Bulletin No. 2008-11 HIGHLIGHTS OF THIS ISSUEBulletin No. 2008-11 March 17, 2008 HIGHLIGHTS OF THIS ISSUE These synopses are intended only as aids to the reader in identifying the

Bulletin No. 2008-11March 17, 2008

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. 2008–14, page 578.Fringe benefits aircraft valuation formula. The StandardIndustry Fare Level (SIFL) cents-per-mile rates and terminalcharge in effect for the first half of 2008 are set forth forpurposes of determining the value of noncommercial flightson employer-provided aircraft under section 1.61–21(g) of theregulations.

Rev. Rul. 2008–16, page 585.S corporations; charitable contributions. This ruling pro-vides guidance for S corporations that made charitable contri-butions of appreciated property during a taxable year begin-ning after December 31, 2005 and before January 1, 2008.The ruling provides that the amount of the charitable deductionthe shareholder may claim may not exceed the sum of (i) theshareholder’s pro rata share of the fair market value of the con-tributed property over the shareholder’s pro rata share of thecontributed property’s adjusted tax basis, and (ii) the amountof the Code section 1366(d) loss limitation amount that is al-locable to the contributed property’s basis under regulationssection 1.1366–2(a)(4).

T.D. 9376, page 587.Final regulations under section 1502 of the Code provide guid-ance regarding the manner in which the items (including itemsdescribed in section 381(c) but excluding intercompany itemsunder regulations section 1.1502–13) of a liquidating corpora-tion are succeeded to and taken into account in cases in whichmultiple members acquire the assets of the liquidating corpo-ration in a complete liquidation to which section 332 applies.The regulations affect corporations filing consolidated returns.

T.D. 9377, page 578.Final regulations under section 338 of the Code relate to thedetermination of the adjusted basis of amortizable section 197intangible assets in the hands of an insurance company result-ing from certain reinsurance transactions, increases in an in-surance company’s reserves after a deemed sale, and a car-ryover to the new (target) insurance company of an electionto use the old (target) insurance company’s historical paymentpattern to discount unpaid losses. The final regulations applyto insurance companies.

Notice 2008–31, page 592.This notice updates procedures for issuers of tax-exemptbonds and tax credit bonds to submit requests for voluntaryclosing agreements to resolve violations of the Code. Notice2001–60 modified and superseded.

Notice 2008–32, page 593.This notice provides interim guidance on the treatment undersection 67 of the Code of investment advisory costs and othercosts subject to the 2-percent floor under section 67(a) that arebundled as part of one commission or fee paid to the trusteeor executor and are incurred by a trust other than a grantortrust or an estate.

(Continued on the next page)

Finding Lists begin on page ii.

EMPLOYEE PLANS

REG–104946–07, page 596.Proposed regulations provide guidance under sections411(a)(13) and 411(b)(5) of the Code, which were addedby the Pension Protection Act of 2006. Section 411(a)(13)provides rules relating to vesting and payment of benefits thatmust be satisfied in order for hybrid defined benefit plans tobe tax-qualified. Section 411(b)(5) provides age discriminationrules for tax-qualified defined benefit plans, including hybriddefined benefit plans.

REG–136701–07, page 616.Proposed regulations under section 401 of the Code provideguidance relating to diversification requirements for certain de-fined contribution plans and to publicly traded employer secu-rities.

EXEMPT ORGANIZATIONS

Announcement 2008–20, page 625.The IRS has revoked its determination that Drive for Youth 2020of Missouri City, TX; Rise and Shine, Inc., of Medical Lake, WA;Bluegrass Gymnastic Boosters, Inc., of Lexington, KY; Debt-Tech of Columbia, MD; Nexum Credit Counseling, Inc., of VeroBeach, FL; New Home Gallery, Inc., of Louisville, KY; AlbanCommunity Services Foundation of Lititz, PA; Union Oaks, Inc.,of Omaha, NE; Shiloh Ministries of Hagerstown, Inc., of Hager-stown, MD; Credicure, Inc., of Martinsburg, WV; Newton Fam-ily Foundation of West Jordan, UT; Alliance to Rebuild LA ofSanta Monica, CA; The Down Payment Assistance Group of SanDiego, CA; Phillip J. Kronzer Foundation for Religious Researchof Los Gatos, CA; Credit Success Company of Jacksonville, FL;Mario C. and Elva G. Rapanotti Charitable Supporting Organ-ization of San Antonio, TX; and Anthony & Megan WolfendenCharitable Supporting Organization of Santa Clara, CA, qualifyas organizations described in sections 501(c)(3) and 170(c)(2)of the Code.

ADMINISTRATIVE

Rev. Proc. 2008–19, page 594.Qualified mortgage bonds; mortgage credit certificates;national median gross income. Guidance is provided con-cerning the use of the national and area median gross incomefigures by issuers of qualified mortgage bonds and mortgagecredit certificates in determining the housing cost/income ratiodescribed in section 143(f) of the Code. Rev. Proc. 2007–31obsoleted in part.

Announcement 2008–19, page 624.This announcement contains changes to Publication 1187 forfiling procedures for Form 1042–S, Foreign Person’s U.S.Source Income Subject to Withholding, filed electronicallyor magnetically. These changes are effective immediately.Announcement 2008–6 superseded.

March 17, 2008 2008–11 I.R.B.

The IRS MissionProvide America’s taxpayers top quality service by helping themunderstand and meet their tax responsibilities and by applying

the tax law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are 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, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

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 taxpayersor technical advice to Service field offices, identifying detailsand 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 berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe facts and circumstances 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,Tax Conventions and Other Related Items, and Subpart B, Leg-islation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe Department of the Treasury’s Office of the Assistant Secre-tary (Enforcement).

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

The last Bulletin for each month includes a cumulative indexfor the matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

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.

2008–11 I.R.B. March 17, 2008

March 17, 2008 2008–11 I.R.B.

Place missing child here.

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 25.—Interest onCertain Home Mortgages

A revenue procedure provides guidance with re-spect to the United States and area median gross in-come figures that are to be used by issuers of qualifiedmortgage bonds, as defined in § 143(a) of the InternalRevenue Code, and issuers of mortgage credit certifi-cates, as defined in § 25(c), in computing the housingcost/income ratio described in § 143(f)(5). See Rev.Proc. 2008-19, page 594.

Section 61.—Gross IncomeDefined26 CFR 1.61–21: Taxation of fringe benefits.

Fringe benefits aircraft valuation for-mula. The Standard Industry Fare Level

(SIFL) cents-per-mile rates and terminalcharge in effect for the first half of 2008are set forth for purposes of determiningthe value of noncommercial flights onemployer-provided aircraft under section1.61–21(g) of the regulations.

Rev. Rul. 2008–14

For purposes of the taxation of fringebenefits under section 61 of the Inter-nal Revenue Code, section 1.61–21(g) ofthe Income Tax Regulations provides arule for valuing noncommercial flightson employer-provided aircraft. Section1.61–21(g)(5) provides an aircraft valua-tion formula to determine the value of suchflights. The value of a flight is determined

under the base aircraft valuation formula(also known as the Standard Industry FareLevel formula or SIFL) by multiplyingthe SIFL cents-per-mile rates applicablefor the period during which the flight wastaken by the appropriate aircraft multipleprovided in section 1.61–21(g)(7) and thenadding the applicable terminal charge. TheSIFL cents-per-mile rates in the formulaand the terminal charge are calculated bythe Department of Transportation and arereviewed semi-annually.

The following chart sets forth the termi-nal charge and SIFL mileage rates:

Period During Whichthe Flight Is Taken

TerminalCharge

SIFL MileageRates

1/1/08 - 6/30/08 $39.86 Up to 500 miles= $.2180 per mile

501-1500 miles= $.1662 per mile

Over 1500 miles= $.1598 per mile

DRAFTING INFORMATION

The principal author of this revenueruling is Kathleen Edmondson of theOffice of Division Counsel/AssociateChief Counsel (Tax Exempt/Govern-ment Entities). For further informationregarding this revenue ruling, contactMs. Edmondson at (202) 622–0047 (not atoll-free call).

Section 103.—Interest onState and Local Bonds


Section 143.—MortgageRevenue Bonds: QualifiedMortgage Bond andQualified Veterans’Mortgage Bond


Section 338.—CertainStock Purchases Treatedas Asset Acquisitions26 CFR 1.338–11: Effect on section 338 election oninsurance company targets.

T.D. 9377

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Parts 1 and 602

Application of Section 338 toInsurance Companies

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations and removalof temporary regulations.

SUMMARY: This document contains fi-nal regulations under section 197 of the

2008–11 I.R.B. 578 March 17, 2008

Internal Revenue Code (Code) that applyto a section 197 intangible resulting froman assumption reinsurance transaction, andunder section 338 that apply to reserve in-creases after a deemed asset sale. The finalregulations also provide guidance with re-spect to existing section 846(e) elections touse historical loss payment patterns. Thefinal regulations apply to insurance com-panies.

DATES: Effective Date: These regulationsare effective on January 23, 2008.

Applicability Date: For date of ap-plicability of these regulations, see§1.197–2(g)(5)(ii)(E), §1.338–11(d)(7)and §1.846–4(b).

FOR FURTHER INFORMATIONCONTACT: William T. Sullivan (202)622–7052 or Donald J. Drees, Jr. (202)622–3970 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information in thesefinal regulations has been reviewed andapproved by the Office of Manage-ment and Budget in accordance withthe Paperwork Reduction Act of 1995(44 U.S.C. 3507(d)) under control number1545–1990.

The collection of information in thesefinal regulations is in §1.338–11(e)(2).This information is required by the IRSto allow an insurance company to chooseto cease using its historical loss paymentpattern, and instead use industry-wide fac-tors, to discount unpaid losses.

An agency may not conduct or sponsor,and the person is not required to respondto a collection of information unless thecollection of information displays a validcontrol number.

Books or records relating to a collectionof information must be retained as long astheir contents may become material in theadministration of any internal revenue law.Generally, tax returns and tax informationare confidential, as required by 26 U.S.C.6103.

Background and Explanation ofProvisions:

On March 8, 2002, the IRS and theTreasury Department published a notice

of proposed rulemaking REG–118861–00,2002–1 C.B. 651, in the Federal Register(67 FR 10640) (2002–1 Cumulative Bul-letin (C.B.) 651) (the 2002 proposed regu-lations) that set forth rules applying to tax-able acquisitions and dispositions of insur-ance businesses, including those that aredeemed to occur when an election undersection 338 of the Code is made. (See§601.601(d)(2)(ii)(b)). The C.B. is madeavailable by the Superintendent of Docu-ments, U.S. Government Printing Office,Washington, DC 20402. Written com-ments were received in response to the2002 proposed regulations, and a publichearing was held. After consideration ofall the comments, the IRS and the Trea-sury Department published final regula-tions in the Federal Register on April10, 2006, (T.D. 9257, 2006–1 C.B. 821)(71 FR 17990), as corrected in the FederalRegister (T.D. 9257) (71 FR 26826) toremove an error that might have proven tobe misleading.

