Section 412 of the Internal Revenue Code provides minimum funding requirements with respect to certain defined benefit pension plans.^[1] Title I of the Pension Protection Act of 2006 (PPA), Pub. L. No. 109-280, 120 Stat. 780, makes extensive changes to the rules of section 412, generally applicable to plan years beginning on or after January 1, 2008. Except as otherwise stated, all references to section 412 in this document refer to section 412 without regard to the amendments made by Title I of PPA.

Section 412(l) provides additional funding requirements for certain defined benefit pension plans, based in part on a plan’s unfunded current liability, as defined in section 412(l)(8). Pursuant to section 412(c)(6), if the otherwise applicable minimum funding requirement exceeds the plan’s full funding limitation (defined in section 412(c)(7) as the excess of a specified measure of plan liability over the plan assets), then the minimum funding requirement for the year is reduced by that excess. Under section 412(c)(7)(E), the full funding limitation cannot be less than the excess of 90% of the plan’s current liability (including the expected increase in current liability due to benefits accruing during the plan year) over the value of the plan’s assets. For this purpose, the term current liability generally has the same meaning given that term under section 412(l)(7).

Section 412(l)(7)(C)(ii) provides that, for purposes of determining current liability in plan years beginning on or after January 1, 1995, the mortality table used is the table prescribed by the Secretary. Under section 412(l)(7)(C)(ii)(I), the initial mortality table used in determining current liability under section 412(l)(7) must be based on the prevailing commissioners’ standard table (described in section 807(d)(5)(A)) used to determine reserves for group annuity contracts issued on January 1, 1993. For purposes of section 807(d)(5), Rev. Rul. 92-19, 1992-1 C.B. 227, specifies the prevailing commissioners’ standard table used to determine reserves for group annuity contracts issued on January 1, 1993, as the 1983 Group Annuity Mortality Table (1983 GAM). Accordingly, Rev. Rul. 95-28, 1995-1 C.B. 74, sets forth two gender-specific mortality tables, based on 1983 GAM, for purposes of determining current liability for participants and beneficiaries (other than disabled participants).

Section 412(l)(7)(C)(iii)(I) specifies that the Secretary is to establish different mortality tables to be used to determine current liability for individuals who are entitled to benefits under the plan on account of disability. One such set of tables is to apply to individuals whose disabilities occur in plan years beginning before January 1, 1995, and a second set of tables for individuals whose disabilities occur in plan years beginning on or after such date. Under section 412(l)(7)(C)(iii)(II), the separate tables for disabilities that occur in plan years beginning after December 31, 1994, apply only with respect to individuals who are disabled within the meaning of title II of the Social Security Act and the regulations thereunder. Rev. Rul. 96-7, 1996-1 C.B. 59, sets forth the mortality tables established under section 412(l)(7)(C)(iii).

Under section 412(l)(7)(C)(ii)(III), the Secretary is required to periodically (at least every 5 years) review any tables in effect under that subsection and, to the extent necessary, by regulation update the tables to reflect the actual experience of pension plans and projected trends in such experience. Section 412(l)(7)(C)(ii)(II) provides that the updated tables are to take into account the results of available independent studies of mortality of individuals covered by pension plans. Pursuant to section 412(l)(7)(C)(ii)(II), any new mortality tables prescribed by regulation can be effective no earlier than the first plan year beginning after December 31, 1999. Under section 412(l)(10), increases in current liability arising from the adoption of such a new mortality table are required to be amortized over a 10-year period.

Notice 2003-62, 2003-2 C.B. 576, was issued as part of the periodic review by the IRS and the Treasury Department of the mortality tables used in determining current liability under section 412(l)(7). At the time Notice 2003-62 was issued, the IRS and the Treasury Department were aware of two reviews of mortality experience for retirement plan participants undertaken by the Retirement Plans Experience Committee of the Society of Actuaries (the UP-94 Study and the RP-2000 Mortality Tables Report),^[2] and commentators were invited to submit any other independent studies of pension plan mortality experience. Notice 2003-62 also requested the submission of studies regarding projected trends in mortality experience. With respect to projecting mortality improvements, the IRS and the Treasury Department requested comments regarding the advantages and disadvantages of reflecting these trends on an ongoing basis through the use of generational, modified generational, or sequentially static mortality tables.

The IRS and the Treasury Department have reviewed the mortality tables that are used for purposes of determining current liability for participants and beneficiaries (other than disabled participants). The existing mortality table for determining current liability (1983 GAM) was compared to independent studies of mortality of individuals covered by pension plans, after reflecting projected trends for mortality improvement through 2007. The comparison indicated that the 1983 GAM is no longer appropriate for determining current liability.

Based on this review of the 1983 GAM compared to more recent mortality experience, the IRS and the Treasury Department have determined that updated mortality tables based on the RP-2000 Mortality Tables Report should be used to determine current liability for participants and beneficiaries (other than disabled participants).^[3]

On December 2, 2005, the IRS issued proposed regulations under section 412(l)(7) (REG-124988-05, 2005-2 C.B. 1186 [70 FR 72260]) setting forth mortality tables, proposed to be effective for plan years beginning on or after January 1, 2007, to be used for nondisabled pension plan participants. The proposed regulations would have required plans of 500 or more participants to use separate mortality tables (derived from the RP-2000 mortality tables) for nonannuitant and annuitant periods. These separate tables were developed by projecting mortality improvement from a base year of 2007 over the period of the approximate expected duration of liabilities (7 years for the annuitant tables and 15 years for the nonannuitant tables). Small plans, defined as those with fewer than 500 participants (including both active and inactive participants), would have been permitted to use a combined table that applies the same mortality rates to both annuitants and nonannuitants. The proposed regulations provided for updated tables to be issued annually reflecting a new base year and using the projection factors described in the proposed regulations, to reflect expected improvements in mortality. Two comments on the proposed regulation were received, and no public hearing was requested or held.

On August 17, 2006, PPA was enacted. PPA contains a comprehensive revision of the minimum funding requirements for single employer plans, based on the calculation of a funding target that replaces the current liability calculation under section 412(l). These minimum funding provisions of PPA are generally effective for plan years beginning after December 31, 2007. Under section 430(h)(3)(A) as enacted in PPA, the Secretary is directed to prescribe by regulation the mortality tables used in determining present value or making any computation under the funding rules. The specifications for developing the mortality tables under section 430(h)(3)(A) are the same as the specifications set forth in section 412(l)(7)(C)(ii)(III).

These regulations set forth the mortality tables to be used under section 412(l)(7)(C)(ii) to determine current liability for participants and beneficiaries (other than disabled participants) for plan years beginning on or after January 1, 2007. These mortality tables are the same mortality tables that were published for 2007 in the proposed regulations, and are based on the tables contained in the RP-2000 Mortality Tables Report. The IRS and the Treasury Department have reviewed the RP-2000 mortality tables and the accompanying report published by the Society of Actuaries, and have determined that the RP-2000 mortality tables form the best available basis for predicting mortality of pension plan participants and beneficiaries (other than disabled participants) based on pension plan experience and expected trends. As under the mortality tables applicable for earlier plan years, the mortality tables set forth in these regulations are gender-distinct because of significant differences between expected male mortality and expected female mortality.

Of the two comments received on the proposed regulations, one commentator stated that requiring separate annuitant and nonannuitant mortality tables adds complexity without increasing accuracy. According to this commentator, the complexity could be avoided without loss of accuracy by using the RP-2000 blended table. This commentator suggested that, if separate annuitant and nonannuitant mortality tables are required, they should not be required to be used before 2008. The other commentator agreed with the use of separate annuitant and nonannuitant tables.

In a change from the proposed regulations, the IRS and the Treasury Department have chosen to permit all plans to use a blended table for 2007 rather than require the use of separate annuitant and nonannuitant tables. This decision was made because of the sweeping changes made to the minimum funding requirements for single employer plans by PPA that will generally become effective in 2008. The IRS and the Treasury Department believe that using separate annuitant and nonannuitant tables results in a more accurate measure of a plan’s current liability. However, in view of the sweeping PPA changes and the resulting need to overhaul actuarial valuation systems, it was determined that all plans (and not just small plans) should be permitted to use the combined mortality tables for the 2007 plan year.^[4] It is expected that proposed regulations under section 430(h)(3)(A) providing mortality tables for purposes of determining present value under section 430 will require large plans to use separate annuitant and nonannuitant tables to achieve a more accurate measure of the present value of plan benefits.

