the definition of the term sale, see §48.0-2(a)(5). For rules relating to the lease of an article by the manufacturer, producer, or importer, see section 4217 and §48.4217-1 through §48.4217-2. For rules relating to the use of an article by the manufacturer, producer, or importer, see section 4218 and §48.4218-1 through §48.4218-5.

(d) Procedural rules. For the procedural rules relating to section 4191, see part 40 of this chapter.

(e) Tax-free sales for further manufacture or export. For rules relating to tax-free sales of taxable medical devices for further manufacture or export, see section 4221 and §48.4221-1 through §48.4221-3.

(f) Effective/applicability date. This section applies to sales of taxable medical devices on and after January 1, 2013.

(a) Taxable medical device—(1) In general. A taxable medical device is any device, as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act, that is intended for humans. For purposes of this section, a device defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act that is intended for humans means a device that is listed as a device with the Food and Drug Administration (FDA) under section 510(j) of the Federal Food, Drug, and Cosmetic Act and 21 CFR Part 807, pursuant to FDA requirements.

(2) Devices that should have been listed with the FDA. If a device is not listed as a device with the FDA but the FDA determines that the device should have been listed as a device, the device will be deemed to be listed as a device with the FDA as of the date the FDA notifies the manufacturer or importer in writing that corrective action with respect to listing is required.

(b) Exemptions—(1) In general . The term taxable medical device does not include eyeglasses, contact lenses, hearing aids, and any other device of a type that is generally purchased by the general public at retail for individual use (the retail exception).

(2) Retail exemption. A device will be considered to be of a type generally purchased by the general public at retail for individual use if it is regularly available for purchase and use by individual consumers who are not medical professionals, and if the design of the device demonstrates that it is not primarily intended for use in a medical institution or office or by a medical professional. Whether a device is of a type described in the preceding sentence is evaluated based on all the relevant facts and circumstances. Factors relevant to this evaluation are listed in paragraphs (b)(2)(i) and (ii) of this section. There may be facts and circumstances that are relevant in evaluating whether a device is of a type generally purchased by the general public at retail for individual use in addition to those described in paragraphs (b)(2)(i) and (ii) of this section. The fact that a device is of a type that requires a prescription is not a factor in the determination of whether or not the device falls under the retail exemption.

(i) Regularly available for purchase and use by individual consumers. The following factors suggest that a device is of a type that is regularly available for purchase and use by individual consumers who are not medical professionals:

(A) Consumers who are not medical professionals can purchase the device through retail businesses that also sell items other than medical devices, such as drug stores, supermarkets, and similar vendors.

(B) Consumers who are not medical professionals can use the device safely and effectively for its intended medical purpose with minimal or no training from a medical professional.

(C) The device is classified by the FDA under Subpart D of 21 CFR Part 890 (Physical Medicine Devices).

(ii) Primarily for use in a medical institution or office or by a medical professional. The following factors suggest that the device is designed primarily for use in a medical institution or office or by a medical professional:

(A) The device generally must be implanted, inserted, operated, or otherwise administered by a medical professional.

(B) The cost to acquire, maintain, and/or use the device requires a large initial investment and/or ongoing expenditure that is not affordable for the average consumer.

(C) The device is a Class III device under the FDA system of classification.

(D) The device is classified by the FDA under—

(1) 21 CFR Part 862 (Clinical Chemistry and Clinical Toxicology Devices), 21 CFR Part 864 (Hematology and Pathology Devices), 21 CFR Part 866 (Immunology and Microbiology Devices), 21 CFR Part 868 (Anesthesiology Devices), 21 CFR Part 870 (Cardiovascular Devices), 21 CFR Part 874 (Ear, Nose, and Throat Devices), 21 CFR Part 876 (Gastroenterology — Urology Devices), 21 CFR Part 878 (General and Plastic Surgery Devices), 21 CFR Part 882 (Neurological Devices), 21 CFR Part 886 (Ophthalmic Devices), 21 CFR Part 888 (Orthopedic Devices), or 21 CFR Part 892 (Radiology Devices);

(2) Subpart B, Subpart D, or Subpart E of 21 CFR Part 872 (Dental Devices);

(3) Subpart B, Subpart C, Subpart D, Subpart E, or Subpart G of 21 CFR Part 884 (Obstetrical and Gynecological Devices); or

(4) Subpart B of 21 CFR Part 890 (Physical Medicine Devices).

(E) The device qualifies as durable medical equipment, prosthetics, orthotics, and supplies for which payment is available exclusively on a rental basis under the Medicare Part B payment rules, and is an “item requiring frequent and substantial servicing” as defined in 42 CFR 414.222.

(iii) Safe Harbor. The following devices will be considered to be of a type generally purchased by the general public at retail for individual use:

(A) Devices that are included in the FDA’s online IVD Home Use Lab Tests (Over-the-Counter Tests) database, available at http://www.accessdata.fda.gov/scripts/cdrh/cfdocs/cfIVD/Search.cfm.

(B) Devices that are described as “OTC” or “over the counter” devices in the relevant FDA classification regulation heading.

(C) Devices that are described as “OTC” or “over the counter” devices in the FDA’s product code name, the FDA’s device classification name, or the “classification name” field in the FDA’s device registration and listing database, available at http://www.accessdata.fda.gov/scripts/cdrh/cfdocs/cfrl/rl.cfm.

(D) Devices that qualify as durable medical equipment, prosthetics, orthotics, and supplies, as described in Subpart C of 42 CFR Part 414 (Parenteral and Enteral Nutrition) and Subpart D of 42 CFR Part 414 (Durable Medical Equipment and Prosthetic and Orthotic Devices), for which payment is available on a purchase basis under Medicare Part B payment rules, and are—

(1) “Prosthetic and orthotic devices,” as defined in 42 CFR 414.202, that do not require implantation or insertion by a medical professional;

(2) “Parenteral and enteral nutrients, equipment, and supplies” as defined in 42 CFR 411.351 and described in 42 CFR 414.102(b);

(3) “Customized items” as described in 42 CFR 414.224;

(4) “Therapeutic shoes,” as described in 42 CFR 414.228(c); or

(5) Supplies necessary for the effective use of DME, as described in section 110.3 of chapter 15 of the Medicare Benefit Policy Manual (Centers for Medicare and Medicaid Studies Publication 100-02).

(iv) Examples. The following examples illustrate the rules of this paragraph (b).

