HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 2003–1, page 291.Constructive sales; reestablished positions. This ruling pro-vides guidance on the interaction between section 1259(c)(3)(A)of the Code (exception for certain closed transactions) and sec-tion 1259(c)(3)(B) (treatment of positions which are reestab-lished).

Rev. Rul. 2003–8, page 290.Costa Rican income tax law; withholding taxes. This rul-ing holds that certain Costa Rican taxes are noncreditable soak-uptaxes under sections 901 and 903 of the Code. The ruling alsoserves as an official confirmation to the Costa Rican Tax Admin-istration that these taxes are noncreditable in the United States.

Rev. Rul. 2003–10, page 288.Accrual of income. This ruling addresses the accrual of grossincome when a taxpayer’s customer disputes its liability to thetaxpayer because of (1) a clerical mistake in a sales invoice, (2)the shipment of the wrong goods, or (3) the shipment of moreitems than the customer ordered.

Rev. Rul. 2003–12, page 283.Gross income; general welfare; gifts; disaster relief pay-ments. This ruling holds that amounts paid to an individual bya state agency, a charity, or an employer to reimburse the indi-vidual for certain expenses the individual incurs as a result of aPresidentially declared disaster are excluded from the individu-al’s gross income under the administrative general welfare ex-clusion, sections 102 and 139 of the Code, respectively. Rev.Rul. 53–131 modified.

REG–151043–02, page 300.Proposed regulations under section 61 of the Code authorize theCommissioner to provide, through administrative guidance, rulesfor deferring inclusion of advance rentals in gross income to ataxable year other than the year of receipt.

Notice 2003–4, page 294.LIFO recapture installment payments. This document in-forms taxpayers of the federal income tax consequences of afailure to timely make an installment payment attributable to theLIFO recapture requirement of section 1363(d) of the Code.

Notice 2003–5, page 294.This notice provides guidance relating to the application of sepa-rate foreign tax credit limitations under section 904 of the Codeto dividends from a noncontrolled section 902 corporation (10/50corporation) in taxable years beginning after December 31, 2002.

EMPLOYEE PLANS

Rev. Rul. 2003–6, page 286.Employee stock ownership plans; delayed effective date;abuse. This ruling states that where the intent of section 409(p)of the Code to limit the establishment of ESOPs by S corpora-tions to those that provide broad-based employee coverage andthat benefit rank-and-file employees (as well as highly compen-sated employees and historical owners) is not present, the de-layed effective date in section 656(d)(2) of EGTRRA is not availableand that such transactions are listed transactions.

(Continued on the next page)

Bulletin No. 2003–3January 21, 2003

Finding List begins on page ii.

Rev. Rul. 2003–11, page 285.Limitation on annual compensation; section 611(c) ofEGTRRA. This ruling pertains to whether the allowable compen-sation limit enacted by section 611(c) of EGTRRA may be ap-plied to former employees and meet the nondiscrimination andcoverage requirements of the Code.

Notice 2003–6, page 298.Nondiscrimination rules; certain governmental plans. Thisdocument announces that the Service intends to issue regula-tions regarding how, and the extent to which, the nondiscrimi-nation rules apply to governmental plans under section 414(d)of the Code other than those maintained by a state or local gov-ernment, political subdivision, agency, or instrumentality thereof.Comments are requested regarding the content of these regu-lations. Notice 2001–46 modified.

ADMINISTRATIVE

Announcement 2003–2, page 301.New Form 8883, Asset Allocation Statement Under Section338, is now available. This form is used to report informationabout transactions involving the deemed sale of corporate as-sets under section 338 of the Code.

January 21, 2003 2003–3 I.R.B.

The IRS Mission

Provide America’s taxpayers top quality service by helping themunderstand and meet their tax responsibilities and by applyingthe tax law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument of theCommissioner of Internal Revenue for announcing official rul-ings and procedures of the Internal Revenue Service and for pub-lishing Treasury Decisions, Executive Orders, Tax Conventions,legislation, court decisions, and other items of general inter-est. It is published weekly and may be obtained from the Super-intendent of Documents on a subscription basis. Bulletin contentsare consolidated semiannually into Cumulative Bulletins, whichare sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, modify,or amend any of those previously published in the Bulletin. All pub-lished rulings apply retroactively unless otherwise indicated. Pro-cedures relating solely to matters of internal management arenot published; however, statements of internal practices and pro-cedures that affect the rights and duties of taxpayers are pub-lished.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpay-ers or technical advice to Service field offices, identifying de-tails and information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not be re-lied on, used, or cited as precedents by Service personnel in thedisposition of other cases. In applying published rulings and pro-cedures, the effect of subsequent legislation, regulations, court

decisions, rulings, and procedures must be considered, and Ser-vice personnel and others concerned are cautioned against reach-ing the same conclusions in other cases unless the facts andcircumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisions ofthe Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A, TaxConventions and Other Related Items, and Subpart B, Legisla-tion and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to these sub-jects are contained in the other Parts and Subparts. Also in-cluded in this part are Bank Secrecy Act Administrative Rulings.Bank Secrecy Act Administrative Rulings are issued by the De-partment of the Treasury’s Office of the Assistant Secretary (En-forcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative index forthe matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the first Bulletin of the succeeding semiannual pe-riod, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2003–3 I.R.B. January 21, 2003

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 61.—Gross IncomeDefined

26 CFR 1.61–1(a): Gross income(Also §§ 102; 139; 7805; 1.102–1; 301.7805–1.)

Gross income; general welfare; gifts;disaster relief payments. This ruling holdsthat amounts paid to an individual by a stateagency, a charity, or an employer to reim-burse the individual for certain expenses theindividual incurs as a result of a Presiden-tially declared disaster are excluded fromthe individual’s gross income under the ad-ministrative general welfare exclusion, sec-tions 102 and 139 of the Code, respectively.

Rev. Rul. 2003–12

ISSUES

(1) Are grants individuals receive un-der a state’s program to pay or reimbursecertain reasonable and necessary medical,temporary housing, or transportation ex-penses they incur as a result of a flood in-cludible in gross income?

(2) Are grants individuals receive un-der a charitable organization’s program topay or reimburse certain medical, tempo-rary housing, or transportation expenses theyincur as a result of a flood includible ingross income?

(3) Are grants employees receive un-der an employer’s program to pay or re-imburse certain reasonable and necessarymedical, temporary housing, or transpor-tation expenses they incur as a result of aflood includible in gross income?

FACTS

Situation 1. An area within state ST wasaffected by a flood that was a Presiden-tially declared disaster as defined in§ 1033(h)(3) of the Internal Revenue Code.ST enacted emergency legislation appro-priating funds for grants to pay or reim-burse medical, temporary housing, andtransportation expenses individuals incur asa result of the flood that are not compen-sated for by insurance or otherwise. ST willnot require individuals to provide proof ofactual expenses to receive a grant pay-ment. ST ’s program, however, contains re-quirements (which are described in theprogram documents) to ensure that the grantamounts are reasonably expected to be com-mensurate with the amount of unreimbursed

reasonable and necessary medical, tempo-rary housing, and transportation expensesindividuals incur as a result of the flood.The grants are not intended to indemnifyall flood-related losses or to reimburse thecost of nonessential, luxury, or decorativeitems and services.

Situation 2. O, a charitable organiza-tion described in § 501(c)(3) that is ex-empt from tax under § 501(a), whosepurpose is to provide assistance to indi-viduals who are affected by disasters, alsomakes grants to distressed individuals af-fected by the flood described in Situation1. The grants will pay or reimburse indi-viduals for medical, temporary housing, andtransportation expenses they incur as a re-sult of the flood that are not compensatedfor by insurance or otherwise.

Situation 3. Employer R makes grants toits employees who are affected by the flooddescribed in Situation 1. The grants will payor reimburse employees for medical, tem-porary housing, and transportation expensesthey incur as a result of the flood that arenot compensated for by insurance or oth-erwise. R will not require individuals to pro-vide proof of actual expenses to receive agrant payment. R’s program, however, con-tains requirements (which are described inthe program documents) to ensure that thegrant amounts are reasonably expected tobe commensurate with the amount of un-reimbursed reasonable and necessary medi-cal, temporary housing, and transportationexpenses R’s employees incur as a resultof the flood. The grants are not intended toindemnify all flood-related losses or to re-imburse the cost of nonessential, luxury, ordecorative items and services. The grantsare available to all employees regardless oflength or type of service with R.

LAW AND ANALYSIS

Section 61(a) provides that, except asotherwise provided by law, gross incomemeans all income from whatever source de-rived. Rev. Rul. 131, 1953–2 C.B. 112, con-cludes, in part, that certain payments by anemployer to its employees for the pur-pose of helping the employees defray coststhey incurred from personal injury and prop-erty loss resulting from a tornado do notcome within the concept of gross incometo the employees under the predecessor of§ 61 because the payments are gratuitous,

measured solely by need, not related to ser-vices rendered, and designed to place theemployees in about the same economic po-sition as they were before the tornado. In1955, the Supreme Court of the UnitedStates held that Congress intended under§ 61 to tax all gains or undeniable acces-sions to wealth, clearly realized, over whichtaxpayers have complete dominion. Com-missioner v. Glenshaw Glass Co., 348 U.S.426 (1955), 1955–1 C.B. 207.

The Internal Revenue Service has con-cluded that payments made by governmen-tal units under legislatively provided socialbenefit programs for the promotion of thegeneral welfare (i.e., based on need) are notincludible in the gross income of the re-cipients of the payments (“general wel-fare exclusion”). For example, Rev. Rul. 98–19, 1998–1 C.B. 840, concludes that arelocation payment, authorized by the Hous-ing and Community Development Act of1974 and funded under the 1997 Emer-gency Supplemental Appropriations Act forRecovery From Natural Disasters, made bya local jurisdiction to an individual mov-ing from a flood-damaged residence to an-other residence, is not includible in theindividual’s gross income. Likewise, Rev.Rul. 76–144, 1976–1 C.B. 17, concludesthat grants received under the Disaster Re-lief Act of 1974 by individuals unable tomeet necessary expenses or serious needsas a result of a disaster are in the interestof general welfare and are not includible inthe recipients’ gross income.

Section 102(a) provides that the valueof property acquired by gift is excludedfrom gross income. Under § 102(a) a gift“must proceed from a ‘detached and dis-interested generosity,’ ... ‘out of affec-tion, respect, admiration, charity or likeimpulses.’” Commissioner v. Duberstein,363 U.S. 278, 285 (1960), 1960–2 C.B. 428,431. In general, a payment made by a char-ity to an individual that responds to the in-dividual’s needs, and does not proceed fromany moral or legal duty, is motivated by de-tached and disinterested generosity. Rev.Rul. 99–44, 1999–2 C.B. 549. Section102(c) provides that § 102(a) shall not ex-clude from gross income any amount trans-ferred by or for an employer to, or for thebenefit of, an employee. Governmentalgrants in response to a disaster generally donot qualify as gifts because the govern-

2003–3 I.R.B. 283 January 21, 2003

ment’s intent in making the payments pro-ceeds from its duty to relieve the hardshipcaused by the disaster. Kroon v. UnitedStates, Civ. No. A–90–71 (D. Alaska 1974).

The Victims of Terrorism Tax Relief Actof 2001, Pub. L. No. 107–134, 115 Stat.2427 (2001), added § 139 to the Code. Sec-tion 139(a) provides that gross income doesnot include any amount received by an in-dividual as a qualified disaster relief pay-ment.

Section 139(b) provides, in part, that theterm “qualified disaster relief payment”means any amount paid to or for the ben-efit of an individual:

(1) to reimburse or pay reasonable andnecessary personal, family, living, or fu-neral expenses incurred as a result of aqualified disaster (§ 139(b)(1));

(2) to reimburse or pay reasonable andnecessary expenses incurred for the re-pair or rehabilitation of a personal resi-dence or repair or replacement of itscontents to the extent that the need for suchrepair, rehabilitation, or replacement, is at-tributable to a qualified disaster(§ 139(b)(2)); or

(3) by a Federal, State, or local govern-ment, or agency or instrumentality thereof,in connection with a qualified disaster inorder to promote the general welfare(§ 139(b)(4)).

Thus, § 139(b)(4) codifies (but does notsupplant) the administrative general wel-fare exclusion with respect to certain dis-aster relief payments to individuals. Section139(b) also provides that the exclusion fromincome applies only to the extent any ex-pense compensated by such payment is nototherwise compensated for by insurance orotherwise.

Section 139(c) provides that the term“qualified disaster” means:

(1) a disaster that results from a terror-istic or military action (as defined in§ 692(c)(2));

(2) a Presidentially declared disaster asdefined in § 1033(h)(3) (generally, a disas-ter in an area that has been subsequently de-termined by the President to warrant federalassistance under the Disaster Relief andEmergency Assistance Act);

(3) a disaster resulting from any eventthat the Secretary determines to be of acatastrophic nature; or

(4) with respect to amounts described in§ 139(b)(4), a disaster that is determined byan applicable Federal, State, or local au-

thority (as determined by the Secretary) towarrant assistance from the Federal, State,or local government or an agency or in-strumentality thereof.

Because “of the extraordinary circum-stances surrounding a qualified disaster, itis anticipated that individuals will not berequired to account for actual expenses inorder to qualify for the [§ 139] exclusion,provided that the amount of the paymentscan be reasonably expected to be commen-surate with the expenses incurred.” JointCommittee on Taxation Staff, Technical Ex-planation of the “Victims of Terrorism TaxRelief Act of 2001,” as Passed by the Houseand Senate on December 20, 2001, 107th

Cong., 1st Sess. 16 (2001). As under § 139,the Service will not require individuals toaccount for actual disaster-related expensesfor governmental payments to qualify un-der the administrative general welfare ex-clusion if the amount of the payments isreasonably expected to be commensuratewith the expenses incurred.