If the separate tables for annuitants and nonannuitants are used, the nonannuitant mortality table is applied to determine the probability of survival for a nonannuitant for the period before the nonannuitant is projected to commence receiving benefits. The annuitant mortality table is applied to determine the present value of benefits for each annuitant, and for each nonannuitant for the period after which the nonannuitant is projected to commence receiving benefits. For purposes of this section, an annuitant means a plan participant who has commenced receiving benefits and a nonannuitant means a plan participant who has not yet commenced receiving benefits (e.g., an active employee or a terminated vested participant). Thus, for example, with respect to a 45-year-old active participant who is projected to commence receiving an annuity at age 55, current liability would be determined using the nonannuitant mortality table for the period before the participant attains age 55 (i.e., so that the probability of an active male participant living from age 45 to the age of 55 for the table that applies in plan years beginning in 2007 is 98.59%) and the annuitant mortality table for the period ages 55 and above. Similarly, if a 45-year-old terminated vested participant is projected to commence an annuity at age 65, current liability would be determined using the nonannuitant mortality table for the period before the participant attains age 65 and the annuitant mortality table for ages 65 and above. A participant whose benefit has partially commenced is treated as an annuitant with respect to the portion of the benefit which has commenced and a nonannuitant with respect to the balance of the benefit.

As under the proposed regulations, the annuitant and nonannuitant tables were developed by applying projected mortality improvements to the annuitant and nonannuitant tables from the RP-2000 Mortality Tables Report. Mortality improvement was projected forward from the base year of 2007 by 7 years for annuitants and 15 years for nonannuitants, to approximate an average expected duration of liabilities. The projection factors used are from Mortality Projection Scale AA, which was also recommended for use in the UP-94 Study and RP-2000 Mortality Tables Report.

The blended table provided under these regulations was constructed in the same manner as under the proposed regulations, by applying the nonannuitant/annuitant weighting factors published in the RP-2000 Mortality Tables Report. However, because the RP-2000 Mortality Tables Report does not provide weighting factors before age 50 or after age 70, the IRS and the Treasury Department have extended the table of weighting factors for ages 41 through 50 (ages 45-50 for females) and for ages 70 through 79 in order to develop the blended table.

For most plans, these regulations will be in effect only for the 2007 plan year because the minimum funding requirements enacted in PPA will replace the currently applicable minimum funding requirements for plan years beginning on or after January 1, 2008. For plans that remain subject to the pre-PPA requirements of section 412 after the 2007 plan year (see sections 104 through 106 of PPA), these regulations require that the mortality tables that will be provided pursuant to section 430(h)(3)(A) are to be used as the mortality tables that apply for determining current liability under section 412 for those later plan years.

These regulations apply to plan years beginning on or after January 1, 2007.

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

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

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

Par. 2. Section 1.412(l)(7)-1 is added to read as follows:

Section 4965(a) requires Non-Plan Entities to pay an excise tax “for the taxable year in which the entity becomes [a party to a prohibited tax shelter transaction] and any subsequent taxable year in the amount determined under [section 4965(b)].” Non-Plan Entities include those entities described in section 4965(c)(1) through (3) — i.e., entities described in section 501(c), 501(d), section 170(c) (other than the United States), and Indian tribal governments (within the meaning of section 7701(a)(40)). Section 4965(e)(1) defines the term “prohibited tax shelter transaction” to mean (1) “any listed transaction,” and (2) “any prohibited reportable transaction.” A “listed transaction” is defined by cross-reference to section 6707A(c)(2). A “prohibited reportable transaction” means any confidential transaction under Treas. Reg. § 1.6011-4(b)(3) or any transaction with contractual protection under Treas. Reg. § 1.6011-4(b)(4) which is a reportable transaction as defined by section 6707A(c)(1). Pursuant to Revenue Procedure 2007-20, 2007-7 I.R.B. 517 (Feb. 2, 2007), transactions in which the refundable or contingent fee is related to tax credits under sections 42 and 45D of the Code will not be treated as reportable transactions for purposes of Treas. Reg. § 1.6011-4(b)(4) and, thus, will not be subject to section 4965.

Section 4965(b)(1) provides that, for a transaction other than a “subsequently listed transaction” as defined in section 4965(e)(2), the amount of the excise tax imposed on the Non-Plan Entity is computed based on the greater of (1) the entity’s net income “for the taxable year” attributable to the transaction or (2) 75 percent of the proceeds “received by the entity for the taxable year” which are attributable to the transaction.

Section 4965(e)(2) defines the term “subsequently listed transaction” as any transaction to which a tax-exempt entity is a party and which is determined by the Secretary to be a listed transaction at any time after the entity has become a party to the transaction, provided, however, that the transaction was not a prohibited reportable transaction at the time the entity became a party to the transaction.

Section 4965(b)(1) provides that, for a subsequently listed transaction, the amount of the excise tax is based on the greater of (1) the entity’s net income for the taxable year which is attributable to the prohibited tax shelter transaction and is “properly allocable” to the period beginning on the later of the date the transaction is identified as a listed transaction or the first day of the taxable year, or (2) 75 percent of the proceeds received by the entity for the taxable year which are attributable to the prohibited tax shelter transaction and which are “properly allocable” to the period beginning on the later of the date the transaction is identified as a listed transaction or the first day of the taxable year.

Section 516(d) of TIPRA provides that section 4965 generally applies to taxable years ending after the date of enactment with respect to transactions entered into before, on, or after that date. However, “no tax under section 4965(a) . . . shall apply with respect to income or proceeds that are properly allocable to any period ending on or before the date which is 90 days after the date of enactment.” The 90^th day after the date of enactment was August 15, 2006.

Section 4965(f) authorizes the Secretary to promulgate regulations providing guidance “regarding the determination of the allocation of net income or proceeds of a tax-exempt entity attributable to a transaction to various periods, including before and after the listing of the transaction or the date which is 90 days after the date of the enactment of this section.”

On July 11, 2006, the Internal Revenue Service (“Service”) released Notice 2006-65, 2006-31 I.R.B. 102, which alerted taxpayers to the new provisions and solicited comments regarding these provisions. The Service received numerous written comments in response to Notice 2006-65. Many of the comments requested guidance regarding the circumstances under which a tax-exempt entity will be considered a “party” to a prohibited tax shelter transaction, as well as how the Service intends to exercise its allocation authority under section 4965(f), particularly with respect to transactions entered into prior to the enactment of section 4965.

The Service and the Treasury Department intend to issue further guidance under section 4965 and the related statutory provisions. Pending the issuance of further guidance, taxpayers may rely upon the guidance in this notice.

For purposes of sections 4965, 6033(a)(2) and 6011(g), a tax-exempt entity is a party to a transaction if it (1) facilitates the transaction by reason of its tax-exempt, tax indifferent or tax-favored status; or (2) is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965, 6033(a)(2) and 6011(g).

Example 1. A tax-exempt entity enters into a transaction (“Transaction A”) with an S corporation. Transaction A is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2004-30, 2004-1 C.B. 828. The tax-exempt entity’s role in Transaction A is similar to the role of the exempt party, as described in Notice 2004-30. The tax-exempt entity purportedly receives the S corporation stock and, due to the tax-exempt entity’s tax-exempt status, aids the S corporation and its shareholders in avoiding taxable income. The tax-exempt entity facilitates Transaction A by reason of its tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity is a party to Transaction A for purposes of sections 4965, 6033(a)(2) and 6011(g).

Example 2. A tax-exempt entity is a partner in a partnership. The partnership has a number of other taxable and tax-exempt partners. The partnership enters into a number of transactions, including a transaction (“Transaction B”) which is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2002-35, 2002-1 C.B. 992 (as clarified and modified by Notice 2006-16, 2006-9 I.R.B. 538). The partnership participates in Transaction B in a role similar to the role of T, as described in Notice 2002-35, i.e., the role of the taxpayer receiving the purported tax benefits from the transaction. The tax and economic consequences from Transaction B to the other partners are not dependent on the tax-exempt entity’s tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity does not facilitate Transaction B by reason of its tax-exempt, tax indifferent or tax-favored status. The tax-exempt entity also has not been identified, by type, class or role, as a party to a prohibited tax shelter transaction in published guidance. Therefore, the tax-exempt entity is not a party to Transaction B for purposes of sections 4965, 6033(a)(2) and 6011(g).