Example 1. X manufactures non-sterile absorbent tipped applicators. X sells the applicators to distributors Y and Z, which, in turn, sell the applicators to medical institutions and offices, medical professionals, and to retail establishments. The FDA requires manufacturers and importers of non-sterile absorbent tipped applicators to list the applicators as a device with the FDA. The applicators are classified by the FDA under 21 CFR Part 880 (General Hospital and Personal Use Devices) and product code KXF. Absorbent tipped applicators do not fall within a retail exception safe harbor set forth in paragraph (b)(2)(iii) of this section. Therefore, the determination of whether the absorbent tipped applicators are devices of a type generally purchased by the general public at retail for individual use must be made on a facts and circumstances basis. Individual consumers who are not medical professionals can regularly purchase the absorbent tipped applicators at drug stores, supermarkets, cosmetic supply stores and other similar establishments, and can use the applicators safely and effectively for their intended medical purpose without training from a medical professional. Further, the absorbent tipped applicators do not need to be implanted, inserted, operated, or otherwise administered by a medical professional, do not require a large investment and/or ongoing expenditure, are not a Class III device, are not classified by the FDA under a category described in paragraph (b)(2)(ii)(D) of this section, and are not “items requiring frequent and substantial servicing” as defined in 42 CFR 414.222. Thus, the applicators have multiple factors that tend to show they are regularly available for purchase and use by individual consumers and none of the factors that tend to show they are designed primarily for use in a medical institution or office or by medical professionals. Based on the totality of the facts and circumstances, the applicators are devices that are of a type that are generally purchased by the general public at retail for individual use.

Example 2. X manufactures adhesive bandages. X sells the adhesive bandages to distributors Y and Z, which, in turn, sell the bandages to medical institutions and offices, medical professionals, and to retail establishments. The FDA requires manufacturers and importers of adhesive bandages to list the bandages as a device with the FDA. The adhesive bandages are classified by the FDA under 21 CFR Part 880 (General Hospital and Personal Use Devices) and product code KGX. Adhesive bandages do not fall within a retail exception safe harbor set forth in paragraph (b)(2)(iii) of this section. Therefore, the determination of whether the adhesive bandages are devices of a type generally purchased by the general public at retail for individual use must be made on a facts and circumstances basis. Individual consumers who are not medical professionals can regularly purchase the adhesive bandages at drug stores, supermarkets and other similar establishments, and can use the adhesive bandages safely and effectively for their intended medical purpose without training from a medical professional. Further, the adhesive bandages do not need to be implanted, inserted, operated, or otherwise administered by a medical professional, do not require a large investment and/or ongoing expenditure, are not Class III devices, are not classified by the FDA under a category described in paragraph (b)(2)(ii)(D) of this section, and are not “items requiring frequent and substantial servicing” as defined in 42 CFR 414.222. Thus, the bandages have multiple factors that tend to show they are regularly available for purchase and use by individual consumers and none of the factors that tend to show they are designed primarily for use in a medical institution or office or by medical professionals. Based on the totality of the facts and circumstances, the adhesive bandages are devices that are of a type that are generally purchased by the general public at retail for individual use.

Example 3. X manufactures snake bite suction kits. X sells the snake bite suction kits to distributors Y and Z, which, in turn, sell the kits to medical institutions and offices, medical professionals, and to retail establishments. The FDA requires manufacturers and importers of snake bite suction kits to list the kits as a device with the FDA. The FDA classifies the snake bit suction kits under 21 CFR Part 880 (General Hospital and Personal Use Devices) and product code KYP. Snake bite suction kits do not fall within a retail exemption safe harbor set forth in paragraph (b)(2)(iii) of this section. Therefore, the determination of whether the snake bite suction kits are devices of a type generally purchased by the general public at retail for individual use must be made on a facts and circumstances basis. Individual consumers who are not medical professionals can regularly purchase the snake bite suction kits at sporting goods stores, camping stores, and other similar establishments, and can use the kits safely and effectively for their intended medical purpose without training from a medical professional. Further, the snake bite suction kits do not need to be implanted, inserted, operated or otherwise administered by a medical professional, do not require a large investment and/or ongoing expenditure, are not Class III devices, are not classified by the FDA under a category described in paragraph (b)(2)(ii)(D) of this section, and are not “items requiring frequent and substantial servicing” as defined in 42 CFR 414.222. Thus, the snake bite suction kits have multiple factors that tend to show they are regularly available for purchase and use by individual consumers and none of the factors that tend to show they are designed primarily for use in a medical institution or office or by medical professionals. Based on the totality of the facts and circumstances, the snake bite suction kits are devices that are of a type that are generally purchased by the general public at retail for individual use.

Example 4. X manufactures denture adhesives. X sells the denture adhesives to distributors Y and Z, which, in turn, sell the adhesives to dental offices and retail establishments. The FDA requires manufacturers and importers of denture adhesives to list the adhesive as a device with the FDA. The FDA classifies the denture adhesives under 21 CFR Part 872 (Dental Devices) and product code KXX. The denture adhesives do not fall within a retail exemption safe harbor set forth in paragraph (b)(2)(iii) of this section. Therefore, the determination of whether the denture adhesives are devices of a type generally purchased by the general public at retail for individual use must be made on a facts and circumstances basis. Individual consumers who are not medical professionals can regularly purchase the denture adhesives at drug stores, supermarkets, and other similar establishments, and can use the adhesives safely and effectively for their intended medical purpose with minimal or no training from a medical professional. Further, the denture adhesives do not need to be implanted, inserted, operated, or otherwise administered by a medical professional, do not require a large investment and/or ongoing expenditure, are not Class III devices, are not classified by the FDA under a category described in paragraph (b)(2)(ii)(D) of this section, and are not “items requiring frequent and substantial servicing” as defined in 42 CFR 414.222. Thus, the denture adhesives have multiple factors that tend to show they are regularly available for purchase and use by individual consumers and none of the factors that tend to show they are designed primarily for use in a medical institution or office or by medical professionals. Based on the totality of the facts and circumstances, the denture adhesives are devices that are of a type that are generally purchased by the general public at retail for individual use.

Example 5. X manufactures mobile x-ray systems. X sells the x-ray systems to distributors Y and Z, which, in turn, sell the systems generally to medical institutions and offices, and medical professionals. The FDA requires manufacturers and importers of mobile x-ray systems to list the systems as a device with the FDA. The FDA classifies the mobile x-ray systems under 21 CFR Part 892 (Radiology Devices) and product code IZL. Mobile x-ray systems do not fall within a retail exemption safe harbor set forth in paragraph (b)(2)(iii) of this section. Therefore, the determination of whether the mobile x-ray systems are devices of a type generally purchased by the general public at retail for individual use must be made on a facts and circumstances basis. Individual consumers who are not medical professionals cannot regularly purchase the mobile x-ray systems at drug stores, supermarkets, and other similar establishments, and cannot use the x-ray systems safely and effectively for their intended medical purpose without training from a medical professional. Although the mobile x-ray systems are not Class III devices and are not “items requiring frequent and substantial servicing” as defined in 42 CFR 414.222, they need to be operated by a medical professional, require a large investment and/or ongoing expenditure, and are of a type classified by the FDA under 21 CFR Part 892 (Radiology Devices). Thus, the x-ray systems do not meet any of the factors that tend to show that they are regularly available for purchase and use by individual consumers. However, the x-ray systems do meet several of the factors that tend to show they are designed primarily for use in a medical institution or office or by medical professionals. Based on the totality of the facts and circumstances, the mobile x-ray systems are not devices that are of a type generally purchased by the general public at retail for individual use.