The grants that individuals receive fromST, O, and R, and the payments that the em-ployees receive from their employer in Rev.Rul. 131, are accessions to wealth clearlyrealized over which the recipients havecomplete dominion, and therefore comewithin the concept of gross income under§ 61 as described in Glenshaw Glass. Thus,these amounts are included in gross in-come unless specifically excluded by an-other provision of law. Accordingly, Rev.Rul. 131 is modified to the extent that itholds that the payments received by the em-ployees from their employer do not comewithin the concept of gross income.

In Situation 1, the grants made by ST arereasonably expected to be commensuratewith the unreimbursed reasonable and nec-essary medical, temporary housing, or trans-portation expenses individuals incur as aresult of the flood. These expenses are per-sonal, living, or family expenses within themeaning of § 139. Moreover, they are paidto compensate individuals for expenses thatare not compensated for by insurance orotherwise. Thus, the grants are in the na-ture of general welfare and are, therefore,excluded from the recipients’ gross in-come under the general welfare exclusion.The payments also qualify for exclusionfrom gross income under § 139. BecauseST ’s intent in making the grants proceedsfrom its duty to relieve the hardship causedby the disaster, not from a detached and dis-

interested generosity, the grants made by STdo not qualify for exclusion from incomeas gifts under § 102.

In Situation 2, the grants made by O aredesigned to help distressed individuals withunreimbursed medical, temporary hous-ing, or transportation expenses they incuras a result of the flood. Under these facts,O’s grants are made out of detached anddisinterested generosity rather than to ful-fill any moral or legal duty. Thus, the grantsare excluded from the gross income of therecipients as gifts under § 102. Because pay-ments by non-governmental entities are notconsidered payments for the general wel-fare, the grants made by O are not ex-cluded from the recipients’ gross incomeunder the general welfare exclusion. Rev.Rul. 82–106, 1982–1 C.B. 16. It is not nec-essary to reach the question of whether§ 139 applies to the grants.

In Situation 3, the grants made by R toits employees do not qualify as gifts un-der § 102. Also, because payments by non-governmental entities are not consideredpayments for the general welfare, the grantsmade by R are not excluded from the re-cipients’ gross income under the generalwelfare exclusion. The grants, however, arereasonably expected to be commensuratewith the unreimbursed reasonable and nec-essary personal, living, or family expensesthat R’s employees incur as a result of aflood that is a qualified disaster as de-fined in § 139(c). Moreover, they are paidto compensate individuals for expenses thatare not compensated for by insurance orotherwise. Therefore, R’s grants are quali-fied disaster relief payments that are ex-cluded from the gross income of R’semployees under § 139. Similar to thegrants in Situation 3, the payments madeby the employer described in Rev. Rul. 131do not qualify as gifts under § 102 and arenot excluded from the employees’ gross in-come under the general welfare exclusion.Whether the payments described in Rev.Rul. 131 are included in an employee’sgross income depends on whether the pay-ments qualify for exclusion under § 139.

HOLDINGS

Under the facts of this ruling:(1) Payments individuals receive un-

der a state’s program to pay or reimburseunreimbursed reasonable and necessarymedical, temporary housing, or transpor-tation expenses they incur as a result of a

January 21, 2003 284 2003–3 I.R.B.

flood are excluded from gross income un-der the general welfare exclusion. Such pay-ments also qualify for exclusion under§ 139.

(2) Payments that individuals receive un-der a charitable organization’s program topay or reimburse unreimbursed medical,temporary housing, or transportation ex-penses they incur as a result of a flood areexcluded from gross income under § 102.

(3) Payments that employees receive un-der an employer’s program to pay or re-imburse unreimbursed reasonable andnecessary medical, temporary housing, ortransportation expenses they incur as a re-sult of a flood are excluded from gross in-come under § 139.

Amounts that are excluded from grossincome under this revenue ruling are notsubject to information reporting under§ 6041.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 131 is modified.

PROSPECTIVE APPLICATION

Pursuant to the authority contained in§ 7805(b), this revenue ruling will not ap-ply adversely to payments received on orbefore January 21, 2003.

DRAFTING INFORMATION

The principal author of this revenueruling is Sheldon A. Iskow of the Office ofAssociate Chief Counsel (Income Tax andAccounting). For further information re-garding this revenue ruling, contactMr. Iskow at (202) 622–4920 (not a toll-free call).

Section 401.—Qualified Pen-sion, Profit-Sharing and StockBonus Plans

26 CFR 1.401–1: Qualified pension, profit-sharing and

stock bonus plans.

Whether an S corporation ESOP is eligible for the

delayed effective date of section 409(p) of the Inter-

nal Revenue Code as added by section 656(d)(2) of

the Economic Growth and Tax Relief Reconcil-

iation Act of 2001. See Rev. Rul. 2003–6, page 286.

26 CFR 1.401(a)(17)–1: Limitation on annualcompensation.

Limitation on annual compensation;section 611(c) of EGTRRA. This rulingpertains to whether the allowable compen-sation limit enacted by section 611(c) ofEGTRRA may be applied to former em-ployees and meet the nondiscrimination andcoverage requirements of the Code.

Rev. Rul. 2003–11

ISSUE

Whether a plan amendment that reflectsthe increase in the allowable compensa-tion limit contained in section 611(c) of theEconomic Growth and Tax Relief Recon-ciliation Act of 2001 (EGTRRA), Pub. L.107–16, and applies that increase to formeremployees, will satisfy the nondiscrimina-tion rules of § 401(a)(4) and the minimumcoverage requirements of § 410(b) of theInternal Revenue Code (Code).

FACTS

Plan A is a nongovernmental definedbenefit plan with a calendar year plan yearand a benefit formula that provides for allparticipants an annual benefit at normal re-tirement age equal to the product of: (yearsof service) x (1 percent) x (high 3-year av-erage compensation). For this purpose, high3-year average compensation is the aver-age of the compensation over the 3 con-secutive plan years for which the averageis the highest, and compensation for eachyear is limited to $150,000, as adjusted forcost-of-living increases (the limit under§ 401(a)(17) of the Code prior to the ef-fective date of the EGTRRA amendmentsto that section). B is a former participantin Plan A who retired as of December 31,2001. As of December 31, 2001, B has 10years of service and compensation of$250,000 for each of the 3 years 1999,2000, and 2001. B’s high 3-year averagecompensation of $166,667 is determined asthe average of annual compensation (as lim-ited by § 401(a)(17) of the Code) of$160,000 for 1999, $170,000 for 2000, and$170,000 for 2001. B’s annual benefit un-der the plan formula as of December 31,2001, is $16,667, calculated as (10) x (.01)x ($166,667). As of December 31, 2001, Bis a “highly compensated former employee,”as defined in § 1.410(b)–9, and a “formerHCE,” as defined in § 1.401(a)(4)–12, for

purposes of applying the nondiscrimina-tion rules under §§ 410(b) and 401(a)(4) re-spectively.

In 2002, Plan A is amended (1) to usethe $200,000 compensation limit for com-pensation paid in years beginning after De-cember 31, 2001, (2) to use the $200,000compensation limit for compensation paidin years beginning prior to January 1, 2002,in determining benefit accruals in years be-ginning after December 31, 2001, and (3)to use the $200,000 compensation limit indetermining retirement benefits to be paidafter December 31, 2001, to employees whoretired on or before December 31, 2001. Ahigh 3-year average compensation of$200,000 is determined for B as of De-cember 31, 2002, as the average of an-nual compensation (as limited by§ 401(a)(17) of the Code, as amended byEGTRRA) of $200,000 for 1999, $200,000for 2000, and $200,000 for 2001. As of De-cember 31, 2002, B’s annual benefit un-der the plan formula is $20,000, calculatedas (10) x (.01) x ($200,000).

LAW AND ANALYSIS

Section 401(a)(17) limits the annualcompensation that may be taken into ac-count for purposes of determining a par-ticipant’s benefit accruals under a definedbenefit plan or a participant’s allocations un-der a defined contribution plan. Section401(a)(17) also limits the annual compen-sation that may be taken into account forpurposes of certain nondiscrimination re-quirements, including those in §§ 401(a)(4),401(a)(5), 401(l), 401(k), 401(m),403(b)(12), 404(a)(2), and 410(b)(2), andfor purposes of determining whether a defi-nition of compensation is nondiscrimina-tory under § 414(s)(3). Under § 401(a)(17),as in effect prior to the effective date of theEGTRRA amendment, the compensationlimit was $150,000, indexed in $10,000 in-crements for cost-of-living adjustments. For2001, the compensation limit was $170,000.A higher compensation limit applies to eli-gible participants in certain governmentalplans. See § 1.401(a)(17)–1(d)(4)(ii) of theIncome Tax Regulations.

Section 611(c) of EGTRRA amended§ 401(a)(17) of the Code by increasing the$150,000 limit (as adjusted) to $200,000,and changing the method used for cost-of-living adjustments. Section 611(c) ofEGTRRA made similar amendments to

2003–3 I.R.B. 285 January 21, 2003

§§ 404(l), 408(k), and 505(b)(7) of theCode.

Section 611(i)(1) of EGTRRA providesthat the increase in the compensation limitunder § 401(a)(17) of the Code applies toyears beginning after December 31, 2001.Thus, for purposes of determining benefitaccruals or the amount of allocations forplan years beginning on or after January 1,2002, compensation taken into account maynot exceed the compensation limit under§ 401(a)(17), as amended by section 611(c)of EGTRRA.

Notice 2001–56, 2001–2 C.B. 277, pro-vides that in the case of a plan that uses an-nual compensation for periods prior to thefirst plan year beginning on or after Janu-ary 1, 2002, to determine accruals or allo-cations for a plan year beginning on or afterJanuary 1, 2002, the plan is permitted toprovide that the $200,000 compensationlimit applies to annual compensation forsuch prior periods in determining such ac-cruals or allocations.

Section 1.401(a)(4)–5 provides gen-eral rules for determining whether the tim-ing of a plan amendment has the effect ofdiscriminating significantly in favor ofhighly compensated employees. Section1.401(a)(4)–5(a) provides that whether thetiming of a plan amendment has the ef-fect of discriminating significantly in fa-vor of HCEs or former HCEs is determinedat the time the plan amendment first be-comes effective for purposes of § 401(a),and is based on all of the relevant facts andcircumstances.

Section 1.401(a)(4)–10 provides rules fordetermining whether a plan satisfies thenondiscrimination requirements of§ 401(a)(4) with respect to benefits pro-vided to former employees, generally in theform of a plan amendment. Section1.401(a)(4)–10(b)(1) provides that a plan isnondiscriminatory with respect to theamount of benefits provided to former em-ployees if, under all of the relevant facts andcircumstances, the amount of benefits pro-vided to former employees does not dis-criminate significantly in favor of formeremployees who are highly compensated em-ployees (HCEs). For this purpose,§ 1.401(a)(4)–10(b)(1) specifies that ben-efits provided to former employees in-clude all benefits provided to formeremployees or, at the employer’s option, onlythose benefits arising out of the amend-ment providing the benefits.

Section 1.410(b)–2(c) provides rules fordetermining whether the group of formeremployees benefiting under a plan for ayear satisfies the coverage requirements of§ 410(b) with respect to former employ-ees. Section 1.410(b)–2(c)(2) provides thata plan satisfies § 410(b) with respect toformer employees if, under all of the rel-evant facts and circumstances, a group offormer employees benefiting under the plandoes not discriminate significantly in fa-vor of highly compensated former employ-ees. Section 1.410(b)–3(b) provides that forthis purpose, a former employee is treatedas benefiting for a plan year if and only ifthe plan provides a benefit increase to theformer employee for the plan year.

Based on all the relevant facts and cir-cumstances, the amendment to Plan A sat-isfies the requirements of § 401(a)(4) and§ 410(b).

HOLDING

A plan amendment to apply the increasedcompensation limits under section 611(c)of EGTRRA to all former employees (or allformer employees who retain accrued ben-efits under the plan) that is effective as ofthe first plan year beginning after Decem-ber 31, 2001, satisfies the requirements of§ 401(a)(4) and § 410(b) of the Code.

DRAFTING INFORMATION

The principal drafters of this revenue rul-ing are Steven Linder of the EmployeePlans, Tax Exempt and Government Enti-ties Division and Linda Phillips of the Of-fice of the Associate Chief Counsel/DivisionCounsel (TEGE). For further informationrearding this revenue ruling, please con-tact the Employee Plans’ taxpayer assis-tance telephone service at 1–877–829–5500 (a toll-free number) between the hoursof 8:00 a.m. and 6:30 p.m. Eastern Time,Monday through Friday. Mr. Linder may bereached at (202) 283–9888; Ms. Phillipsmay be reached at (202) 622–6090. Thetelephone numbers in the preceding sen-tence are not toll-free.

Section 409(p).—ProhibitedAllocations of Securities in anS Corporation

(Also, §§ 401, 4975, 4979A, 6011, 6111 and 6112;1.401–1, 54.4975–11, 1.6011–4T, 301.6111–2T and301.6112–1T.)

Employee stock ownership plans; de-layed effective date, abuse. This rulingstates that where the intent of section 409(p)of the Code to limit the establishment ofESOPs by S corporations to those that pro-vide broad-based employee coverage andthat benefit rank-and-file employees (as wellas highly compensated employees and his-torical owners) is not present, the delayedeffective date in section 656(d)(2) of theEGTRRA is not available and that suchtransactions are listed transactions.

Rev. Rul. 2003–6

PURPOSE

The Internal Revenue Service and theTreasury Department understand that cer-tain arrangements involving employee stockownership plans (ESOPs) that hold em-ployer securities in an S corporation are be-ing used for the purpose of claimingeligibility for the delayed effective date of§ 409(p) of the Internal Revenue Code, un-der section 656(d)(2) of the EconomicGrowth and Tax Relief Reconciliation Actof 2001 (EGTRRA) (Pub. L. 107–16). Thisrevenue ruling alerts taxpayers and their rep-resentatives that the tax benefits purport-edly generated by these transactions are notallowable for federal income tax purposes.This revenue ruling also alerts taxpayers,their representatives, and organizers or sell-ers of these transactions to certain respon-sibilities that may arise from participatingin these transactions.