The IRS and Treasury Department recognize that “party” as used in section 4965 applies more broadly than the term is defined for purposes of this interim notice. Accordingly, the IRS and Treasury Department will propose regulations that will define “party” under section 4965 to include a tax-exempt entity that enters into a prohibited tax shelter transaction that reduces such entity’s liability for applicable Federal taxes (i.e., employment taxes, excise taxes, and in appropriate cases unrelated business income tax).

For purposes of section 4965(a), the amount and the timing of the net income and proceeds attributable to the prohibited tax shelter transaction will be computed in a manner consistent with the substance of the transaction. In determining the substance of listed transactions, the Service will look to, among other items, the listing guidance and any subsequent published guidance relating to the transaction.

In general, for purposes of section 4965(a), the net income and proceeds attributable to a prohibited tax shelter transaction must be allocated to a particular taxable year in a manner consistent with the Non-Plan Entity’s established method of accounting for Federal income tax purposes. If the Non-Plan Entity has not established a method of accounting for Federal income tax purposes, the Non-Plan Entity must use the cash receipts and disbursements method of accounting (“cash method”) provided for in section 446 of the Code to determine the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction solely for purposes of section 4965(a). If a Non-Plan Entity has established a method of accounting other than the cash method, the Non-Plan Entity may nevertheless use the cash method of accounting to determine the amount of the net income and proceeds attributable to a prohibited tax shelter transaction entered into prior to the date of enactment of section 4965 and allocable to pre- and post-enactment periods.

If a Non-Plan Entity has not established a taxable year for Federal income tax purposes, the entity’s taxable year for the purpose of determining the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction will be deemed to be the annual period the entity has used in keeping its books and records.

Any net income or proceeds attributable to a prohibited tax shelter transaction allocated to a taxable year ending on or before August 15, 2006 under this section IV, will not be subject to the excise tax imposed by section 4965(a).

Example 3. In 1999, X, a calendar year Non-Plan Entity using the cash method of accounting, entered into a lease-in/lease-out transaction (“LILO”) substantially similar to the transaction described in Notice 2000-15, 2000-1 C.B. 826 (describing Rev. Rul. 99-14, 1999-1 C.B. 835, superseded by Rev. Rul. 2002-69, 2002-2 C.B. 760). In 1999, X purported to lease property to Y pursuant to a “head lease,” and Y purported to lease the property back to X pursuant to a “sublease” of a shorter term. In form, X received $268M as an advance payment of head lease rent. Of this amount, $200M had been, in form, financed by a nonrecourse loan obtained by Y. X deposited the $200M with a “debt payment undertaker.” This served to defease both a portion of X’s rent obligation under its sublease and Y’s repayment obligation under the nonrecourse loan. Of the remainder of the $268M advance head lease rent payment, X deposited $54M with an “equity payment undertaker.” This served to defease the remainder of X’s rent obligation under the sublease. This amount inures to the benefit of Y and enables Y to recover its investment in the transaction and a return on that investment. In substance, the $54M is a loan from Y to X. X retained the remaining $14M of the advance head lease rent payment. In substance, this represents an accommodation fee for X’s participation in the transaction.

According to the substance of the transaction, the head lease, sublease and nonrecourse debt will be ignored for Federal income tax purposes. Therefore, any net income or proceeds resulting from these elements of the transaction will not be considered net income or proceeds attributable to the LILO transaction for purposes of section 4965(a).

Under X’s established cash basis method of accounting, any net income and proceeds received in 1999 and attributable to the LILO transaction are allocated to X’s December 31, 1999, tax year for purposes of section 4965. Because the 1999 tax year is before the effective date of TIPRA, X will not be subject to any excise tax under section 4965 for the amounts received in 1999.

In the case of the taxable year that includes August 16, 2006 (“the transition year”), the Service will treat the period beginning on the first day of the transition year and ending on August 15, 2006, and the period beginning on August 16, 2006, and ending on the last day of the transition year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965, and the Non-Plan Entity does not file tax returns with respect to these short taxable years or otherwise take the short taxable year into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the transition year in accordance with this section IV will be treated as follows:

Example 4. B, a Non-Plan Entity using the cash method of accounting, has an annual accounting period that ends on December 31, 2006. B became a party to a prohibited tax shelter transaction on March 15, 2006. On that date, B received a payment of $600,000 as an accommodation fee for its involvement in the transaction. B received no other proceeds or income attributable to this transaction in 2006. Under B’s method of accounting, the payment received by B on March 15, 2006, is taken into account in the deemed short year ending on August 15, 2006. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to a period ending on or before August 15, 2006, and is not subject to the excise tax imposed by section 4965(a).

Example 5. The facts are the same as in Example 4, above, except that B received an additional payment of $400,000 on September 30, 2006. Under B’s method of accounting, the payment received by B on September 30, 2006, is taken into account in the deemed short year beginning on August 16, 2006. Accordingly, solely for purposes of section 4965, the payment is treated as allocable to a period beginning after August 15, 2006, and is subject to the excise tax imposed by section 4965(a).

Under § 509(a)(3), a supporting organization is a § 501(c)(3) charitable organization that is classified as a public charity, not as a private foundation, as a result of the supporting organization’s close relationship to one or more organizations described in §§ 509(a)(1) or 509(a)(2) (referred to in regulations under section 509(a)(3) as “publicly supported organizations”). To qualify as a supporting organization under § 509(a)(3), an organization must satisfy three requirements:

(A) the organization must be organized and at all times thereafter operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified publicly supported organizations;

(B) the organization must be operated, supervised, or controlled by or in connection with one or more publicly supported organizations; and

(C) the organization must not be controlled directly or indirectly by one or more disqualified persons (as defined in § 4946) other than foundation managers and other than one or more publicly supported organizations.

Section 1.509(a)-4 of the Income Tax Regulations provides that the second requirement is met if the supporting organization has one of three relationships with one or more publicly supported organizations. A “Type I” supporting organization is “operated, supervised, or controlled by” a publicly supported organization. This relationship is comparable to that of a parent and subsidiary in that one or more publicly supported organizations can direct the policies, programs or activities of the supporting organization. A “Type II” supporting organization is “supervised or controlled in connection with” one or more publicly supported organizations. In this relationship, the supporting organization and the publicly supported organization(s) are under common supervision or control. A “Type III” supporting organization is “operated in connection with” a publicly supported organization. An organization will qualify as a Type III supporting organization only if it meets certain tests designed to ensure that the organization will be responsive to, and significantly involved in the operations of, the publicly supported organization(s). Under the PPA, this previously informal nomenclature used to describe the relationship between a supporting organization and its publicly supported organizations is incorporated into new §§ 4942(g)(4), 4943(f)(5) and (6), and 4966(d)(4).

Prior to the PPA, the term donor advised fund was not defined in the Code. However, the term generally was understood to refer to separate funds or accounts established and maintained by public charities to receive contributions from a single donor or a group of donors. The charities had ultimate authority over how the assets in each account were invested and distributed, but the donors, or individuals selected by the donors, were permitted to provide nonbinding recommendations regarding account distributions and/or investments. Donor advised funds often were compared to component funds of certain community trusts. See §§ 1.170A-9(e)(10) and (11).

The PPA adds new § 4966(d)(2), which defines a donor advised fund as a fund or account that is owned and controlled by a sponsoring organization, separately identified by reference to contributions of a donor or donors, and with respect to which the donor or a person appointed or designated by the donor (donor advisor) has or reasonably expects to have advisory privileges with respect to the distribution or investment of the assets in the fund. The term donor advised fund does not include a fund or account (1) that makes distributions only to a single identified organization or governmental entity, or (2) with respect to which a donor advises a sponsoring organization regarding grants for travel, study or similar purposes, provided that certain requirements are met.

A sponsoring organization is defined under new § 4966(d)(1) as a § 170(c) organization that is not a governmental organization (referenced in §§ 170(c)(1) and (2)(A)) or a private foundation and maintains one or more donor advised funds.

Traditionally, supporting organizations and donor advised funds have offered donors certain advantages relative to private foundations, such as the possibility of a higher charitable contribution deduction and the avoidance of certain limitations that apply to private foundations, including the § 4941 self-dealing rules, the § 4942 annual payout requirements, and the § 4943 business holdings limits. Although certain advantages remain, new rules enacted as part of the PPA add certain requirements for deductibility of charitable contributions to donor advised funds and impose new restrictions on the operations of donor advised funds and supporting organizations.