Example 6. X manufactures pregnancy test kits. X sells the kits to distributors Y and Z, which, in turn, sell the pregnancy test kits to medical institutions and offices, medical professionals, and to retail establishments. The FDA requires manufacturers and importers of pregnancy test kits to list the kits as a device with the FDA. The FDA classifies the kits under 21 CFR Part 862 (Clinical Chemistry and Clinical Toxicology Devices) and product code LCX. The pregnancy test kits are included in the FDA’s online IVD Home Use Lab Tests (Over-the-Counter Tests) database. Therefore, the over the counter pregnancy test kits fall within the safe harbor set forth in paragraph (b)(2)(iii)(A) of this section. Further, the FDA product code name for LCX is “Kit, Test, Pregnancy, HCG, Over The Counter.” Therefore, the pregnancy test kits also fall within the safe harbor set forth in paragraph (b)(2)(iii)(C) of this section. Accordingly, the pregnancy test kits are devices that are of a type generally purchased by the general public at retail for individual use.

Example 7. X manufactures blood glucose monitors, blood glucose test strips, and lancets. X sells the blood glucose monitors, test strips and lancets to distributors Y and Z, which, in turn, sell the monitors, test strips, and lancets to medical institutions and offices, medical professionals, and to retail establishments. The FDA requires manufacturers and importers of blood glucose monitors, test strips, and lancets to list the items as devices with the FDA. The FDA classifies the blood glucose monitors under 21 CFR Part 862 (Clinical Chemistry and Clinical Toxicology Devices) and product code NBW. The FDA classifies the test strips under 21 CFR Part 862 (Clinical Chemistry and Clinical Toxicology Devices) and product code NBW. The FDA classifies the lancets under 21 CFR 878 (General and Plastic Surgery Devices) and product code FMK. The blood glucose monitors and test strips are included in the FDA’s online IVD Home Use Lab Tests (Over-the-Counter Tests) database. Therefore, the blood glucose monitors and test strips fall within the safe harbor set forth in paragraph (b)(2)(iii)(A) of this section. Further, the FDA product code name for NBW is “System, Test, Blood Glucose, Over the Counter.” Therefore, the blood glucose monitors and test strips also fall within the safe harbor set forth in paragraph (b)(2)(iii)(C) of this section. In addition, the lancets are supplies necessary for the effective use of DME as described in chapter 15 of the Medicare Policy Benefit Manual. Therefore, the lancets fall within the safe harbor set forth in paragraph (b)(2)(iii)(D)(5) of this section. Accordingly, the blood glucose monitors, test strips, and lancets are devices that are of a type generally purchased by the general public at retail for individual use.

(c) Effective/applicability date. This section applies to sales of taxable medical devices on and after January 1, 2013.

Par. 4. Section 48.4221-1 is amended by adding paragraph (a)(2)(vii) to read as follows:

(a) * * *

(2) * * *

(vii) The exemptions under section 4221(a)(3) through (a)(6) do not apply to the tax imposed by section 4191 (medical device tax).

* * * * *

Par. 5. Section 48.4221-2 is amended by adding headings to paragraphs (b)(1) and (b)(2) and adding paragraph (b)(3).

The additions read as follows:

(b) * * *

(1) In general. * * *

(2) Material in the manufacture or production of another article. * * *

(3) Kits—(i) The process of producing or assembling a kit that is a taxable medical device (as defined in §48.4191-2) constitutes further manufacture. Under such circumstances, the taxable and nontaxable articles used in the production or assembly of the kit lose their identity as separate articles once they are incorporated into the kit because the kit is a new taxable article. Accordingly, the provisions of §48.4216(a)-1(e) do not apply upon the sale of a kit that is a taxable medical device, and the entire sale price of the kit is subject to tax under section 4191.

(ii) For purposes of this section, the term kit means a set of two or more articles that is enclosed in a single package, such as a bag, tray, or box, for the convenience of a medical or health care professional or the end user. A kit may contain a combination of one or more taxable medical devices and other articles.

(iii) The following example illustrates the rule of this paragraph (b)(3).

Example. X is a manufacturer of scalpels. X is registered with the IRS as a manufacturer of taxable medical devices in accordance with §48.4222(a)-1. Y is a distributor of taxable medical devices. Y is registered with the IRS as a manufacturer of taxable medical devices and as a buyer of taxable medical devices for use in further manufacture in accordance with §48.4222(a)-1. Y purchases scalpels from X for inclusion in surgical kits that Y produces. Both the scalpels and the kits are “taxable medical devices” as defined in §48.4191-2. Accordingly, X may sell the scalpels to Y tax free, provided Y furnishes its registration number to X and certifies in writing that the scalpels will be used in further manufacture.

(iv) This paragraph (b)(3) applies to sales of taxable medical devices on and after January 1, 2013.

* * * * *

Par. 6. Section 48.6416(b)(2)-2 is amended by adding paragraph (a)(4) to read as follows:

(a) * * *

(4) Beginning on January 1, 2013, sections 6416(b)(2)(B), (C), (D), and (E) do not apply to any tax paid under section 4191 (medical device tax).

* * * * *

The proposed regulations provide that, in order to constitute a QLAC, the amount of the premiums paid for the contract under the plan on a given date may not exceed the lesser of a dollar or a percentage limitation. The proposed regulations prescribe rules for applying these limitations to participants who purchase multiple contracts or make multiple premium payments for the same contract.

Under the dollar limitation, the amount of the premiums paid for a contract under the plan may not exceed $100,000. If, on or before the date of a premium payment, an employee has paid premiums for the same contract or for any other contract that is intended to be a QLAC and that is purchased for the employee under the plan or under any other plan, annuity or account, the $100,000 limit is reduced by the amount of those other premium payments.^[4]

Under the percentage limitation, the amount of the premiums paid for a contract under the plan may not exceed an amount equal to 25 percent of the employee’s account balance on the date of payment. If, on or before the date of a premium payment, an employee has paid premiums for the same contract or for any other contract that is intended to be a QLAC and that is held or purchased for the employee under the plan, the maximum amount under the 25-percent limit is reduced by the amount of those other payments.

For purposes of determining whether premiums for a contract exceed the dollar or percentage limitation, unless the plan administrator has actual knowledge to the contrary, the plan administrator would generally be permitted to rely on an employee’s representation of the amount of premiums paid on or before that date under any other contract that is intended to be a QLAC and that is purchased for an employee under any other plan, annuity, or account. However, this reliance is not available with respect to a plan, annuity, or account that is maintained by an employer (or an entity that is treated as a single employer with the employer under section 414(b), (c), (m), or (o)) with respect to purchases for an employee under any other plan, annuity, or account maintained by that employer.

If a premium for a contract causes the total premiums to exceed either the dollar or percentage limitation, the contract would fail to be a QLAC as of the date on which the excess premiums were paid. Thus, beginning on that date, the value of the contract would no longer be excluded from the account balance used to determine required minimum distributions.

For calendar years beginning on or after January 1, 2014, the dollar limitation would be adjusted at the same time and in the same manner as under section 415(d), except that (1) the base period would be the calendar year quarter beginning July 1, 2012, and (2) any increase that is not a multiple of $25,000 would be rounded to the next lowest multiple of $25,000. If a contract failed to be a QLAC immediately before an adjustment because the premiums exceeded the dollar limitation, an adjustment of the dollar limitation would not cause the contract to become a QLAC.

