These final regulations retain the special rules which were included in the proposed regulations relating to designated Roth contributions under a section 401(k) plan. Thus, these final regulations amend §1.401(k)-1(f) to provide a definition of designated Roth contributions and special rules with respect to such contributions. Under these final regulations, designated Roth contributions are defined as elective contributions under a qualified cash or deferred arrangement that are: (1) designated irrevocably by the employee at the time of the cash or deferred election as designated Roth contributions that are being made in lieu of all or a portion of the pre-tax elective contributions the employee is otherwise eligible to make under the plan; (2) treated by the employer as includible in the employee’s gross income at the time the employee would have received the contribution amounts in cash if the employee had not made the cash or deferred election (e.g., by treating the contributions as wages subject to applicable withholding requirements); and (3) maintained by the plan in a separate account. The regulations also provide that elective contributions may only be treated as designated Roth contributions to the extent permitted under the plan.

Some commentators requested that an employer sponsoring a qualified cash or deferred arrangement be permitted to offer only designated Roth contributions. However, under section 402A(b)(1), designated Roth contributions are made in lieu of all or a portion of elective contributions that the employee is otherwise eligible to make under the cash or deferred arrangement. If a cash or deferred arrangement offered only designated Roth contributions, an employee participating in the arrangement would not be electing to make such contributions in lieu of elective contributions he or she was otherwise eligible to make under the plan. Thus, these final regulations clarify that, in order to provide for designated Roth contributions, a qualified cash or deferred arrangement must also offer pre-tax elective contributions.

These final regulations also retain the rule that, under the separate accounting requirement, contributions and withdrawals of designated Roth contributions must be credited and debited to a designated Roth account maintained for the employee and the plan must maintain a record of the employee’s investment in the contract (i.e., designated Roth contributions that have not been distributed) with respect to the employee’s designated Roth account. In addition, gains, losses, and other credits or charges must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan. The proposed regulations provided that forfeitures may not be allocated to the designated Roth account. The final regulations retain this rule and, in response to comments, clarify that no contributions other than designated Roth contributions and rollover contributions described in section 402A(c)(3)(B) are permitted to be allocated to a designated Roth account. For example, matching contributions are not permitted to be allocated to a designated Roth account. The final regulations also retain the rule that the separate accounting requirement applies at the time the designated Roth contribution is contributed to the plan and must continue to apply until the designated Roth account is completely distributed.

These final regulations retain the requirement that a designated Roth contribution must satisfy the requirements applicable to any other elective contributions made under a qualified cash or deferred arrangement. Thus, designated Roth contributions are subject to the nonforfeitability and distribution restrictions applicable to elective contributions and are taken into account under the actual deferral percentage test (ADP test) of section 401(k)(3) in the same manner as pre-tax elective contributions. Similarly, designated Roth contributions may be treated as catch-up contributions and serve as the basis for a participant loan.

A number of commentators discussed the application of section 401(a)(9) to plans to which designated Roth contributions are made. These commentators pointed out that under section 408A, Roth IRAs are not subject to the rules of section 401(a)(9)(A) (i.e., Roth IRAs are not subject to the rules of section 401(a)(9) while the Roth IRA owner is alive). Although Roth IRAs are not subject to section 401(a)(9) while the IRA owner is alive, section 402A does not provide comparable rules regarding the application of section 401(a)(9) to designated Roth accounts under a cash or deferred arrangement. Thus, such designated Roth accounts are subject to the rules of section 401(a)(9)(A) and (B) in the same manner as pre-tax elective contributions.

In response to comments asking for clarification, the final regulations provide rules regarding elections to make designated Roth contributions. These rules specifically provide that the rules in §1.401(k)-1(e)(2)(ii) regarding frequency of elections to make pre-tax elective contributions also apply to elections to make designated Roth contributions. The rules also specifically address automatic enrollment and permit a plan to utilize automatic enrollment in conjunction with designated Roth contributions. Under the final regulations, a plan that provides for a cash or deferred election under which contributions are made in the absence of an affirmative election and that has both pre-tax elective contributions and designated Roth contributions must set forth the extent to which those default contributions are pre-tax elective contributions or designated Roth contributions. If the default contributions are designated Roth contributions, then an employee who has not made an affirmative election is deemed to have irrevocably designated the contributions (in accordance with section 402A(c)(1)(B)) as designated Roth contributions.

A number of commentators addressed direct rollovers of amounts from a designated Roth account. In response to these comments, the regulations clarify that a direct rollover from a designated Roth account under a qualified cash or deferred arrangement may only be made to another designated Roth account under an applicable retirement plan described in section 402A(e)(1) or to a Roth IRA described in section 408A, and only to the extent the direct rollover is permitted under the rules of section 402(c). In addition, a plan is permitted to treat the balance of the participant’s designated Roth account and the participant’s other accounts under the plan as accounts held under two separate plans (within the meaning of section 414(l)) for purposes of applying the special rule in A-11 of §1.401(a)(31)-1 (under which a plan will satisfy section 401(a)(31) even though the plan administrator does not permit any distributee to elect a direct rollover with respect to eligible rollover distributions during a year that are reasonably expected to total less than $200). Thus, if a participant’s balance in the designated Roth account is less than $200, then the plan is not required to offer a direct rollover election with respect to that account or to apply the automatic rollover provisions of section 401(a)(31)(B) with respect to that account.

Section 1.401(k)-2 contains correction methods that may be used when a plan fails to satisfy the ADP test for a year. These final regulations retain the rule in the proposed regulations relating to these correction methods that permits a highly compensated employee (HCE), as defined in section 414(q), with elective contributions for a year that include both pre-tax elective contributions and designated Roth contributions to elect whether excess contributions are to be attributed to pre-tax elective contributions or designated Roth contributions. There is no requirement that the plan provide this option, and a plan may provide for one of the correction methods described in the final regulations without permitting an HCE to make such an election.

These final regulations also retain the rule that a distribution of excess contributions is not includible in gross income to the extent it represents a distribution of designated Roth contributions. However, the income allocable to a corrective distribution of excess contributions that are designated Roth contributions is includible in gross income in the same manner as income allocable to a corrective distribution of excess contributions that are pre-tax elective contributions. The regulations also provide a similar rule under the correction methods that may be used when a plan fails to satisfy the actual contribution percentage (ACP) test in §1.401(m)-2.