The PPA contains several provisions intended to improve the accountability of donor advised funds and supporting organizations (see §§ 1226, 1231-1235 and 1241-1245 of the PPA). Those PPA provisions add §§ 4966 and 4967 to the Code, and amend §§ 170, 508, 509, 2055, 2522, 4942, 4943, 4945, 4958, and 6033 of the Code. For a description of some of the new rules, see Notice 2006-109, 2006-51 I.R.B. 1121 (December 18, 2006).

The new rules affecting supporting organizations include: excise taxes on certain payments to a substantial contributor or a related person and on the entire amount of any loan to a disqualified person (§ 4958(c)(3)); the extension of § 4958 to transactions between a supported organization and a person who is a disqualified person of a supporting organization (§ 4958(f)); a grant of regulatory authority to adopt a new payout requirement for certain Type III supporting organizations (PPA § 1241(d)); limits on the permitted business holdings of certain supporting organizations (§ 4943(f)); organizational and operational requirements (§ 509(f)); and reporting requirements (§§ 6033(a)(3)(B) and 6033(l)). In addition, new rules apply to certain private foundations that make grants to certain supporting organizations (§§ 4942(g)(4) and 4945(d)(4)(A)).

The new rules affecting donor advised funds include: definitions of the terms “sponsoring organization” and “donor advised fund” (§ 4966(d)); excise taxes on certain taxable distributions from a donor advised fund (§ 4966(c)); excises taxes on donors, advisors, or related persons who receive certain benefits as a result of a distribution from a donor advised fund (or who advise as to such a distribution) (§ 4967); excise taxes on payments from a donor advised fund to any donor, advisor, or a related person (§§ 4958(c)(2) and 4958(f)(1)(E)); the extension of § 4958 to transactions between the sponsoring organization and certain investment advisors or related persons (§§ 4958(f)(1)(F) and 4958(f)(8)); limits on permitted business holdings (§ 4943(e)); substantiation requirements (§§ 170(f)(18), 2055(e)(5) and 2522(c)(5)); and reporting and disclosure requirements for sponsoring organizations (§§ 508(f) and 6033(k)).

Generally, an income tax deduction is allowed under § 170 for a charitable contribution made in the year the deduction is claimed, subject to certain limitations and substantiation requirements. See, e.g., U.S. v. American Bar Endowment, 477 U.S. 105 (1986); §§ 1.170A-1(a) and 1.170A-13. Charitable contributions also may be deductible for gift or estate tax purposes. §§ 2522 and 2055. Under the PPA, a taxpayer may deduct a contribution to a donor advised fund only if the sponsoring organization receiving the contribution is one of certain specified types, and the taxpayer making the contribution obtains an acknowledgement from the sponsoring organization that the organization has exclusive legal control over the property contributed. §§ 170(f)(18), 2522(c)(5), and 2055(e)(5).

This document contains proposed amendments to the Procedure and Administration Regulations (26 CFR part 301) under sections 6325, 6503, and 7426 of the Code. Section 6325(b)(4) was enacted by section 3106(a) of the IRS Restructuring and Reform Act of 1998 (RRA 1998), Pub. L. No. 105-206 (112 Stat. 685). Section 6503(f)(2) was enacted by section 3106(b)(3) of RRA 1998. Sections 7426(a)(4) and (b)(5) were enacted by section 3106(b)(1) of RRA 1998. These provisions of RRA 1998 provide a statutory mechanism for a person other than the person against whom the underlying tax was assessed, upon furnishing a deposit or bond, to obtain a discharge of the Federal tax lien from property owned by him, and for the IRS or the courts to determine the disposition of the deposit or bond amount.

The provisions added by RRA 1998 were enacted in response to United States v. Williams, 514 U.S. 527 (1995). In Williams, the Supreme Court held that a third party who paid another person’s tax liability under protest had standing to bring a civil suit for refund pursuant to 28 U.S.C. 1346(a)(1), which waives the Government’s sovereign immunity with respect to refund suits for Federal taxes alleged to have been erroneously or illegally assessed or collected. The Government argued in Williams that section 1346(a)(1) was intended to afford a remedy only to the person against whom a tax is assessed, and not a third party in this situation. In rejecting this argument, the Supreme Court reasoned that the plaintiff in Williams, who was not the taxpayer and who needed a discharge of the Federal tax lien in order to sell her property, had no effective remedy other than to pay the tax giving rise to the lien and to institute a refund suit. Sections 6325(b)(4), 6503(f)(2), and 7426(a)(4) and (b)(5) afford such a remedy to an owner of the property in this situation if the owner is not the person whose unsatisfied liability gave rise to the lien (a third-party owner). In light of the addition of these provisions to the Code, the continuing applicability of Williams is extremely limited, as the IRS has noted in other published guidance. See Rev. Rul. 2005-50, 2005-2 C.B. 124 (2005).

The current Code of Federal Regulations contains both temporary and final regulations under sections 6325, 6503, and 7426. Neither the temporary regulations nor the final regulations reflect the amendments to the Code made by RRA 1998. These proposed regulations, if adopted as final, would constitute permanent regulations that would incorporate the amendments made by RRA 1998 by replacing the existing temporary regulations and updating the existing final regulations under sections 6325, 6503, and 7426. In particular, these proposed regulations contain procedures for processing a request for a certificate of discharge of a Federal tax lien under section 6325(b)(4). In addition, these proposed regulations clarify the impact of these procedures on the collection limitations period tolling provisions of section 6503(f)(2) and on the judicial remedy provisions of sections 7426(a)(4) and (b)(5).

The proposed regulations also incorporate, with updates, the language of the existing temporary regulations relating to release of lien under section 6325(a), while withdrawing the existing temporary regulations. Changes to the language of the existing temporary regulations have been made to account for the IRS’s acceptance of additional forms of payment since the temporary regulations became effective in 1983. Although section 7805(e)(2) provides that temporary regulations expire after three years, this provision applies only to temporary regulations issued after November 20, 1988. Since the temporary regulations relevant here were issued prior to that date, they are not subject to the three-year statutory limit. The proposed regulations provide that the existing temporary regulations under section 6325(a) are removed as of the date the proposed regulations become effective as final regulations.

The existing permanent and temporary regulations do not account for the current organizational structure of the IRS. The existing permanent regulations under sections 6325 and 6503(f) employ the title “district director,” in numerous instances, in indicating the highest official of a local office of the IRS. That title was used under an organizational structure of the IRS that no longer exists. In order to account for the IRS’s current organizational structure and to allow for future reorganizations of the IRS, the proposed regulations remove the title “district director” throughout §§301.6325-1 and 301.6503(f)-1, and replace that title with the term “appropriate official.” Section 301.6325-1(h) and Section 301.6503(f)-1(c) of the proposed regulations state that as used throughout section 301.6325-1 and section 301.6503(f)-1, respectively, the term “appropriate official” means the official or office identified in the relevant IRS Publication, or if such official is not so identified, the Secretary or his delegate. In this context, the relevant publication is either IRS Publication 1450, “Instructions on How to Request a Certificate of Release of Federal Tax Lien,” or IRS Publication 783, “Instructions on How to Apply for a Certificate of Discharge of Property From Federal Tax Lien.”

These regulations are proposed to apply to any release of lien or discharge of property that is requested after the date that these regulations are published as final regulations in the Federal Register.

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

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are timely submitted to the IRS. The IRS and Treasury Department request comments on the clarity of the proposed rules and how they may be made easier to understand. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register.

Paragraph 1. The authority citation for part 301 continues to read, in part, as follows:

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

Par. 2. Section 301.6325-1 is amended as follows:

1. Paragraphs (a) and (b)(1)(i), (b)(2)(i), and (b)(2)(ii) are revised.

2. Paragraph (b)(2)(iii) is redesignated as paragraph (b)(6) and revised.

3. Paragraph (b)(4) is redesignated as paragraph (b)(5) and revised.

4. A new paragraph (b)(4) is added.

5. Paragraphs (c)(1) and (c)(2) are amended by removing the language “district director” and adding the language “appropriate official” in its place, wherever it appears.

6. The first sentence of paragraph (d)(1) is amended by removing the language “A district director” and adding the language “The appropriate official” in its place, by removing the word “Code” and adding the language “Internal Revenue Code” in its place, and by removing the language “the district director” and adding the language “the appropriate official” in its place. The third sentence is amended by removing the language “a district director” and adding the language “the appropriate official” in its place, and removing the language “the district director” and adding “the appropriate official” in its place.

7. Paragraph (d)(2)(i) is amended by removing the language “A district director” and adding the language “The appropriate official” in its place, by removing the word “Code” and adding the language “Internal Revenue Code” in its place, and by removing the language “the district director” and adding the language “the appropriate official” in its place.