The proposed regulations provide that, in order to constitute a QLAC, the contract must provide that distributions under the contract commence not later than a specified annuity starting date set forth in the contract. The specified annuity starting date must be no later than the first day of the month coincident with or next following the employee’s attainment of age 85. This age reflects the approximate life expectancy of an employee at retirement, and was recommended in a number of the comments received in response to the Request for Information. Any contract for which premiums are paid after the latest permissible specified annuity starting date would not be a QLAC, because such a contract could not require distributions to commence by that date.

The proposed regulations would permit a QLAC to allow a participant to elect an earlier annuity starting date than the specified annuity starting date. For example, if the specified annuity starting date under a contract were the date on which a participant attains age 85, the contract would not fail to be a QLAC solely because it allows the participant to commence distributions at an earlier date. On the other hand, these rules would not require a QLAC to provide an option to commence distributions before the specified annuity starting date, so that a QLAC could provide that distributions must commence only at the specified annuity starting date. For a given premium, such a contract could provide a substantially higher periodic annuity payment beginning on the specified annuity starting date than a contract with an acceleration option. Similarly, premiums could be lower for a given level of periodic annuity payment, leaving a larger portion of the remaining account balance for the participant to use for living expenses before the specified annuity starting date.

The proposed regulations provide that the maximum age may also be adjusted to reflect changes in mortality. The adjusted age (if any) would be prescribed by the Commissioner in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b)). The Treasury Department and the IRS anticipate that such changes will not occur more frequently than the adjustment of the $100,000 limit described in subheading I.A. “Limitations on premiums.” If a contract failed to be a QLAC immediately before an adjustment because it failed to provide that distributions must commence by the requisite age, an adjustment of the age would not cause the contract to become a QLAC.

Under a QLAC, the only benefit permitted to be paid after the employee’s death is a life annuity, payable to a designated beneficiary, that meets certain requirements. Thus, for example, a contract that provides a distribution form with a period certain or a refund of premiums in the case of an employee’s death would not be a QLAC. These types of payments are inconsistent with the purpose of providing lifetime income to employees and their beneficiaries, as described in the Background section of this preamble. A contract that provides a given lifetime periodic annuity payment to an employee would be less expensive if it provided for a life annuity payable to a designated beneficiary upon the employee’s death rather than additional features such as an optional single-sum death benefit. After paying a lower premium for such a life annuity, the employee would be able to retain a larger portion of his or her account, maximizing the employee’s lifetime benefits, while also leaving larger death benefits for a beneficiary, from the remaining amount of the account.

The proposed regulations provide that if the sole beneficiary of an employee under the contract is the employee’s surviving spouse, the only benefit permitted to be paid after the employee’s death is a life annuity payable to the surviving spouse that does not exceed 100 percent of the annuity payment payable to the employee. The proposed regulations include a special exception that would allow a plan to comply with any applicable requirement to provide a qualified preretirement survivor annuity^[5] (which would have an effect only if the employee has a substantially older spouse).

If the employee’s surviving spouse is not the sole beneficiary under the contract,^[6] the only benefit permitted to be paid after the employee’s death is a life annuity payable to a designated beneficiary. In order to satisfy the MDIB requirements of section 401(a)(9)(G), the life annuity is not permitted to exceed an applicable percentage of the annuity payment payable to the employee. The applicable percentage is determined under one of two alternative tables, and the determination of which table applies depends on the different types of death benefits that are payable to the designated beneficiary.

Under the first alternative, the applicable percentage is the percentage described in the existing table in §1.401(a)(9)-6, A-2(c). Because the existing applicable percentage table does not take into account the potential for a death benefit to be paid to the non-spouse designated beneficiary during the period between the required beginning date and the annuity starting date, this table is available only if, under the contract, no death benefits are payable to such a beneficiary if the employee dies before the specified annuity starting date. Furthermore, in order to address the possibility that an employee with a shortened life expectancy could accelerate the annuity starting date in order to avoid this rule, this table is available only if, under the contract, no benefits are payable in any case in which the employee selects an annuity starting date that is earlier than the specified annuity starting date under the contract and the employee dies less than 90 days after making that election, even if the employee’s death occurs after his or her selected annuity starting date.

Under the second alternative, the applicable percentage is the percentage described in a new table set forth in the proposed regulations. The table is available for use when the contract provides a pre-annuity-starting-date death benefit to the non-spouse designated beneficiary. The table takes into account that a significant portion of the premium is used to provide death benefits to a designated beneficiary if death occurs during the deferral period between age 70¹/₂ and age 85. In order to limit the portion of the premium that is used to provide death benefits to a designated beneficiary, use of the table is limited to contracts under which any non-spouse designated beneficiary must be irrevocably selected as of the required beginning date. Accordingly, the applicable percentages in the table are based on the expected longevity for the designated beneficiary, determined as of the employee’s required beginning date.

The Treasury Department and the IRS considered whether to prescribe a special rule under which a QLAC could provide for a pre-annuity-starting-date death benefit to a non-spouse designated beneficiary and also allow the designated beneficiary to be changed at any time before the annuity starting date. However, in order to satisfy the MDIB requirements in such a case, the applicable percentages would need to be much smaller than the percentages set forth in the special table. This is because a larger portion of the cost of the contract would be allocable to death benefits if, after the required beginning date and before the annuity starting date, the participant were able to replace a designated beneficiary who has died (or to replace a designated beneficiary who has a short life expectancy with one who has a longer life expectancy). Comments are requested on whether the proposed regulations should be modified to permit alternative death benefits that would be subject to such lower applicable percentages.

If the employee dies before the specified annuity starting date under the contract, the date by which benefits must commence to the designated beneficiary depends on whether the beneficiary is the employee’s surviving spouse. If the sole beneficiary under the contract is the employee’s surviving spouse, the life annuity is not required to commence until the employee’s specified annuity starting date under the contract (in lieu of the otherwise applicable rule that would require distributions to commence by the later of the end of the calendar year following the calendar year in which the employee died or the end of the calendar year in which the employee would have attained age 70¹/₂). If the employee’s sole beneficiary under the contract is not the surviving spouse, the life annuity payable to the designated beneficiary must commence by the last day of the calendar year immediately following the calendar year of the employee’s death.

The proposed regulations include a rule for applying the limitations on amounts payable to a surviving spouse or a designated beneficiary in the event the employee dies before the annuity starting date. Under this rule, if the contract does not allow an employee to select an annuity starting date that is earlier than the date on which the annuity payable to the employee would have commenced under the contract if the employee had not died, the contract must nonetheless provide a way to determine the periodic annuity payments that would have been payable if payments to the employee had commenced immediately prior to the date on which benefit payments to the designated beneficiary commence.

Under the proposed regulations, a QLAC would not include a variable contract under section 817, equity-indexed contract, or similar contract, because the purpose of a QLAC is to provide a participant with a predictable stream of lifetime income. In addition, exposure to equity-based returns is available through control over the remaining portion of the account balance so that a participant can achieve adequate diversification.