T.D. 9257 also contains temporaryregulations under sections 197, 338,and 846, which serve as the basis for across-reference notice of proposed rule-making published in the Federal Register(REG–146384–05, 2006–1 C.B. 843) (71FR 18053) with respect to issues thatwere the subject of comments on the2002 proposed regulations. Specifically,§1.197–2T(g)(5)(ii) provides guidancewith regard to the interplay between sec-tion 197(f)(5) (concerning the treatmentof certain reinsurance transactions) andsection 848 (requiring the capitalizationof certain policy acquisition expenses);§1.338–11T(d) addresses reserve increasesafter a deemed asset sale that results froma section 338 election; and §1.338–11T(e)provides guidance on the effect of a section338 election on an insurance company’selection under section 846(e) to use itshistorical loss payment pattern to discountcertain unpaid losses.

Although the 2002 proposed regula-tions generated a number of commentswhich are discussed in detail in the pream-ble to T.D. 9257, no new comments werereceived with respect to the temporaryregulations that served as a cross-refer-ence notice of proposed rulemaking in2006. Accordingly, this Treasury decisionadopts the proposed regulations withoutsubstantive change and removes the cor-responding temporary regulations. This

Treasury decision also revises cross-ref-erences where appropriate to reflect theremoval of temporary regulations andtheir replacement with final regulationsand corrects two obvious errors, one amathematical error in the last sentenceof §1.381(c)(22)–1(b)(7)(v), Example 3,the other an error in the captioning of§1.338(i)–1(c)(2)(ii)(B).

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. It is hereby certified thatthe collection of information requirementin these regulations will not have a sig-nificant economic impact on a substantialnumber of small entities. This certificationis based on the fact that these regulationsdo not have a substantial economic im-pact because they merely provide guidanceabout the operation of the tax law in thecontext of acquisitions of insurance com-panies and businesses. Moreover, they areexpected to apply predominantly to trans-actions involving larger businesses. In ad-dition, the collection of information re-quirement merely requires a taxpayer toprepare a written representation that con-tains minimal information relating to themaking of an election. Therefore, a Regu-latory Flexibility Analysis under the Reg-ulatory Flexibility Act (5 U.S.C. chapter6) is not required. Under section 7805(f)of the Code, the notice of proposed rule-making preceding this regulation was sub-mitted to the Chief Counsel for Advocacyof the Small Business Administration forcomment on its impact on small business.

Drafting Information

The principal author of the final regu-lations is William T. Sullivan, Office ofChief Counsel (Financial Institutions andProducts). However, other personnel fromthe IRS and the Treasury Department par-ticipated in the development of these reg-ulations.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR parts 1 and 602are amended as follows:

March 17, 2008 579 2008–11 I.R.B.

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by removing the entriesfor §§1.197–2T, 1.338–1T, and 1.338–11Tto read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.197–0 is amended by:1. Revising the introductory text and

the entries for §1.197–2(g)(5)(ii).2. Removing the entries for §1.197–2T.The revisions read as follows:

§1.197–0 Table of contents.

This section lists the headings that ap-pear in §1.197–2.

§1.197–2 Amortization of goodwill andcertain other intangibles.

* * * * *(g) * * *(5) * * *(ii) Determination of adjusted basis of

amortizable section 197 intangible result-ing from an assumption reinsurance trans-action.

(A) In general.(B) Amount paid or incurred by ac-

quirer (reinsurer) under the assumptionreinsurance transaction.

(C) Amount required to be capitalizedunder section 848 in connection with thetransaction.

(1) In general.(2) Required capitalization amount.(3) General deductions allocable to the

assumption reinsurance transaction.(4) Treatment of a capitalization short-

fall allocable to the reinsurance agreement.(i) In general.(ii) Treatment of additional capitalized

amounts as the result of an election under§1.848–2(g)(8).

(5) Cross references and special rules.(D) Examples.(E) Effective/applicability date.

* * * * *Par. 3. Section 1.197–2(g)(5)(ii) is re-

vised to read as follows:

§1.197–2 Amortization of goodwill andcertain other intangibles.

* * * * *(g) * * *(5) * * *

(ii) Determination of adjusted basis ofamortizable section 197 intangible result-ing from an assumption reinsurance trans-action—(A) In general. Section 197(f)(5)determines the basis of an amortizable sec-tion 197 intangible for insurance or an-nuity contracts acquired in an assumptionreinsurance transaction. The basis of suchintangible is the excess, if any, of—

(1) The amount paid or incurred by theacquirer (reinsurer) under the assumptionreinsurance transaction; over

(2) The amount, if any, required to becapitalized under section 848 in connec-tion with such transaction.

(B) Amount paid or incurred by ac-quirer (reinsurer) under the assumptionreinsurance transaction. The amount paidor incurred by the acquirer (reinsurer) un-der the assumption reinsurance transactionis—

(1) In a deemed asset sale resultingfrom an election under section 338, theamount of the adjusted grossed-up basis(AGUB) allocable thereto (see §§1.338–6and 1.338–11(b)(2));

(2) In an applicable asset acquisitionwithin the meaning of section 1060, theamount of the consideration allocablethereto (see §§1.338–6, 1.338–11(b)(2),and 1.1060–1(c)(5)); and

(3) In any other transaction, the ex-cess of the increase in the reinsurer’s taxreserves resulting from the transaction(computed in accordance with sections807, 832(b)(4)(B), and 846) over the valueof the net assets received from the cedingcompany in the transaction.

(C) Amount required to be capitalizedunder section 848 in connection with thetransaction—(1) In general. The amountrequired to be capitalized under section848 for specified insurance contracts (asdefined in section 848(e)) acquired in anassumption reinsurance transaction is thelesser of—

(i) The reinsurer’s required capitaliza-tion amount for the assumption reinsur-ance transaction; or

(ii) The reinsurer’s general deductions(as defined in section 848(c)(2)) allocableto the transaction.

(2) Required capitalization amount.The reinsurer determines the requiredcapitalization amount for an assumptionreinsurance transaction by multiplyingthe net positive or net negative considera-tion for the transaction by the applicable

percentage set forth in section 848(c)(1)for the category of specified insurancecontracts acquired in the transaction. See§1.848–2(g)(5). If more than one categoryof specified insurance contracts is acquiredin an assumption reinsurance transaction,the required capitalization amount for eachcategory is determined as if the transfer ofthe contracts in that category were madeunder a separate assumption reinsurancetransaction. See §1.848–2(f)(7).

(3) General deductions allocable to theassumption reinsurance transaction. Thereinsurer determines the general deduc-tions allocable to the assumption reinsur-ance transaction in accordance with theprocedure set forth in §1.848–2(g)(6). Ac-cordingly, the reinsurer must allocate itsgeneral deductions to the amount requiredunder section 848(c)(1) on specified insur-ance contracts that the reinsurer has issueddirectly before determining the generaldeductions allocable to the assumptionreinsurance transaction. For purposes ofallocating its general deductions under§1.848–2(g)(6), the reinsurer includes pre-miums received on the acquired specifiedinsurance contracts after the assumptionreinsurance transaction in determining theamount required under section 848(c)(1)on specified insurance contracts that thereinsurer has issued directly. If the rein-surer has entered into multiple reinsur-ance agreements during the taxable year,the reinsurer determines the general de-ductions allocable to each reinsuranceagreement (including the assumption rein-surance transaction) by allocating thegeneral deductions allocable to reinsur-ance agreements under §1.848–2(g)(6) toeach reinsurance agreement with a posi-tive required capitalization amount.

(4) Treatment of a capitalization short-fall allocable to the reinsurance agree-ment—(i) In general. The reinsurer deter-mines any capitalization shortfall allocableto the assumption reinsurance transactionin the manner provided in §§1.848–2(g)(4)and 1.848–2(g)(7). If the reinsurer hasa capitalization shortfall allocable to theassumption reinsurance transaction, theceding company must reduce the net neg-ative consideration (as determined under§1.848–2(f)(2)) for the transaction bythe amount described in §1.848–2(g)(3)unless the parties make the election pro-vided in §1.848–2(g)(8) to determine theamounts capitalized under section 848 in

2008–11 I.R.B. 580 March 17, 2008

connection with the transaction withoutregard to the general deductions limitationof section 848(c)(2).

(ii) Treatment of additional capitalizedamounts as the result of an election under§1.848–2(g)(8). The additional amountscapitalized by the reinsurer as the result ofthe election under §1.848–2(g)(8) reducethe adjusted basis of any amortizable sec-tion 197 intangible with respect to speci-fied insurance contracts acquired in the as-sumption reinsurance transaction. If theadditional capitalized amounts exceed theadjusted basis of the amortizable section197 intangible, the reinsurer must reduceits deductions under section 805 or section832 by the amount of such excess. Theadditional capitalized amounts are treatedas specified policy acquisition expenses at-tributable to the premiums and other con-sideration on the assumption reinsurancetransaction and are deducted ratably overa 120-month period as provided under sec-tion 848(a)(2).

(5) Cross references and special rules.In general, for rules applicable to the de-termination of specified policy acquisitionexpenses, net premiums, and net consid-eration, see section 848(c) and (d), and§1.848–2(a) and (f). However, the follow-ing special rules apply for purposes of thisparagraph (g)(5)(ii)(C)—

(i) The amount required to be capital-ized under section 848 in connection withthe assumption reinsurance transactioncannot be less than zero;

(ii) For purposes of determining thecompany’s general deductions under sec-tion 848(c)(2) for the taxable year ofthe assumption reinsurance transaction,the reinsurer takes into account a tenta-tive amortization deduction under section197(a) as if the entire amount paid or in-curred by the reinsurer for the specifiedinsurance contracts were allocated to anamortizable section 197 intangible withrespect to insurance contracts acquiredin an assumption reinsurance transaction;and

(iii) Any reduction of specified policyacquisition expenses pursuant to an elec-tion under §1.848–2(i)(4) (relating to anassumption reinsurance transaction withan insolvent insurance company) is disre-garded.