8. Paragraph (d)(2)(ii), Examples 1 through 4, are amended by removing the language “district director” and adding the language “appropriate official” in its place, wherever it appears.

9. Paragraphs (d)(3) and (d)(4) are amended by removing the language “district director” and adding the language “appropriate official” in its place, wherever it appears.

10. The first sentence of paragraph (e) is amended by removing the language “a district director” and adding the language “the appropriate official” in its place, and by removing the language “the district director” and adding the language “the appropriate official” in its place. The third and fourth sentences are amended by removing the language “district director” and adding the language “appropriate official” in its place.

11. Paragraphs (f)(1) and (f)(2)(i) are amended by removing the language “a district director” and adding the language “the appropriate official” in its place, paragraph (f)(2)(i)(b) is amended by removing the language “the district director” and adding the language “the appropriate official” in its place, and paragraph (f)(3) is amended by removing the word “Code” and adding the language “Internal Revenue Code” in its place.

12. Paragraphs (h), (i), and (j) are added.

The revisions and additions read as follows:

Section 409A was added to the Code by § 885 of the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418). Section 409A generally provides that, unless certain requirements are met, amounts deferred under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. In addition, the amount includible in income under § 409A is subject to certain additional taxes discussed below (referred to as § 409A taxes).

On December 20, 2004, the IRS issued Notice 2005-1, 2005-1 C.B. 274, setting forth initial guidance on the application of § 409A, and supplying transition guidance in accordance with the statutory provisions. A notice of proposed rulemaking (REG-158080-04, 2005-2 C.B. 786 [70 FR 57930]) was published in the Federal Register on October 4, 2005. The preamble to the proposed regulations clarified and extended certain provisions of the transition guidance provided in Notice 2005-1, generally through December 31, 2006. On October 4, 2006, the IRS issued Notice 2006-79, 2006-43 I.R.B. 763, which further clarified and extended certain provisions of the transition guidance through December 31, 2007.

Pursuant to Notice 2006-100, 2006-51 I.R.B. 1109, issued on November 30, 2006, service recipients generally are required to report amounts includible under § 409A for 2006 on a timely filed Form W-2 or 1099, as applicable. Service providers are required to report amounts includible under § 409A for the service provider’s 2006 tax year and to pay any taxes due in accordance with the requirements of Notice 2006-100.

The IRS has become aware of numerous instances in which stock options were issued with an exercise price less than the fair market value of the underlying stock on the date of grant or in which stock appreciation rights were issued under which the compensation payable upon exercise of such right was more than the excess of the fair market value of the stock subject to such right on the date of exercise over the fair market value of such stock on the date of grant of such right (collectively such options and rights are referred to as discounted stock rights). In many cases, the discount resulted from a discrepancy between the purported grant date and the actual grant date. In some cases, the employee exercised the stock right during 2006.

Such discounted stock rights, to the extent they were issued or became earned and vested on or after January 1, 2005, are generally treated as providing nonqualified deferred compensation subject to § 409A. By contrast, a stock option granted with an exercise price that can never be less than the fair market value of the underlying stock on the date of grant, and that does not include any additional deferral feature, generally is not subject to § 409A, and the exercise of such stock option does not implicate § 409A. Similarly, a stock appreciation right that does not provide compensation in excess of the difference between the fair market value of the stock subject to such right on the date of exercise and the fair market value of such stock on the date of grant of such right, and that does not include any additional deferral feature, generally is not subject to § 409A, and the exercise of such stock right does not implicate § 409A.

In the absence of affirmative steps taken before the exercise of a stock right to avoid a violation of § 409A, the exercise of a discounted stock right during 2006, where the term of the stock right otherwise extended beyond 2006, generally is treated as an impermissible payment of nonqualified deferred compensation under § 409A. Such an impermissible payment generally triggers adverse Federal income tax consequences under § 409A for the service provider, and reporting requirements for the service recipient, with respect to the stock rights that were exercised and with respect to any additional amounts that are treated as deferred under the same plan for purposes of § 409A under the applicable plan aggregation rules. Such tax consequences include immediate income inclusion; an additional 20% income tax (in accordance with § 409A(a)(1)(B)(i)(II)) on the amounts required to be so included (the 20% tax); and a second additional tax (in accordance with § 409A(a)(1)(B)(ii)) equal to the interest on unpaid taxes from the year of initial deferral (or if later, the first year the deferred amount was not subject to a substantial risk of forfeiture), calculated at the underpayment rate plus 1% (the interest tax).

Notice 2006-100 provides that where there is a required income inclusion under § 409A in the service provider’s tax year 2006, the plan aggregation rules apply in determining the amount required to be included in income. For purposes of participation in, and the relief provided by, the Program, taxpayers may assume, in the case of a violation involving a stock right, that the plan aggregation rules apply only to aggregate all amounts deferred under stock rights subject to § 409A held by the employee with respect to whom the violation occurred. In the case of an unexercised stock right, Notice 2006-79 permits the service recipient to substitute for such a stock right a stock right that is not subject to § 409A. In the case of certain stock rights granted to a service provider who was subject to the disclosure requirements of section 16(a) of the Securities Exchange Act of 1934 on the date of grant of the stock right, the substitution was required to be completed by December 31, 2006. For other service providers, the substitution must be completed by December 31, 2007. If a taxpayer utilizes the available transition rules to exclude a right to an amount (including an unexercised stock right) from coverage under § 409A, then the amount is treated as always having been excluded from coverage under § 409A. Accordingly, the amount is not required to be aggregated for purposes of determining the amount includible in income under § 409A in 2006. If the right to the amount is not excluded from coverage under § 409A by the applicable deadline, the right to the amount will remain subject to the plan aggregation rules regardless of whether the right to the amount is, or is amended to be, compliant with the requirements of § 409A. However, because a stock right may be removed from coverage under § 409A retroactively, any income inclusion under § 409A with respect to an unexercised stock right due to the plan aggregation rules will not be treated as income for any of the service provider’s taxable years before the 2007 tax year.

An employer must submit to the IRS by February 28, 2007 a notice of the employer’s intent to participate in the Program. The notice of intent to participate must state, under penalties of perjury, the following:

An employer must also submit a Form 2848, Power of Attorney and Declaration of Representative, as appropriate. For information regarding the submission of this notice, see section 6 of this announcement.

No later than 15 days after the employer submits the notice of intent to participate described in section 4.A of this announcement, an employer must provide a notice to all employees that the employer reasonably anticipates may be affected by the employer’s participation in the Program. Such notice must provide the following information:

(i) the employer has notified the IRS of the employer’s intent to participate in the Program (the Program must be specifically referred to in the notice to employees as the program set forth in Announcement 2007-18, Compliance Resolution Program for Employees Other than Corporate Insiders for Additional 2006 Taxes Arising Under § 409A due to the Exercise of Stock Rights);

(ii) the employer intends to provide further notice to the employee on or before July 15, 2007 certifying that the employer has made a further submission to the IRS that to the best of its information, knowledge, and belief, satisfies the requirements of this announcement, or certifying that the employer has not made such a further submission;

(iii) the employer’s participation in the Program may affect the employee’s Federal income tax obligations solely with respect to the additional taxes imposed under § 409A of the Internal Revenue Code due to the exercise of discounted stock options or stock appreciation rights, but does not affect the employee’s obligation to report on Form 1040 the compensation income arising from the exercise that is shown on the Form W-2 (or W-2c, if applicable) provided to the employee or to pay the applicable Federal taxes (other than the additional § 409A taxes).

The notice to affected employees may provide additional information that is not inconsistent with the required information. The notice must be provided directly to the individual employee, but may be provided electronically. If an employer provides such notices to employees that the employer reasonably anticipates may be affected by the employer’s participation in the Program, and subsequently determines that an exercise of a stock right by an additional employee is eligible to be included in this Program, the employer may include such additional employee and exercise in a further submission without providing the notices required by this Section 4.B, provided all other requirements of this announcement are met with respect to such additional employee.

No later than 15 days after the employer submits the notice of intent to participate described in section 4.A of this announcement, the employer must provide a notice to the IRS stating the number of employees to whom the notices required by section 4.B.i of this announcement were provided.

An employer must make a further submission of information and payment (a further submission) to the IRS by June 30, 2007 meeting all of the requirements of this section 4.C.