The proposed regulations also provide that, in order to be a QLAC, the contract is not permitted to make available any commutation benefit, cash surrender value, or other similar feature. As in the case of the limitations on benefits payable after death, these limitations would allow an annuity contract to maximize the annuity payments that are made while a participant or beneficiary is alive. In addition, having a limited set of options available to purchasers would make these contracts more readily understandable and enhance purchasers’ ability to compare products across providers. Ease of comparison will be particularly important to the extent that contracts provided under plans are priced on a unisex basis, while contracts offered under IRAs generally take gender into account in establishing premiums.

The proposed regulations provide that a contract is not a QLAC unless it states, when issued, that it is intended to be a “qualifying longevity annuity contract” or a “QLAC.” This rule would ensure that the issuer, participant, plan sponsor, and IRS know that the rules applicable to QLACs apply to this contract.

The proposed regulations provide that distributions under a QLAC must satisfy the generally applicable section 401(a)(9) requirements relating to annuities at §1.401(a)(9)-6, other than the requirement that annuity payments commence on or before the employee’s required beginning date. Thus, for example, the limitation on increasing payments under §1.401(a)(9)-6, A-1(a), applies to the contract.

The proposed regulations provide that, in order to constitute a QLAC, the amount of the premiums paid for the contract under an IRA on a given date may not exceed $100,000. If, on or before the date of a premium payment, a participant has paid premiums for the same contract or for any other contract that is intended to be a QLAC and that is purchased for the participant under the IRA or under any other IRA, plan, or annuity, the $100,000 limit is reduced by the amount of those other premium payments.

The proposed regulations also provide that in order to constitute a QLAC, the amount of the premiums paid for the contract under an IRA on a given date generally may not exceed 25 percent of a participant’s IRA account balances. Consistent with the rule under which a required minimum distribution from an IRA could be satisfied by a distribution from another IRA (applied separately to traditional IRAs and Roth IRAs), the proposed regulations would allow a QLAC that could be purchased under an IRA within these limitations to be purchased instead under another IRA. Specifically, the amount of the premiums paid for the contract under an IRA may not exceed an amount equal to 25 percent of the sum of the account balances (as of December 31 of the calendar year before the calendar year in which a premium is paid) of the IRAs (other than Roth IRAs) that an individual holds as the IRA owner. If, on or before the date of a premium payment, an individual has paid other premiums for the same contract or for any other contract that is intended to be a QLAC and that is held or purchased for the individual under his or her IRAs, the premium payment cannot exceed the amount determined to be 25 percent of the individual’s IRA account balances, reduced by the amount of those other premiums.

The proposed regulations provide that, for purposes of both the dollar and percentage limitations, unless the trustee, custodian, or issuer of an IRA has actual knowledge to the contrary, the trustee, custodian, or issuer may rely on the IRA owner’s representations of the amount of the premiums (other than the premiums paid under the IRA) and, for purposes of applying the percentage limitation, the amount of the individual’s account balances (other than the account balance under the IRA).

Under the proposed regulations, an annuity purchased under a Roth IRA would not be treated as a QLAC. This is because a Roth IRA (unlike a designated Roth account under a plan, as described in section 402A) is not subject to the section 401(a)(9)(A) requirement that the individual’s benefits commence and be paid over the lives or life expectancy of the individual and a designated beneficiary (but, after the death of the individual, benefits must be paid under the same section 401(a)(9)(B) rules that apply to traditional IRAs). Because the rules of section 401(a)(9)(A) do not apply to a Roth IRA owner, a longevity annuity contract purchased using a portion of the individual’s Roth IRA would not need to provide the right to accelerate payments in order to ensure compliance with those rules. Thus, there is no need to permit the value of a longevity annuity contract to be excluded from the account balance that is used to determine required minimum distributions during the life of a Roth IRA owner. Accordingly, the proposed regulations would not apply the rules regarding QLACs to Roth IRAs.

The proposed regulations would not preclude the use of assets in a Roth IRA to purchase a longevity annuity contract, nor would such a contract be subject to the same restrictions as a QLAC. For example, a longevity annuity contract purchased using assets of a Roth IRA could have an annuity starting date that is later than age 85 and offer features, such as a cash surrender right, that are not permitted under a QLAC. Although such a contract could not be excluded from the account balance used to determine required minimum distributions, this exclusion is not necessary because the required minimum distribution rules do not apply during the life of a Roth IRA owner.

In addition, the dollar and percentage limitations on premiums that apply to a QLAC would not take into account premiums paid for a contract that is purchased or held under a Roth IRA, even if the contract satisfies the requirements to be a QLAC. If a QLAC is purchased or held under a plan, annuity, contract, or traditional IRA that is later rolled over or converted to a Roth IRA, the QLAC would cease to be a QLAC (and would cease to be treated as intended to be a QLAC) after the date of the rollover or conversion. In that case, the premiums would then be disregarded in applying the dollar and percentage limitations to premiums paid for other contracts after the date of the rollover or conversion.^[7]

Comments are requested on whether the regulations should be modified to apply the QLAC rules to a Roth IRA or to reduce the availability of the section 401(a)(9) relief for purchases of QLACs by the amount of assets that the individual holds in a Roth IRA. Comments are also requested as to whether any special rules should apply where a QLAC is purchased using assets of a Roth IRA, such as special disclosure in order to minimize any potential confusion.

The proposed regulations apply the tax-qualified plan rules, instead of the IRA rules, to the purchase of a QLAC under a section 403(b) plan. For example, the 25-percent limitation on premiums would be separately determined for each section 403(b) plan in which an employee participates. The proposed regulations also provide that the tax-qualified plan rules relating to reliance on representations, rather than the IRA rules, apply to the purchase of a QLAC under a section 403(b) plan.

The proposed regulations provide that, if the sole beneficiary of an employee under a contract is the employee’s surviving spouse and the employee dies before the annuity starting date under the contract, a life annuity that is payable to the surviving spouse after the employee’s death is permitted to exceed the annuity that would have been payable to the employee to the extent necessary to satisfy the requirement to provide a qualified preretirement survivor annuity (as discussed for qualified plans under subheading I.C. “Benefits payable after death of the employee”). A section 403(b) plan may be subject to this requirement under ERISA, whereas IRAs are generally not subject to this requirement. See §1.401(a)-20, Q&A-3(d), and §1.403(b)-5(e).

Section 1.457-6(d) provides that an eligible section 457(b) plan must meet the requirements of section 401(a)(9) and the regulations under section 401(a)(9). Thus, these proposed regulations relating to the purchase of a QLAC under a tax-qualified defined contribution plan would automatically apply to an eligible section 457(b) plan. However, the rule relating to QLACs is limited to eligible governmental section 457(b) plans. Because section 457(b)(6) requires that an eligible section 457(b) plan that is not a governmental plan be unfunded, the purchase of an annuity contract under such a plan would be inconsistent with this requirement.