In addition to the rules relating to sections 401(k) and (m) discussed above, there are other aspects of designated Roth contributions that would be reflected in plan terms and are not addressed in these regulations. For example, while a plan is permitted to allow an employee to elect the character of a distribution (i.e., whether the distribution will be made from the designated Roth account or other accounts), the extent to which a plan so permits must be set forth in the terms of the plan.

These final regulations do not provide guidance with respect to the taxation of distributions of designated Roth contributions. For example, the regulations do not provide guidance with respect to the recovery of an employee’s investment in the contract associated with his or her designated Roth contributions. Proposed regulations under section 402A, to be issued in the near future, address these taxation issues.

* * * * *

* * * * *

(f) Special rules for designated Roth contributions.

(1) In general.

(2) Separate accounting required.

(3) Designated Roth contributions must satisfy rules applicable to elective contributions.

(i) In general.

(ii) Special rules for direct rollovers.

(4) Rules regarding designated Roth contribution elections.

(i) Frequency of elections.

(ii) Default elections.

(5) Effective date.

(i) In general.

(ii) Sunset provisions.

* * * * *

* * * * *

(b) * * *

(2) * * *

(vi) * * *

(C) Corrective distributions attributable to designated Roth contributions.

* * * * *

Par. 3. Section 1.401(k)-1(f) is revised as follows:

* * * * *

(f) Special rules for designated Roth contributions—(1) In general. The term designated Roth contribution means an elective contribution under a qualified cash or deferred arrangement that, to the extent permitted under the plan, is—

(i) Designated irrevocably by the employee at the time of the cash or deferred election as a designated Roth contribution that is being made in lieu of all or a portion of the pre-tax elective contributions the employee is otherwise eligible to make under the plan;

(ii) Treated by the employer as includible in the employee’s gross income at the time the employee would have received the amount in cash if the employee had not made the cash or deferred election (e.g., by treating the contributions as wages subject to applicable withholding requirements); and

(iii) Maintained by the plan in a separate account (in accordance with paragraph (f)(2) of this section).

(2) Separate accounting required. Under the separate accounting requirement of this paragraph (f)(2), contributions and withdrawals of designated Roth contributions must be credited and debited to a designated Roth account maintained for the employee and the plan must maintain a record of the employee’s investment in the contract (i.e., designated Roth contributions that have not been distributed) with respect to the employee’s designated Roth account. In addition, gains, losses, and other credits or charges must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan. However, forfeitures may not be allocated to the designated Roth account and no contributions other than designated Roth contributions and rollover contributions described in section 402A(c)(3)(B) may be allocated to such account. The separate accounting requirement applies at the time the designated Roth contribution is contributed to the plan and must continue to apply until the designated Roth account is completely distributed.

(3) Designated Roth contributions must satisfy rules applicable to elective contributions—(i) In general. A designated Roth contribution must satisfy the requirements applicable to elective contributions made under a qualified cash or deferred arrangement. Thus, for example, a designated Roth contribution must satisfy the requirements of paragraphs (c) and (d) of this section and is treated as an employer contribution for purposes of sections 401(a), 401(k), 402, 404, 409, 411, 412, 415, 416 and 417. In addition, the designated Roth contributions are treated as elective contributions for purposes of the ADP test. Similarly, the designated Roth account under the plan is subject to the rules of section 401(a)(9)(A) and (B) in the same manner as an account that contains pre-tax elective contributions.

(ii) Special rules for direct rollovers. A direct rollover from a designated Roth account under a qualified cash or deferred arrangement may only be made to another designated Roth account under an applicable retirement plan described in section 402A(e)(1) or to a Roth IRA described in section 408A, and only to the extent the rollover is permitted under the rules of section 402(c). Moreover, a plan is permitted to treat the balance of the participant’s designated Roth account and the participant’s other accounts under the plan as accounts held under two separate plans (within the meaning of section 414(l)) for purposes of applying the special rule in A-11 of §1.401(a)(31)-1 (under which a plan will satisfy section 401(a)(31) even though the plan administrator does not permit any distributee to elect a direct rollover with respect to eligible rollover distributions during a year that are reasonably expected to total less than $200).

(4) Rules regarding designated Roth contribution elections—(i) Frequency of elections. The rules under paragraph (e)(2)(ii) of this section regarding frequency of elections apply in the same manner to both pre-tax elective contributions and designated Roth contributions. Thus, an employee must have an effective opportunity to make (or change) an election to make designated Roth contributions at least once during each plan year.

(ii) Default elections—(A) In the case of a plan that provides for both pre-tax elective contributions and designated Roth contributions and in which, under paragraph (a)(3)(ii) of this section, the default in the absence of an affirmative election is to make a contribution under the cash or deferred arrangement, the plan terms must provide the extent to which the default contributions are pre-tax elective contributions and the extent to which the default contributions are designated Roth contributions.

(B) If the default contributions under the plan are designated Roth contributions, then an employee who has not made an affirmative election is deemed to have irrevocably designated the contributions (in accordance with section 402A(c)(1)(B)) as designated Roth contributions.

(5) Effective date—(i) In general. Section 402A is effective for taxable years beginning after December 31, 2005.

(ii) Sunset provisions. The rules set forth in this paragraph (f) do not address the application of section 901 of the Economic Growth and Tax Relief Reconciliation Act of 2001 (Public Law 107-16; 115 Stat. 38) (under which the amendments made by that Act do not apply to taxable, plan, or limitation years beginning after December 31, 2010).

* * * * *

Par. 4. Section 1.401(k)-2 is amended as follows:

1. A new sentence is added after the second sentence in paragraph (b)(1)(ii).

2. The last sentence in paragraph (b)(2)(vi)(B) is amended by adding the phrase “, except to the extent provided in paragraph (b)(2)(vi)(C) of this section.”