An employer must include in the further submission to the IRS the following information, signed under penalties of perjury:

a. The employer’s name and taxpayer identification number.

b. A list of employees for whom the employer is remitting the § 409A taxes due (the 20% tax and the interest tax) under section 4.C.ii below, including each such employee’s taxpayer identification number.

c. For each identified employee, an identification of each stock right exercise resulting in the § 409A taxes, including information that specifically identifies the specific stock right that was exercised, the date of exercise, the exercise price, the fair market value of the underlying shares on the date of exercise, and the number of shares purchased or, in the case of a stock appreciation right, the number of shares used to calculate the payment made.

d. For each identified stock right exercise for each identified employee, the amount of § 409A taxes remitted, including the manner in which such § 409A taxes were calculated.

With respect to an exercise of a stock right subject to § 409A by an employee during 2006, the employer must remit to the IRS by June 30, 2007, an amount equal to the full amount of the additional tax liability of the employee under § 409A that results from such exercise. Such additional tax consists of the 20% tax and the interest tax described below. For purposes of determining the § 409A taxes, the amount of income includible under § 409A must be determined in accordance with applicable guidance under § 409A. With respect to such exercise of a stock right, an employer is treated as having remitted an amount equal to the full amount of the additional tax liability if the employer remits substantially all of the additional tax liability based upon a reasonable, good faith interpretation of the applicable guidance. Where it is determined that an employer has failed to submit substantially all of the additional tax liability that results from the exercise of a stock right subject to § 409A during 2006 based upon a reasonable, good faith interpretation of the applicable guidance, neither the employer nor the employee is entitled to any relief under this announcement with respect to the § 409A taxes resulting from the exercise of such stock right.

For purposes of this Program, the amount of the 20% tax equals 20% of the excess of the fair market value of the stock on the date of exercise over the sum of the exercise price paid by the employee and any other amount paid by the employee for the stock right. See Notice 2006-100.

For purposes of this Program, the amount of the interest tax equals the amount of interest at the underpayment rate plus 1% on the underpayment of Federal income tax that would have occurred had the portion of the amount deferred under the stock right as of December 31, 2005, that was not subject to a substantial risk of forfeiture (as defined for purposes of § 409A) as of December 31, 2005, been includible in gross income as of December 31, 2005. For this purpose, the amount deferred under the stock right as of December 31, 2005 equals the excess of the fair market value of the underlying stock on December 31, 2005 over the sum of the exercise price and any other amount paid by the employee for the stock right. For purposes of this Program, employers must calculate the underpayment based on the highest marginal Federal income tax rate in effect for 2005 (35%). For purposes of determining the applicable interest, the underpayment is treated as due on April 17, 2006, and the interest runs from that date through the earlier of April 17, 2007 or the date the further submission is sent to the IRS with payment.

For payments sent to the IRS after April 17, 2007, the amount required to be submitted is increased by an amount equal to the underpayment interest rate applied to the amount that would otherwise be due on April 17, 2007 through the date the further submission (with payment) is sent to the IRS.

The payment of the § 409A taxes due as part of this Program constitutes additional compensation income to the employee for the employee’s taxable year in which such payment is made. Accordingly, the employer must represent under penalties of perjury that the employer is treating such payment as additional compensation to the employee for the taxable year of such employee in which such payment is made, in accordance with this section iii. With respect to any employee for whom a payment of § 409A taxes has been made as part of the further submission, no relief shall be provided under this announcement with respect to the exercise of a stock right by such employee during 2006 if it is determined that the employer has failed to treat such payments as additional compensation for the taxable year of such employee in which such payment is made, in accordance with this section iii.

Payments made on behalf of an employee or former employee to cover § 409A taxes are wages for Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and Federal income tax withholding purposes for the employee’s taxable year in which the payment is made. Such wages, as well as any additional wages resulting from the employer’s payment of the employee’s share of FICA tax and income tax without withholding such amounts from the employee, must be reported on Form 941, Employer’s QUARTERLY Federal Tax Return, and in box 1, 3 and 5 of the employee’s Form W-2, Wage and Tax Statement, for the year in which the payment is made. See Rev. Rul. 58-113, 1958-1 C.B. 362, and Rev. Proc. 81-48, 1981-2 C.B. 623, for methods of computing gross wages when paying FICA and Federal income tax withholding on behalf of an employee.

The further submission must include the following representations by the employer, signed under penalties of perjury:

a. In accordance with section 4.B.i of this announcement, the employer provided the notices of the employer’s intent to participate in the Program to all employees the employer reasonably anticipated would be affected by the employer’s participation in the program by no later than 15 days after the employer submitted its notice of intent to participate in the Program to the IRS.

b. With respect to any employee for which a payment of § 409A taxes has been made as part of the further submission, the employer has made reasonable, good faith efforts to identify all exercises of a stock right by such employee during 2006 that resulted in the inclusion of income under § 409A, applying a reasonable, good faith interpretation of the applicable guidance under § 409A, has listed all such identified exercises of a stock right in its further submission, and has accurately calculated and paid the § 409A taxes resulting from such identified exercises of a stock right in accordance with this announcement.

c. The employer will, upon a written request from an affected employee, disclose to the employee any portion of such information that is relevant to the employee’s 2006 Federal income tax return, including information the employee reasonably needs to respond to an information request from the IRS, an examination, or tax litigation involving issues related to the exercise of a stock right and the application of § 409A.

An employer must provide a notice to all employees to whom a notice was provided pursuant to section 4.B.i, and any additional employees that are listed in the employer’s further submission to the IRS, by no later than July 15, 2007, certifying the following:

The notice to affected employees may provide additional information that is not inconsistent with the required information. The notice must be provided directly to the individual employee, but may be provided electronically.

If an employer complies fully with the provisions of section 4 with respect to an exercise of a stock right by an employee, the employer will not be required to report the § 409A inclusion amount with respect to such stock right exercise in box 12 of Form W-2 using code Z. If an employer complies fully with the provisions of section 4 with respect to an exercise of a stock right by an employee, but has already reported the § 409A inclusion amount with respect to such exercise of a stock right by an employee in box 12 of Form W-2 using Code Z, the employer may provide a Form W-2c that does not report the § 409A inclusion amount in box 12 of Form W-2c using Code Z, and such employer will not be subject to any penalties under § 6721 or § 6722 of the Code. Nothing in this Program relieves the employer of any information reporting requirements with respect to an employee or an exercise of a stock right that was not identified in the employer’s further submission. Nothing in this announcement or Program affects the employer’s obligation to report the amount that would be required, without regard to § 409A, to be included in income and wages due to the exercise of a stock right, and to withhold and pay the applicable employment taxes, or the employee’s obligations to include such amounts in income and pay Federal taxes on them (other than § 409A taxes).

If an employer complies fully with the provisions of section 4 of this announcement with respect to amounts includible in income under § 409A due to the exercise of an applicable stock right by an employee during 2006, the employee will not be required to pay the § 409A taxes on the applicable Federal income tax return for the 2006 tax year with respect to such amounts includible in income under § 409A. Nothing in this Program relieves the employee of any § 409A taxes with respect to an exercise of a stock right that was not identified in the employer’s further submission, or relieves the employee or employer of any other tax, including Federal income tax and employment taxes that would otherwise arise from the exercise of the stock right. In addition, nothing in this Program addresses or relieves the employee of any § 409A taxes due to participation in a nonqualified deferred compensation plan, other than the exercise of an applicable stock right in 2006.

An employee who received a notice of application under section 4.B.i of this announcement, and who files a return before finding out that, due to a failure by the employer to comply with the requirements for relief set forth in this announcement, the employee is not relieved of the duty to report and pay § 409A taxes, will be treated as having had reasonable cause and as having acted in good faith with respect to the portion of any underpayment that is due to the employee’s failure to timely pay § 409A taxes arising from the exercise of an applicable stock right in 2006, and will not be subject to penalties for the 2006 tax year under § 6654 for any estimated tax underpayment attributable to such failure. An employee who received a notice of application under section 4.B.i of this announcement, requested an extension of time to file a return, and files a timely income tax return on extension after learning that he or she is not relieved of the duty to report and pay § 409A taxes due to a failure by the employer to comply with the requirements for relief set forth in this announcement, will not be subject to penalties under § 6651(a)(2) or § 6654 for the failure to timely pay § 409A taxes arising from the exercise of an applicable stock right in 2006, provided such § 409A taxes are paid with the filed return.