(D) Examples. The following examplesillustrate the principles of this paragraph(g)(5)(ii):

Example 1. (i) Facts. On January 15, 2006, Pacquires all of the stock of T, an insurance com-pany, in a qualified stock purchase and makes asection 338 election for T. T issues individual lifeinsurance contracts which are specified insurancecontracts as defined in section 848(e)(1). P and newT are calendar year taxpayers. Under §§1.338–6and 1.338–11(b)(2), the amount of AGUB allo-cated to old T’s individual life insurance contracts is$300,000. On the acquisition date, the tax reservesfor old T’s individual life insurance contracts are$2,000,000. After the acquisition date, new T re-ceives $1,000,000 of net premiums with respect tonew and renewal individual life insurance contractsand incurs $100,000 of general deductions undersection 848(c)(2) through December 31, 2006. NewT engages in no other reinsurance transactions otherthan the assumption reinsurance transaction treatedas occurring by reason of the section 338 election.

(ii) Analysis. The transfer of insurance contractsand the assumption of related liabilities deemed tooccur by reason of the election under section 338is treated as an assumption reinsurance transaction.New T determines the adjusted basis under section197(f)(5) for the life insurance contracts acquired inthe assumption reinsurance transaction as follows.The amount paid or incurred for the individual lifeinsurance contracts is $300,000. To determine theamount required to be capitalized under section 848in connection with the assumption reinsurance trans-action, new T compares the required capitalizationamount for the assumption reinsurance transactionwith the general deductions allocable to the transac-tion. The required capitalization amount for the as-sumption reinsurance transaction is $130,900, whichis determined by multiplying the $1,700,000 net pos-itive consideration for the transaction ($2,000,000reinsurance premium less $300,000 ceding com-mission) by the applicable percentage under section848(c)(1) for the acquired individual life insurancecontracts (7.7 percent). To determine its generaldeductions, new T takes into account a tentativeamortization deduction under section 197(a) as if theentire amount paid or incurred for old T’s individuallife insurance contracts ($300,000) were allocable toan amortizable section 197 intangible with respectto insurance contracts acquired in the assumptionreinsurance transaction. Accordingly, for the yearof the assumption reinsurance transaction, new T istreated as having general deductions under section848(c)(2) of $120,000 ($100,000 + $300,000/15).Under §1.848–2(g)(6), these general deductionsare first allocated to the $77,000 capitalization re-quirement for new T’s directly written business($1,000,000 x .077). Thus, $43,000 ($120,000 -$77,000) of the general deductions are allocable tothe assumption reinsurance transaction. Becausethe general deductions allocable to the assumptionreinsurance transaction ($43,000) are less than therequired capitalization amount for the transaction($130,900), new T has a capitalization shortfall of$87,900 ($130,900 - $43,000) with regard to thetransaction. Under §1.848–2(g), this capitalizationshortfall would cause old T to reduce the net negativeconsideration taken into account with respect to theassumption reinsurance transaction by $1,141,558($87,900 ÷ .077) unless the parties make the elec-tion under §1.848–2(g)(8) to capitalize specifiedpolicy acquisition expenses in connection with the

assumption reinsurance transaction without regardto the general deductions limitation. If the partiesmake the election, the amount capitalized by new Tunder section 848 in connection with the assump-tion reinsurance transaction would be $130,900.The $130,900 capitalized by new T under section848 would reduce new T’s adjusted basis of theamortizable section 197 intangible with respect tothe specified insurance contracts acquired in theassumption reinsurance transaction. Accordingly,new T would have an adjusted basis under section197(f)(5) with respect to the individual life insurancecontracts acquired from old T of $169,100 ($300,000- $130,900). New T’s actual amortization deductionunder section 197(a) with respect to the amortiz-able section 197 intangible for insurance contractsacquired in the assumption reinsurance transactionwould be $11,273 ($169,100 ÷15).

Example 2. (i) Facts. The facts are the sameas Example 1, except that T only issues accidentand health insurance contracts that are qualifiedlong-term care contracts under section 7702B. Un-der section 7702B(a)(5), T’s qualified long-termcare insurance contracts are treated as guaranteedrenewable accident and health insurance contracts,and, therefore, are considered specified insurancecontracts under section 848(e)(1). Under §§1.338–6and 1.338–11(b)(2), the amount of AGUB allocableto T’s qualified long-term care insurance contractsis $250,000. The amount of T’s tax reserves for thequalified long-term care contracts on the acquisitiondate is $7,750,000. Following the acquisition, newT receives net premiums of $500,000 with respect toqualified long-term care contracts and incurs generaldeductions of $75,000 through December 31, 2006.

(ii) Analysis. The transfer of insurance contractsand the assumption of related liabilities deemed tooccur by reason of the election under section 338is treated as an assumption reinsurance transaction.New T determines the adjusted basis under section197(f)(5) for the insurance contracts acquired in theassumption reinsurance transaction as follows. Theamount paid or incurred for the insurance contractsis $250,000. To determine the amount requiredto be capitalized under section 848 in connectionwith the assumption reinsurance transaction, new Tcompares the required capitalization amount for theassumption reinsurance transaction with the generaldeductions allocable to the transaction. The requiredcapitalization amount for the assumption reinsur-ance transaction is $577,500, which is determinedby multiplying the $7,500,000 net positive consid-eration for the transaction ($7,750,000 reinsurancepremium less $250,000 ceding commission) by theapplicable percentage under section 848(c)(1) forthe acquired insurance contracts (7.7 percent). Todetermine its general deductions, new T takes intoaccount a tentative amortization deduction undersection 197(a) as if the entire amount paid or incurredfor old T’s insurance contracts ($250,000) wereallocable to an amortizable section 197 intangiblewith respect to insurance contracts acquired in theassumption reinsurance transaction. Accordingly,for the year of the assumption reinsurance transac-tion, new T is treated as having general deductionsunder section 848(c)(2) of $91,667 ($75,000 +$250,000/15). Under §1.848–2(g)(6), these generaldeductions are first allocated to the $38,500 capi-talization requirement for new T’s directly written

March 17, 2008 581 2008–11 I.R.B.

business ($500,000 x .077). Thus, $53,167 ($91,667- $38,500) of general deductions are allocable tothe assumption reinsurance transaction. Becausethe general deductions allocable to the assumptionreinsurance transaction ($53,167) are less than therequired capitalization amount for the transaction($577,500), new T has a capitalization shortfall of$524,333 ($577,500 - $53,167) with regard to thetransaction. Under §1.848–2(g), this capitalizationshortfall would cause old T to reduce the net negativeconsideration taken into account with respect to theassumption reinsurance transaction by $6,809,519($524,333 ÷ .077) unless the parties make the elec-tion under §1.848–2(g)(8) to capitalize specifiedpolicy acquisition expenses in connection with theassumption reinsurance transaction without regardto the general deductions limitation. If the partiesmake the election, the amount capitalized by new Tunder section 848 in connection with the assumptionreinsurance transaction would increase from $53,167to $577,500. Pursuant to paragraph (g)(5)(ii)(C)(4)of this section, the additional $524,333 ($577,500- $53,167) capitalized by new T under section 848would reduce new T’s adjusted basis of the amor-tizable section 197 intangible with respect to theinsurance contracts acquired in the assumption rein-surance transaction. Accordingly, new T’s adjustedbasis of the section 197 intangible with regard tothe insurance contracts is reduced from $196,833($250,000 - $53,167) to $0. Because the additional$524,333 capitalized pursuant to the §1.848–2(g)(8)election exceeds the $196,833 adjusted basis of thesection 197 intangible before the reduction, new T isrequired to reduce its deductions under section 805by the $327,500 ($524,333 - $196,833).

(E) Effective/applicability date. Thissection applies to acquisitions and dispo-sitions of insurance contracts on or afterApril 10, 2006.

* * * * *

§1.197–2T [Removed]

Par. 4. Section 1.197–2T is removed.Par. 5. Section 1.338–0 is amended by

revising the entries for §1.338–11(d) and(e) to read as follows:

§1.338–0 Outline of topics.

* * * * *

§1.338–11 Effect of section 338 electionon insurance company targets.

* * * * *(d) Reserve increases by new target af-

ter the deemed asset sale.(1) In general.(2) Exceptions.(3) Amount of additional premium.(i) In general.(ii) Increases in unpaid loss reserves.(iii) Increases in other reserves.(4) Limitation on additional premium.

(5) Treatment of additional premiumunder section 848.

(6) Examples.(7) Effective/applicability date.(i) In general.(ii) Application to pre-effective date in-

creases to reserves.(e) Effect of section 338 election on sec-

tion 846(e) election.(1) In general.(2) Revocation of existing section

846(e) election.

* * * * *Par. 6. Section 1.338–1 is amended

by adding paragraph (b)(2)(vii) to read asfollows:

§1.338–1 General principles; status of oldtarget and new target.

* * * * *(b) * * *(2) * * *(vii) Section 846(e) (relating to an elec-

tion to use an insurance company’s histor-ical loss payment pattern).

* * * * *


Par. 7. Section 1.338–1T is removed.Par. 8. Section 1.338–11 is amended

by revising paragraphs (d) and (e) to readas follows:

§1.338–11 Effect of section 338 electionon insurance company targets.

* * * * *(d) Reserve increases by new target

after the deemed asset sale—(1) In gen-eral. If in new target’s first taxable year orany subsequent year, new target increasesits reserves for any acquired contracts,new target is treated as receiving an ad-ditional premium, which is computedunder paragraph (d)(3) of this section, inthe assumption reinsurance transactiondescribed in paragraph (c)(1) of this sec-tion. New target includes the additionalpremium in gross income for the taxableyear in which new target increases itsreserves for acquired contracts. New tar-get’s increase in reserves for the insurancecontracts acquired in the deemed assetsale is a liability of new target not orig-inally taken into account in determining

AGUB that is subsequently taken intoaccount. Thus, AGUB is increased bythe amount of the additional premiumincluded in new target’s gross income.See §§1.338–5(b)(2)(ii) and 1.338–7. Oldtarget has no deduction under this para-graph (d) and makes no adjustments under§§1.338–4(b)(2)(ii) and 1.338–7.

(2) Exceptions. New target is nottreated as receiving additional premiumunder paragraph (d)(1) of this section if—

(i) It is under state receivership as ofthe close of the taxable year for which theincrease in reserves occurs; or

(ii) It is required by section 807(f) tospread the reserve increase over the 10 suc-ceeding taxable years.

(3) Amount of additional premium—(i)In general. The additional premium takeninto account under this paragraph (d) is anamount equal to the sum of the positiveamounts described in paragraphs (d)(3)(ii)and (d)(3)(iii) of this section. However,the additional premium cannot exceed thelimitation described in paragraph (d)(4) ofthis section.