3. Paragraph (b)(2)(vi)(C) is added.

The additions read as follows:

* * * * *

(b) * * *

(1) * * *

(ii) * * * Similarly, a plan may permit an HCE with elective contributions for a year that includes both pre-tax elective contributions and designated Roth contributions to elect whether the excess contributions are to be attributed to pre-tax elective contributions or designated Roth contributions. * * *

* * * * *

(2) * * *

(vi) * * *

(C) Corrective distributions attributable to designated Roth contributions. Notwithstanding paragraphs (b)(2)(vi)(A) and (B) of this section, a distribution of excess contributions is not includible in gross income to the extent it represents a distribution of designated Roth contributions. However, the income allocable to a corrective distribution of excess contributions that are designated Roth contributions is included in gross income in accordance with paragraph (b)(2)(vi)(A) or (B) of this section (i.e., in the same manner as income allocable to a corrective distribution of excess contributions that are pre-tax elective contributions).

* * * * *

Par. 5. Section 1.401(k)-6 is amended as follows:

1. The definitions of “Designated Roth account” and “Designated Roth contributions” are added after the definition of Current year testing method.

2. A new definition of “Pre-tax elective contributions” is added after the definition of Pre-ERISA money purchase pension plan.

The additions read as follows:

* * * * *

Designated Roth account. Designated Roth account means a separate account maintained by a plan to which only designated Roth contributions (including income, expenses, gains and losses attributable thereto) are made.

Designated Roth contributions. Designated Roth contributions means designated Roth contributions as defined in §1.401(k)-1(f)(1).

* * * * *

Pre-tax elective contributions. Pre-tax elective contributions means elective contributions under a qualified cash or deferred arrangement that are not designated Roth contributions.

* * * * *

Par. 6. Section 1.401(m)-0 is amended by adding an entry for §1.401(m)-2(b)(2)(vi)(C) to read as follows:

* * * * *

* * * * *

(b) * * *

(2) * * *

(vi) * * *

(C) Corrective distributions attributable to designated Roth contributions.

* * * * *

Par. 7. Section 1.401(m)-2 is amended as follows:

1. The last sentence in paragraph (b)(2)(vi)(B) is amended by adding the phrase “, or as provided in paragraph (b)(2)(vi)(C) of this section.”

2. Paragraph (b)(2)(vi)(C) is added.

The additions read as follows:

* * * * *

(b) * * *

(2) * * *

(vi) * * *

(C) Corrective distributions attributable to designated Roth contributions. Notwithstanding paragraphs (b)(2)(vi)(A) and (B) of this section, a distribution of excess aggregate contributions is not includible in gross income to the extent it represents a distribution of designated Roth contributions. However, the income allocable to a corrective distribution of excess aggregate contributions that are designated Roth contributions is taxed in accordance with paragraph (b)(2)(vi)(A) or (B) of this section (i.e., in the same manner as income allocable to a corrective distribution of excess aggregate contributions that are not designated Roth contributions).

* * * * *

Par. 8. Section 1.401(m)-5 is amended by adding a new definition of “Designated Roth contributions” after the definition of Current year testing method to read as follows:

* * * * *

Designated Roth contributions. Designated Roth contributions means designated Roth contributions as defined in §1.401(k)-1(f)(1).

* * * * *

* * * * *

(b) * * *

Approved December 13, 2005.

(a) * * *

(5) [Reserved]. For further guidance, see §31.6011(a)-1T(a)(5).

* * * * *

Par. 6. Section 31.6011(a)-1T is added to read as follows:

(a)(1) through (a)(4) [Reserved]. For further guidance, see §31.6011(a)-1(a)(1) through (a)(4).

(5) Employers in the Employers’ Annual Federal Tax Program (Form 944)—(i) In general. For taxable years beginning on or after January 1, 2006, employers notified of their qualification for the Employers’ Annual Federal Tax Program (Form 944) are required to file Form 944, “Employer’s Annual Federal Tax Return.” The Internal Revenue Service (IRS) will notify employers in writing of their qualification for the Employers’ Annual Federal Tax Program (Form 944). For provisions relating to the time and place for filing returns, see §§31.6071(a)-1 and 31.6091-1, respectively.

(ii) Qualification for the Employers’ Annual Federal Tax Program (Form 944). The IRS will send notifications of qualification for the Employers’ Annual Federal Tax Program (Form 944) to employers with an estimated annual employment tax liability of $1,000 or less. New employers who timely notify the IRS that they anticipate their estimated annual employment tax liability to be $1,000 or less will be notified of their qualification for the Employers’ Annual Federal Tax Program (Form 944). If an employer in the Employers’ Annual Federal Tax Program (Form 944) reports an annual employment tax liability of more than $1,000, the IRS will notify the employer that the employer’s filing status has changed and the employer will be required to file the quarterly Form 941 for succeeding tax years.

(iii) Exception to qualification for the Employers’ Annual Federal Tax Program (Form 944). Notwithstanding notification by the IRS of qualification for the Employers’ Annual Federal Tax Program (Form 944), an employer may file Form 941 if—

(A) One of the following conditions applies—

(1) The employer anticipates that its annual employment tax liability will exceed $1,000, or

(2) The employer prefers to electronically file Forms 941 quarterly in lieu of filing Form 944 annually;

(B) The employer contacts the IRS, pursuant to the instructions in the IRS’ written notification, to request to file Form 941; and

(C) The IRS sends the employer a written notification that the employer’s filing requirement has been changed to Form 941.

(b) through (f) [Reserved]. For further guidance, see §31.6011(a)-1(b) through (f).

Par. 7. Section 31.6011(a)-4 is amended by adding paragraph (a)(4) to read as follows:

(a) * * *

(4) [Reserved]. For further guidance, see §31.6011(a)-4T(a)(4).

* * * * *

Par. 8. Section 31.6011(a)-4T is added to read as follows:

(a)(1) through (a)(3) [Reserved]. For further guidance, see §31.6011(a)-4(a)(1) through (a)(3).

(4) Employers in the Employers’ Annual Federal Tax Program (Form 944)—(i) In general. For taxable years beginning on or after January 1, 2006, employers notified of their qualification for the Employers’ Annual Federal Tax Program (Form 944) are required to file a Form 944, “Employer’s Annual Federal Tax Return.” The Internal Revenue Service (IRS) will notify employers in writing of their qualification for the Employers’ Annual Federal Tax Program (Form 944). For provisions relating to the time and place for filing returns, see §§31.6071(a)-1 and 31.6091-1, respectively.