Information and representations required under this Program are material, and an employer who knowingly makes a false statement or representation will be deemed to have failed to make a further submission under the Program so that no relief under this Program is available to the employer or any employee. Except as provided in paragraph 5.B with respect to certain penalties, no relief is provided under this Program with respect to an employer or to an employee if the employer fails to comply with the requirements of this announcement, provided that the Commissioner may, in his sole discretion, determine that the employer has substantially complied with the requirements of this announcement with respect to some or all of the employees identified by the employer and that, accordingly, such employer and some or all of such employees are entitled to the relief provided under this announcement.

Nothing in this Program relieves the employer or employee of any requirements regarding information reporting, filing of tax returns, or the payment of any taxes, to the extent such requirements relate to any state or local tax. This includes any state or local tax information reporting requirement which relates to the Form W-2.

A notice of intent to participate in the Program in accordance with section 4.A of this announcement, a second notice to the IRS in accordance with section 4.B.ii of this announcement, or a further submission in accordance with section 4.C of this announcement, shall be submitted to the following address:

The IRS reserves the right to request further information from an employer at any time following the employer’s submission of a notice of intent to participate in the Program. In addition, nothing in this announcement or Program limits or otherwise affects the IRS’s right to request further information, to examine a taxpayer’s federal tax return, and except as otherwise explicitly provided in this announcement and Program, to assess any unpaid taxes, penalties or interest.

The employer retains the right to withdraw a notice of intent to participate or a further submission at any time on or before June 30, 2007, provided that notices are provided under section 4.D of this announcement that reflect the withdrawal. The employer also retains the right to modify a further submission at any time on or before June 30, 2007, provided that a modification after April 17, 2007 involving the payment of additional § 409A taxes is subject to the requirement of an additional amount due for further submissions after April 17, 2007 with respect to the additional § 409A taxes identified in the modification, and provided that notices are provided under section 4.D of this announcement that reflect the modification. Where an employer withdraws a submission on or before June 30, 2007, the employer is entitled to a return of the funds submitted to the IRS, without interest. Where an employer modifies a further submission in a manner that reduces the § 409A taxes covered by the further submission, the employer may obtain a return of amounts previously submitted to the IRS consistent with such modification, without interest, provided such modification is submitted on or before June 30, 2007. After June 30, 2007, an employer may obtain a return of any amount paid to the IRS with respect to an employee pursuant to the announcement if the employer demonstrates that the employee for whom the § 409A taxes were paid has paid the § 409A taxes in full.

For information about this announcement, call (630) 493-5167 (not a toll-free number).

(a) * * *

(8) * * *

Example 1. * * *

(iii) * * * If Y elected to withhold income tax using paragraph (a)(7) of this section, Y would withhold on the $400,000 component at 25 percent (pursuant to paragraph (a)(7)(iii)(F) of this section), which would result in $100,000 tax withheld. * * *

* * * * *

Example 3. (i) * * * Unrelated company U pays D sick pay as an agent of the employer R and such sick pay is supplemental wages pursuant to § 31.3401(a)-1(b)(8)(i)(b)(2). * * *

* * * * *

(iv) * * * If R elects to use optional flat rate withholding provided under paragraph (a)(7)(iii)(f) of this section, withholding would be calculated at 25 percent of the $1,000,000 portion of the payment and would be $250,000.

* * * * *

(vi) * * * If U elects to withhold income tax at the flat rate provided under paragraph (a)(7)(iii)(F) of this section, withholding on the $50,000 of sick pay would be calculated at 25 percent of the $50,000 payment and would be $12,500. * * *

* * * * *

The final regulations (T.D. 9263) that are subject to this correction are under section 199 of the Internal Revenue Code.

On June 1, 2006, final regulations (T.D. 9263) were published in the Federal Register at 71 FR 31268. These regulations contain errors that may prove to be misleading and are in need of clarification.

* * * * *

Accordingly, 26 CFR Part 1 is corrected by making the following correcting amendments:

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

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

Par. 2. Section 1.199-1(b)(1) is amended by revising the first sentence of the paragraph to read as follows:

* * * * *

(b) * * *

(1) In general. For purposes of paragraph (a) of this section, the definition of taxable income under section 63 applies, except that taxable income (or alternative minimum taxable income, if applicable) is determined without regard to section 199 and without regard to any amount excluded from gross income pursuant to section 114 or pursuant to section 101(d) of the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418) (Act). * * *

* * * * *

Par. 3. Section 1.199-2 is amended by revising the first sentence of paragraph (a)(3)(ii) and the last sentence of paragraph (e)(3) to read as follows:

(a) * * *

(3) * * *

(ii) Corrected return filed to correct a return that was filed within 60 days of the due date. If a corrected information return (Return B) is filed with SSA on or before the 60^th day after the due date (including extensions) of Return B to correct an information return (Return A) that was filed with SSA on or before the 60^th day after the due date (including extensions) of the information return (Return A) and paragraph (a)(3)(iii) of this section does not apply, then the wage information on Return B must be included in determining W-2 wages. * * *

* * * * *

(e) * * *

(3) * * * For example, see Rev. Proc. 2006-22, 2006-23 I.R.B. 1033. (See § 601.601(d)(2) of this chapter).

Par. 4. Section 1.199-3(l)(4)(iv)(A) is amended by revising the first sentence of the paragraph to read as follows:

* * * * *

(l) * * *

(4) * * *

(iv) * * *

(A) * * * DPGR. Notwithstanding paragraphs (l)(4)(i), (ii), and (iii) of this section, if less than 5 percent of a taxpayer’s gross receipts derived from a sale, exchange, or other disposition of utilities are attributable to the transmission or distribution of the utilities and the storage of potable water after completion of treatment of the potable water, then the gross receipts derived from the lease, rental, license, sale, exchange, or other disposition of the utilities that are attributable to the transmission and distribution of the utilities and the storage of potable water after completion of treatment of the potable water may be treated as being DPGR (assuming all other requirements of this section are met). * * *

* * * * *

Par. 5. Section 1.199-4(d)(6) is amended by revising paragraph (i) of Examples 1 and 2 to read as follows:

* * * * *

(d) * * *

(6) * * *

Example 1. * * *

(i) Facts. X, a United States corporation that is not a member of an expanded affiliated group (EAG) (as defined in § 1.199-7), engages in activities that generate both DPGR and non-DPGR. All of X’s production activities that generate DPGR are within Standard Industrial Classification (SIC) Industry Group AAA (SIC AAA). All of X’s production activities that generate non-DPGR are within SIC Industry Group BBB (SIC BBB). X is able to specifically identify CGS allocable to DPGR and to non-DPGR. X incurs $900 of research and experimentation expenses (R&E) that are deductible under section 174, $300 of which are performed with respect to SIC AAA and $600 of which are performed with respect to SIC BBB. None of the R&E is legally mandated R&E as described in § 1.861-17(a)(4) and none of the R&E is included in CGS. X incurs section 162 selling expenses that are not includible in CGS and are definitely related to all of X’s gross income. For 2010, the adjusted basis of X’s assets is $5,000, $4,000 of which generates gross income attributable to DPGR and $1,000 of which generates gross income attributable to non-DPGR. For 2010, X’s taxable income is $1,380 based on the following Federal income tax items: * * *

* * * * *

Example 2. * * *

(i) Facts. The facts are the same as in Example 1 except that X owns stock in Y, a United States corporation, equal to 75% of the total voting power of stock of Y and 80% of the total value of stock in Y. X and Y are not members of an affiliated group as defined in section 1504(a). Accordingly, the rules of § 1.861-14T do not apply to X’s and Y’s selling expenses, R&E, and charitable contributions. X and Y are, however, members of an affiliated group for purposes of allocating and apportioning interest expense (see § 1.861-11T(d)(6)) and are also members of an EAG. For 2010, the adjusted basis of Y’s assets is $45,000, $21,000 of which generates gross income attributable to DPGR and $24,000 of which generates gross income attributable to non-DPGR. All of Y’s activities that generate DPGR are within SIC Industry Group AAA (SIC AAA). All of Y’s activities that generate non-DPGR are within SIC Industry Group BBB (SIC BBB). None of X’s and Y’s sales are to each other. Y is not able to specifically identify CGS allocable to DPGR and non-DPGR. In this case, because CGS is definitely related under the facts and circumstances to all of Y’s gross receipts, apportionment of CGS between DPGR and non-DPGR based on gross receipts is appropriate. For 2010, Y’s taxable income is $1,910 based on the following Federal income tax items: * * *

* * * * *

Par. 6. Section 1.199-6 is amended as follows:

1. The last sentence of paragraph (g) is revised.

2. The last sentence of Example 2 (i) in paragraph (m) is revised.

The revisions read as follows:

* * * * *

(g) Written notice to patrons. * * * The cooperative must report the amount of the patron’s section 199 deduction on Form 1099-PATR, “Taxable Distributions Received From Cooperatives,” issued to the patron.