(ii) Increases in unpaid loss reserves.The positive amount with respect to un-paid loss reserves is computed using theformula A/B x (C - [D + E]) where—

(A) A equals old target’s discountedunpaid losses (determined under section846) included in AGUB under paragraph11(b)(1) of this section;

(B) B equals old target’s undiscountedunpaid losses (determined under section846(b)(1)) as of the close of the acquisitiondate;

(C) C equals new target’s undiscountedunpaid losses (determined under section846(b)(1)) at the end of the taxable yearthat are attributable to losses incurred byold target on or before the acquisition date;

(D) D (which may be a negative num-ber) equals old target’s undiscounted un-paid losses as of the close of the acquisitiondate, reduced by the cumulative amountof losses, loss adjustment expenses, andreinsurance premiums paid by new targetthrough the end of the taxable year forlosses incurred by old target on or beforethe acquisition date; and

(E) E equals the amount obtained bydividing the cumulative amount of reserveincreases taken into account under thisparagraph (d) in prior taxable years byA/B.

2008–11 I.R.B. 582 March 17, 2008

(iii) Increases in other reserves. Thepositive amount with respect to reservesother than discounted unpaid loss reservesis the net increase of those reserves dueto changes in estimate, methodology, orother assumptions used to compute the re-serves (including the adoption by new tar-get of a methodology or assumptions dif-ferent from those used by old target).

(4) Limitation on additional premium.The additional premium taken into accountby new target under paragraph (d)(1) ofthis section is limited to the excess, if any,of—

(i) The fair market value of old tar-get’s assets acquired by new target in thedeemed asset sale (other than Class VI andClass VII assets); over

(ii) The AGUB allocated to those as-sets (including increases in AGUB allo-cated to those assets as the result of re-serve increases by new target in prior tax-able years).

(5) Treatment of additional premiumunder section 848. If a portion of thepositive amounts described in paragraphs(d)(3)(ii) and (iii) of this section are at-tributable to an increase in reserves forspecified insurance contracts (as definedin section 848(e)), new target takes an al-locable portion of the additional premiumin determining its specified policy acqui-sition expenses under section 848(c) forthe taxable year of the reserve increase.

(6) Examples. The following examplesillustrate this paragraph (d):

Example 1. (i) Facts. On January 1, 2006, Ppurchases all of the stock of T, a non-life insurancecompany, for $120 and makes a section 338 elec-tion for T. On the acquisition date, old T has totalreserve liabilities under state law of $725, consistingof undiscounted unpaid losses of $625 and unearnedpremiums of $100. Old T’s tax reserves on the ac-quisition date are $580, which consist of discountedunpaid losses (as defined in section 846) of $500and unearned premiums (as computed under section832(b)(4)(B)) of $80. Old T has Class I through ClassV assets with a fair market value of $800. Old T alsohas a Class VI asset with a fair market value of $75,consisting of the future profit stream of certain insur-ance contracts. During 2006, new T makes loss andloss adjustment expense payments of $200 with re-spect to the unpaid losses incurred by old T beforethe acquisition date. As of December 31, 2006, newT reports undiscounted unpaid losses of $475 attrib-utable to losses incurred before the acquisition date.The related amount of discounted unpaid losses (asdefined in section 846) for those losses is $390.

(ii) Computation and allocation of AGUB. Under§1.338–5 and paragraph (b)(1) of this section, as ofthe acquisition date, AGUB is $700, reflecting thesum of the amount paid for old T’s stock ($120) and

the tax reserves assumed by new T in the transac-tion ($580). The fair market value of old T’s ClassI through V assets is $800, whereas the AGUB avail-able for such assets under §1.338–6 is $700. There isno AGUB available for old T’s Class VI assets, eventhough such assets have a fair market value of $75 onthe acquisition date.

(iii) Adjustments for increases in reserves for un-paid losses. Under paragraph (d) of this section, newT must determine whether there are any amounts bywhich it increased its unpaid loss reserves that willbe treated as an additional premium and an increasein AGUB. New T applies the formula of paragraph(d)(3) of this section, where A equals $500, B equals$625, C equals $475, D equals $425 ($625 - $200),and E equals $0. Under this formula, new T is treatedas having increased its reserves for discounted unpaidlosses attributable to losses incurred by old T by $40($500/$625 x ($475 -[$425+0]). The limitation underparagraph (d)(5) of this section based on the differ-ence between the fair market value of old T’s ClassI through Class V assets and the AGUB allocated tosuch assets is $100. Accordingly, new T includes anadditional premium of $40 in gross income for 2006,and increases the AGUB allocated to old T’s Class Ithrough Class V assets to reflect this additional pre-mium.

Example 2. (i) Facts. Assume the same facts as inExample 1. Further assume that during 2007 new Tdeducts total loss and loss expense payments of $375with respect to losses incurred by old T before the ac-quisition date. On December 31, 2007, new T reportsundiscounted unpaid losses of $150 with respect tolosses incurred before the acquisition date. The re-lated amount of discounted unpaid losses (as definedin section 846) for those unpaid losses is $125.

(ii) Analysis. New T must determine whether anyamounts by which it increased its unpaid losses dur-ing 2007 will be treated as an additional premium inparagraph (d)(3) of this section. New T applies theformula under paragraph (d)(3) of this section, whereA equals $500, B equals $625, C equals $150, Dequals $50 ($625 - $575), and E equals $50 ($40 di-vided by .8). In paragraph (d)(3) of this section, newT is treated as increasing its reserves for discountedunpaid losses by $40 during 2007 with respect tolosses incurred by old T ($500/$625 x ($150 - [$50 +$50]). New T determines the limitation of paragraph(d)(5) of this section by comparing the $800 fair mar-ket value of the Class I through V assets on the acqui-sition date to the $740 AGUB allocated to such assets(which includes the $40 addition to AGUB includedduring 2006). Thus, new T recognizes $40 of addi-tional premium as a result of the increase in reservesduring 2007, and adjusts the AGUB allocable to theClass I through V assets acquired from old T to re-flect such additional premium.

Example 3. (i) Facts. The facts are the sameas Example 2, except that on January 1, 2008, newT reinsures the outstanding liability with respect tolosses incurred by old T before the acquisition datethrough a portfolio reinsurance transaction with R,another non-life insurance company. R agrees to as-sume any remaining liability relating to losses in-curred by old T before the acquisition date in ex-change for a reinsurance premium of $200. Accord-ingly, as of December 31, 2008, new T reports noundiscounted unpaid losses with respect to losses in-curred by old T before the acquisition date.

(ii) Analysis. New T must determine whether anyamount by which it increased its unpaid loss reserveswill be treated as an additional premium under para-graph (d) of this section. New T applies the formulaof paragraph (d)(3) of this section, where A equals$500, B equals $625, C equals $0, and D equals -$150($625 - ($575 + $200), and E equals $100 ($80 di-vided by .8). Thus, new T is treated as having in-creased its discounted unpaid losses by $40 in 2008with respect to losses incurred by old T before theacquisition date ($500/$625 x (0 - [-$150 + $100]).New T includes this positive amount in gross income,subject to the limitation of paragraph (d)(4) of thissection. The limitation of paragraph (d)(4) of this sec-tion equals $20, which is computed by comparing the$800 fair market value of the Class I through V as-sets acquired from old T with the $780 AGUB allo-cated to such assets (which includes the $40 additionto AGUB in 2006 and the $40 addition to AGUB in2007). Thus, New T includes $20 in additional pre-mium, and increases the AGUB allocated to the ClassI through V assets acquired from old T by $20. As aresult of these adjustments, the limitation under para-graph (d)(4) of this section is reduced to zero.

(7) Effective/applicability date—(i) Ingeneral. This section applies to increasesto reserves made by new target after adeemed asset sale occurring on or afterApril 10, 2006.

(ii) Application to pre-effective dateincreases to reserves. If either new targetmakes an election under §1.338(i)–1(c)(2)or old target makes an election under§1.338(i)–1(c)(3) to apply the rules ofthis section, in whole, to a qualified stockpurchase occurring before April 10, 2006,then the rules contained in this sectionshall apply in whole to the qualified stockpurchase.

(e) Effect of section 338 election on sec-tion 846(e) election—(1) In general. Newtarget and old target are treated as the samecorporation for purposes of an election byold target to use its historical loss pay-ment pattern under section 846(e). See§1.338–1(b)(2)(vii). Therefore, if old tar-get has a section 846(e) election in effecton the acquisition date, new target willcontinue to use the historical loss paymentpattern of old target to discount unpaidlosses incurred in accident years coveredby the election, unless new target elects torevoke the section 846(e) election. In addi-tion, new target may consider old target’shistorical loss payment pattern when deter-mining whether to make the section 846(e)election for a determination year that in-cludes or is subsequent to the acquisitiondate.

(2) Revocation of existing section846(e) election. New target may revoke

March 17, 2008 583 2008–11 I.R.B.

old target’s section 846(e) election to useits historical loss payment pattern to dis-count unpaid losses. If new target electsto revoke old target’s section 846(e) elec-tion, new target will use the industry-widepatterns determined by the Secretary todiscount unpaid losses incurred in accidentyears beginning on or after the acquisitiondate through the subsequent determinationyear. New target may revoke old tar-get’s section 846(e) election by attachinga statement to new target’s original taxreturn for its first taxable year.

* * * * *


Par. 9. Section 1.338–11T is removed.Par. 10. Section 1.338(i)–1 is amended

by:1. Revising the section heading to read

as set forth below.2. Redesignating paragraph

(c)(2)(ii)(b) as paragraph (c)(2)(ii)(B).The revisions read as follows:

§1.381(i)–1 Effective/applicability date.

* * * * *Par. 11. Section 1.381(c)(22)–

1(b)(7)(v) is amended by revising the lastsentence of Example 3 to read as follows:

§1.381(c)(22)–1 Successor life insurancecompany.

* * * * *(b) * * *(7) * * *(v) * * *Example 3. * * * In that case, in the taxable year

of the indemnity reinsurance transaction, S takes intoaccount as ordinary income the portion of the old T’saccounts ($1) that old T or S has not previously takeninto account as income.

* * * * *

§1.846–0 [Amended]

Par. 12. Section 1.846–0 is amended byremoving the entries for §§1.846–2T and1.846–4T.

Par. 13. Section 1.846–2(d) is revisedto read as follows:

§1.846–2 Election by taxpayer to use itsown historical loss payment pattern.

* * * * *(d) Effect of section 338 election on

section 846(e) election. For rules re-garding qualified stock purchase oc-curring on or after April 10, 2006, see§§1.338–1(b)(2)(vii) and 1.338–11(e).

Par. 14. Section 1.846–4 is amended byrevising the section heading and paragraph(b) to read as follows:

§1.846–4 Effective/applicability date.