Although defined benefit plans are subject to the minimum required distribution rules, they offer annuities which provide longevity protection. Because this protection is therefore already available, these proposed regulations would not apply to defined benefit plans.^[8]

Under the proposed regulations, the issuer of a QLAC would be required to create a report containing the following information about the QLAC:

This report is not required to be filed with the Internal Revenue Service. Each issuer required to create a report would be required to furnish to the individual in whose name the contract has been purchased a statement containing the information in the report. This statement must be furnished prior to or at the time of purchase. In addition, in order to avoid duplicating state law disclosure requirements, the statement would not be required to include information that the issuer has already provided to the employee in order to satisfy any applicable state disclosure law. Comments are requested on whether the information listed is appropriate, and whether (and, if so, the extent to which) this list would duplicate disclosure requirements under existing state law. Comments are also requested on whether there is other information that should be included in the disclosure, such as the special tax attributes of a QLAC.

The proposed regulations prescribe annual reporting requirements under section 6047(d) which would require any person issuing any contract that states that it is intended to be a QLAC to file annual calendar-year reports and provide a statement to the individual in whose name the contract has been purchased regarding the status of the contract. The Commissioner will prescribe an applicable form and instructions for this purpose, which will contain the filing deadline and other information.

The report will be required to identify that the contract is intended to be a QLAC and to include, at a minimum, the following items of information:

Each issuer required to file the report with respect to a contract would also be required to provide to the individual in whose name the contract has been purchased a statement containing the information that is required to be furnished in the report. This requirement may be satisfied by providing the individual with a copy of the required form, or in another form that contains the following language: “This information is being furnished to the Internal Revenue Service.” The statement is required to be furnished to the individual on or before January 31 following the calendar year for which the report is required.

An issuer that is subject to these annual reporting requirements must comply with the requirements for each calendar year beginning with the year in which premiums are first paid and ending with the earlier of the year in which the individual for whom the contract has been purchased attains age 85 (as adjusted in calendar years beginning on or after January 1, 2014) or dies. However, if the individual dies and the sole beneficiary under the contract is the individual’s spouse (so that the spouse’s annuity might not commence until the individual would have attained age 85), the annual reporting requirement continues until the year in which the distributions to the spouse commence.

* * * * *

A-3. (a) In the case of an individual account, the benefit used in determining the required minimum distribution for a distribution calendar year is the account balance as of the last valuation date in the calendar year immediately preceding that distribution calendar year (valuation calendar year) adjusted in accordance with paragraphs (b), (c), and (d) of this A-3.

* * * * *

(d) The account balance does not include the value of any qualifying longevity annuity contract described in A-17 of §1.401(a)(9)-6 that is held under the plan. This paragraph (d) only applies for purposes of determining required minimum distributions for distribution calendar years beginning on or after January 1, 2013.

(e) If an amount is distributed from a plan and rolled over to another plan (receiving plan), A-2 of §1.401(a)(9)-7 provides additional rules for determining the benefit and required minimum distribution under the receiving plan. If an amount is transferred from one plan (transferor plan) to another plan (transferee plan) in a transfer to which section 414(l) applies, A-3 and A-4 of §1.401(a)(9)-7 provide additional rules for determining the amount of the required minimum distribution and the benefit under both the transferor and transferee plans.

* * * * *

Par. 3. Section 1.401(a)(9)-6 is amended by revising the last sentence in A-12(a) and adding Q&A-17 to read as follows:

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A-12. (a) * * * See A-1(e) of §1.401(a)(9)-5 for rules relating to the satisfaction of section 401(a)(9) in the year that annuity payments commence, A-3(d) of §1.401(a)(9)-5 for rules relating to qualifying longevity annuity contracts described in A-17 of this section, and A-2(a)(3) of §1.401(a)(9)-8 for rules relating to the purchase of an annuity contract with a portion of an employee’s account balance.

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Q-17. What is a qualifying longevity annuity contract?

A-17. (a) Definition of qualifying longevity annuity contract. A qualifying longevity annuity contract (QLAC) is an annuity contract (that is not a variable contract under section 817, equity-indexed contract, or similar contract) that is purchased from an insurance company for an employee and that satisfies each of the following requirements—

(1) Premiums for the contract satisfy the requirements of paragraph (b) of this A-17;

(2) The contract provides that distributions under the contract must commence not later than a specified annuity starting date that is no later than the first day of the month coincident with or next following the employee’s attainment of age 85;

(3) The contract provides that, after distributions under the contract commence, those distributions must satisfy the requirements of this section (other than the requirement in A-1(c) of this section that annuity payments commence on or before the required beginning date);

(4) The contract does not make available any commutation benefit, cash surrender right, or other similar feature;

(5) No benefits are provided under the contract after the death of the employee other than the life annuities payable to a designated beneficiary that are described in paragraph (c) of this A-17; and

(6) The contract, when issued, states that it is intended to be a QLAC.

(b) Limitations on premium—(1) In general. The premiums paid for the contract on a date do not exceed the lesser of the dollar limitation in paragraph (b)(2) of this A-17 or the percentage limitation in paragraph (b)(3) of this A-17.

(2) Dollar limitation. The dollar limitation is an amount equal to the excess of—

(i) $100,000, over

(ii) The sum of—

(A) The premiums paid before that date under the contract, and

(B) The premiums paid on or before that date under any other contract that is intended to be a QLAC and that is purchased for the employee under the plan, or any other plan, annuity, or account described in section 401(a), 403(a), 403(b), or 408 or eligible governmental section 457(b) plan.

(3) Percentage limitation. The percentage limitation is an amount equal to the excess of—

(i) 25 percent of the employee’s account balance under the plan determined on that date, over

(ii) The sum of—

(A) The premiums paid before that date under the contract, and

(B) The premiums paid on or before that date under any other contract that is intended to be a QLAC and that is held or was purchased for the employee under the plan.

(c) Payments after death of the employee—(1) Surviving spouse is sole beneficiary—(i) In general. Except as provided in paragraph (c)(1)(ii)(B) of this A-17, if the sole beneficiary of an employee under the contract is the employee’s surviving spouse, the only benefit permitted to be paid after the employee’s death is a life annuity payable to the surviving spouse where the periodic annuity payment is not in excess of 100 percent of the periodic annuity payment that is payable to the employee (or, in the case of the employee’s death before the employee’s annuity starting date, the periodic annuity payment that would have been payable to the employee as of the date that benefits to the surviving spouse commence under paragraph (c)(1)(ii)(A) of this A-17).

(ii) Death before employee’s annuity starting date. If the employee dies before the employee’s annuity starting date and the employee’s surviving spouse is the sole beneficiary under the contract—

(A) The life annuity, if any, payable to the surviving spouse under paragraph (c)(1)(i) of this A-17 must commence not later than the date on which the annuity payable to the employee would have commenced under the contract if the employee had not died; and

(B) The amount of the periodic annuity payment payable to the surviving spouse is permitted to exceed 100 percent of the periodic annuity payment that is payable to the employee to the extent necessary to satisfy the requirement to provide a qualified preretirement survivor annuity (as defined under section 417(c)(2) of the Internal Revenue Code (Code) or section 205(e)(2) of the Employee Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)), as amended (ERISA)) pursuant to sections 401(a)(11) and 417 of the Code or section 205(a)(2) of ERISA.