(ii) Qualification for the Employers’ Annual Federal Tax Program (Form 944). The IRS will send notifications of qualification for the Employers’ Annual Federal Tax Program (Form 944) to employers with an estimated annual employment tax liability of $1,000 or less. New employers who timely notify the IRS that they anticipate their estimated annual employment tax liability to be $1,000 or less will be notified of their qualification for the Employers’ Annual Federal Tax Program (Form 944). If an employer in the Employers’ Annual Federal Tax Program (Form 944) reports an annual employment tax liability of more than $1,000, the IRS will notify the employer that the employer’s filing status has changed and that the employer will be required to file the quarterly Form 941 for succeeding tax years.

(iii) Exception to qualification for the Employers’ Annual Federal Tax Program (Form 944). Notwithstanding notification by the IRS of qualification for the Employers’ Annual Federal Tax Program (Form 944), an employer may file Form 941 if—

(A) One of the following conditions applies—

(1) The employer anticipates that its annual employment tax liability will exceed $1,000, or

(2) The employer prefers to electronically file Forms 941 quarterly in lieu of filing Form 944 annually;

(B) The employer contacts the IRS, pursuant to the instructions in the IRS’ written notification, to request to file Form 941; and

(C) The IRS sends the employer a written notification that the employer’s filing requirement has been changed to Form 941.

(b) through (c) [Reserved]. For further guidance, see §31.6011(a)-4(b) through (c).

Par. 9. In §31.6071(a)-1, the first sentence in paragraph (a)(1) is revised to read as follows:

(a) * * *

(1) Quarterly or annual returns. Except as provided in subparagraph (4) of this paragraph, each return required to be made under §§31.6011(a)-1 and 31.6011(a)-1T, in respect of the taxes imposed by the Federal Insurance Contributions Act (26 U.S.C. §§3101-3128), or required to be made under §§31.6011(a)-4 and 31.6011(a)-4T, in respect of income tax withheld, shall be filed on or before the last day of the first calendar month following the period for which it is made. * * *

* * * * *

Par. 10. Section 31.6302-0 is amended by:

1. Adding new entries for §31.6302-1(b)(4), (c)(5) and (6), (d), (f)(4), and (f)(5).

2. Removing the entries for §31.6302-1(b)(5) and (i).

3. Redesignating the entries for §31.6302-1(h), (j), (k), and (m) as (i), (k), (m), and (n), respectively.

4. Adding new entries for §31.6302-1(h) and (j).

5. Revising the entry for newly designated §31.6302-1(k)(1).

6. Adding entries for §31.6302-1T.

The revision and additions read as follows:

* * * * *

* * * * *

(b) * * *

(4) Lookback period.

(i) [Reserved].

(ii) [Reserved].

(c) * * *

(5) [Reserved].

(6) [Reserved].

(d) * * *

Example 6 [Reserved].

* * * * *

(f) * * *

(4) De minimis rule.

(i) De minimis deposit rule for quarterly and annual return periods beginning on or after January 1, 2001.

(ii) [Reserved].

(iii) [Reserved].

(5) * * *

Example 3. [Reserved].

* * * * *

(h) Time and manner of deposit — deposits required to be made by electronic funds transfer.

(1) In general.

(2) Applicability of requirement.

(i) Deposits for return periods beginning before January 1, 2000.

(ii) Deposits for return periods beginning after December 31, 1999.

(iii) Voluntary deposits.

(3) Taxes required to be deposited by electronic funds transfer.

(4) Definitions.

(i) Electronic funds transfer.

(ii) Taxpayer.

(5) Exemptions.

(6) Separation of deposits.

(7) Payment of balance due.

(8) Time deemed deposited.

(9) Time deemed paid.

* * * * *

(j) Voluntary payments by electronic funds transfer.

(k) * * *

(1) Notice exception.

* * * * *

(a) through (b)(4)(ii) [Reserved].

(b)(4)(i) In general.

(ii) Adjustments.

(c)(1) through (c)(4) [Reserved].

(c)(5) Exception to the monthly and semi-weekly deposit rules for employers in the Employers’ Annual Federal Tax Program (Form 944).

(c)(6) Extension of time to deposit rule for employers in the Employers’ Annual Federal Tax Program (Form 944) during the preceding year.

(d) Examples 1 through 5 [Reserved].

Example 6. Extension of time to deposit rule for employers in the Employers’ Annual Federal Tax Program (Form 944) during the preceding year satisfied.

(e) through (f)(4)(ii) [Reserved].

(f)(4)(iii) De minimis deposit rule for employers currently in the Employers’ Annual Federal Tax Program (Form 944).

(f)(5) Examples 1 and 2 [Reserved].

Example 3. De minimis deposit rule for employers currently in the Employers’ Annual Federal Tax Program (Form 944) satisfied.

(g) through (n) [Reserved].

Par. 11. Section 31.6302-1 is amended by:

1. Revising paragraph (b)(4).

2. Adding paragraphs (c)(5) and (6), (d) Example 6, and (f)(5) Example 3.

3. Removing paragraph (b)(5).

4. Revising paragraph (f)(4).

The revisions and additions read as follows:

* * * * *

(b) * * *

* * * * *

(4) Lookback period—(i) [Reserved]. For further guidance, see §31.6302-1T(b)(4)(i).

(ii) [Reserved]. For further guidance, see §31.6302-1T(b)(4)(ii).

(c) * * *

* * * * *

(5) [Reserved]. For further guidance, see §31.6302-1T(c)(5).

(6) [Reserved]. For further guidance, see §31.6302-1T(c)(6).

(d) * * *

* * * * *

Example 6. For further guidance, see §31.6302-1T(d) Example 6.

* * * * *

(f) * * *

* * * * *

(4) De minimis rule—(i) De minimis deposit rule for quarterly and annual return periods beginning on or after January 1, 2001. If the total amount of accumulated employment taxes for the return period is less than $2,500 and the amount is fully deposited or remitted with a timely filed return for the return period, the amount deposited or remitted will be deemed to have been timely deposited.

(ii) [Reserved].