* * * * *(b) Section 338 election. Section

1.846–2(d) applies to section 846(e) elec-tions made with regard to a qualified stockpurchase made on or after April 10, 2006.

Par. 15. For each entry in the “Sec-tion” column remove the phrase in the“Remove” column and add the phrase inthe “Add” column in its place.

Section Remove Add

§1.338(i)–1(c)(2)(i) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.338(i)–1(c)(2)(i) 1.197–2T(g)(5)(ii),

§1.338(i)–1(c)(2)(ii) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.338(i)–1(c)(2)(ii) 1.197–2T(g)(5)(ii),

§1.338(i)–1(c)(2)(ii)(B)(First sentence)

§§1.338–11 and 1.338–11T(d) §1.338–11


1.197–2T(g)(5)(ii),

§1.338(i)–1(c)(2)(ii)(B)(Second sentence)

§§1.338–11 and 1.338–11T(d) §1.338–11


1.197–2T(g)(5)(ii),

§1.338(i)–1(c)(3)(i) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.338(i)–1(c)(3)(i) 1.197–2T(g)(5)(ii),

§1.338(i)–1(c)(3)(ii) §§1.338–11 and1.338–11T(d) §1.338–11

§1.338(i)–1(c)(3)(ii) 1.197–2T(g)(5)(ii),


§§1.338–11 and 1.338–11T(d) §1.338–11


1.197–2T(g)(5)(ii),


§§1.338–11 and 1.338–11T(d) §1.338–11

2008–11 I.R.B. 584 March 17, 2008

Section Remove Add


1.197–2T(g)(5)(ii),

§1.1060–1(a)(2)(i) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.1060–1(a)(2)(i) 1.197–2T(g)(5)(ii),

§1.1060–1(a)(2)(ii) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.1060–1(a)(2)(ii) 1.197–2T(g)(5)(ii),

§1.1060–1(a)(2)(ii)(B) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.1060–1(a)(2)(ii)(B) 1.197–2T(g)(5)(ii),

§1.1060–1(a)(2)(iii) §§1.338–11T(d) and 1.338–11T(d) §1.338–11(d)

§1.1060–1(a)(2)(iii) 1.197–2T(g)(5)(ii),

§1.1060–1(a)(2)(iii)(B) §§1.338–11 and 1.338–11T(d) §1.338–11

§1.1060–1(a)(2)(iii)(B) 1.197–2T(g)(5)(ii),

PART 602 — OMB CONTROLNUMBERS UNDER THE PAPERWORKREDUCTION ACT

Par. 16. The authority citation for part602 continues to read as follows:

Authority: 26 U.S.C. 7805.Par. 17. In §602.101, paragraph (b)

is amended by removing the entry for§1.338–11T from the table and adding anentry to the table in numerical order toread as follows:

§602.101 OMB Control numbers.

* * * * *(b) * * *

CFR part or section whereIdentified and described

Current OMBcontrol No.

* * * * *1.338–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1990* * * * *

Linda Stiff,Deputy Commissioner forServices and Enforcement.

Approved January 9, 2008.

Eric Solomon,Assistant Secretary of the

Treasury (Tax Policy).

(Filed by the Office of the Federal Register on January 22,2008, 8:45 a.m., and published in the issue of the FederalRegister for January 23, 2008, 73 F.R. 3868)

Section 1366.—Pass-Thruof Items to Shareholders26 CFR 1.1366–2: Limitations on deduction of pass-through items of an S corporation to its shareholders.(Also § 1367; 1.1367–1.)

S corporations; charitable contribu-tions. This ruling provides guidance forS corporations that made charitable con-tributions of appreciated property during ataxable year beginning after December 31,

2005 and before January 1, 2008. The rul-ing provides that the amount of the chari-table deduction the shareholder may claimmay not exceed the sum of (i) the share-holder’s pro rata share of the fair marketvalue of the contributed property over theshareholder’s pro rata share of the con-tributed property’s adjusted tax basis, and(ii) the amount of the Code section 1366(d)loss limitation amount that is allocable tothe contributed property’s basis under reg-ulations section 1.1366–2(a)(4).

Rev. Rul. 2008–16

ISSUE

If an S corporation makes a charitablecontribution of appreciated property in ataxable year beginning after December 31,2005, and before January 1, 2008, what isthe amount of the charitable contributiondeduction that a shareholder may claimin circumstances where § 1366(d) of theInternal Revenue Code (Code) limits the

shareholder’s pro rata share of the S cor-poration’s losses and deductions for thetaxable year in which the property is con-tributed?

FACTS

Individual A is the sole shareholder ofS Corporation X. At the beginning of X’s2007 taxable year, A has a basis of $50x inthe X stock. During 2007, X makes a char-itable contribution of unencumbered realproperty, with an adjusted basis of $100xand a fair market value of $190x, in atransaction that qualifies under § 170(c).The charitable contribution is not subjectto the limitations of § 170(e)(1). In 2007,X has §1363 taxable income of $30x and along-term capital loss of $25x.

LAW

Section 170(a) allows as a deductionany charitable contribution (as defined in§ 170(c)) the payment of which is made

March 17, 2008 585 2008–11 I.R.B.

during the taxable year. The deduction al-lowable by § 170(a) is subject to the limi-tations of § 170(b).

Section 1.170A–1(c)(1) of the IncomeTax Regulations provides that if a charita-ble contribution is made in property otherthan money, the amount of the contributionis the fair market value of the property atthe time of the contribution reduced as pro-vided in § 170(e)(1) and § 1.170A–4(a), or§ 170(e)(3) and § 1.170A–4A(c).

Section 1363(b)(2) provides that thetaxable income of an S corporation shallbe computed in the same manner as inthe case of an individual, except that thedeductions referred to in § 703(a)(2),including the deduction for charitable con-tributions provided in § 170, shall not beallowed to the corporation.

Section 1366(a)(1)(A) provides that,in determining the tax of a shareholder,there shall be taken into account the share-holder’s pro rata share of the corporation’sitems of income, loss, deduction, or creditthe separate treatment of which could af-fect the liability for tax of any shareholder.Section 1366(a)(1) provides further thatthe items referred to in § 1366(a)(1)(A)include amounts described in § 702(a)(4).Section 702(a)(4) refers to charitable con-tributions (as defined in § 170(c)).

Section 1366(a)(1)(B) provides that,in determining the tax of a shareholder,there shall be taken into account the share-holder’s pro rata share of any nonsepa-rately computed income or loss.

Section 1366(d)(1) provides that the ag-gregate amount of losses and deductionstaken into account by a shareholder under§ 1366(a) for any taxable year shall notexceed the sum of (A) the adjusted basisof the shareholder’s stock in the S corpo-ration, and (B) the shareholder’s adjustedbasis of any indebtedness of the S corpo-ration to the shareholder.

Section 1366(d)(2)(A) generally pro-vides that any loss or deduction which isdisallowed for any taxable year by reasonof § 1366(d)(1) shall be treated as incurredby the corporation in the succeeding tax-able year with respect to that shareholder.

Section 1.1366–1(a)(2)(i) and (iii) pro-vides that each S corporation shareholdermust take into account separately theshareholder’s pro rata share of the S cor-poration’s gains and losses from sales orexchanges of capital assets and the corpo-ration’s charitable contributions.

Section 1.1366–1(a)(3) provides thateach shareholder must take into accountseparately the shareholder’s pro rata shareof the nonseparately computed income orloss of the S corporation.

Section 1.1366–1(b)(1) provides, inpart, that the character of any item of in-come, loss, deduction, or credit describedin § 1366(a)(1)(A) or (B) is determined forthe S corporation and retains that characterin the hands of the shareholder.

Section 1.1366–2(a)(4) generally pro-vides that if a shareholder’s pro rata shareof the aggregate amount of losses anddeductions exceeds the sum of the ad-justed basis of the shareholder’s stock inthe corporation and the adjusted basis ofany indebtedness of the corporation to theshareholder, then the limitation on lossesand deductions under § 1366(d)(1) mustbe allocated among the shareholder’s prorata share of each loss or deduction. Theamount of the limitation allocated to anyloss or deduction is an amount that bearsthe same ratio to the amount of the limi-tation as the loss or deduction bears to thetotal of the losses and deductions.

Section 1367(a)(1)(B) provides that thebasis of each shareholder’s stock in anS corporation is increased for any periodby any nonseparately computed incomedetermined under § 1366(a)(1)(B).

Section 1367(a)(2)(B) provides thatthe basis of each shareholder’s stockin an S corporation is decreased forany period (but not below zero) by theitems of loss and deduction described in§ 1366(a)(1)(A).

Section 1.1367–1(f) provides that in-creases in an S corporation shareholder’sstock basis that are attributable to incomeitems described in § 1367(a)(1)(B) aremade before decreases in such basis thatare attributable to items of loss or deduc-tion described in § 1367(a)(2)(B).

Section 1203(a) of the Pension Pro-tection Act of 2006 (Pension Act),P.L. 109–280, 120 Stat. 780 (2006),amended Code § 1367(a)(2) to provide thatthe decrease in shareholder basis under§ 1367(a)(2)(B) by reason of a charitablecontribution (as defined in § 170(c)) ofproperty shall be the amount equal to theshareholder’s pro rata share of the adjustedbasis of such property. The TechnicalExplanation of the Pension Act, TechnicalExplanation of H.R. 4, “The PensionProtection Act of 2006,” JCX–38–06 page

271, provides the following illustration of§ 1203:

Thus, for example, assume an S corpo-ration with one individual shareholdermakes a charitable contribution of stockwith a basis of $200 and a fair marketvalue of $500. The shareholder will betreated as having made a $500 chari-table contribution (or a lesser amountif the special rules of section 170(e)apply), and will reduce the basis of theS corporation stock by $200. (Footnote306: This example assumes that basisof the S corporation stock (beforereduction) is at least $200.)Section 3(b) of the Tax Technical Cor-

rections Act of 2007 (Technical Correc-tions Act), P.L. 172, 121 Stat. 2473 (2007),added § 1366(d)(4), which concerns theapplication of the basis limitation rule of§ 1366(d)(1) to charitable contributionsof appreciated property by S corporations.Generally, under § 1366(d)(1), the amountof losses and deductions which a share-holder of an S corporation may take intoaccount in any taxable year is limited tothe shareholder’s adjusted basis in hisstock and indebtedness of the corpora-tion. Section 1366(d)(4) provides that,in the case of a charitable contribution ofproperty, § 1366(d)(1) shall not apply tothe extent of the excess (if any) of (A)the shareholder’s pro rata share of suchcontribution, over (B) the shareholder’spro rata share of the adjusted basis ofsuch property. Thus, the basis limitationrule of § 1366(d)(1) does not apply tothe amount of deductible appreciation inthe contributed property. See Descriptionof the Tax Technical Corrections Act of2007, JCX–119–07, pages 2–3.