ISSUE

Is an S corporation ESOP described be-low eligible for the delayed effective dateunder § 409(p) of the Code provided un-der section 656(d)(2) of EGTRRA?

FACTS

On or before March 14, 2001, A, a per-son in the business of providing advice toother companies or individuals, arranges forthe establishment of a number of S corpo-

January 21, 2003 286 2003–3 I.R.B.

rations that have no substantial assets orbusiness, and forms an ESOP for each ofthose corporations. A takes the position thatsome or all of the employees of A are eli-gible to participate under the terms of theESOP sponsored by each S corporation, butthere is no reasonable expectation that theseindividuals will accrue more than insub-stantial benefits under the plans or morethan an insubstantial share in the owner-ship of the S corporations. After March 14,2001, A markets these S corporations andthe associated ESOPs to other taxpayers, in-cluding individuals or companies.

After one of the S corporations (and itsESOP) are transferred to one or more tax-payers, the taxpayers restructure their busi-nesses so that the S corporation receivesincome from those businesses. After the re-structuring, the S corporation is wholly orsubstantially owned by the ESOP. In ad-dition, there are one or more individual tax-payers who are disqualified persons, withinthe meaning of § 409(p) of the Code (re-lating to prohibited allocations under anESOP that holds stock in an S corpora-tion), who are deemed to own in the ag-gregate at least 50% of the number ofshares of the S corporation.

LAW

Section 4975(e)(7) provides that anESOP is a defined contribution plan whichis (1) either a stock bonus plan which isqualified or a stock bonus plan and moneypurchase pension plan both of which arequalified under § 401(a), and (2) designedto invest primarily in qualifying employersecurities. A plan is not treated as an ESOPunless it meets the following requirements,to the extent applicable: § 409(h) (relat-ing to participants’ right to receive em-ployer securities and put options); § 409(o)(relating to participants’ distribution rightsand payment requirements); § 409(n) (re-lating to securities received in transac-tions to which § 1042 applies); § 409(p)(relating to prohibited allocations of secu-rities in an S corporation); § 664(g) (relat-ing to qualified gratuitous transfers ofqualified employer securities); and § 409(e)(relating to participants’ voting rights), if theemployer has a registration-type class of se-curities (as defined in § 409(e)(4)). As au-thorized by § 4975(e)(7), additionalrequirements are imposed under§ 54.4975–11 of the Excise Tax Regula-tions.

The legislative history to the Tax Re-form Act of 1976 (TRA ’76) (Pub.L. 94–455) states that an ESOP “is a techniqueof corporate finance designed to buildbeneficial equity ownership of shares in theemployer corporation into its employees. . . .” (See S. Rep. 94–938 at 180 and1976–3 C.B. Vol. 3, 218.)

Section 1.401–1(a)(2)(ii) of the IncomeTax Regulations provides that a qualifiedprofit-sharing plan is established and main-tained by an employer to enable employ-ees or their beneficiaries to participate inthe profits of the employer’s trade or busi-ness. However, § 401(a)(27) permits con-tributions to be made without regard toprofits if the plan is designated as a profit-sharing plan. Under § 1.401–1(a)(2)(iii), astock bonus plan is a plan that provides em-ployees or their beneficiaries benefits simi-lar to those of a profit-sharing plan, exceptthat benefits are distributable in stock of theemployer.

Section 409(p) requires that an ESOPthat holds employer securities consisting ofstock in an S corporation provide that noportion of the assets of the plan attribut-able to such employer securities may, dur-ing a nonallocation year, accrue (or beallocated directly or indirectly under anyplan of the employer meeting the require-ments of § 401(a)) for the benefit of anydisqualified person. Indirect allocations in-clude allocations of income on S corpora-tion stock held in the account of adisqualified person. H.R. Conf. Rep. 107–84at 276.

Any prohibited allocations in a nonal-location year are treated as distributions andare currently taxable to the disqualified per-son. Section 409(p)(3) provides that a “non-allocation year” means a plan year duringwhich, at any time, disqualified persons ownat least 50 percent of the number of sharesof the S corporation. Section 409(p)(4) pro-vides, in general, that a “disqualified per-son” means a person for whom (1) theaggregate number of deemed-owned sharesof such person and the members of suchperson’s family is at least 20 percent of thenumber of deemed-owned shares of stockin the S corporation or (2) the number ofsuch deemed-owned shares is at least 10percent of the number of deemed-ownedshares of stock in the S corporation. If anESOP fails § 409(p), prohibited alloca-tions are treated as currently taxable to thedisqualified person under § 409(p)(2), and

an excise tax equal to 50 percent of the al-locations is imposed on the S corporationunder § 4979A.

Section 409(p) is effective for plan yearsbeginning after December 31, 2004. How-ever, pursuant to section 656(d)(2) ofEGTRRA, § 409(p) of the Code is effec-tive for plan years ending after March 14,2001, for an ESOP that is established af-ter that date, or if the employer securitiesheld by the plan consist of stock in an Scorporation that did not have an S elec-tion in effect on that date. Notice 2002–2,Q & A–15, 2002–2 I.R.B. 285, provides thatan S corporation does not have an elec-tion in effect on March 14, 2001, unless avalid election was actually filed on or be-fore that date and is effective with respectto such corporation on or before that date.

The legislative history to section 656 ofEGTRRA, which added § 409(p) to theCode, states that § 409(p) is intended tolimit the establishment of ESOPs by S cor-porations to those that provide broad-basedemployee coverage and that benefit rank-and-file employees as well as highly com-pensated employees and historical owners.(See H.R. Rep. 107–51, pt. 1, at 100, andH.R. Conf. Rep. 107–84, at 274 (2001).) Inaddition, Congress has expressed concernregarding techniques to avoid or evade therequirements of § 409(p). (See § 409(p)(7)(B), which provides that the Secre-tary may, by regulation or other guidanceof general applicability, provide that a non-allocation year occurs in any case in whichthe principal purpose of the ownershipstructure of an S corporation constitutes anavoidance or evasion of the nonallocationrequirements of § 409(p).)

ANALYSIS

In these transactions, A has not formedthe ESOPs to provide substantial benefits,or substantial participation in the owner-ship of the S corporations, to the initial pur-ported participants in the ESOPs. The initialemployees of the entity forming the ESOPdo not receive more than insubstantial ben-efits or more than insubstantial owner-ship interests through the ESOP. Forpurposes of the effective date of § 409(p),an ESOP is not established until it isadopted by an employer for the purpose ofenabling its employees to participate in amore than insubstantial manner in the own-ership of the employer’s business and to

2003–3 I.R.B. 287 January 21, 2003

provide its employees with more than in-substantial benefits under the ESOP.

For the foregoing reasons, an ESOPadopted by an S corporation under the factsprovided above will not be treated as hav-ing been established on or before March 14,2001, and is not entitled to the delayed 2005effective date for purposes of the nonallo-cation rules of § 409(p).

Accordingly, because there is a nonal-location year under § 409(p), the disquali-fied persons under § 409(p)(4) are treatedas receiving deemed distributions to the ex-tent of any allocation to their account, pur-suant to § 409(p)(2)(A). In addition, excisetaxes under § 4979A apply to any nonal-location year.

HOLDING

An S corporation ESOP described in thisruling is not eligible for the delayed effec-tive date under § 409(p) of the Code pro-vided under section 656(d)(2) of EGTRRA,and thus is subject to the nonallocation rulesof § 409(p) of the Code effective for planyears ending after March 14, 2001. Any tax-payer who is a disqualified person with re-spect to the S corporation ESOP is treatedas receiving a deemed distribution of stockallocated to the taxpayer’s account and in-come with respect to that account. In ad-dition, excise taxes under § 4979A apply toany nonallocation year.

LISTED TRANSACTIONS

Transactions that are the same as, or sub-stantially similar to, the transaction de-scribed in this revenue ruling are identifiedas “listed transactions” for purposes of§ 1.6011–4T(b)(2) of the temporary In-come Tax Regulations and § 301.6111–2T(b)(2) of the temporary Procedure andAdministration Regulations with respect toeach disqualified person for plan years be-ginning prior to January 1, 2005. See also§ 301.6112–1T, A–4. Further, it should benoted that, independent of their classifica-tion as “listed transactions” for purposes of§§ 1.6011–4T(b)(2) and 301.6111–2T(b)(2),transactions that are the same as, or sub-stantially similar to, the transaction de-scribed in this revenue ruling may alreadybe subject to the disclosure requirements of§ 6011, the tax shelter registration require-ments of § 6111 or the list maintenance re-quirements of § 6112 (§§ 1.6011–4T,301.6111–1T, 301.6111–2T, and 301.6112–1T, A-3 and A–4).

Persons who are required to satisfy theregistration requirement of § 6111 with re-spect to the transaction described in this rev-enue ruling and who fail to do so may besubject to the penalty under § 6707(a). Per-sons who are required to satisfy the list-keeping requirement of § 6112 with respectto the transaction and who fail to do so maybe subject to the penalty under § 6708(a).In addition, the Service may impose pen-alties on participants in this transaction orsubstantially similar transactions, or, as ap-plicable, on persons who participate in thereporting of this transaction or substan-tially similar transactions, including theaccuracy-related penalty under § 6662, andthe return preparer penalty under § 6694.

FURTHER GUIDANCE

The Service is developing further guid-ance to address other abusive arrangementsinvolving S corporation ESOPs.

DRAFTING INFORMATION

The principal drafters of this rev-enue ruling are Steven Linder of the Em-ployee Plans, Tax Exempt and GovernmentEntities Division and John Ricotta of theOffice of the Associate Chief Counsel/Division Counsel (TEGE). For further in-formation regarding this revenue ruling,please contact the Employee Plans’ tax-payer assistance telephone service at 1–877–829–5500 (a toll-free number) between thehours of 8:00 a.m. and 6.30 p.m. EasternTime, Monday through Friday. Mr. Lindermay be reached at (202) 283–9888;Mr. Ricotta may be reached at (202) 622–6060. The telephone numbers in the pre-ceding sentence are not toll-free.

Section 451.—General Rulefor Taxable Year of Inclusion

26 CFR 1.451–1: General rule for taxable year ofinclusion.

Accrual of income. This ruling ad-dresses the accrual of gross income whena taxpayer’s customer disputes its liabil-ity to the taxpayer because of (1) a cleri-cal mistake in a sales invoice, (2) theshipment of the wrong goods, or (3) theshipment of more items than the customerordered.

Rev. Rul. 2003–10

ISSUES

(1) Under the all events test of § 451 ofthe Internal Revenue Code, when does ataxpayer using an accrual method of ac-counting accrue gross income if the tax-payer ships goods and the customer disputesits liability to the taxpayer because of aclerical mistake in the sales invoice dis-covered in the next taxable year?

(2) Under the all events test of § 451,when does a taxpayer using an accrualmethod of accounting accrue gross incomeif the taxpayer ships the wrong goods andthe customer disputes its liability during thetaxable year of sale?

(3) Under the all events test of § 451,when does a taxpayer using an accrualmethod of accounting accrue gross incomeif the taxpayer ships more items than thecustomer ordered, the excess quantity is dis-covered by the customer in the next tax-able year, and, in accordance with anagreement with the customer, the taxpayerreduces the quantity that would otherwisehave been included in the next shipment?

FACTS

Taxpayer P manufactures products H andM and sells them to retailers for resale. Puses an accrual method of accounting anda calendar taxable year. For federal in-come tax purposes, P recognizes gross in-come from sales of products H and M whenit ships the product to the retailer.

Situation 1. In October 2002, X, a re-tailer, orders 1,000 cases of product M fromP at a price of $15 per case. In Novem-ber 2002, P ships 1,000 cases of M to X andsends X an invoice for the 1,000 cases ofM. As the result of a data entry mistake, theamount of the invoice is improperly statedas $16,000 rather than $15,000. In Janu-ary 2003, X notifies P of the erroneous in-voice and P acknowledges that it is entitledto receive only $15,000 for the 1,000 casesof M. X subsequently pays the $15,000 toP.

Situation 2. Y is a retailer that purchasesproduct M from P. In September 2002, Yorders 600 cases of M from P at a price of$15 per case. In October 2002, P ships 600cases of H to Y and sends Y an invoice for$9,000. In November 2002, Y discovers thatP shipped H rather than M and notifies Pthat it will not pay for the H. In January

January 21, 2003 288 2003–3 I.R.B.

2003, P and Y settle the dispute by agree-ing that Y will pay P $4,500 for the H.

Situation 3. Z is a retailer that purchasesproducts H and M from P. Each month Pships Z 300 cases of H at a price of $10 percase and 700 cases of M at a price of $15per case. On December 28, 2002, P mis-takenly ships 400 cases of H and 600 casesof M to Z and sends Z an invoice for$13,000. On January 3, 2003, Z discoversthat P shipped the wrong amount of H andM and notifies P. Z asks P to correct thesituation by adjusting the amount of H andM it ships to Z in January’s monthly ship-ment. On January 28, 2003, P ships 200cases of H and 800 cases of M to Z to ad-just for the amount of H and M mistak-enly shipped to Z in December 2002. InFebruary 2003, Z pays P $13,000 for theH and M it received in December 2002 andin March 2003, Z pays P $14,000 for theH and M it received in January 2003.

LAW AND ANALYSIS

Section 61(a) provides that, except asotherwise provided, gross income means allincome from whatever source derived. Sec-tion 1.61–3(a) of the Income Tax Regula-tions provides that in a manufacturing,merchandising, or mining business, “grossincome” means the total sales, less the costof goods sold, plus any income from in-vestments and from incidental or outside op-erations or sources.