(iii) [Reserved]. For further guidance, see §31.6302-1T(f)(4)(iii).

(5) * * *

* * * * *

Example 3. For further guidance, see §31.6302-1T(f)(5) Example 3.

Par. 12. Section 31.6302-1T is added to read as follows:

(a) through (b)(3) [Reserved]. For further guidance, see §31.6302-1(a) through (b)(3).

(4) Lookback period—(i) In general. For employers who file Form 941, the lookback period for each calendar year is the twelve month period ended the preceding June 30. For example, the lookback period for calendar year 2006 is the period July 1, 2004 to June 30, 2005. The lookback period for employers who are in the Employers’ Annual Federal Tax Program (Form 944), or were in it during the previous calendar year, is the second calendar year preceding the current calendar year. For example, the lookback period for calendar year 2006 is calendar year 2004. In determining status as either a monthly or semi-weekly depositor, an employer should determine the aggregate amount of employment tax liabilities reported on its return(s) (Form 941 or Form 944) for the lookback period. New employers shall be treated as having employment tax liabilities of zero for any part of the lookback period before the date the employer started or acquired its business.

(ii) Adjustments. The tax liability shown on an original return for the return period shall be the amount taken into account in determining whether more than $50,000 has been reported during the lookback period. In determining the aggregate employment taxes for each return period in a lookback period, an employer does not take into account any adjustments for the return period made on a supplemental return filed after the due date of the return. However, adjustments made on a Form 941c, Supporting Statement To Correct Information, attached to a Form 941 or Form 944 filed for a subsequent return period are taken into account in determining the employment tax liability for the subsequent return period.

(c)(1) through (c)(4) [Reserved]. For further guidance, see §31.6302-1(c)(1) through (c)(4).

(5) Exception to the monthly and semi-weekly deposit rules for employers in the Employers’ Annual Federal Tax Program (Form 944). Generally, an employer in the Employers’ Annual Federal Tax Program (Form 944) may remit its accumulated employment taxes with its timely filed return and is not required to deposit under either the monthly or semi-weekly rules set forth in paragraphs (c)(1) and (2) of this section. An employer in the Employers’ Annual Federal Tax Program (Form 944) whose actual employment tax liability exceeds the eligibility threshold, as set forth in §31.6011(a)-1T(a)(5)(ii) and §31.6011(a)-4T(a)(4)(ii), will not qualify for this exception and should follow the deposit rules set forth in this section.

(6) Extension of time to deposit for employers in the Employers’ Annual Federal Tax Program (Form 944) during the preceding year. An employer who was in the Employers’ Annual Federal Tax Program (Form 944) in the preceding year, but who is no longer qualified because its annual employment tax liability exceeded the eligibility threshold set forth in §31.6011(a)-1T(a)(5)(ii) and §31.6011(a)-4T(a)(4)(ii) in that preceding year, is required to deposit pursuant to §31.6302-1. The employer will be deemed to have timely deposited its January deposit obligation(s) under §31.6302-1(c)(1) through (4) for the first quarter of the year in which it must file quarterly using Form 941 if the employer deposits the amount of such deposit obligation(s) by March 15 of that year.

(d) Examples 1 through 5 [Reserved]. For further guidance, see §31.6302-1(d) Examples 1 through 5.

Example 6. Extension of time to deposit for employers in the Employers’ Annual Federal Tax Program (Form 944) during the preceding year satisfied. F (a monthly depositor) was notified to file Form 944 to report its employment tax liabilities for the 2006 calendar year. F filed Form 944 on January 31, 2007, reporting a total employment tax liability for 2006 of $3,000. Because F’s annual employment tax liability for the 2006 taxable year exceeded $1,000 (the eligibility requirement threshold), F may not file Form 944 for calendar year 2007. Based on F’s liability during the lookback period (calendar year 2005, pursuant to §31.6302-1T(b)(4)(i)), F is a monthly depositor for 2007. F accumulates $1,000 in employment taxes during January 2007. Because F is a monthly depositor, F’s January deposit obligation is due February 15, 2007. F does not deposit these accumulated employment taxes on February 15, 2007. F accumulates $1,500 in employment taxes during February 2007. F’s February deposit is due March 15, 2007. F deposits the $2,500 of employment taxes accumulated during January and February on March 15, 2007. Pursuant to §31.6302-1T(c)(6), F will be deemed to have timely deposited the employment taxes due for January 2007, and, thus, the IRS will not impose a failure-to-deposit penalty under section 6656 for that month.

(e) through (f)(4)(ii) [Reserved]. For further guidance, see §31.6302-1(e) through (f)(4)(ii).

(iii) De minimis deposit rule for employers currently in the Employers’ Annual Federal Tax Program (Form 944). An employer in the Employers’ Annual Federal Tax Program (Form 944) whose employment tax liability for the year equals or exceeds $2,500 but whose employment tax liability for a quarter of the year is de minimis pursuant to §31.6302-1(f)(4)(i) will be deemed to have timely deposited the employment taxes due for that quarter if the employer fully deposits the employment taxes accumulated during the quarter by the last day of the month following the close of that quarter. Employment taxes accumulated during the fourth quarter can be either deposited by January 31 or remitted with a timely filed return for the return period.

(5) Examples 1 and 2 [Reserved]. For further guidance, see §31.6302-1(f)(5) Examples 1 and 2.

Example 3. De minimis deposit rule for employers currently in the Employers’ Annual Federal Tax Program (Form 944) satisfied. K (a monthly depositor) was notified to file Form 944 to report its employment tax liabilities for the 2006 calendar year. In the first quarter of 2006, K accumulates employment taxes in the amount of $1,000. On April 28, 2006, K deposits the $1,000 of employment taxes accumulated in the 1st quarter. K accumulates another $1,000 of employment taxes during the second quarter of 2006. On July 31, 2006, K deposits the $1,000 of employment taxes accumulated in the 2nd quarter. K’s business grows and accumulates $1,500 in employment taxes during the third quarter of 2006. On October 31, 2006, K deposits the $1,500 of employment taxes accumulated in the 3rd quarter. K accumulates another $2,000 in employment taxes during the fourth quarter. K files Form 944 on January 31, 2007, reporting a total employment tax liability for 2006 of $5,500 and submits a check for the remaining $2,000 of employment taxes with the return. K will be deemed to have timely deposited the employment taxes due for all of 2006, because K complied with the de minimis deposit rule provided in §31.6302-1T(f)(4)(iii). Therefore, the IRS will not impose a failure-to-deposit penalty under section 6656 for any month of the year. Under this de minimis deposit rule, as K was required to file Form 944 for calendar year 2006, if K’s employment tax liability for a quarter is de minimis, then K may deposit that quarter’s liability by the last day of the month following the close of the quarter. This new de minimis rule allows K to have the benefit of the same quarterly de minimis amount K would have received if K filed Form 941 each quarter instead of Form 944 annually. Thus, as K’s employment tax liability for each quarter was de minimis, K could deposit quarterly.