* * * * *

(m) * * *

Example 2. (i) * * * Cooperative X must report the amount of Patron A’s section 199 deduction on Form 1099-PATR, “Taxable Distributions Received From Cooperatives,” issued to Patron A for the calendar year 2008.

* * * * *

Par. 7. Section 1.199-7 is amended as follows:

1. By revising paragraph (a)(4), Example 3.

2. By revising paragraph (e), Example 10 (i).

The revisions read as follows:

(a) * * *

(4) * * *

Example 3. The facts are the same as in Example 2 except that rather than reselling the machinery, B rents the machinery to unrelated persons and B takes the gross receipts attributable to the rental of the machinery into account under its methods of accounting in 2007, 2008, and 2009. In addition, as of the close of business on December 31, 2008, A and B cease to be members of the same EAG. With respect to the machinery acquired from C and the unrelated persons, B’s gross receipts attributable to the rental of the machinery in 2007, 2008, and 2009 are non-DPGR because no member of the EAG MPGE the machinery and because C does not qualify as an EAG partnership. With respect to machinery acquired from A, B’s gross receipts in 2007 and 2008 attributable to the rental of the machinery are DPGR because at the time B takes into account the gross receipts derived from the rental of the machinery under its methods of accounting, B is a member of the same EAG as A and B is treated as conducting A’s previous MPGE activities. However, with respect to the rental receipts in 2009, because A and B are not members of the same EAG in 2009, B’s rental receipts are non-DPGR.

* * * * *

(e) * * *

Example 10. (i) Facts. Corporation P owns all of the stock of Corporations S and T, and P, S, and T file a consolidated Federal income tax return on a calendar year basis. In 2007, P MPGE QPP in the United States at a cost of $1,000. On November 30, 2007, P sells the QPP to S for $2,500. On February 28, 2008, P disposes of 60% of the stock of S. On June 30, 2008, S sells the QPP to an unrelated person for $3,000.

* * * * *

Par. 8. Section 1.199-8 is amended by revising paragraph (h) to read as follows:

* * * * *

(h) Disallowed losses or deductions. Except as provided by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter), losses or deductions of a taxpayer that otherwise would be taken into account in computing the taxpayer’s section 199 deduction are taken into account only if and to the extent the deductions are not disallowed by section 465 or 469, or any other provision of the Code. If only a portion of the taxpayer’s share of the losses or deductions is allowed for a taxable year, the proportionate share of those allowable losses or deductions that are allocated to the taxpayer’s qualified production activities, determined in a manner consistent with sections 465 and 469, and any other applicable provision of the Code, is taken into account in computing QPAI for purposes of the section 199 deduction for that taxable year. To the extent that any of the disallowed losses or deductions are allowed in a later year, the taxpayer takes into account a proportionate share of those losses or deductions in computing its QPAI for that later taxable year. Losses or deductions of the taxpayer that are disallowed for taxable years beginning on or before December 31, 2004, are not taken into account in a later year for purposes of computing the taxpayer’s QPAI and the wage limitation of section 199(d)(1)(A)(iii) under § 1.199-9 for that taxable year, regardless of whether the losses or deductions are allowed for other purposes. For taxpayers that are partners in partnerships, see § 1.199-9(b)(2). For taxpayers that are shareholders in S corporations, see § 1.199-9(c)(2).

* * * * *

Par. 9. Section 1.199-9(b)(6) is amended as follows:

1. By revising Example 1 paragraphs (i), (iii)(B)(1), and the seventh sentence of (iii)(B)(2).

2. By revising Example 2 paragraphs (i), and (iii)(B)(1), and the table following (iii)(B)(3).

3. Paragraph (h) is revised.

The revisions read as follows:

* * * * *

(b) * * *

(6) * * *

Example 1. * * * (i) Partnership Federal income tax items. X and Y, unrelated United States corporations, are each 50% partners in PRS, a partnership that engages in production activities that generate both DPGR and non-DPGR. X and Y share all items of income, gain, loss, deduction, and credit 50% each. Both X and Y are engaged in a trade or business. PRS is not able to specifically identify CGS allocable to DPGR and non-DPGR. In this case, because CGS is definitely related under the facts and circumstances to all of PRS’s gross income, apportionment of CGS between DPGR and non-DPGR based on gross receipts is appropriate. For 2006, the adjusted basis of PRS’s business assets is $5,000, $4,000 of which generate gross income attributable to DPGR and $1,000 of which generate gross income attributable to non-DPGR. For 2006, PRS has the following Federal income items: * * *

* * * * *

(iii) * * *

(B) * * * (1) For 2006, in addition to the activities of PRS, Y engages in production activities that generate both DPGR and non-DPGR. Y is able to specifically identify CGS allocable to DPGR and to non-DPGR. For 2006, the adjusted basis of Y’s non-PRS assets attributable to its production activities that generate DPGR is $8,000 and to other production activities that generate non-DPGR is $2,000. Y has no other assets. Y has the following Federal income tax items relating to its non-PRS activities: * * *

(2) * * * Y has $1,290 of gross income attributable to DPGR ($3,000 DPGR ($1,500 from PRS and $1,500 from non-PRS activities) — $1,710 CGS ($810 from PRS and $900 from non-PRS activities)). * * *

* * * * *

Example 2. * * * (i) Partnership items of income, gain, loss, deduction or credit. X and Y, unrelated United States corporations each of which is engaged in a trade or business, are partners in PRS, a partnership that engages in production activities that generate both DPGR and non-DPGR. Neither X nor Y is a member of an affiliated group. X and Y share all items of income, gain, loss, deduction, and credit 50% each. All of PRS’s domestic production activities that generate DPGR are within Standard Industrial Classification (SIC) Industry Group AAA (SIC AAA). All of PRS’s production activities that generate non-DPGR are within SIC Industry Group BBB (SIC BBB). PRS is not able to specifically identify CGS allocable to DPGR and to non-DPGR and, therefore, apportions CGS to DPGR and non-DPGR based on its gross receipts. PRS incurs $900 of research and experimentation expenses (R&E) that are deductible under section 174, $300 of which are performed with respect to SIC AAA and $600 of which are performed with respect to SIC BBB. None of the R&E is legally mandated R&E as described in § 1.861-17(a)(4) and none is included in CGS. PRS incurs section 162 selling expenses (that include W-2 wage expense) that are not includible in CGS and are definitely related to all of PRS’s gross income. For 2006, PRS has the following Federal income tax items: * * *

* * * * *

(iii) * * *

(B) * * * (1) For 2006, in addition to the activities of PRS, Y engages in domestic production activities that generate both DPGR and non-DPGR. With respect to those non-PRS activities, Y is not able to specifically identify CGS allocable to DPGR and to non-DPGR. In this case, because CGS is definitely related under the facts and circumstances to all of Y’s non-PRS gross receipts, apportionment of CGS between DPGR and non-DPGR based on Y’s non-PRS gross receipts is appropriate. For 2006, Y has the following non-PRS Federal income tax items: * * *

* * * * *

(3) * * *

* * * * *

(h) * * * Except as provided in paragraph (i) of this section regarding qualifying in-kind partnerships and paragraph (j) of this section regarding EAG partnerships, an owner of a pass-thru entity is not treated as conducting the qualified production activities of the pass-thru entity, and vice versa. This rule applies to all partnerships, including partnerships that have elected out of subchapter K under section 761(a). Accordingly, if a partnership MPGE QPP within the United States, or produces a qualified film or produces utilities in the United States, and distributes or leases, rents, licenses, sells, exchanges, or otherwise disposes of such property to a partner who then, without performing its own qualifying MPGE or other production, leases, rents, licenses, sells, exchanges, or otherwise disposes of such property, then the partner’s gross receipts from this latter lease, rental, license, sale, exchange, or other disposition are treated as non-DPGR. In addition, if a partner MPGE QPP within the United States, or produces a qualified film or produces utilities in the United States, and contributes or leases, rents, licenses, sells, exchanges, or otherwise disposes of such property to a partnership which then, without performing its own qualifying MPGE or other production, leases, rents, licenses, sells, exchanges, or otherwise disposes of such property, then the partnership’s gross receipts from this latter disposition are treated as non-DPGR.

* * * * *