Section 451 provides rules for deter-mining the taxable year of inclusion foritems of gross income. Sections 1.446–1(c)(1)(ii)(A) and 1.451–1(a) provide thatunder an accrual method of accounting, in-come is includible in gross income whenall the events have occurred that fix theright to receive the income and the amountthereof can be determined with reason-able accuracy. All the events that fix theright to receive income occur when (1) therequired performance takes place, (2) pay-ment is due, or (3) payment is made, which-ever happens first. Schlude v. Commissioner,372 U.S. 128, 133 (1963); Rev. Rul. 84–31, 1984–1 C.B. 127; Rev. Rul. 80–308,1980–2 C.B. 162.

Section 1.446–1(e)(2)(ii)(b) provides thata change in method of accounting does notinclude correction of mathematical or post-ing errors, or errors in the computation ofa tax liability.

Section 1.451–1(a) provides that if anamount of income is properly accrued on

the basis of a reasonable estimate and theexact amount is subsequently determined,the difference, if any, shall be taken into ac-count for the taxable year in which such de-termination is made. Additionally, if ataxpayer ascertains that an item was im-properly included in gross income in a priortaxable year, the taxpayer should, if withinthe period of limitation, file a claim forcredit or refund of any overpayment of taxarising therefrom. Gould-Mersereau Co. v.Commissioner, 21 B.T.A. 1316 (1931) acq.1931–2 C.B. 27. If the right to an amountof income is substantially in controversy theincome may not be accrued until the con-troversy is resolved. North American OilConsolidated v. Burnet, 286 U.S. 417(1932); Jamaica Water Co. v. Commis-sioner, 125 F.2d 512 (2d Cir. 1942); Rev.Rul. 60–237, 1960–2 C.B. 164.

In Situation 1, P’s invoice to X was foran improper amount as a result of a cleri-cal mistake. P may not accrue $16,000 ofgross sales in gross income in 2002 be-cause P does not have a fixed right to thatamount. Rather, P accrues $15,000 of grosssales and includes $15,000, the correctamount, less the corresponding cost ofgoods sold, in gross income in 2002. Gen-erally, if P has already filed its income taxreturn for 2002 when the mistake is dis-covered, P should, if within the period oflimitation, file a claim for refund of anyoverpayment of tax arising from report-ing an improper amount of income on thatreturn. If, however, P has regularly and con-sistently for a period of two or more tax-able years treated invoice amounts as areasonable estimate of accrued income and,if the exact amount is subsequently deter-mined to be different, has taken the differ-ence into account for the taxable year inwhich the determination is made, P shouldseek consent for a change in method of ac-counting if it wants to begin taking such dif-ferences into account in the year of sale.

In Situation 2, the dispute arises in thetaxable year of sale. Accordingly, becauseunder § 451 P does not have a fixed rightto the income P may not include anyamount from that transaction, including thecorresponding cost of goods sold, in grossincome in 2002. P accrues $4,500 of grosssales and includes $4,500, less the corre-sponding cost of goods sold, in gross in-come in 2003, when P and Y settle theirdispute by agreeing that Y will pay P theamount of $4,500 for the H.

In Situation 3, P mistakenly ships thewrong amount of H and M to Z in Decem-ber 2002 and sends an invoice for $13,000to Z. However, because Z does not dis-pute the shipment P has a fixed right to in-come relating to the shipment in 2002.Accordingly, P accrues $13,000 of grosssales and includes $13,000, less the corre-sponding cost of goods sold, in gross in-come in 2002 because the all events test of§ 451 is satisfied.

HOLDINGS

(1) Under the all events test of § 451, ifa taxpayer using an accrual method of ac-counting overbills a customer due to a cleri-cal mistake in an invoice and the customerdiscovers the error and, in the following tax-able year, disputes its liability for the over-billed amount, then the taxpayer accruesgross income in the taxable year of sale forthe correct amount.

(2) Under the all events test of § 451, ataxpayer using an accrual method of ac-counting does not accrue gross income inthe taxable year of sale if, during the tax-able year of sale, the customer disputes itsliability to the taxpayer because the tax-payer shipped incorrect goods.

(3) Under the all events test of § 451, ataxpayer using an accrual method of ac-counting accrues gross income in the tax-able year of sale if the taxpayer ships excessquantities of goods and the customer agreesto pay for the excess quantities of goods.

REQUEST FOR COMMENTS

The Service requests comment on theapplication of § 451 to a situation in whichP ships defective products to a customerthat discovers the defect in the next tax-able year and disputes its liability to P. Inparticular, the Service requests commentsconcerning: (1) whether P has a fixed rightto income within the meaning of § 451 inthe taxable year of sale (compare Hall-mark Cards, Inc. v. Commissioner, 90 T.C.26 (1988), with Celluloid Co. v. Commis-sioner, 9 B.T.A. 989 (1927) acq. VII–1 C.B.6); (2) whether the taxable year concept ofaccounting requires P to accrue gross in-come in the taxable year of sale because thedispute did not arise until the next tax-able year; (3) examples of situations thatshould be treated as shipments of defec-tive products (e.g., shipments of damagedgoods, shipments of incorrect goods); and

2003–3 I.R.B. 289 January 21, 2003

(4) whether the analysis is affected by thecourse of dealing between P and its cus-tomer.

Comments should be submitted by April21, 2003, either to:

Internal Revenue ServiceP.O. Box 7604Ben Franklin StationWashington, DC 20044Attn: CC:PA:T:CRU (CC:ITA:7)Room 5529

or electronically at: Notice.Comments@irscounsel.treas.gov (the Service’s com-ments e-mail address). All comments areavailable for public inspection and copy-ing. During its review of the comments, theService will continue to process private let-ter ruling requests, including requests forconsent to change a method of account-ing.

DRAFTING INFORMATION

The principal author of this revenueruling is John P. Moriarty of the Office ofAssociate Chief Counsel (Income Tax andAccounting). For further information re-garding this revenue ruling, contactMr. Moriarty at (202) 622–4930 (not a toll-free call).

Section 901.—Taxes ofForeign Countries and ofPossessions of United States

26 CFR 1.901–2: Income, war profits or excessprofits tax paid or accrued.(Also sections 903; 1.903–1.)

Costa Rican income tax law; with-holding taxes. This ruling holds that cer-tain Costa Rican taxes are noncreditablesoak-up taxes under sections 901 and 903of the Code. The ruling also serves as anofficial confirmation to the Costa Rican TaxAdministration that these taxes are non-creditable in the United States.

Rev. Rul. 2003–8

ISSUE

Are the withholding taxes specified inArticle 61 of the Costa Rican Income TaxLaw creditable taxes under sections 901 and903 of the Internal Revenue Code of 1986?

FACTS

Costa Rica’s income tax law imposes awithholding tax on various types of in-come paid to persons operating or resid-ing outside of Costa Rica at rates specifiedin Costa Rican Income Tax Law Article 59.The Costa Rican Tax Administration has au-thority to grant a total or partial exemp-tion from liability for withholding taxes onprofits, dividends, social participation, in-terest, commissions, financial expenses, pat-ents, royalties, reinsurance, consolidationand insurance premiums of all types re-ferred to in Article 59. Costa Rican In-come Tax Law art. 61. The exemption canbe given if the persons who act as with-holding or receiving agents, or the inter-ested parties, prove, to the satisfaction ofthe Costa Rican Tax Administration, that therecipient of such income is not granted inthe country in which it operates or residesany credit against its tax liability for thewithholding tax that was paid to Costa Rica.Id. In order to claim an exemption underArticle 61, the Costa Rican Tax Adminis-tration requires the foreign recipient or itswithholding agent to provide certificationfrom the tax authorities of the country inwhich the recipient operates or resides veri-fying that the tax is not creditable in thatcountry. Costa Rican Income Tax Regula-tion art. 65.

LAW AND ANALYSIS

Section 901 of the Code allows a creditagainst United States income tax for theamount of any income, war profits, and ex-cess profits taxes paid or accrued to any for-eign country. Section 1.901–2(a)(1) of theIncome Tax Regulations provides that a for-eign levy is an income tax only if it is a tax,and if the predominant character of that taxis an income tax in the United States sense.Section 1.901–2(a)(3)(ii) provides that thepredominant character of a foreign tax isthat of an income tax in the United Statessense only to the extent that liability for thetax is not dependent, by its terms or oth-erwise, on the availability of a credit for thetax against income tax liability to anothercountry. Section 1.901–2(c)(1) provides thatliability for foreign tax is dependent on theavailability of a credit for the foreign taxagainst income tax liability to another coun-try only if and to the extent that the for-

eign tax would not be imposed on thetaxpayer but for the availability of such acredit.

Section 903 of the Code allows a creditagainst United States income tax for anamount of tax paid or accrued “in lieu of”an income, war profits or excess profits taxotherwise generally imposed by any for-eign country. Section 1.903–1(a) of theregulations provides that a foreign levy isa tax in lieu of an income tax only if it isa tax, and it meets the “substitution re-quirement” of section 1.903–1(b). Sec-tion 1.903–1(b)(2) provides that a foreigntax meets the substitution requirement onlyto the extent that the liability for the for-eign tax is not dependent (by its terms orotherwise) on the availability of a credit forthe foreign tax against the income tax li-ability to another country.

Therefore, if a foreign country imposesa withholding tax only in the event that acredit for the tax is available from the re-cipient’s country of domicile, the tax is notcreditable under section 901 or 903.

HOLDING

The withholding taxes referred to in Ar-ticle 61 of the Costa Rican Income Tax Laware not creditable taxes under section 901or 903 of the Code since they are imposedonly in the event that a credit for the taxis available from the country in which therecipient operates or resides. This ruling isan official confirmation by the Internal Rev-enue Service that the withholding taxes re-ferred to in Article 61 are not creditable inthe United States.

DRAFTING INFORMATION

The principal author of this revenue rul-ing is Margaret A. Hogan of the Office ofAssociate Chief Counsel (International). Forfurther information regarding this revenueruling, contact Ms. Hogan at 202–622–3850 (not a toll-free call).

January 21, 2003 290 2003–3 I.R.B.

Section 1259.—ConstructiveSales Treatment forAppreciated FinancialPositions

Constructive sales; reestablished po-sitions. This ruling provides guidance onthe interaction between section 1259(c)(3)(A) of the Code (exception for certainclosed transactions) and section 1259(c)(3)(B) (treatment of positions which are re-established).

Rev. Rul. 2003–1

ISSUE

If a taxpayer enters into successive shortsales of its entire appreciated financial po-sition, must the taxpayer recognize gain pur-suant to § 1259(a)(1) of the InternalRevenue Code if all of the short sales areclosed before the 30th day after the end ofthe taxpayer’s taxable year and the entireappreciated financial position is held un-hedged for a 60-day period beginning onthe date on which the last of the short salesis closed?

FACTS

A is a calendar year taxpayer. On Janu-ary 1, 2002, A owns 100 shares of stock inX Corporation (X stock). On February 1,2002, A enters into a short sale of 100shares of X stock (Short Sale 1). In Marchof 2002, A purchases an additional 100shares of X stock and delivers those sharesto close Short Sale 1. On April 1, 2002, Aenters into a second short sale of 100 sharesof X stock (Short Sale 2). In May of 2002,A purchases an additional 100 shares of Xstock and delivers those shares to closeShort Sale 2. On June 3, 2002, A enters intoa third short sale of 100 shares of X stock(Short Sale 3). On January 15, 2003, A pur-chases an additional 100 shares of X stock.Prior to the deadline contained in§ 1259(c)(3)(B)(ii)(II), A delivers thoseshares to close Short Sale 3. A continuesto hold the 100 shares of X stock during the60-day period beginning on the date ShortSale 3 is closed. At all relevant times dur-ing that period, A’s risk of loss with re-spect to the 100 shares of X stock is notreduced by reason of a circumstance de-scribed in § 1259(c)(3)(A)(iii). That is, the100 shares of X stock are held “unhedged”

during the 60-day period. At all relevanttimes, the 100 shares of X stock are ap-preciated.

LAW

Section 1259(a)(1) provides that if thereis a constructive sale of an appreciated fi-nancial position (AFP), the taxpayer mustrecognize gain as if the position were sold,assigned, or otherwise terminated at its fairmarket value on the date of the construc-tive sale. “Appreciated financial position”is defined in § 1259(b)(1) to include a po-sition with respect to stock if there wouldbe gain were the position sold, assigned, orotherwise terminated at its fair market value.Section 1259(c)(1)(A) treats a taxpayer ashaving made a constructive sale of an AFPif the taxpayer enters into a short sale ofthe same or substantially identical prop-erty.

Section 1259(c)(3)(A) provides an ex-ception (closed transaction exception) to§ 1259(a)(1) for certain closed transac-tions. The closed transaction exception dis-regards any transaction that would otherwisebe treated as a constructive sale during thetaxable year if: (i) the transaction is closedbefore the end of the 30th day after theclose of the taxable year; (ii) the taxpayerholds the AFP throughout the 60-day pe-riod beginning on the date the transactionis closed; and (iii) at no time during the 60-day period is the taxpayer’s risk of loss withrespect to the position reduced by reasonof a circumstance that would be describedin § 246(c)(4) if references to stock in-cluded references to the position. That is,the taxpayer must hold the AFP “unhedged”for a 60-day period beginning on the dateof the closing of the transaction that wouldotherwise be treated as a constructive sale.

If certain requirements are met, eventhough a subsequent risk-reducing trans-action would otherwise prevent the closedtransaction exception from applying to someprior transaction, § 1259(c)(3)(B) may causethe subsequent transaction to be disre-garded for this purpose. In general, this rule(the reestablished positions exception) ap-plies when a taxpayer closes out a trans-action (the prior transaction) that wouldotherwise cause a constructive sale of anAFP and, during the 60-day period follow-ing the closing of the prior transaction, thetaxpayer enters into a substantially simi-lar transaction (the subsequent transac-tion) that, if not disregarded, would violate

the “unhedged” 60-day period require-ment with respect to the prior transac-tion. The requirements are: (i) the priortransaction is closed during the taxable yearor during the 30 days thereafter; (ii) the sub-sequent transaction is substantially simi-lar to the prior transaction and wouldotherwise cause a constructive sale of theAFP; (iii) the subsequent transaction isclosed before the 30th day after the closeof the taxable year in which the prior trans-action occurs; and (iv) the 60-day unhedgedrequirements of § 1259(c)(3)(A)(ii) and (iii)are met with respect to the subsequent trans-action.