The Pension Act amendment to§ 1367(a)(2) and the Technical Correc-tions Act amendment to § 1366(d) applyto charitable contributions made by S cor-porations in taxable years beginning afterDecember 31, 2005, and before January1, 2008. Charitable contributions madeby S corporations in taxable years begin-ning after December 31, 2007, barring anystatutory change, are subject to the law inexistence prior to these amendments. TheIRS and Treasury Department are consid-ering issuing guidance on the treatment ofcharitable contributions made by S cor-porations in taxable years beginning afterDecember 31, 2007.

2008–11 I.R.B. 586 March 17, 2008

ANALYSIS

Under the facts of this revenue ruling,X makes a charitable contribution of un-encumbered real property with an adjustedbasis of $100x and a fair market value of$190x in a transaction that qualifies un-der § 170(c). The charitable contributionis treated as a separately stated item of de-duction that passes through to A and is de-ductible in computing A’s individual tax li-ability. Section 1.1366–1(a)(2)(iii).

Pursuant to § 1.1367–1(f), A’s $50x ba-sis in the X stock is first increased by $30xunder § 1367(a)(1)(B) to reflect A’s shareof X’s taxable income. A’s basis in theX stock is then decreased (but not belowzero) by A’s pro rata share of the sum ofthe adjusted basis of the contributed prop-erty ($100x) pursuant to the flush languageof § 1367(a)(2) and by A’s pro rata share ofX’s long-term capital loss ($25x) pursuantto § 1367(a)(2)(B). However, A’s pro ratashare of the aggregate amount of lossesand deductions ($125x) exceeds A’s basisin the X stock of $80x. Section 1366(d)(1),accordingly, will limit the allowable lossesand deductions to A for X’s 2007 tax year.

Pursuant to § 1366(d)(4), the basislimitation rule in § 1366(d)(1) does notapply to a contribution of appreciatedproperty to the extent the shareholder’spro rata share of the contribution exceedsthe shareholder’s pro rata share of theadjusted basis of the contributed property.Accordingly, the basis limitation rule of§ 1366(d)(1) does not apply to A’s pro ratashare of the amount of deductible appreci-ation in the contributed property ($90x).

Under § 1.1366–2(a)(4), when a share-holder has losses or deductions in excessof the sum of the shareholder’s basis inthe stock plus indebtedness of the S cor-poration to the shareholder, the limitationon losses must be allocated pro rata toeach item of loss or deduction. In thecase of a charitable contribution deduction,the limitation amount allocable to such de-duction is determined by reference to theshareholder’s pro rata share of the con-tributed property’s adjusted basis pursuantto § 1366(d)(4).

In applying § 1.1366–2(a)(4), theamount of the limitation allocable to acharitable contribution deduction is anamount that bears the same ratio to the§ 1366(d) limitation as the shareholder’s

pro rata share of the contributed prop-erty’s adjusted basis bears to the total ofthe shareholder’s pro rata share of thecorporation’s losses and deductions (ex-cluding the charitable contribution deduc-tion attributable to the shareholder’s prorata share of the fair market value of thecontributed property over the contributedproperty’s tax basis). Accordingly, theamount of the limitation allocable to A’sshare of X’s charitable contribution deduc-tion is determined by multiplying A’s basisin the X stock ($80x) by a fraction, the nu-merator of which is $100x (the contributedproperty’s adjusted basis) and the denom-inator of which is $125x (the total of thecapital loss and the contributed property’sadjusted basis). Thus, $64x is allocated tothe charitable contribution deduction. Theremaining $16x is allocated to the capitalloss.

Accordingly, in 2007, the amount ofthe charitable contribution deduction thatA may claim is $154x. This amount iscomprised of A’s pro rata share of theproperty’s appreciation ($90x) plus theamount of the loss limitation allocatedto A’s pro rata share of the contributedproperty’s adjusted basis ($64x). Under§ 1367(a)(2)(B), A’s basis in the X stock isreduced to 0 to reflect the $16x reductionin basis attributable to the capital loss andthe $64x reduction in basis attributableto the charitable contribution deduction.Pursuant to § 1366(d)(2), the disallowedportion of the charitable contribution de-duction ($36x) and the capital loss ($9x)shall be treated as incurred by X in thesucceeding taxable year with respect to A.

HOLDING

If an S corporation makes a charita-ble contribution of appreciated propertyduring a taxable year beginning afterDecember 31, 2005, and before January1, 2008, the amount of the charitablecontribution deduction the shareholdermay claim may not exceed the sum of(i) the shareholder’s pro rata share ofthe fair market value of the contributedproperty over the contributed property’sadjusted tax basis, and (ii) the amount ofthe § 1366(d) loss limitation amount thatis allocable to the contributed property’sadjusted basis under § 1.1366–2(a)(4).Any disallowed portion of the charitablecontribution retains its character and is

treated as incurred by the corporation inthe corporation’s first succeeding taxableyear, and subsequent taxable years, withrespect to the shareholder.


The principal author of this revenue rul-ing is Cynthia D. Morton of the Office ofAssociate Chief Counsel (Passthroughs &Special Industries). For further informa-tion regarding this revenue ruling, contactCynthia D. Morton at (202) 622–3060 (nota toll-free call).

Section 1502.—Regulations26 CFR 1.1502–80: Applicability of other provisionsof law.

T.D. 9376

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Guidance Under Section 1502;Miscellaneous OperatingRules for Successor Persons;Succession to Items of theLiquidating Corporation


ACTION: Final regulations.

SUMMARY: This document contains fi-nal regulations under section 1502 of theInternal Revenue Code that provide guid-ance regarding the manner in which theitems (including items described in section381(c) but excluding intercompany itemsunder §1.1502–13) of a liquidating cor-poration are succeeded to and taken intoaccount in cases in which multiple mem-bers acquire the assets of the liquidatingcorporation in a complete liquidation towhich section 332 applies. These final reg-ulations affect corporations filing consoli-dated returns.

DATES: Effective Date: These regulationsare effective January 15, 2008.

Applicability Date: For the date of ap-plicability, see §1.1502–80(g)(7).

March 17, 2008 587 2008–11 I.R.B.

FOR FURTHER INFORMATIONCONTACT: Amber C. Vogel orMarie C. Milnes-Vasquez, (202) 622–7530(not a toll-free number).


Background

On February 22, 2005, the IRS andTreasury Department published in theFederal Register (70 FR 8552) a notice ofproposed rulemaking (REG–131128–04,2005–1 C.B. 733) under section 1502proposing guidance as to how multipleconsolidated group members (distributeemembers) that acquire assets in a liquida-tion to which section 332 applies succeedto and take into account the items of theliquidating corporation. The proposedregulations apply single-entity principlesand allocate the items of the liquidatingcorporation that could be used to offsetthe income or tax liability of the group orany member to each distributee memberto the extent that such items would havebeen reflected in investment adjustmentsto the stock of the liquidating corporationowned by such distributee member underthe principles of §1.1502–32(c) if, imme-diately before the liquidation, any stockof the liquidating corporation owned bynonmembers had been redeemed, and thensuch items had been taken into account.

The proposed regulations also provideallocation rules for the credits and earn-ings and profits of the liquidating corpo-ration. Under the proposed regulations,each distributee member succeeds to thecredits of the liquidating corporation tothe extent that the items of income, gain,loss, or deduction attributable to the ac-tivities that gave rise to the credit wouldhave been reflected in investment adjust-ments to the stock of the liquidating cor-poration owned by such distributee mem-ber under the principles of §1.1502–32(c)if, immediately before the liquidation, anystock of the liquidating corporation ownedby nonmembers had been redeemed, andthen such items had been taken into ac-count. The proposed regulations providesimilar rules for allocating the liquidatingcorporation’s earnings and profits to thedistributee members.

Under the proposed regulations, a dis-tributee member generally succeeds to anyother items of the liquidating corporation

if, immediately before the liquidation,such distributee owns stock in the liquidat-ing corporation meeting the requirementsof section 1504(a)(2) without regard to theapplication of §1.1502–34. In contrast,a distributee member that does not meetthe ownership requirements of section1504(a)(2) without regard to the appli-cation of §1.1502–34 (a non-80-percentdistributee) succeeds to any remainingitems of the liquidating corporation only tothe extent that it would have succeeded tothose items if it had purchased, in a taxabletransaction, the assets or businesses of theliquidating corporation that it received inthe liquidation and had assumed the liabil-ities that it assumed in the liquidation.

In addition, the proposed regulationsalso provide guidance regarding themethod for allocating the intercompanyitems of a liquidating subsidiary in cases inwhich multiple members acquire the assetsof a liquidating subsidiary in a completeliquidation to which section 332 applies.The IRS and Treasury Department con-tinue to study those rules. Accordingly,that portion of the notice of proposedrulemaking is withdrawn, and the finalregulations do not apply to the intercom-pany items of the liquidating corporation.For rules applicable to the treatment ofthose items, see §1.1502–13(j)(2)(ii).

No public hearing was requested orheld. Written and electronic commentsresponding to the notice of proposedrulemaking were received. After consid-eration of all the comments, the proposedregulations are adopted as amended bythis Treasury decision. The revisions arediscussed in this preamble.

Explanation and Summary ofComments

The Complete Liquidation Rules

Section 332(a) provides that no gainor loss shall be recognized on the receiptby a corporation of property distributed incomplete liquidation of another corpora-tion. Section 332(b) provides, in part, thata distribution shall be considered to be incomplete liquidation only if the corpora-tion receiving such property was, on thedate of the adoption of the plan of liq-uidation and at all times thereafter untilthe receipt of the property, the owner ofstock meeting the requirements of section

1504(a)(2) and the distribution is made incomplete cancellation or redemption of allof the stock of the liquidating corporation.Section 1.1502–34 provides that in deter-mining the stock ownership of a memberin another corporation (the issuing corpo-ration) for purposes of determining the ap-plication of section 332(b)(1) there shallbe included the stock of the issuing corpo-ration owned by all other members of thegroup.