(2) Surviving spouse is not sole designated beneficiary—(i) In general. If the employee’s surviving spouse is not the sole beneficiary under the contract, the only benefit permitted to be paid after the employee’s death is a life annuity payable to a designated beneficiary where the periodic annuity payment is not in excess of the applicable percentage (determined under paragraph (c)(2)(iv) of this A-17) of the periodic annuity payment that is payable to the employee (or, in the case of the employee’s death before the employee’s annuity starting date, the applicable percentage of the periodic annuity payment that would have been payable to the employee as of the date that benefits to the designated beneficiary commence under this paragraph (c)(2)(i)). In addition, no benefit is permitted to be paid after the employee’s death unless the contract satisfies the requirements of either paragraph (c)(2)(ii) or paragraph (c)(2)(iii) of this A-17. Moreover, except as provided in paragraph (c)(1)(ii)(A) of this A-17, in any case in which the employee dies before the employee’s annuity starting date, any life annuity payable to a designated beneficiary must commence by the last day of the calendar year immediately following the calendar year of the employee’s death.

(ii) No pre-annuity starting date death benefit. The contract satisfies the requirements of this paragraph (c)(2)(ii) if the contract provides that no benefit is permitted to be paid to a beneficiary other than the employee’s surviving spouse after the employee’s death—

(A) In any case in which the employee dies before the selected annuity starting date under the contract; and

(B) In any case in which the employee selects an annuity starting date that is earlier than the specified annuity starting date under the contract and the employee dies less than 90 days after making that election.

(iii) Pre-annuity starting date death benefit. The contract satisfies the requirements of this paragraph (c)(2)(iii) if the contract provides that in any case in which the beneficiary under the contract is not the employee’s surviving spouse, benefits are payable to the beneficiary only if the beneficiary was irrevocably selected on or before the employee’s required beginning date.

(iv) Applicable percentage. If the contract is described in paragraph (c)(2)(ii) of this A-17, the applicable percentage is the percentage described in the table in paragraph A-2(c) of this section. If the contract is described in paragraph (c)(2)(iii) (and not in (c)(2)(ii)) of this A-17, the applicable percentage is the percentage described in the table set forth in this paragraph (c)(2)(iv). The applicable percentage is based on the adjusted employee/beneficiary age difference, determined in the same manner as in paragraph A-2(c) of this section.

(3) Calculation of early annuity payments. For purposes of paragraphs (c)(1)(i) and (c)(2)(i) of this A-17, to the extent the contract does not provide an option for the employee to select an annuity starting date that is earlier than the date on which the annuity payable to the employee would have commenced under the contract if the employee had not died, the contract must provide a way to determine the periodic annuity payment that would have been payable if the employee were to have an option to accelerate the payments and the payments had commenced to the employee immediately prior to the date that benefit payments to the surviving spouse or designated beneficiary commence.

(d) Rules of application—(1) Reliance on representations. For purposes of the limitation on premiums described in paragraphs (b)(2) and (b)(3) of this A-17, unless the plan administrator has actual knowledge to the contrary, the plan administrator may rely on an employee’s representation (made in writing or such other form as may be prescribed by the Commissioner) of the amount of the premiums described in paragraphs (b)(2)(ii)(B) and (b)(3)(ii)(B) of this A-17, but only with respect to premiums that are not paid under a plan, annuity, or contract that is maintained by the employer or an entity that is treated as a single employer with the employer under section 414(b), (c), (m), or (o).

(2) Consequences of excess premiums. If a contract fails to be a QLAC solely because a premium for the contract exceeds the limits under paragraph (b) of this A-17 on the date of the payment of that premium, the contract is not a QLAC beginning on that date. In such a case, none of the value of the contract may be disregarded under §1.401(a)(9)-5, Q&A-3(d), as of the date on which the contract ceases to be a QLAC.

(3) Dollar and age limitations subject to adjustments—(i) Dollar limitation. In the case of calendar years beginning on or after January 1, 2014, the $100,000 amount under paragraph (b)(2)(i) of this A-17 will be adjusted at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter beginning July 1, 2012, and any increase under this paragraph (d)(3)(i) that is not a multiple of $25,000 shall be rounded to the next lowest multiple of $25,000.

(ii) Age limitation. The maximum age set forth in paragraph (a)(2) of this A-17 may also be adjusted to reflect changes in mortality, with any such adjusted age to be prescribed by the Commissioner in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter).

(iii) Prospective application of adjustments. If a contract fails to be a QLAC because it does not satisfy the dollar limitation in paragraph (b)(2) of this A-17 or the age limitation in paragraph (a)(2) of this A-17, any subsequent adjustment that is made pursuant to paragraph (d)(3)(i) or paragraph (d)(3)(ii) of this A-17 will not cause the contract to become a QLAC.

(4) Multiple beneficiaries. If an employee has more than one designated beneficiary under a QLAC, the rules in §1.401(a)(9)-8, A-2(a), apply for purposes of paragraphs (c)(1)(i) and (c)(2)(i) of this A-17.

(5) Roth IRAs. A contract that is purchased under a Roth IRA is not treated as a contract that is intended to be a QLAC for purposes of applying the dollar and percentage limitation rules in paragraphs (b)(2)(ii)(B) and (b)(3)(ii)(B) of this A-17. See §1.408A-6, A-14(d). If a QLAC is purchased or held under a plan, annuity, account, or traditional IRA, and that contract is later rolled over or converted to a Roth IRA, the contract is not treated as a contract that is intended to be a QLAC after the date of the rollover or conversion. Thus, premiums paid for the contract will not be taken into account under paragraph (b)(2)(ii)(B) or paragraph (b)(3)(ii)(B) of this A-17 after the date of the rollover or conversion.

(e) Effective/applicability date. This Q&A-17 applies to contracts purchased on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register and for determining required minimum distributions for distribution calendar years beginning on or after January 1, 2013.

Par. 4. Section 1.403(b)-6 is amended by adding paragraph (e)(9) to read as follows:

* * * * *

(e) * * *

(9) Special rule for qualifying longevity annuity contracts. The rules in §1.401(a)(9)-6, A-17(b) (relating to limitations on premiums for a qualifying longevity annuity contract (QLAC), and §1.401(a)(9)-6, A-17(d)(1) (relating to reliance on representations with respect to a QLAC), apply to the purchase of a QLAC under a section 403(b) plan (rather than the rules in §1.408-8, A-12(b) and (c)).

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Par. 5. Section 1.408-8, Q&A-12, is added to read as follows:

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Q-12. How does the special rule in §1.401(a)(9)-5, A-3(d), for a qualifying longevity annuity contract (QLAC), defined in §1.401(a)(9)-6, A-17, apply to an IRA?

A-12. (a) General rule. The special rule in §1.401(a)(9)-5, A-3, for a QLAC, defined in §1.401(a)(9)-6, A-17, applies to an IRA, subject to the exceptions set forth in this A-12. See §1.408A-6, A-14(d) for special rules relating to Roth IRAs.