ANALYSIS

Short Sale 1

Short Sale 1 is described in § 1259(c)(1)and is closed before the end of the 30th dayafter 2002. In addition, A holds the 100shares of X stock for the 60-day period be-ginning on the date Short Sale 1 is closed.During part of the 60-day period begin-ning on the date Short Sale 1 is closed,however, A’s risk of loss with respect to Xstock is reduced because A entered intoShort Sale 2. Thus, Short Sale 1 fails theclosed transaction exception unless the re-established position exception causes ShortSale 2 to be disregarded.

Short Sale 2 is substantially similar toShort Sale 1, is entered into during the 60-day period beginning on the date Short Sale1 is closed, is described in § 1259(c)(1) andis closed by the deadline contained in§ 1259(c)(3)(B)(ii)(II). In addition, A holdsthe 100 shares of X stock for the 60-day pe-riod beginning on the date Short Sale 2 isclosed. During the 60-day period begin-ning on the date Short Sale 2 is closed,however, A’s risk of loss with respect to Xstock is reduced because A entered intoShort Sale 3. Thus, the reestablished po-sition exception does not cause Short Sale2 to be disregarded unless the reestab-lished position exception also causes ShortSale 3 to be disregarded.

Short Sale 3 is substantially similar toShort Sale 2, is entered into during the 60-day period beginning on the date Short Sale2 is closed, is described in § 1259(c)(1) andis closed by the deadline contained in§ 1259(c)(3)(B)(ii)(II). In addition, A holdsthe 100 shares of X stock for the 60-day pe-riod beginning on the date Short Sale 3 isclosed, and during the 60-day period be-ginning on the date Short Sale 3 is closed,

2003–3 I.R.B. 291 January 21, 2003

A’s risk of loss with respect to X stock isnot reduced. Accordingly, Short Sale 3 isdisregarded as a reestablished position withrespect to Short Sale 2, Short Sale 2 in turnis disregarded as a reestablished positionwith respect to Short Sale 1, and Short Sale1, therefore, is treated as a closed transac-tion under § 1259(c)(3)(A).

Short Sale 2

The next question is whether Short Sale2 causes a constructive sale or whether ittoo is disregarded for this purpose on thegrounds that it is a closed transaction. Theanalysis supporting the application of thatexception is similar to that for Short Sale1. Short Sale 2 is described in § 1259(c)(1)and is closed before the end of the 30th dayafter 2002. In addition, A holds the 100shares of X stock for the 60-day period be-ginning on the date Short Sale 2 is closed.During part of the 60-day period begin-ning on the date Short Sale 2 is closed,however, A’s risk of loss with respect to Xstock is reduced because A entered intoShort Sale 3. Thus, Short Sale 2 fails theclosed transaction exception unless ShortSale 3 is disregarded as a reestablished po-sition. As noted above, Short Sale 3 is dis-regarded as a reestablished position withrespect to Short Sale 2. Therefore, ShortSale 2 is also a closed transaction under§ 1259(c)(3)(A).

Short Sale 3

Short Sale 3 is described in § 1259(c)(1)and is closed before the end of the 30th dayafter 2002. In addition, A holds the 100shares of X stock for the 60-day period be-ginning on the date Short Sale 3 is closed.During the 60-day period beginning on thedate Short Sale 3 is closed, A’s risk of losswith respect to X stock is not reduced.Therefore, Short Sale 3 is a closed trans-action under § 1259(c)(3)(A).

Rapid Series of Transactions

A entered into Short Sale 3 on June 3,2002, more than 60 days after the date onwhich Short Sale 1 closed. If Short Sale 3had occurred within that 60-day period, theanalysis of Short Sale 1 would remain thesame except that, for Short Sale 1 to be aclosed transaction, Short Sale 3 would haveto be a reestablished position not only withrespect to Short Sale 2 but also with re-spect to Short Sale 1 directly. Thus, if A had

entered into Short Sale 2 on March 15,2002, closed Short Sale 2 on March 18,2002, entered into Short Sale 3 on March20, 2002, and closed Short Sale 3 on March25, 2002, Short Sale 3 would qualify to bedisregarded as a reestablished position withrespect to Short Sale 1 as well as with re-spect to Short Sale 2.

Decline in Value of the AFP

Section 1259(c)(3)(B)(ii)(I) describes asubsequent transaction that may be disre-garded as one “which also would other-wise be treated as a constructive sale of [theAFP].” For the reasons explained below, thisprovision requires only that the subse-quent transaction be a transaction describedin § 1259(c)(1) that would cause a con-structive sale of the AFP if the subsequenttransaction occurred on the date of enter-ing into the prior transaction. This provi-sion does not require that the subsequenttransaction independently would cause aconstructive sale based on appreciation inthe position at the time the subsequent trans-action occurs. Thus, the conclusion in thisruling that Short Sale 1 is a closed trans-action under § 1259(c)(3)(A) would ap-ply even if the 100 shares of X stock haddeclined in value below A’s basis at the timeA entered into each subsequent transac-tion.

Requiring appreciation of the 100 sharesof X stock owned by A at the time A en-ters into each subsequent transaction couldcause Short Sale 1 to fail the closed trans-action exception. For example, assume thaton the date that A entered into Short Sale3, the 100 shares of X stock still owned byA had declined in value below A’s basis. If§ 1259(c)(3)(B)(ii)(I) required that the Xstock be appreciated at that time, Short Sale3 would fail to be a disregarded, reestab-lished position with respect to Short Sale2. If Short Sale 3 were not disregarded, thenShort Sale 2 would fail the no-risk-reductionrequirement in § 1259(c)(3)(A)(iii), whichwould then cause Short Sale 2 to fail as adisregarded, reestablished position with re-spect to Short Sale 1.

Requiring appreciation when A entersinto subsequent transactions would createseveral unwarranted results. First, in cer-tain circumstances it would treat more fa-vorably a taxpayer, B, who has a lower taxbasis and, therefore, a larger amount of un-realized appreciation. Thus, if B holds ap-preciated X stock with a basis lower than

that of A and enters into a series of trans-actions identical to those of A, and if thevalue of the 100 shares of X stock at thetime of Short Sale 3 is higher than B’s ba-sis but lower than A’s basis, then A wouldrealize gain because of Short Sale 1 but Bwould not. Nothing in the statute or leg-islative history indicates that Congress in-tended this dissimilar treatment.

Second, requiring appreciation when Aenters into subsequent transactions wouldtreat A differently from a taxpayer, C, whoenters into only Short Sale 1 and holds thatshort position open until the date Short Sale3 is closed. Although C would have re-duced risk for a longer period of time thanA, Short Sale 1 would be a closed trans-action that is not subject to § 1259(a) forC but would be subject to § 1259(a) for A.There also is nothing in the statute or leg-islative history indicating that Congress in-tended this dissimilar treatment.

Third, requiring appreciation when A en-ters into subsequent transactions would cre-ate circularity problems if the value of theAFP at the time of the later short sale is be-tween the taxpayer’s original basis in theAFP and the value of the AFP at the timeof the first short sale. In these cases,whether the later short sale is a disregardedtransaction would depend on whether thefirst short sale produced a basis increase asa result of causing a constructive sale to oc-cur, which would depend, in turn, onwhether the later short sale is disregarded.As a consequence, many reestablished po-sitions would fail to meet the requirementthat they would otherwise be treated as aconstructive sale if the existence of unre-alized appreciation in the position weretested on the date of the subsequent trans-action and, for this purpose, the prior trans-action were treated, at least provisionally,as causing a constructive sale. Failure totreat the prior transaction as causing a con-structive sale, at least provisionally, wouldresult in the reestablished position failingto meet the requirement that the prior trans-action “would otherwise be treated as a con-structive sale.”

Consequently, ignoring changes in valueof the AFP after the initial transaction oc-curs avoids unwarranted, differential ap-plication of the closed transaction exceptionand also avoids a potential circularity prob-lem in the interpretation of the exception.When there is a series of more than twotransactions, the foregoing analysis also ap-

January 21, 2003 292 2003–3 I.R.B.

plies to any of the intermediate transac-tions for purposes of determining whetherthe reestablished positions exception al-lows the intermediate transaction to ben-efit from the closed transaction exception.

HOLDING

Section 1259(c)(3)(A) applies to ShortSale 1, Short Sale 2, and Short Sale 3.Therefore, A does not recognize gain pur-suant to § 1259(a)(1).

DRAFTING INFORMATION

The principal author of this revenueruling is Kate Sleeth of the Office of As-sociate Chief Counsel (Financial Institu-tions and Products). For further informationregarding this revenue ruling, contactMs. Sleeth at (202) 622–3920 (not a toll-free call).

Section 4975.—Tax on Pro-hibited Transactions

26 CFR 54–4975–11: “ESOP” requirements.

Whether an S corporation ESOP is eligible for the

delayed effective date of section 409(p) of the Inter-

nal Revenue Code as added by section 656(d)(2) of

the Economic Growth and Tax Relief Reconcilia-

tion Act of 2001. See Rev. Rul. 2003–6, page 286.

Section 4979A.—Tax on Cer-tain Prohibited Allocations ofQualified Securities

Whether transactions involving an S corporation

ESOP and the delayed effective date of section 409(p)

of the Internal Revenue Code, as added by section

656(d)(2) of the Economic Growth and Tax Relief

Reconciliation Act of 2001, may give rise to the ex-

cise tax on the prohibited allocation of qualified se-

curities. See Rev. Rul. 2003–6, page 286.

Section 6011.—General Re-quirement of Return, State-ment, or List

26 CFR 1.6011–4T: Requirement of statement dis-closing participation in certain transactions bycorporate taxpayers.

Whether transactions involving an S corporation

ESOP and the delayed effective date of section 409(p)

of the Internal Revenue Code, as added by section

656(d)(2) of the Economic Growth and Tax Relief

Reconciliation Act of 2001, are listed transactions. See

Rev. Rul. 2003–6, page 286.

Section 6111.—Registrationof Tax Shelters

26 CFR 301.6111–2T: Confidential corporate taxshelters.

Whether transactions involving an S corporation

ESOP and the delayed effective date of section 409(p)

of the Internal Revenue Code, as added by section

656(d)(2) of the Economic Growth and Tax Relief

Reconciliation Act of 2001, are listed transactions. See

Rev. Rul. 2003–6, page 286.

Section 6112.—Organizersand Sellers of Potentially Abu-sive Tax Shelters Must KeepLists of Investors

26 CFR 301.6112–1T: Questions and answers re-lating to the requirement to maintain a list of in-vestors in potentially abusive tax shelters.

Whether a list must be maintained identifying each

person who was sold an interest in transactions in-

volving an S corporation ESOP and the delayed ef-

fective date of section 409(p) of the Internal Revenue

Code, as added by section 656(d)(2) of the Eco-

nomic Growth and Tax Relief Reconciliation Act of

2001. See Rev. Rul. 2003–6, page 286.

2003–3 I.R.B. 293 January 21, 2003

Part III. Administrative, Procedural, and Miscellaneous

LIFO Recapture

Notice 2003–4

This notice provides information con-cerning the federal income tax consequencesof a taxpayer’s failure to timely make aninstallment payment attributable to the last-in, first-out (LIFO) recapture requirementof § 1363(d) of the Internal Revenue Code.

Section 1363(d)(1) provides that a C cor-poration that accounts for its inventory us-ing the LIFO method and elects Scorporation status must include a “LIFO re-capture amount” in gross income for the lasttaxable year before its S election becomeseffective. Under § 1363(d)(3), the LIFO re-capture amount is the excess of the inven-tory amount of the inventory assets underthe first-in, first-out method over the in-ventory amount of the assets under theLIFO method. The inventory amounts aredetermined as of the close of the taxableyear prior to the taxable year in which thetaxpayer’s S election becomes effective.

Section 1363(d)(2) requires payment ofthe additional tax that is attributable to theinclusion of the LIFO recapture amount ingross income in four equal installments. Thefirst installment payment must be made onor before the due date of the electing cor-poration’s last income tax return as a C cor-poration. An additional installment must bepaid on or before the due date of the cor-poration’s return for each of the 3 succeed-ing taxable years. No interest is payablewith regard to any installment payment thatis paid on or before the due date. Due datesare determined without regard to exten-sions.

A C corporation that accounts for its in-ventory using the LIFO method that electsS status but fails to include a LIFO recap-ture amount in gross income for the last tax-able year before its S election becomeseffective may be liable for a 20 percentaccuracy-related penalty pursuant to § 6662.A corporation that fails to make a LIFO re-capture installment payment by its requireddue date may be liable for a failure to paypenalty under § 6651.

A corporation that fails to make a LIFOrecapture installment payment by its re-quired due date is liable for interest un-

der § 6601, which requires payment ofinterest on the unpaid amount from the lastdate prescribed for payment to the date paid.When determining interest on underpay-ments, the “last date prescribed for pay-ment” is generally ascertained withoutregard to any extension of time for pay-ment or filing. However, under§ 1363(d)(2)(C), no interest is payable withregard to a LIFO recapture installment pay-ment that is paid by its due date.

Failure to pay, or late payment of, aLIFO recapture installment payment due un-der § 1363(d) does not cause any remain-ing unpaid installments to become dueimmediately. The authority in § 6159(b)(4)to alter or modify an installment agree-ment if the taxpayer fails to timely makean installment payment is limited to the spe-cific installment payments described in thatsection and does not apply to installmentpayments under § 1363(d).