Section 337(a) provides that the liqui-dating corporation shall not recognize gainor loss on the distribution to the 80-percentdistributee of any property in a completeliquidation to which section 332 applies.Section 337(c) provides that, for purposesof section 337, the term “80-percent dis-tributee” means only the corporation thatmeets the 80-percent stock ownership re-quirements of section 332(b) without re-gard to the application of any consolidatedreturn regulation. If section 337(a) doesnot apply, under section 336, the liquidat-ing corporation will generally recognizegain or loss on the distribution of propertyin complete liquidation as if such propertywere sold to the distributee at its fair mar-ket value. Therefore, a complete liquida-tion to which section 332 applies may betaxable in whole or in part to the liquidat-ing corporation but tax-free to the distribu-tee members.

Deferred Income Items of the LiquidatingCorporation

Section 1.451–5 generally allows ac-crual method taxpayers to defer the in-clusion in gross income of advance pay-ments for goods until the taxable year inwhich properly accruable under the tax-payer’s method of accounting for tax pur-poses if such method results in gross in-come inclusion no later than when suchitems are included in gross income underthe taxpayer’s method of accounting for fi-nancial reporting purposes. However, if ina taxable year the taxpayer ceases to ex-ist in a transaction other than one to whichsection 381(a) applies, or the liability un-der the agreement otherwise ends, then de-ferred income amounts are includable inthe taxpayer’s gross income for such tax-able year.

Rev. Proc. 2004–34, 2004–1 C.B. 991,(see §601.601(d)(2)(ii)(b) of this chapter)allows taxpayers a limited deferral beyond

2008–11 I.R.B. 588 March 17, 2008

the taxable year of receipt for certain ad-vance payments. However, inclusion ofdeferred income is accelerated to the tax-able year of receipt if, in such taxable year,the taxpayer ceases to exist in a transactionother than a transaction to which section381(a) applies or the taxpayer’s obligationwith respect to the advance payment is sat-isfied or otherwise ends other than in cer-tain types of section 351(a) transfers or ina transaction to which section 381(a) ap-plies.

Section 455 provides accrual methodtaxpayers with an election to include pre-paid subscription income in gross incomein the taxable year in which the liability ex-ists to furnish or deliver a newspaper, mag-azine, or other periodical. However, if theliability to furnish or deliver the periodicalends or the taxpayer ceases to exist, thenthe amount of prepaid subscription incomenot previously included in the taxpayer’sgross income is included in the taxpayer’sgross income for the taxable year in whichthe liability ends. If the taxpayer’s liabil-ity to furnish or deliver the periodical endsas a result of a transaction to which sec-tion 381(a) applies, the prepaid subscrip-tion income will generally not be includedin the taxpayer’s gross income, and the ac-quiring corporation must continue to deferthe prepaid subscription income under sec-tion 455. Treas. Reg. §1.455–4 (citingsection 381(c)(4) and the regulations un-der that section).

Section 381(a) applies to a distributionto which section 332 applies. As describedin this preamble, a complete liquidationto which section 332 applies is taxableto the liquidating corporation to the ex-tent that it distributes property to a non-80-percent distributee. In particular, theliquidating corporation is treated as if ithad sold the property distributed to thenon-80-percent distributee at its fair mar-ket value. If the liquidating corporationhad sold a business with regard to whichincome items had been deferred (for exam-ple, deferred prepaid subscription incomeunder section 455) and the purchaser hadassumed the liquidating corporation’s obli-gation or liability to perform the servicesor provide the goods relating to the de-ferred income, then the liquidating corpo-ration would have recognized the deferredincome. However, the liquidating corpora-tion would also have been entitled to a de-duction under section 162 for any amount

paid (or deemed paid) to the purchaser forits assumption of the obligation or liabil-ity related to the deferred income. SeeRev. Rul. 68–112, 1968–1 C.B. 62 (see§601.601(d)(2)(ii)(b) of this chapter). Theamount paid (or deemed paid) by the liqui-dating corporation to the purchaser for itsliability assumption would have been in-cludible in the purchaser’s gross income.See Rev. Rul. 71–450, 1971–2 C.B. 78(see §601.601(d)(2)(ii)(b) of this chapter).

The IRS and Treasury Department be-lieve that it is appropriate for any deferredincome items of a liquidating corpora-tion attributable to assets and/or liabilitiestransferred to a non-80-percent distributeeto be taken into account under applicableprinciples of law as a result of the liqui-dation despite the fact that the transactionis described in section 381(a). Likewise,section 332(a) does not apply in determin-ing the recognition or nonrecognition ofany income realized by the non-80-percentdistributee attributable to its assumptionof an obligation or liability related to thedeferred income because such income isnot gain or loss recognized with respectto the stock of the liquidating corporation.These final regulations include such rules.

Allocation of Items Specific to Propertyor a Business

The IRS and Treasury Department alsobelieve that it is appropriate to allocatethe full amount of deferred income itemsor deferred deductions of the liquidatingcorporation that are attributable to specificproperty or a specific business to the dis-tributee member that receives such prop-erty or business in the liquidation. Thesefinal regulations include such a rule.

Succession to Credits of the LiquidatingCorporation

As described in this preamble, the pro-posed regulations allocate credits to dis-tributee members based on the items of in-come, gain, loss, or deduction attributableto the activities that gave rise to the cred-its. Comments were received indicatingthat it was unclear how to allocate creditsthat are not clearly associated with itemsof income, gain, loss, or deduction (for ex-ample, the section 53 minimum tax credit).The IRS and Treasury Department agreewith those comments. Accordingly, these

final regulations revise the credit alloca-tion rule and provide that credits will beallocated proportionally based on the valueof the stock of the liquidating corporationowned by each distributee member. TheIRS and Treasury Department believe thatthis rule represents a reasonable and ad-ministrable approach to allocating credits.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. Further, it is hereby cer-tified that these regulations will not havea significant economic impact on a sub-stantial number of small entities. This cer-tification is based on the fact that theseregulations will primarily affect affiliatedgroups of corporations that have elected tofile a consolidated return, which tend to belarger businesses. Accordingly, a regula-tory flexibility analysis under the Regula-tory Flexibility Act (5 U.S.C. chapter 6) isnot required. Pursuant to section 7805(f)of the Internal Revenue Code, the notice ofproposed rulemaking preceding this regu-lation was submitted to the Chief Counselfor Advocacy of the Small Business Ad-ministration for comment on its impact onsmall business.


The principal author of these regula-tions is Amber C. Vogel of the Officeof Associate Chief Counsel (Corporate).However, other personnel from the IRSand Treasury Department participated intheir development.

Partial Withdrawal of ProposedRegulations

Accordingly, we are not adopting theamendments to §1.1502–13 as proposedin the notice of proposed rulemaking(REG–131128–04) that was published inthe Federal Register on Tuesday, Febru-ary 22, 2005 (70 FR 8552).

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

March 17, 2008 589 2008–11 I.R.B.


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

Authority: 26 U.S.C. 7805. * * *Section 1.1502–80 also issued under

26 U.S.C. 1502. * * *Par. 2. Section 1.1502–80 is amended

by:1. Removing the second sentence from

paragraph (a).2. Revising the third sentence of para-

graph (a).3. Adding paragraph (g).The revision and addition read as fol-

lows:

§1.1502–80 Applicability of otherprovisions of law.

(a) * * * For example, sections 269 and482 apply for any consolidated year. * * *

* * * * *(g) Special rules for liquidations to

which section 332 applies. Notwithstand-ing the general rule of section 381, ifmultiple members (distributee members)acquire assets of a corporation in a liq-uidation to which section 332 applies(regardless of whether any single memberowns stock in the liquidating corpora-tion meeting the requirements of section1504(a)(2)), such members succeed toand take into account the items of theliquidating corporation (including itemsdescribed in section 381(c), but excludingintercompany items under §1.1502–13)as provided in this paragraph (g) to theextent not otherwise prohibited by any ap-plicable provision of law. This paragraph(g) does not apply to the intercompanyitems of the liquidating corporation. See§1.1502–13(j)(2)(ii).

(1) Income offset items and deferred in-come. Except as otherwise provided in thisparagraph (g)(1), each distributee mem-ber succeeds to and takes into account theitems of the liquidating corporation thatcould be used to offset the income of thegroup or any member (including deferreddeductions, net operating loss carryovers,and capital loss carryovers) (income offsetitems) to the extent that such items wouldhave been reflected in investment adjust-ments to the stock of the liquidating corpo-ration owned by such distributee memberunder §1.1502–32(c) if, immediately priorto the liquidation, any stock of the liqui-

dating corporation owned by nonmembershad been redeemed and then such itemshad been taken into account. However,each distributee member succeeds to thefull amount of any deferred deduction ordeferred income item attributable to theparticular property or business operationsdistributed to such distributee in the liqui-dation to the extent that such item is nottaken into account in the determination ofthe income or loss of the liquidating cor-poration with regard to the liquidation un-der chapter 1 of the Internal Revenue Code(Code). If the liquidating corporation isnot a member of the group at the time ofthe liquidation, the rules of this paragraph(g)(1) are applied as if the liquidating cor-poration had been a member of the group.

(2) Accounting for deferred incomeitems. Solely for the purpose of deter-mining whether deferred income items ofa liquidating corporation are taken intoaccount under applicable principles of lawas a result of a liquidation to which section332 applies, the transfer of property to,and the assumption of liabilities by, a dis-tributee member that does not own stock inthe liquidating corporation meeting the re-quirements of section 1504(a)(2) withoutregard to the application of §1.1502–34immediately prior to the liquidation is nottreated as part of a transaction to whichsection 381(a) applies. In addition, sec-tion 332(a) does not apply in determiningthe recognition or nonrecognition of anyincome realized by the distributee mem-ber under applicable principles of lawon account of consideration received (ordeemed received) on the assumption of theliquidating corporation’s obligation or lia-bility attributable to any deferred incomeitem.

(3) Credits and earnings and profits.Each distributee member succeeds to andtakes into account a percentage of eachcredit of the liquidating corporation equalto the value of the stock of the liquidatingcorporation owned by such distributee atthe time of the liquidation divided by thetotal value of all the stock of the liquidat-ing corporation owned by members of thegroup at the time of the liquidation. Exceptto the extent that the distributee member’searnings and profits already reflect the liq-uidating corporation’s earnings and prof-its, each distributee member succeeds toand takes into account under the principlesof §1.1502–32(c) the earnings and profits,

or deficit in earnings and profits, of the liq-uidating corporation (determined after tak-ing into account the amount of earningsand profits properly applicable to distribu-tions to non-member shareholders under§1.381(c)(2)–1(c)(2)). If the liquidatingcorporation is not a member of the groupat the time of the liquidation, the rules ofthis paragraph (g)(3) are applied as if theliquidating corporation had been a mem-ber of the group.