(g) through (n) [Reserved]. For further guidance, see §31.6302-1(g) through (n).

Approved December 8, 2005.

(a) Scope. Section 7874(c)(2)(A) provides that stock of the foreign corporation referred to in section 7874(a)(2)(B) held by members of the expanded affiliated group that includes such foreign corporation (the EAG) shall not be taken into account in determining, for purposes of section 7874(a)(2)(B)(ii), the percentage of stock in such foreign corporation held, after the acquisition, by former shareholders or partners of the domestic corporation or partnership referred to in section 7874(a)(2)(B)(i) (the domestic entity) by reason of having held stock or a partnership interest in the domestic entity. This section provides rules under section 7874(c)(2)(A).

(b) General rule. Except as provided in paragraph (c) of this section, for purposes of the ownership percentage determination required by section 7874(a)(2)(B)(ii), stock held by one or more members of the EAG is not included in either the numerator or the denominator of the fraction that determines such percentage. For purposes of this §1.7874-1T, stock held by a partnership shall be considered as held proportionately by its partners.

(c) Special rules. For purposes of the ownership percentage determination required by section 7874(a)(2)(B)(ii), stock held by one or more members of the EAG shall be included in the denominator, but not in the numerator, of the fraction that determines the percentage if—

(1) (i) Before the acquisition, 80 percent or more of the stock (by vote or value) or the capital or profits interest in the domestic entity was owned directly or indirectly by the corporation that is the common parent of the EAG after the acquisition; and

(ii) After the acquisition, stock held by non-members of the EAG by reason of holding stock or a capital or profits interest in the domestic entity, if any, does not exceed 20 percent of the stock (by vote or value) of the foreign corporation; or

(2) After the acquisition, the former shareholders or partners of the domestic entity do not own, in the aggregate, directly or indirectly, more than 50 percent of the stock (by vote or value) of any member of the EAG.

(d) Disregard of subsidiary-owned interests. Stock or partnership interests owned by an entity in which at least 50 percent of the stock (by vote or value), or at least 50 percent of the capital or profits interest, is owned directly or indirectly by the issuer of such stock or by the partnership in question shall not be taken into account for purposes of—

(1) Determining the percentage of ownership of an entity under paragraphs (c)(1) and (c)(2) of this section; or

(2) Treating stock held by one or more members of the EAG as included in the denominator but not in the numerator under paragraph (c) of this section.

(e) Examples. The application of this section is illustrated by the following examples. It is assumed that all transactions in the examples occur after March 4, 2003. In all the examples, the EAG means the expanded affiliated group which includes the foreign corporation that has completed the direct or indirect acquisition referred to in section 7874(a)(2)(B)(i). In all the examples, if an entity or other person is not described as either domestic or foreign, it may be either domestic or foreign. The analysis of the following examples is limited to a discussion of issues under section 7874, even though the examples may raise other issues (for example, under section 367).

Example 1. Disregard of hook stock—(i) Facts. A is a domestic corporation with 100 shares of a single class of common stock outstanding. A’s stock is held by a group of individuals. Pursuant to a plan, A forms F, a foreign corporation, and transfers to F the stock of several wholly owned foreign subsidiaries, in exchange for 90 shares of F stock. F then forms Merger Sub, a domestic corporation. Under a merger agreement and state law, Merger Sub merges into A, with A surviving the merger as a subsidiary of F. In exchange for their A stock, the former shareholders of A receive, in the aggregate, 100 shares of F stock. A continues to hold 90 shares of F stock.

(ii) Analysis. F has indirectly acquired substantially all the properties of A pursuant to a plan. After the acquisition, the former shareholders of A own 100 shares of F stock by reason of holding stock in A, and A owns 90 shares of F stock. Under paragraph (b) of this section, the 90 shares of F stock held by A, a member of the EAG, are not included in either the numerator or the denominator of the fraction that determines the percentage of F stock owned by former shareholders of A by reason of holding stock in A. Accordingly, the fraction is 100/100 and the percentage is 100%. If the condition stated in section 7874(a)(2)(B)(iii) regarding relatively insubstantial business activities in F’s country of incorporation is satisfied, F is a surrogate foreign corporation which is treated as a domestic corporation under section 7874(b).

Example 2. Intra-group restructuring; wholly owned corporation—(i) Facts. USS, a domestic corporation, has 100 shares of common stock outstanding, all of which are owned by P, a corporation. As part of an internal restructuring within the P group, USS transfers all its assets to FS, a newly formed foreign corporation, in exchange for stock of FS, in a reorganization described in section 368(a)(1)(F). P exchanges its USS stock for FS stock under section 354.

(ii) Analysis. FS has acquired substantially all the properties held directly or indirectly by USS pursuant to a plan. P, the common parent of the EAG, held more than 80% of the stock of USS before the acquisition. After the acquisition, less than 20% of FS’s stock is owned by non-members of the EAG. Under paragraph (c)(1) of this section, the FS stock owned by P by reason of holding stock in USS is included in the denominator but not in the numerator of the fraction that determines the percentage of FS stock owned by former shareholders of USS by reason of holding stock in USS. Accordingly, the fraction is 0/100 and the percentage is 0%. FS is not a surrogate foreign corporation.

Example 3. Intra-group restructuring; wholly owned corporation—(i) Facts. The facts are the same as in Example 2 except that USS does not transfer any of its assets. P transfers all 100 shares of USS stock to FS in exchange for FS stock.