DRAFTING INFORMATION

The principal author of this notice isScott Rabinowitz of the Office of the As-sociate Chief Counsel (Income Tax & Ac-counting). For further information regardingthis notice, contact Mr. Rabinowitz at (202)622–4970 (not a toll-free call).

Application of SeparateLimitations to Dividends FromNoncontrolled Section 902Corporations

Notice 2003–5

I. PURPOSE

This notice provides guidance relatingto the application of section 904 to divi-dends paid by a foreign corporation that isa noncontrolled section 902 corporation asdefined in section 904(d)(2)(E) (10/50 cor-poration).1 This guidance is necessary to re-flect the provisions of the Taxpayer ReliefAct of 1997 that modified the treatment ofdividends from 10/50 corporations in tax-able years beginning after December 31,2002 (post-2002 taxable years). Treasuryand the Service intend to issue regula-

tions concerning the treatment of divi-dends paid by a 10/50 corporation thatincorporate the guidance set forth in this no-tice.

II. BACKGROUND

Prior to the Taxpayer Relief Act of 1997(Public Law 105–34, 111 Stat. 788 (the1997 Act)), section 904(d)(1)(E) requireda domestic corporation meeting the stockownership requirements of section 902(a)(qualifying shareholder) to compute a sepa-rate foreign tax credit limitation for divi-dends received from each 10/50 corporation.The 1997 Act eliminated the requirementthat the foreign tax credit limitation be com-puted on the basis of a separate category(basket) for dividends from each 10/50 cor-poration, and instead provided that divi-dends paid by a 10/50 corporation out ofearnings and profits accumulated in post-2002 taxable years (post-2002 earnings)generally will be treated as income in aseparate basket based on the separate bas-ket of the underlying earnings and profitsbeing distributed (look-through treatment).Section 904(d)(4). Dividends paid by 10/50corporations that are not passive foreign in-vestment companies (PFICs) out of earn-ings and profits accumulated in taxableyears beginning before January 1, 2003(pre-2003 taxable years, and pre-2003 earn-ings), will be assigned to a single 10/50dividend basket. Dividends paid by each10/50 corporation that is a PFIC out of pre-2003 earnings will be assigned to a sepa-rate 10/50 dividend basket. Sections904(d)(1)(E) and 904(d)(2)(E)(iv).

The 1997 Act amendments provide look-through treatment to qualifying sharehold-ers for dividends paid by a 10/50corporation in a manner similar to the treat-ment of dividends paid by a controlled for-eign corporation (CFC). Dividends paid bya CFC to a U.S. shareholder (as defined insection 951(b)) are entitled to look-throughtreatment if the distribution is out of earn-ings and profits accumulated during peri-ods in which the CFC was a CFC. Sections904(d)(2)(E)(i) and 904(d)(3). A dividendpaid by a CFC out of earnings accumu-lated when the CFC was not a CFC but wasa 10/50 corporation is treated as a divi-dend from a 10/50 corporation. Accord-

1Unless otherwise noted, references to section 904 in this notice are to the Internal Revenue Code of 1986 (Code), as in effect for taxable years beginning after December 31, 2002.

January 21, 2003 294 2003–3 I.R.B.

ingly, such a dividend receives look-throughtreatment if paid out of post-2002 earn-ings, but is treated as income in the single10/50 dividend basket if paid out of pre-2003 earnings. Section 904(d)(3) extendslook-through treatment to interest, rents, androyalties paid to a U.S. shareholder by aCFC as well as to inclusions of income un-der section 951(a)(1)(A) (subpart F inclu-sions). In the case of a 10/50 corporation,however, only dividends paid out of post-2002 earnings are eligible for look-throughtreatment.

III. APPLICATION OFLOOK-THROUGH RULES TODIVIDENDS PAID BY 10/50CORPORATIONS IN POST-2002TAXABLE YEARS

A. In general

Under section 904(d)(4), dividends paidby a 10/50 corporation out of post-2002earnings generally will be eligible for look-through treatment. Dividends paid by a10/50 corporation out of pre-2003 earn-ings will be treated as income in the single10/50 dividend basket (or, in the case ofdividends from a PFIC, in a separate 10/50dividend basket). Sections 904(d)(1)(E) and904(d)(2)(E)(iv). Look-through treatmentalso applies to dividends paid by a CFC outof earnings accumulated during periodswhen it was a CFC. Section 904(d)(2)(E)(i).In light of this rule, Treasury and the Ser-vice believe that it is appropriate to pro-vide comparable treatment for dividendspaid by a 10/50 corporation out of suchearnings. Accordingly, the regulations willapply look-through treatment to dividendspaid by a 10/50 corporation out of pre-2003 earnings that were accumulated in pe-riods during which the 10/50 corporationwas a CFC, except as discussed below.

Proposed § 1.904–4(g)(3)(i)(C)(1) wouldnot provide look-through treatment in thecase of earnings accumulated while the dis-tributing corporation was a CFC but dis-tributed after a pre-2003 intervening periodduring which the distributing corporationwas a 10/50 corporation. See also Pro-posed § 1.904–4(g)(3)(i)(C)(2) (providingthe same result more generally where alook-through corporation has an interven-ing period during which such corporationwas not a look-through corporation). Trea-sury and the Service are considering modi-fying the proposed regulations when they

are finalized to provide for look-throughtreatment in such cases.

B. Distributions by 10/50 corporationsout of pre-acquisition earnings andprofits

The Secretary is authorized to prescriberegulations regarding the treatment of dis-tributions by a 10/50 corporation out ofearnings and profits accumulated in peri-ods prior to the taxpayer’s acquisition of thestock. See section 904(d)(4)(C)(ii)(II). Pur-suant to this authority, the regulations willapply look-through treatment to dividendspaid to a new qualifying shareholder by a10/50 corporation out of post-2002 earn-ings accumulated during periods when theforeign corporation was either a 10/50 cor-poration with respect to any qualifyingshareholder or a CFC but before the re-cipient became a shareholder of the cor-poration. The regulations also will providethat dividends paid by a 10/50 corpora-tion out of post-2002 earnings accumu-lated in periods when the 10/50 corporationwas neither a 10/50 corporation with re-spect to any qualifying shareholder nor aCFC are assigned to the single 10/50 divi-dend basket in the case of a distributionfrom a 10/50 corporation that is not a PFIC,and to a separate 10/50 dividend basket inthe case of a 10/50 corporation that is aPFIC. Consistent with § 1.904–4(g)(3)(iii)(concerning earnings accumulated in thetaxable year in which a corporation be-comes a CFC), the regulations also will pro-vide that earnings and profits accumulatedin the taxable year in which the corpora-tion became a 10/50 corporation will beconsidered earnings and profits accumu-lated after the corporation became a 10/50corporation.

C. Ordering rule for post-2002distributions from 10/50 corporations

Under section 902(c)(3), the multi-yearpools of post-1986 undistributed earnings(as defined in section 902(c)(1)) and post-1986 foreign income taxes (as defined insection 902(c)(2)) of a foreign corpora-tion are determined by taking into accountonly periods beginning on and after the firstday of the foreign corporation’s first tax-able year in which a domestic corpora-tion owns 10 percent or more of its votingstock, or in the case of a lower-tier for-eign corporation, such corporation is a

member of a “qualified group” (as definedin section 902(b)(2)).

Under section 902(c)(6)(B)(i), dividendsare treated as paid first out of the post-1986 undistributed earnings. Pre-1987 ac-cumulated profits (defined in section902(c)(6)(A) and § 1.902–1(a)(10) to in-clude both earnings accumulated in pre-1987 taxable years and earningsaccumulated in post-1986 taxable years pre-ceding the first year in which the foreigncorporation has a qualifying shareholder) aretreated as distributed only after the poolsof post-1986 undistributed earnings are ex-hausted, and then out of annual layers ofearnings and taxes on a last-in, first-out(LIFO) basis. Distributions out of pre-1987 accumulated profits are governed bythe section 902 rules in effect under pre-1987 law. Section 902(c)(6)(A).

Section 1.904–4(g)(3)(i)(B) sets forth aLIFO ordering rule for determining theearnings to which a dividend paid by a CFCis attributable. The dividend is deemedmade first from the pools of post-1986 un-distributed earnings attributable to the pe-riod after the corporation was a CFC (look-through pools), next from the non-look-through pool of post-1986 undistributedearnings (as defined in § 1.904–4(g)(3)(iv)(B)), if any, and finally on a LIFObasis from the annual layers of pre-1987 ac-cumulated profits. Since 10/50 corpora-tions will be considered look-throughentities beginning in post-2002 taxableyears, the regulations will provide a simi-lar LIFO ordering rule for dividends froma 10/50 corporation. Specifically, a divi-dend from a 10/50 corporation will bedeemed made first from post-1986 undis-tributed earnings attributable to the post-2002 period when the corporation waseligible for look-through; second, from thenon-look-through pool of post-1986 undis-tributed earnings; and finally, on a LIFO ba-sis from pre-1987 accumulated profits.Treasury and the IRS request comments onthe allocation of deficits in the look-throughpools or the non-look-through pool in de-termining the earnings to which a divi-dend from a 10/50 corporation isattributable, consistent with the rules of§ 1.902–2.

2003–3 I.R.B. 295 January 21, 2003

IV. ALLOCATING ANDAPPORTIONING EXPENSES OF 10/50CORPORATIONS; DIVIDENDS PAIDBY LOWER-TIER CORPORATIONS

A. Expense allocation

Because 10/50 corporations will betreated as look-through entities with re-spect to certain dividends paid in post-2002 taxable years, deductible expenses ofa 10/50 corporation will reduce the corpo-ration’s pools of post-1986 undistributedearnings. The regulations will generally pro-vide that expenses of a 10/50 look-throughcorporation will be allocated and appor-tioned in the same manner as expenses ofa CFC. See, e.g., section 954(b)(5); § 1.904–5(c)(2)(ii).

However, the regulations will not ex-tend the special allocation rule for relatedperson interest expense under section954(b)(5) and § 1.904–5(c)(2)(ii) (provid-ing that interest paid by a CFC to a U.S.shareholder or any related look-through en-tity is first allocated to reduce foreign per-sonal holding company income which ispassive income) to interest paid by 10/50corporations, since such corporations are notlook-through entities with respect to inter-est payments and are not subject to sub-part F. Accordingly, all interest paid by a10/50 corporation will be apportioned to re-duce the payor’s pools of post-1986 un-distributed earnings under the rulesapplicable to unrelated person interest ex-pense.

B. Look-through treatment of dividendspaid by certain lower-tier corporations

In order for a taxpayer to qualify forlook-through treatment with respect to adividend from a 10/50 corporation, the tax-payer must be a qualifying shareholder withrespect to the 10/50 corporation. Sections904(d)(2)(E) and 904(d)(4). Because ashareholder’s eligibility for look-throughtreatment under section 904(d)(4) is basedon the eligibility requirements under sec-tion 902, the regulations will apply look-through treatment to a dividend paid by a10/50 corporation to another foreign cor-poration where the recipient is eligible tocompute foreign taxes deemed paid un-der section 902(b)(1), (i.e., where both thepayor and payee corporations are mem-bers of the same qualified group as de-fined in section 902(b)(2)).

A taxpayer’s eligibility for look-throughtreatment of a dividend paid by a 10/50 cor-poration is based on eligibility require-ments under section 902. In contrast, ataxpayer’s eligibility for look-through treat-ment of a dividend from a CFC is based onwhether the taxpayer is a U.S. shareholderwith respect to the CFC. See sections904(d)(3)(A) and 904(d)(3)(D). Treasuryand the Service believe that the eligibilityrequirements for look-through treatment for10/50 corporations and CFCs should beconformed to the extent possible, taking intoaccount the differing eligibility require-ments under the Code for look-throughtreatment of dividends from CFCs and10/50 corporations. Accordingly, the regu-lations will apply look-through treatment toany dividend paid by a CFC to anothermember of the same qualified group (as de-fined in section 902(b)). Finally, the regu-lations will retain the current rule of§ 1.904–5(i)(3), to the extent it applies look-through treatment to dividends betweenCFCs that have a common 10 percent U.S.shareholder but do not meet the qualifiedgroup test.

C. Tax accounting elections

Section 1.964–1(c)(3) permits “control-ling U.S. shareholders” of a CFC to makeor change tax accounting elections on be-half of the CFC. The controlling U.S. share-holders must meet several requirementsbefore an election is deemed made on be-half of the CFC. See § 1.964–1(c)(3). Sec-tion 1.861–9T(f)(3)(ii) provides similar rulesto allow the controlling U.S. shareholdersto elect the asset method or modified grossincome method for purposes of apportion-ing interest expense.

The regulations will apply similar rulesin order to provide a mechanism for share-holders of a 10/50 corporation to make orchange tax elections on behalf of the cor-poration for purposes of computing the10/50 corporation’s earnings and profits forU.S. tax purposes. Specifically, the regu-lations will permit the majority domesticcorporate shareholders of a 10/50 corpo-ration to make or change tax elections onbehalf of the corporation (subject to gen-erally applicable restrictions, such as elec-tions requiring the consent of theCommissioner). The term “majority do-mestic corporate shareholders” means thosedomestic corporations that meet the own-ership requirements of section 902(a) with

respect to the 10/50 corporation (or to afirst-tier foreign corporation that is a mem-ber of the same qualified group as the 10/50corporation), that, in the aggregate, own di-rectly or indirectly more than 50 percent ofthe combined voting power of all of the vot-ing stock of the 10/50 corporation that isowned directly or indirectly by all domes-tic corporations that meet the ownership re-quirements of section 902(a) with respectto the 10/50 corporation (or a relevant first-tier foreign corporation). See § 1.985–2(c)(3)(i).