(b) Limitations on premium—(1) In general. In lieu of the limitations described in §1.401(a)(9)-6, A-17(b), the premiums paid for the contract on a date are not permitted to exceed the lesser of the dollar limitation in paragraph (b)(2) of this A-12 or the percentage limitation in paragraph (b)(3) of this A-12.

(2) Dollar limitation. The dollar limitation is an amount equal to the excess of—

(i) $100,000, over

(ii) The sum of—

(A) The premiums paid before that date under the contract, and

(B) The premiums paid on or before that date under any other contract that is intended to be a QLAC and that is purchased for the IRA owner under the IRA, or any other plan, annuity, or account described in section 401(a), 403(a), 403(b), or 408 or eligible governmental section 457(b) plan.

(3) Percentage limitation. The percentage limitation is an amount equal to the excess of—

(i) 25 percent of the total account balances of the IRAs (other than Roth IRAs) that an individual holds as the IRA owner as of December 31 of the calendar year immediately preceding the calendar year in which a premium is paid, over

(ii) The sum of—

(A) The premiums paid before that date under the contract, and

(B) The premiums paid on or before that date under any other contract that is intended to be a QLAC and that is held or was purchased for the individual under those IRAs.

(c) Reliance on representations. For purposes of the limitations described in paragraphs (b)(2) and (b)(3) of this A-12, unless the trustee, custodian, or issuer of an IRA has actual knowledge to the contrary, the trustee, custodian, or issuer may rely on the IRA owner’s representation (made in writing or such other form as may be prescribed by the Commissioner) of the amount of the premiums described in paragraphs (b)(2)(ii)(B) and (b)(3)(ii)(B) of this A-12 that are not paid under the IRA, and the amount of the account balances described in paragraph (b)(3)(i) of this A-12, other than the account balance under the IRA.

(d) Roth IRAs. A contract that is purchased under a Roth IRA is not treated as a contract that is intended to be a QLAC for purposes of applying the dollar and percentage limitation rules in paragraphs (b)(2)(ii)(B) and (b)(3)(ii)(B) of this A-12. See §1.408A-6, A-14(d). If a QLAC is purchased or held under a plan, annuity, account, or traditional IRA, and that contract is later rolled over or converted to a Roth IRA, the contract is not treated as a contract that is intended to be a QLAC after the date of the rollover or conversion. Thus, premiums paid for the contract will not be taken into account under paragraph (b)(2)(ii)(B) or paragraph (b)(3)(ii)(B) of this A-12 after the date of the rollover or conversion.

(e) Effective/applicability date. This Q&A-12 applies to contracts purchased on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register and for determining required minimum distributions for distribution calendar years beginning on or after January 1, 2013.

Par. 6. Section 1.408A-6 is amended by adding paragraph A-14(d) to read as follows:

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A-14. * * *

(d) The special rules in §1.401(a)(9)-5, A-3, and §1.408-8, Q&A-12, for a QLAC, defined in §1.401(a)(9)-6, A-17, do not apply to a Roth IRA.

* * * * *

Par. 7. Section 1.6047-2 is added to read as follows:

(a) Requirement and form of report—(1) In general. Any person issuing any contract that states that it is intended to be a qualifying longevity annuity contract (QLAC), defined in §1.401(a)(9)-6, Q&A-17, shall make reports required by this section. This requirement applies only to contracts purchased or held under any plan, annuity, or account described in section 401(a), 403(a), 403(b), or 408 (other than a Roth IRA) or eligible governmental section 457(b) plan.

(2) Initial disclosure. The issuer shall be required to prepare a report identifying that the contract is intended to be a QLAC and containing the following information—

(i) A plain-language description of the dollar and percentage limitations on premiums;

(ii) The annuity starting date under the contract, and, if applicable, a description of the individual’s ability to elect to commence payments before the annuity starting date;

(iii) The amount (or estimated amount) of the periodic annuity payment that is payable after the annuity starting date as a single life annuity (including, if an estimated amount, the assumed interest rate or rates used in making this determination), and a statement that there is no commutation benefit or right to surrender the contract in order to receive its cash value;

(iv) A statement of any death benefit payable under the contract, including any differences between benefits payable if the individual dies before the annuity starting date and benefits payable if the individual dies on or after the annuity starting date;

(v) A description of the administrative procedures associated with an individual’s elections under the contract, including deadlines, how to obtain forms, and where to file forms, and the identity and contact information of a person from whom the individual may obtain additional information about the contract; and

(vi) Such other information as the Commissioner may require.

(3) Annual report. The issuer shall make annual calendar-year reports on the applicable form prescribed by the Commissioner for this purpose concerning the status of the contract. The report shall identify that the contract is intended to be a QLAC and shall contain the following information—

(i) The name, address, and identifying number of the issuer of the contract, along with information on how to contact the issuer for more information about the contract;

(ii) The name, address, and identifying number of the individual in whose name the contract has been purchased;

(iii) If the contract was purchased under a plan, the name of the plan, the plan number, and the Employer Identification Number (EIN) of the plan sponsor;

(iv) If payments have not yet commenced, the annuity starting date on which the annuity is scheduled to commence, the amount of the periodic annuity payable on that date, and whether that date may be accelerated;

(v) The amount of each premium paid for the contract, along with the date of the premium payment; and

(vi) Such other information as the Commissioner may require.

(b) Manner and time for filing—(1) Initial disclosure. The report required by paragraph (a)(2) of this section shall not be filed with the Internal Revenue Service.

(2) Annual report—(i) Timing. The report required by paragraph (a)(3) of this section shall be filed in accordance with the forms and instructions prescribed by the Commissioner. Such a report must be filed for each calendar year beginning with the year in which premiums for a contract are first paid and ending with the earlier of the year in which the individual in whose name the contract has been purchased attains age 85 (as adjusted pursuant to §1.401(a)(9)-6, A-17(d)(3)(ii)) or dies.

(ii) Surviving spouse. If the individual dies and the sole beneficiary under the contract is the individual’s spouse (in which case the spouse’s annuity would not be required to commence until the individual would have attained age 85), the report must continue to be filed for each calendar year until the calendar year in which the distributions to the spouse commence or in which the spouse dies, if earlier.

(c) Issuer statements. (1) Initial disclosure. Each issuer required to make a report required by paragraph (a)(2) of this section shall furnish to the individual in whose name the contract has been purchased a statement containing the information in the report. The statement shall be furnished at the time of purchase. The statement is not required to include information that the issuer has already provided to the individual in order to comply with any applicable state disclosure law.

(2) Annual report. Each issuer required to file the report required by paragraph (a)(3) of this section shall furnish to the individual in whose name the contract has been purchased a statement containing the information required to be furnished in the report, except that such statement shall be furnished to a surviving spouse to the extent that the report is required to be filed under paragraph (b)(2)(ii) of this section. A copy of the required form may be used to satisfy the statement requirement of this paragraph (c)(2). If a copy of the required form is not used to satisfy the statement requirement of this paragraph (c)(2), the statement shall contain the following language: “This information is being furnished to the Internal Revenue Service.” The statement required by this paragraph (c)(2) shall be furnished on or before January 31 following the calendar year for which the report required by paragraph (a)(3) of this section is required.

(d) Effective/applicability date. This section applies on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.