(ii) Analysis. FS has indirectly acquired substantially all the properties held directly or indirectly by USS pursuant to a plan. P, the common parent of the EAG, held more than 80% of the stock of USS before the acquisition. After the acquisition, less than 20% of FS’s stock is owned by non-members of the EAG. Under paragraph (c)(1) of this section, the FS stock owned by P by reason of holding stock in USS is included in the denominator but not in the numerator of the fraction that determines the percentage of stock owned by former shareholders of USS by reason of holding stock in USS. Accordingly, the fraction is 0/100 and the percentage is 0%. FS is not a surrogate foreign corporation.

Example 4. Intra-group restructuring; less than wholly owned corporation—(i) Facts. The facts are the same as in Example 2 except that P owns 85 shares of USS stock. The remaining 15 shares of USS stock are owned by A, a person unrelated to P. As part of an internal restructuring within the P group, P and A transfer all their USS stock to FS, in exchange for an equal number of shares of FS stock.

(ii) Analysis. FS has indirectly acquired substantially all the properties held directly or indirectly by USS pursuant to a plan. After the acquisition, P owns 85 shares of FS stock by reason of holding stock in USS, and A owns 15 shares of FS stock by reason of holding stock in USS. Before the acquisition, USS was more than 80% owned by P, which is the common parent of the EAG, and after the acquisition, less than 20% of FS’s stock is owned by non-members of the EAG (i.e., by A) by reason of holding stock in USS. Under paragraph (c)(1) of this section, the FS stock owned by P is included in the denominator, but is not included in the numerator, of the fraction that determines the percentage of FS stock owned by former shareholders of USS by reason of holding stock in USS. Accordingly, the fraction is 15/100 and the percentage is 15%. FS is not a surrogate foreign corporation. FS is a controlled foreign corporation.

Example 5. Formation of joint venture corporation—(i) Facts. M, a corporation, owns all the outstanding stock of S, a domestic corporation engaged in business Y in the United States. B, a corporation unrelated to M, owns several foreign subsidiaries that are engaged in business Y outside the United States. M and B enter into an agreement under which each will transfer certain assets to FJV, a newly formed foreign corporation, in exchange for stock of FJV. FJV will conduct business Y on a worldwide basis. Pursuant to the plan, M transfers to FJV all the outstanding stock of S in exchange for 40 shares of FJV stock, and B transfers to FJV the stock of several foreign corporations in exchange for 60 shares of FJV stock. FJV has no other stock outstanding.

(ii) Analysis. FJV has indirectly acquired substantially all the properties held directly or indirectly by S pursuant to a plan. After the acquisition, M owns 40 shares of FJV stock by reason of holding stock in S, and B owns the remaining 60 shares of FJV stock. M does not own, directly or indirectly, more than 50% of the stock of any member of the EAG. Under paragraph (c)(2) of this section, the FJV stock owned by B is included in the denominator but not the numerator of the fraction that determines the percentage of FJV stock owned by former shareholders of S by reason of holding stock in S. Accordingly, the fraction is 40/100 and the percentage is 40%. FJV is not a surrogate foreign corporation.

Example 6. Acquisition of existing joint venture entity—(i) Facts. K and L are unrelated corporations. T is a domestic corporation with 100 shares of stock outstanding, 55 of which are held by K and 45 of which are held by L. K and L contribute their T stock to U, a newly formed foreign corporation, in exchange for an equal number of shares of U stock.

(ii) Analysis. U has indirectly acquired substantially all the properties held directly or indirectly by T pursuant to a plan. After the acquisition, K owns 55 shares of U stock by reason of holding stock in T, and L owns 45 shares of U stock by reason of holding stock in T. Under paragraph (b) of this section, the U stock held by K is not included in either the numerator or the denominator of the fraction that determines the percentage of U stock owned by former shareholders of T by reason of holding stock in T. Accordingly, the fraction is 45/45 and the percentage is 100%. If the EAG does not have substantial business activities in U’s country of incorporation when compared to the total business activities of the EAG, U is a surrogate foreign corporation which is treated as a domestic corporation under section 7874(b).

Example 7. Intra-group restructuring; less than wholly owned partnership—(i) Facts. LLC, a Delaware limited liability company engaged in the conduct of a trade or business, is 90% owned by C, a corporation, and 10% owned by D, a person unrelated to C. LLC has not elected to be treated as an association taxable as a corporation. As part of an internal restructuring within the C group, C and D transfer their interests in LLC to E, a newly formed foreign corporation, in exchange for 90 shares and 10 shares, respectively, of E’s common stock, which are all of the issued and outstanding shares of E.

(ii) Analysis. LLC is a domestic partnership for Federal income tax purposes. E has indirectly acquired substantially all the properties constituting a trade or business of LLC pursuant to a plan. After the acquisition, C holds 90% of E’s stock by reason of holding a capital or profits interest in LLC, and D holds 10% of E’s stock by reason of holding a capital or profits interest in LLC. Before the acquisition, LLC is more than 80% owned by C, the common parent of the EAG, and after the acquisition, less than 20% of E’s stock is owned by non-members of the EAG (that is by D) by reason of holding a capital or profits interest in LLC. Under paragraph (c)(1) of this section, the E stock held by C is included in the denominator but not the numerator of the fraction that determines the percentage of E stock owned by former partners of LLC by reason of holding an interest in LLC. Accordingly, the fraction is 10/100 and the percentage is 10%. E is not a surrogate foreign corporation.

Example 8. Acquisition of 50-50 joint venture partnership—(i) Facts. The facts are the same as in Example 7 except that C and D each own 50% of the capital and profits interests in LLC. C and D transfer their interests in LLC to G, a newly formed foreign corporation, in exchange for 50 shares each of G’s common stock, which are all of the issued and outstanding shares of G.

(ii) Analysis. G has indirectly acquired substantially all the properties constituting a trade or business of LLC, a domestic partnership, pursuant to a plan. After the acquisition, C and D each hold 50% of G’s stock by reason of holding an interest in LLC. G is not included in an expanded affiliated group after the acquisition. Accordingly, none of the stock of G is disregarded under this section in determining the percentage of G stock held by former partners of LLC by reason of holding an interest in LLC. Thus, the fraction is 100/100 and the percentage is 100%. If the EAG does not have substantial business activities in G’s country of incorporation when compared to the total business activities of the EAG, G is a surrogate foreign corporation which is treated as a domestic corporation under section 7874(b).