V. CARRYOVERS AND CARRYBACKSOF EXCESS FOREIGN TAXES UNDERSECTION 904(c)

Section 904(c) provides that to the ex-tent a taxpayer’s foreign income taxes paidor accrued in any taxable year exceed thelimitation under section 904 for that year,the excess is carried back first to the sec-ond taxable year preceding the taxable year,and then to the first taxable year preced-ing the taxable year, and finally is carriedforward to the five taxable years follow-ing the taxable year. As discussed below,regulations will provide transition rules forthe carryover and carryback of excess for-eign income taxes (excess credits) betweenpre-2003 taxable years (when pre-2003 dis-tributions from 10/50 corporations aretreated as income in separate 10/50 divi-dend baskets) and post-2002 taxable years(when distributions out of post-2002 earn-ings are subject to look-through treatment,and distributions out of pre-2003 earn-ings are treated as income in the single10/50 dividend basket or, in the case of aPFIC, a separate 10/50 dividend basket).

Except as discussed below in Part VI.A,to the extent a taxpayer has pre-2003 ex-cess credits in any non-PFIC separate 10/50dividend basket and these credits are car-ried forward to post-2002 taxable years, theregulations will provide that such creditsmay be used to the extent that the single10/50 dividend basket has excess foreigntax credit limitation. This treatment is con-sistent with consolidating in the single 10/50dividend basket dividends paid by all non-PFIC 10/50 corporations out of pre-2003 ac-cumulated earnings. Treasury and theService do not believe that it is consis-tent with the statute to carry forward ex-cess credits in the separate 10/50 dividendbaskets, on a look-through basis, to the bas-kets to which dividends paid by a 10/50

January 21, 2003 296 2003–3 I.R.B.

corporation out of post-2003 earnings areassigned. Excess credits in separate 10/50dividend baskets should be carried for-ward to the single 10/50 dividend basketand not the look-through baskets becausesuch excess credits are most appropriatelyassociated with pre-2003 earnings, divi-dends out of which are allocated to thesingle 10/50 dividend basket.

With respect to carrybacks of excesscredits from post-2002 taxable years to pre-2003 taxable years, the regulations will ap-ply a rule similar to the carryforward rulediscussed above: to the extent a taxpayerhas post-2002 excess credits in the single10/50 dividend basket and these credits arecarried back to pre-2003 taxable years, thecredits will reduce excess limitation in sepa-rate 10/50 dividend baskets (other than10/50 dividend baskets with respect toPFICs). If the amount of credits carried backto the 2001 or 2002 taxable year is smallerthan the aggregate excess limitation in allof the taxpayer’s separate 10/50 dividendbaskets for the year, the regulations will pro-vide that the amount will be allocated prorata among the non-PFIC separate 10/50dividend baskets based on the relativeamount of excess limitation in each suchbasket. The regulations will provide that tothe extent a taxpayer has post-2002 ex-cess credits in a look-through basket andthese credits are carried back to pre-2003taxable years, the credits will be carriedback within the same look-through bas-ket and not to the separate 10/50 divi-dend baskets. Excess credits in one separate10/50 dividend basket carried forward fromtaxable years beginning in 1998–2002 can-not then be carried back to reduce excesslimitation in a different separate 10/50 divi-dend basket with excess limitation in tax-able years beginning in 2001 or 2002.Under section 904(c), only foreign taxes thatare paid or accrued in a taxable year (andnot taxes that are carried forward from aprior taxable year) are eligible to be car-ried back to prior taxable years.

VI. SEPARATE LIMITATION LOSSESAND OVERALL FOREIGN LOSSES

Section 904(f) contains rules for allo-cating and recapturing foreign losses. To theextent a loss in a separate basket (sepa-rate limitation loss or SLL) exceeds in-come in the same basket, the SLL isallocated to and reduces income in otherbaskets on a proportionate basis. Section

904(f)(5)(B). The SLL is subject to recap-ture in subsequent years to the extent in-come is earned in the loss basket. Section904(f)(5)(C). An overall foreign loss (OFL)arises where there is a loss in all of a tax-payer’s baskets combined. To the extent anOFL reduces U.S. source taxable income,it is subject to recapture in subsequent yearsat a rate of 50 percent (or such larger per-cent as the taxpayer may choose) of anyforeign source income earned. Section904(f)(1); § 1.904(f)–1(d)(1). Since all thenon-PFIC separate 10/50 dividend bas-kets will be replaced by a single 10/50 divi-dend basket in post-2002 taxable years, theregulations will provide transition rules, asdescribed below, for recapture in a post-2002 taxable year of (1) an OFL or SLL ina separate 10/50 dividend basket that off-set U.S. source income or foreign sourceincome in other baskets in a pre-2003 tax-able year, and (2) an SLL in another bas-ket (e.g., the general or passive basket) thatoffset income in a separate 10/50 divi-dend basket in a pre-2003 taxable year.

A. Recapture of an OFL or SLL arisingin a separate 10/50 dividend basket

The regulations will provide that a tax-payer consolidates OFL and SLL accountsof non-PFIC separate 10/50 dividend bas-kets (i.e., OFLs and SLLs arising in non-PFIC separate 10/50 dividend baskets thatoffset U.S. source income or foreign sourceincome in other baskets, respectively) intoone set of OFL and SLL accounts of thesingle 10/50 dividend basket beginning inthe taxpayer’s first post-2002 taxable year.Thus, for example, where a taxpayer hadOFLs and SLLs in non-PFIC separate 10/50dividend baskets that offset U.S. source in-come and foreign source income in the gen-eral and passive baskets, the OFL and SLLrecapture accounts will be consolidated inthe single 10/50 dividend basket, and in-come subsequently earned in the single10/50 dividend basket will be recaptured asU.S. source income and foreign source in-come in the general and passive baskets tothe extent of the respective OFL and SLLcombined accounts. Any SLL recapture ac-count in a non-PFIC separate 10/50 divi-dend basket with respect to another non-PFIC separate 10/50 dividend basket willbe eliminated since “recapture” to and fromthe single 10/50 dividend basket would bemeaningless.

Treasury and the Service recognize thatrequiring taxpayers to consolidate the sepa-rate 10/50 OFL and SLL recapture accountsinto one set of OFL and SLL accounts ofthe single 10/50 dividend basket may be un-favorable to taxpayers that have an OFL orSLL account in a separate 10/50 dividendbasket and that no longer are qualifyingshareholders with respect to the foreign cor-poration. In pre-2003 taxable years, recap-ture of the OFL or SLL account would notoccur because the taxpayer would not re-ceive any additional dividends from the cor-poration that would be treated as 10/50dividend income in the separate 10/50 lossbasket (unless the former shareholder re-acquired a sufficient interest in the corpo-ration to become a qualifying shareholder).Accordingly, the regulations will providethat where a taxpayer no longer is a quali-fying shareholder with respect to a for-eign corporation on December 20, 2002 (orno longer is a qualifying shareholder on thefirst day of the taxpayer’s first post-2002taxable year, pursuant to a transaction thatis the subject of a binding contract whichis in effect on December 20, 2002), anyOFL or SLL recapture accounts with re-spect to the taxpayer’s separate 10/50 divi-dend basket for that corporation will not beconsolidated into the single 10/50 divi-dend basket’s OFL and SLL accounts.

Consistent with the exception for OFLand SLL accounts with respect to stock ofa foreign corporation in which the tax-payer is no longer a qualifying shareholder,the regulations will not permit a taxpayerto carry over excess credits arising in sepa-rate 10/50 dividend baskets to the single10/50 dividend basket where OFL and SLLaccounts in the separate 10/50 dividend bas-kets are not consolidated into the OFL andSLL accounts of the single 10/50 divi-dend basket. However, the regulations willallow a taxpayer to elect to carry over allexcess credits in non-PFIC separate 10/50dividend baskets to the single 10/50 divi-dend basket if the taxpayer consolidates theOFL and SLL recapture accounts of all suchseparate 10/50 dividend baskets into theOFL and SLL accounts of the single 10/50dividend basket.

B. Recapture of an SLL arising in otherbaskets

The regulations will provide that to theextent an SLL in another basket (e.g., thegeneral or passive basket) offset income in

2003–3 I.R.B. 297 January 21, 2003

a non-PFIC separate 10/50 dividend bas-ket in a pre-2003 taxable year, income inthe loss basket subsequently earned in post-2002 taxable years will be recaptured as in-come in the single 10/50 dividend basket.Recapturing SLL accounts that originallyoffset income in separate 10/50 dividendbaskets as income in the single 10/50 divi-dend basket is consistent with the rule (dis-cussed in Part V, above) permittingtaxpayers to carry over excess credits fromseparate 10/50 dividend baskets into thesingle 10/50 dividend basket. For example,assume a general basket SLL offset in-come in a separate 10/50 dividend bas-ket. In such a case, any excess credits inthat separate 10/50 basket will carry overto the single 10/50 dividend basket, andgeneral basket income in a post-2002 tax-able year will be recharacterized as in-come in the single 10/50 dividend basket.

VII. TREATMENT OF SEPARATE 10/50DIVIDEND BASKETS MAINTAINED ATTHE CFC LEVEL

Where a CFC has non-PFIC separate10/50 dividend baskets containing earn-ings and deficits accumulated in pre-2003taxable years, the regulations will require,as a general rule, that the earnings and defi-cits be consolidated in and form the open-ing balance of the earnings pool of thesingle 10/50 dividend basket beginning inthe CFC’s first U.S. post-2002 taxable year.The pools of post-1986 foreign incometaxes in the non-PFIC separate 10/50 divi-dend baskets similarly will be consoli-dated in the post-1986 foreign income taxespool of the single 10/50 dividend basket.However, a separate 10/50 dividend bas-ket containing non-look-through earningsof the CFC accumulated in periods prior tobecoming a CFC will not be consolidated.These earnings will be treated as earn-ings in the non-look-through pool of post-1986 undistributed earnings, which aredeemed distributed only after distribu-tions exhaust the post-1986 look-throughpools, which include the earnings in thepool of the post-2002 single 10/50 divi-dend basket. See § 1.904–4(g)(3)(i)(B).

The regulations also will provide an ex-ception from the general rule combiningearnings and deficits and foreign incometaxes where a CFC has an accumulateddeficit in a separate 10/50 dividend bas-ket with respect to stock in a foreign cor-poration that is no longer a member of a

qualified group that includes the CFC. Trea-sury and the Service were concerned thatrequiring consolidation in this case couldresult in a large deficit in the single 10/50dividend basket for some CFCs. Treasuryand the Service also believe it is appropri-ate in this situation to simplify the gen-eral rule requiring the ratable allocation ofdeficits in determining deemed-paid taxesin connection with distributions or inclu-sions. See § 1.960–1(i)(4). Accordingly, theregulations will provide that where a CFChas a deficit in a separate 10/50 dividendbasket with respect to stock in a foreign cor-poration that is not a member of a quali-fied group that includes the CFC onDecember 20, 2002 (or is not a qualifiedgroup member on the first day of the CFC’sfirst post-2002 taxable year pursuant to abinding contract in effect on December 20,2002), the deficit in the separate 10/50 divi-dend basket will not be consolidated in theopening balance of the CFC’s single 10/50dividend basket. Instead, the deficit will beallocated to reduce post-1986 undistrib-uted earnings in the CFC’s other baskets(ratably on the basis of accumulated earn-ings in the other baskets as of the first dayof the CFC’s first post-2002 taxable year),and the deficit will be permanently re-duced to zero. In pre-2003 taxable years,only dividend income from the same 10/50corporation could eliminate the deficit in theseparate 10/50 dividend basket, so that ifthe 10/50 corporation was no longer a mem-ber of the same qualified group as the CFC,the CFC would not have any additionalearnings in that basket out of which to paya dividend, and its U.S. shareholder there-fore would be ineligible to claim an indi-rect credit with respect to any foreign taxesin the deficit basket. See § 1.902–1(b)(4).Accordingly, any foreign taxes in the sepa-rate 10/50 dividend basket will remain inthat basket, and a qualifying shareholder ofthe CFC generally will not be eligible toclaim an indirect credit for these taxes.

VIII. EFFECTIVE DATE

Regulations to be issued relating to theguidance set forth in this notice will be ef-fective for taxable years beginning after De-cember 31, 2002. Until such regulations areissued, taxpayers may rely on this notice.

IX. REQUEST FOR COMMENTS ANDCONTACT INFORMATION

Treasury and the Service request com-ments on the rules described in this no-tice and any additional issues that shouldbe addressed by regulations. Written com-ments may be submitted to the Office ofAssociate Chief Counsel (International),Attention: Ginny Chung (Notice 2003–5), room 4555, CC:INTL:Br3, Internal Rev-enue Service, 1111 Constitution Avenue,NW, Washington, DC 20224. Alternatively,taxpayers may submit comments electroni-cally to Notice.Comments@m1.irscounsel.treas.gov. Comments will be available forpublic inspection and copying. Treasury andthe IRS request comments by February 18,2003. For further information regarding thisnotice, contact Ginny Chung of the Of-fice of Associate Chief Counsel (Interna-tional) at (202) 622–3850 (not a toll-freecall).

Extension of Relief Relating toApplication ofNondiscrimination Rules forCertain Governmental Plans

Notice 2003–6I. PURPOSE

The Internal Revenue Service and theTreasury intend to issue regulations that willprovide further guidance on the applica-tion of the nondiscrimination requirementsof the Internal Revenue Code for govern-mental plans within the meaning of§ 414(d), other than for plans of State andlocal governments or political subdivi-sions, agencies or instrumentalities thereof.It is anticipated that these regulations willprovide that such governmental plans willbe deemed to satisfy §§ 401(a)(4),401(a)(26), 401(k)(3), and 401(m) of theCode until the first day of the first plan yearbeginning on or after the date final regu-lations are issued. In addition, this noticerequests comments on how the nondis-crimination requirements should be ap-plied to such governmental plans underthese regulations.

II. BACKGROUND

Section 414(d) of the Code provides thatthe term “governmental plan” means a planestablished and maintained for its employ-

January 21, 2003 298 2003–3 I.R.B.

ees by the government of the United States,by the government of any State or politi-cal subdivision thereof, or by any agencyor instrumentality of any of the forego-ing. The term “governmental plan” also in-cludes any plan to which the RailroadRetirement Act of 1935 or 1937 (the “Act”)applies and which is financed by contri-butions under that Act, and any plan of aninternational organization which is ex-empt from taxation by reason of the Inter-national Organizations Immunities Act (59Stat. 669).

Section 1505 of the Taxpayer Relief Actof 1997 (“TRA ’97”) generally provides thatthe nondiscrimination rules do not apply toState and local governmental plans. In par-ticular, § 1505 of TRA ’97 amended theCode to provide that §§ 401(a)(3),401(a)(4), and 401(a)(26) shall not apply tosuch plans. Section 1505 of TRA ’97amended § 401(k) of the Code to providethat State and local governmental plans shallbe treated as meeting the requirements of§ 401(k)(3). In addition, § 1505(a)(3) ofTRA ’97 amended § 410(c) of the Code toprovide that governmental plans shall betreated as meeting the requirements of § 410for purposes of § 401(a). This amendmentto § 410(c), by its terms, is not limited toState and local governmental plans but ap-plies to all governmental plans within themeaning of § 414(d).

Notice 2001–46, 2001–2 C.B. 122, pro-vided that governmental plans, other than

plans maintained by State or local govern-ments or political subdivisions or instru-mentalities thereof, would be deemed tosatisfy §§ 401(a)(4), 401(a)(26), 401(k)(3),and 401(m) of the Internal Revenue Codeuntil the first day of the first plan year be-ginning on or after January 1, 2003. No-tice 2001–46 also provided that theregulations relating to these provisionswould not apply until plan years begin-ning on or after that date.

III. EXTENSION OF RELIEFRELATING TO APPLICATION OFNONDISCRIMINATION RULESFOR CERTAIN GOVERNMENTALPLANS

It is anticipated that future regulationswill provide that governmental plans withinthe meaning of § 414(d), other than thosemaintained by State or local governmentsor political subdivisions, agencies or in-strumentalities thereof, shall be treated assatisfying the requirements of §§ 401(a)(4),401(a)(26), 401(k)(3), and 401(m) until thefirst day of the first plan year beginning onor after the date final regulations describ-ing the application of these provisions tosuch plans are issued.

IV. REQUEST FOR COMMENTS

The Service and Treasury request com-ments on how the nondiscrimination re-quirements described above should beapplied to governmental plans within the

meaning of § 414(d) other than those main-tained by State or local governments or po-litical subdivisions, agencies orinstrumentalities thereof. Comments shouldbe submitted by February 28, 2003, toCC:ITA:RU (Notice 2003–6), Room 5226,Internal Revenue Service, POB 7604 BenFranklin Station, Washington, D.C. 20044.Comments may be hand-delivered betweenthe hours of 8 a.m. and 4 p.m., Mondaythrough Friday to CC:ITA:RU (Notice2003–6), Courier’s Desk, Internal Rev-enue Service, 1111 Constitution Ave., NW,Washington D.C. Alternatively, commentsmay be submitted via the Internet atNotice.Comments@irscounsel.treas.gov. Allcomments will be available for public in-spection.

V. EFFECT ON OTHERDOCUMENTS

Notice 2001–46 is modified.

DRAFTING INFORMATION

The principal author of this notice isDiane S. Bloom of Employee Plans, TaxExempt and Government Entities Divi-sion. For further information regarding thisnotice, contact the Employee Plans tax-payer assistance telephone service betweenthe hours of 8:00 a.m. and 6:30 p.m. East-ern Time, Monday through Friday, by call-ing (877) 829–5500 (a toll-free number).Ms. Bloom may be reached at (202) 283–9888 (not a toll-free number).

2003–3 I.R.B. 299 January 21, 2003

Part IV. Items of General Interest

Notice of ProposedRulemaking

Rents and Royalties

REG–151043–02

AGENCY: Internal Revenue Service (IRS),Treasury.

ACTION: Notice of proposed rulemak-ing.

SUMMARY: This document contains pro-posed regulations relating to the inclu-sion in gross income of advance rentals. Theproposed regulations authorize the Com-missioner to provide rules allowing for theinclusion of advance rentals in gross in-come in a year other than the year of re-ceipt. The proposed regulations will affecttaxpayers that receive advance payments forthe use of certain items (such as intellec-tual property) to be designated by the Com-missioner.

DATES: Written or electronic commentsand requests for a public hearing must bereceived by February 17, 2003.

ADDRESSES: Send submissions to:CC:ITA:RU (REG–151043–02), room 5226,Internal Revenue Service, P.O. Box7604, Ben Franklin Station, Washington,DC 20044. Submissions may be hand de-livered Monday through Friday between thehours of 8 a.m. and 4 p.m. to: CC:ITA:RU(REG–151043–02), Courier’s Desk Inter-nal Revenue Service, 1111 Constitution Av-enue, NW, Washington, DC Alternatively,taxpayers may submit electronic commentsdirectly to the IRS Internet site atwww.irs.gov/regs.

FOR FURTHER INFORMATION CON-TACT: Concerning the proposed regula-tions, Edwin B. Cleverdon, at (202) 622–7900; concerning submissions of comments,Guy Traynor, at (202) 622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposedamendments to 26 CFR part 1 relating to

the inclusion in gross income of advancerentals under section 61.

Explanation of Provisions

Currently § 1.61–8(b) provides that, ex-cept as provided in section 467 and theregulations thereunder, advance rentals mustbe included in gross income in the year ofreceipt regardless of the period covered orthe method of accounting employed by thetaxpayer. The proposed amendments au-thorize the Commissioner to provide,through administrative guidance, rules fordeferring income inclusion of advance rent-als to a taxable year other than the year ofreceipt. This amendment will ensure that theCommissioner, in modifying Rev. Proc. 71–21, 1971–2 C.B. 549, may provide defer-ral rules for licenses of intellectual property.

Proposed Effective Date

The regulations, as proposed, are effec-tive on the date of publication of a Trea-sury decision adopting these rules as finalregulations in the Federal Register.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in Ex-ecutive Order 12866. Therefore, a regulatoryassessment is not required. It has also beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to these regulationsand, because the regulations do not im-pose a collection of information on smallentities, the Regulatory Flexibility Act (5U.S.C. chapter 6) does not apply. Pursu-ant to section 7805(f) of the Internal Rev-enue Code, this notice of proposedrulemaking will be submitted to the ChiefCounsel for Advocacy of the Small Busi-ness Administration for comment on its im-pact on small business.

Comments and Requests for a PublicHearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written (a signed origi-nal and eight (8) copies) or electronic com-ments that are submitted timely to the IRS.

The IRS and the Treasury Department spe-cifically request comments on the clarity ofthe proposed regulations and how they canbe made easier to understand. All com-ments will be available for public inspec-tion and copying. A public hearing may bescheduled if requested in writing by anyperson that timely submits written com-ments. If a public hearing is scheduled, no-tice of the date, time, and place for thehearing will be published in the FederalRegister.

Drafting Information

The principal author of these regula-tions is Edwin B. Cleverdon, Office of As-sociate Chief Counsel (Income Tax andAccounting). However, other personnel fromthe IRS and Treasury Department partici-pated in their development.

* * * * *

Proposed Amendment to the Regula-tions

Accordingly, 26 CFR part 1 is proposedto be amended as follows:

PART—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. In § 1.61–8, the first sentence of

paragraph (b) is revised to read as follows:

§ 1.61–8 Rents and royalties.* * * * *(b) * * * Except as provided in sec-

tion 467 and the regulations thereunder, andexcept as otherwise provided by the Com-missioner in published guidance (see§ 601.601(d)(2) of this chapter), gross in-come includes advance rentals, which mustbe included in income for the year of re-ceipt regardless of the period covered or themethod of accounting employed by the tax-payer. * * *

David A. Mader,Assistant Deputy Commissioner

of Internal Revenue.

(Filed by the Office of the Federal Register on December 17, 2002, 8:45

a.m., and published in the issue of the Federal Register for December

18, 2002, 67 F.R. 77450)

January 21, 2003 300 2003–3 I.R.B.

New Form 8883, AssetAllocation Statement UnderSection 338

Announcement 2003–2

The IRS has released new Form 8883,Asset Allocation Statement Under Section338. Form 8883 is used to report informa-tion about transactions involving the deemedsale of corporate assets under section 338.

You can obtain Form 8883 by telephoneor by using IRS electronic information ser-vices.

Request by Number or address

Telephone 1–800–TAX–FORM(1–800–829–3676)

Personal Computer:

IRS Web SiteFile transfer protocol

www.irs.govftp.irs.gov

2003–3 I.R.B. 301 January 21, 2003

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as“rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe theeffect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus, ifan earlier ruling held that a principleapplied to A, and the new ruling holdsthat the same principle also applies to B,the earlier ruling is amplified. (Comparewith modified, below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previouslypublished ruling and points out an essen-tial difference between them.

Modified is used where the substanceof a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A but notto B, and the new ruling holds that it

applies to both A and B, the prior rulingis modified because it corrects a pub-lished position. (Compare with amplifiedand clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly usedin a ruling that lists previously publishedrulings that are obsoleted because ofchanges in law or regulations. A rulingmay also be obsoleted because the sub-stance has been included in regulationssubsequently adopted.

Revoked describes situations where theposition in the previously published rul-ing is not correct and the correct positionis being stated in the new ruling.

Superseded describes a situation wherethe new ruling does nothing more thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over aperiod of time in separate rulings. If the

new ruling does more than restate thesubstance of a prior ruling, a combinationof terms is used. For example, modifiedand superseded describes a situationwhere the substance of a previously pub-lished ruling is being changed in part andis continued without change in part and itis desired to restate the valid portion ofthe previously published ruling in a newruling that is self contained. In this case,the previously published ruling is firstmodified and then, as modified, is super-seded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further namesin subsequent rulings. After the originalruling has been supplemented severaltimes, a new ruling may be published thatincludes the list in the original ruling andthe additions, and supersedes all prior rul-ings in the series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in currentuse and formerly used will appear inmaterial published in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.

E.O.—Executive Order.ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign Corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.

PO—Possession of the U.S.PR—Partner.PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statements of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D.—Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z—Corporation.

January 21, 2003 i 2003–3 I.R.B.

Numerical Finding List1

Bulletins 2003–1 and 2

Announcements:

2003–1, 2003–2 I.R.B. 281

Notices:

2003–1, 2003–2 I.R.B. 2572003–2, 2003–2 I.R.B. 2572003–3, 2003–2 I.R.B. 258

Proposed Regulations:

REG–209500–86, 2003–2 I.R.B. 262REG–164464–02, 2003–2 I.R.B. 262

Revenue Procedures:

2003–1, 2003–1, I.R.B. 12003–2, 2003–1, I.R.B. 762003–3, 2003–1, I.R.B. 1132003–4, 2003–1, I.R.B. 1232003–5, 2003–1, I.R.B. 1632003–6, 2003–1, I.R.B. 1912003–7, 2003–1, I.R.B. 2332003–8, 2003–1, I.R.B. 2362003–10, 2003–2 I.R.B. 259

Revenue Rulings:

2003–2, 2003–2 I.R.B. 2512003–3, 2003–3 I.R.B. 2522003–4, 2003–4 I.R.B. 2532003–5, 2003–5 I.R.B. 254

1 A cumulative list of all revenue rulings, revenue

procedures, Treasury decisions, etc., published in

Internal Revenue Bulletins 2002–26 through 2002–52 is

in Internal Revenue Bulletin 2003–1, dated January 6, 2003.

2003–3 I.R.B. ii January 21, 2003

Finding List of Current Actionson Previously Published Items2

Bulletins 2003–1 and 2

Notices:

97–19Modified byRev. Proc. 2003–1, 2003–1 I.R.B. 1

2001–69Modified and superseded byNotice 2003–1, 2003–2 I.R.B. 257

2002–27Clarified byNotice 2003–3, 2003–2 I.R.B. 258

Revenue Procedures:

84–37Modified byRev. Proc. 2003–1, 2003–1 I.R.B. 1

2002–1Superseded byRev. Proc. 2003–1, 2003–1 I.R.B. 1

2002–2Superseded byRev. Proc. 2003–2, 2003–1 I.R.B. 76

2002–3Superseded byRev. Proc. 2003–3, 2003–1 I.R.B. 113

2002–4Superseded byRev. Proc. 2003–4, 2003–1 I.R.B. 123

2002–5Superseded byRev. Proc. 2003–5, 2003–1 I.R.B. 163

2002–6Superseded byRev. Proc. 2003–6, 2003–1 I.R.B. 191

2002–7Superseded byRev. Proc. 2003–7, 2003–1 I.R.B. 233

2002–8Superseded byRev. Proc. 2003–8, 2003–1 I.R.B. 236

2002–9Modified and amplified byRev. Rul. 2003–3, 2003–2 I.R.B. 252

2002–22Modified byRev. Proc. 2003–3, 2003–1 I.R.B. 113

2002–29Modified byRev. Proc. 2003–10, 2003–2 I.R.B. 259

Revenue Procedures—Continued:

2002–52Modified byRev. Proc. 2003–1, 2003–1 I.R.B. 1

2002–75Superseded byRev. Proc. 2003–3, 2003–1 I.R.B. 113

Revenue Rulings:

65–190Revoked byRev. Rul. 2003–3, 2003–2 I.R.B. 252

69–372Revoked byRev. Rul. 2003–3, 2003–2 I.R.B. 252

2 A cumulative list of current actions on previously

published items in Internal Revenue Bulletins

2002–26 through 2002–52 is in Internal Revenue

Bulletin 2003–1, dated January 6, 2003.

January 21, 2003 iii 2003–3 I.R.B.������ �������������������������3�496-919/60066