(e) Effective date. This section applies to taxable years ending after March 4, 2003.

Approved December 13, 2005.

In addition to establishing the Form 944 Program, these proposed regulations will provide a safe harbor for small employers that have an unexpected increase in their deposit liability for a quarterly return period. The proposed regulations provide an alternate method for determining whether the employer’s employment tax obligations are de minimis, which is based on its employment taxes due for the prior return period. This special rule applies only to employers filing quarterly tax returns and therefore has no application to the Form 944 Program.

Under the existing regulations, deposits of taxes reported on Form 941, “Employer’s Quarterly Federal Tax Return,” generally are due monthly or semi-weekly. If an employer fails to make timely deposits of employment taxes, then, absent reasonable cause, the employer will be subject to the penalty for failure to deposit under section 6656. Currently, §31.6302-1(f)(4) (the de minimis deposit rule) provides that, for quarterly and annual return periods, if the aggregate amount of employment taxes for the return period is less than $2,500 and that amount is deposited or remitted with a timely filed return for that return period, the amount will be deemed to have been timely deposited and the employer will not be subject to the penalty for failure to deposit. Thus, currently under the de minimis deposit rule, employers remitting their employment taxes with their timely filed quarterly returns will only be deemed to have timely deposited their taxes if the amount of taxes due is less than $2,500 for that quarter. Similarly, under the current de minimis deposit rule, employers remitting their employment taxes with their timely filed annual returns will only be deemed to have timely deposited if the amount of taxes due is less than $2,500 for the entire year.

Under the proposed amendments, employers may remit their employment taxes with their timely filed quarterly returns and be deemed to have timely deposited if the amount of the taxes due for the current quarter or for the prior quarter is less than $2,500. This special rule can be illustrated by the following example: an employer has less than $50,000 in employment taxes reported during the lookback period and is therefore a monthly depositor under §31.6302-1(b)(2). The employer’s employment tax liabilities for the first and second quarters of 2004 were $2,450 and $2,400, respectively. In the third quarter of 2004, however, the employer’s employment tax liability was $2,550. Under the existing de minimis deposit rule, if the employer remits the $2,550 with its third quarter return, the amount is not considered timely deposited for that quarter and, therefore, the employer would be assessed the section 6656 penalty for failure to deposit. Modifying the de minimis deposit rule to allow employers to base the determination on the employment taxes due for the immediately preceding quarter provides a safe harbor for employers regarding their deposit obligations. Thus, in this example, when the employer had an increase in its employment tax liability for the third quarter of 2004, its remittance would still be deemed to have been timely deposited because the taxes for the immediately preceding return period were de minimis. The proposed amendment has no application to the One-Day rule in §31.6302-1(c)(2), which requires employers to make a deposit on the next banking day if they accumulate $100,000 or more of employment taxes.

(a) * * *

(5) [The text of proposed §31.6011(a)-1(a)(5) is the same as the text of §31.6011(a)-1T(a)(5) published elsewhere in this issue of the Bulletin].

* * * * *

Par. 3. Section 31.6011(a)-4 is amended by revising paragraph (a)(4) to read as follows:

(a) * * *

(4) [The text of proposed §31.6011(a)-4(a)(4) is the same as the text of §31.6011(a)-4T(a)(4) published elsewhere in this issue of the Bulletin].

* * * * *

Par. 4. Section 31.6302-1 is amended by revising paragraphs (b)(4), (c)(5) and 6, (d) Example 6, (f)(4), and (f)(5) Example 3 to read as follows:

* * * * *

(b) * * *

(4) * * *

(i) [The text of the proposed §31.6302-1(b)(4)(i) is the same as the text of §31.6302-1T(b)(4)(i) published elsewhere in this issue of the Bulletin].

(ii) [The text of the proposed §31.6302-1(b)(4)(ii) is the same as the text of §31.6302-1T(b)(4)(ii) published elsewhere in this issue of the Bulletin].

(c) * * *

(5) [The text of proposed §31.6302-1(c)(5) is the same as the text of §31.6302-1T(c)(5) published elsewhere in this issue of the Bulletin].

(6) [The text of proposed §31.6302-1(c)(6) is the same as the text of §31.6302-1T(c)(6) published elsewhere in this issue of the Bulletin].

(d) * * *

Example 6. [The text of proposed §31.6302-1(d) Example 6 is the same as the text of §31.6302-1T(d) Example 6 published elsewhere in this issue of the Bulletin].

* * * * *

(f) * * *

(4) De minimis rule—(i) De minimis deposit rule for quarterly and annual return periods beginning on or after January 1, 2001. If the total amount of accumulated employment taxes for the return period is de minimis and the amount is fully deposited or remitted with a timely filed return for the return period, the amount deposited or remitted will be deemed to have been timely deposited. The total amount of accumulated employment taxes is de minimis if it is less than $2,500 for the return period or if it is de minimis pursuant to paragraph (f)(4)(ii) of this section.

(ii) De minimis deposit rule for quarterly return periods. For purposes of paragraph (f)(4)(i) of this section, if the total amount of accumulated employment taxes for the immediately preceding quarter was less than $2,500, unless paragraph (c)(3) of this section applies to require a deposit at the close of the next banking day, then the employer will be deemed to have timely deposited the employer’s employment taxes for the current quarter if the employer complies with the time and method of payment requirements contained in paragraph (f)(4)(i) of this section.

(iii) [The text of proposed §31.6302-1(f)(4)(iii) is the same as the text of §31.6302-1T(f)(4)(iii) published elsewhere in this issue of the Bulletin].

(5) * * *

Example 3. [The text of proposed §31.6302-1(f)(5) Example 3 is the same as the text of §31.6302-1T(f)(5) Example 3 published elsewhere in this issue of the Bulletin]

* * * * *

[The text of proposed §1.7874-1 is the same as the text of §1.7874-1T published elsewhere in this issue of the Bulletin].