(4) Other items. With regard to items towhich neither paragraph (g)(1) nor (g)(3)of this section applies, a distributee mem-ber that, immediately prior to the liqui-dation, owns stock in the liquidating cor-poration meeting the requirements of sec-tion 1504(a)(2) without regard to the ap-plication of §1.1502–34 succeeds to theitems of the liquidating corporation in ac-cordance with section 381 and other ap-plicable principles. A distributee memberthat, immediately prior to the liquidation,does not own stock in the liquidating cor-poration meeting the requirements of sec-tion 1504(a)(2) without regard to the appli-cation of §1.1502–34 succeeds to the itemsof the liquidating corporation to the extentthat it would have succeeded to those itemsif it had purchased, in a taxable transaction,the assets or businesses of the liquidatingcorporation that it received in the liquida-tion and had assumed the liabilities that itassumed in the liquidation.

(5) Determination of the items of aliquidating subsidiary. For purposes ofthis section, the items of a liquidatingsubsidiary include the amount of anyconsolidated tax attribute attributableto the liquidating subsidiary that is de-termined pursuant to the principles of§1.1502–21(b)(2)(iv). In addition, if theliquidating subsidiary is a member of aseparate return limitation year subgroup,the amount of a tax attribute that arosein a separate return limitation year that isattributable to that member shall also bedetermined pursuant to the principles of§1.1502–21(b)(2)(iv).

(6) Examples. The following examplesillustrate the application of this paragraph(g):

Example 1. Liquidation–80 percent distributee.(i) Facts. X has only common stock outstanding. OnJanuary 1 of year 1, X acquired equipment with a10-year recovery period and elected to depreciate theequipment using the straight-line method of depreci-ation. On January 1 of year 7, M1 and M2 own 80percent and 20 percent, respectively, of X’s stock. X

2008–11 I.R.B. 590 March 17, 2008

is a domestic corporation but is not a member of thegroup that includes M1 and M2. On that date, X dis-tributes all of its assets to M1 and M2 in completeliquidation. The equipment is distributed to M1. Un-der section 334(b), M1’s basis in the equipment is thesame as it would be in X’s hands. After computingits tax liability for the taxable year that includes theliquidation, X has net operating losses of $100, busi-ness credits of $40, and earnings and profits of $80.

(ii) Succession to items described in section381(c). (A) Losses. Under paragraph (g)(1) of thissection, each distributee member succeeds to X’sitems that could be used to offset the income of thegroup or any member to the extent that such itemswould have been reflected in investment adjustmentsto the stock of X it owned under §1.1502–32(c) if,immediately prior to the liquidation, such items hadbeen taken into account. Accordingly, M1 and M2succeed to $80 and $20, respectively, of X’s netoperating loss.

(B) Credits and earnings and profits. Under para-graph (g)(3) of this section, because, immediatelyprior to the liquidation, M1 and M2 hold 80 percentand 20 percent, respectively, of the value of the stockof X, M1 and M2 succeed to $32 and $8, respec-tively, of X’s $40 of business credits. In addition, be-cause M1’s and M2’s earnings and profits do not re-flect X’s earnings and profits, X’s earnings and prof-its are allocated to M1 and M2 under the principlesof §1.1502–32(c). Therefore, M1 and M2 succeed to$64 and $16, respectively, of X’s earnings and prof-its.

(C) Depreciation of equipment’s basis. Un-der paragraph (g)(4) of this section, because M1owns stock in X meeting the requirements of sec-tion 1504(a)(2) without regard to the application of§1.1502–34, M1 is required to continue to depreciatethe equipment using the straight-line method of de-preciation over the remaining recovery period of 4.5years (assuming X used a half-year convention).

Example 2. Liquidation-no 80 percent distribu-tee. (i) Facts. The facts are the same as in Example1 except that M1 and M2 own 60 percent and 40 per-cent, respectively, of X’s stock. In addition, on Jan-uary 1 of year 6, X entered into a long-term contractwith Y, an unrelated party. The total contract priceis $1000, and X estimates the total allocable contractcosts to be $500. At the time of the liquidation, X hadreceived $250 in progress payments under the con-tract and incurred costs of $125. X accounted for thecontract under the percentage of completion methoddescribed in section 460(b). In the liquidation, M1assumes X’s contract obligations and rights.

(ii) Succession to items described in section381(c). (A) Losses. Under paragraph (g)(1) of this

section, each distributee member succeeds to X’sitems that could be used to offset the income of thegroup or any member to the extent that such itemswould have been reflected in investment adjustmentsto the stock of X it owned under §1.1502–32(c) if,immediately prior to the liquidation, such items hadbeen taken into account. Accordingly, M1 and M2succeed to $60 and $40, respectively, of X’s netoperating loss.

(B) Credits and earnings and profits. Under para-graph (g)(3) of this section, because, immediatelyprior to the liquidation, M1 and M2 hold 60 percentand 40 percent, respectively, of the value of the stockof X, M1 and M2 succeed to $24 and $16, respec-tively, of X’s $40 of business credits. In addition, be-cause M1’s and M2’s earnings and profits do not re-flect X’s earnings and profits, X’s earnings and prof-its are allocated to M1 and M2 under the principlesof §1.1502–32(c). Therefore, M1 and M2 succeed to$48 and $32, respectively, of X’s earnings and prof-its.

(C) Depreciation of equipment’s basis. Undersection 334(a), M1’s basis in the equipment is its fairmarket value at the time of the distribution. Pursuantto section 168(i)(7), to the extent that M1’s basis inthe equipment does not exceed X’s adjusted basis inthe equipment at the time of the transfer, M1 is re-quired to continue to depreciate the equipment usingthe straight-line method of depreciation over the re-maining recovery period of 4.5 years (assuming Xused a half-year convention). Any portion of M1’sbasis in the equipment that exceeds X’s adjusted basisin the equipment at the time of the transfer is treatedas being placed in service by M1 in the year of thetransfer. Thus, M1 may choose any applicable de-preciation method, recovery period, and conventionunder section 168 for such excess basis.

(D) Method of accounting for long-term contract.Under paragraph (g)(4) of this section, M1 does notsucceed to X’s method of accounting for the con-tract. Rather, under §1.460–4(k)(2), M1 is treatedas having entered into a new contract on the date ofthe liquidation. Under §1.460–4(k)(2)(iii), M1 mustevaluate whether the new contract should be classi-fied as a long-term contract within the meaning of§1.460–1(b) and account for the contract under a per-missible method of accounting.

Example 3. Liquidation—deferred items. (i)Facts. X has only common stock outstanding, andM1 and M2 (who are members of the same group)own 80 percent and 20 percent, respectively, of X’sstock. X operates two divisions, each of which defersprepaid subscription income pursuant to an electionunder section 455. X distributes all of its assets incomplete liquidation. M1 receives all of the assets of

Division 1, including prepaid subscription income,and assumes X’s liability to furnish or deliver thenewspaper, magazine, or other periodical to whichthe prepaid subscription income received by M1relates. M2 receives all of the assets of Division 2,including prepaid subscription income, and assumesX’s liability to furnish or deliver the newspaper,magazine, or other periodical to which the prepaidsubscription income received by M2 relates.

(ii) Acceleration of deferred income items andsuccession to other deferred items. Under paragraph(g)(1) of this section, M1 succeeds to the full amountof the deferred prepaid subscription income of X at-tributable to Division 1. Under applicable law, Xdoes not recognize the deferred prepaid subscriptionincome attributable to Division 1 because X’s liabil-ity to furnish or deliver the newspaper, magazine, orother periodical ends as a result of a transaction towhich section 381(a) applies. Under paragraph (g)(2)of this section, solely for purposes of determiningwhether the deferred income items of X attributableto Division 2 are taken into account as a result of theliquidation, the distribution of property to M2 is nottreated as a transaction to which section 381(a) ap-plies. Therefore, under applicable law, X’s deferredprepaid subscription income attributable to Division2 is taken into account in the determination of X’s in-come or loss with regard to the liquidation. Further,under paragraph (g)(2) of this section, section 332(a)does not apply in determining the recognition or non-recognition of any income that M2 realizes on ac-count of consideration received (or deemed received)on its assumption of X’s liability to furnish or de-liver the newspaper, magazine, or other periodical towhich the prepaid subscription income relates.

(7) Effective/applicability date. Thisparagraph (g) applies to transactions oc-curring after April 14, 2008.

Linda E. Stiff,Deputy Commissioner forServices and Enforcement.

Approved January 8, 2008.

Eric Solomon,Assistant Secretary of

the Treasury (Tax Policy).


March 17, 2008 591 2008–11 I.R.B.

Part III. Administrative, Procedural, and MiscellaneousVoluntary Closing AgreementProgram For Tax-ExemptBonds and Tax Credit Bonds

Notice 2008–31

SECTION 1. PURPOSE

This notice provides information aboutthe voluntary closing agreement programfor tax-exempt bonds and tax credit bonds(“TEB VCAP”). In particular, the no-tice updates procedures whereby issuersof tax-exempt bonds and tax credit bondscan resolve violations of the Internal Rev-enue Code (the “Code”) through closingagreements with the Internal Revenue Ser-vice (the “Service”). The Tax ExemptBonds Compliance & Program Manage-ment (“TEB CPM”) function of Tax Ex-empt and Government Entities (TE/GE) iscontinuing to develop voluntary compli-ance initiatives to insure compliance by is-suers of tax-exempt bonds and tax creditbonds with applicable provisions of theCode. TEB VCAP is part of the TEB CPMvoluntary compliance initiatives and pro-vides appropriate remedies when issuersvoluntarily come forward and express adesire to resolve violations of the Code.TEB VCAP is intended to encourage is-suers and conduit borrowers to exercisedue diligence in complying with the Codeand to provide a vehicle to correct viola-tions of the Code. It is the continuing pol-icy of the Service to attempt to resolve vi-olations of the Code without taxing bond-holders. TEB VCAP reflects this policy.

The Service is continuing to work onmore detailed procedures about the pro-gram, and intends to provide those proce-dures in forthcoming guidance. For ex-ample, the Service anticipates specifyingstandardized closing agreement terms andamounts for particular violations.

SECTION 2. CHANGES

This notice modifies and supersedesNotice 2001–60, 2001–2 C.B. 304. Ingeneral, Notice 2001–60 is amended by:(1) changing references to Outreach Plan-ning and Review (OPR) to Compliance& Program Management (CPM); (2) in-corporating tax credit bonds into the TEBVCAP program; (3) simplifying section

5(a) by referring to Internal Revenue Man-ual (“IRM”) 7.2.3 for the specific infor-mation required for a VCAP submission;(4) clarifying that under section 5(b) CPMstaff will obtain additional information asneeded; (5) clarifying that all informationfor a VCAP submission must be providedin electronic format; and (6) providingemail and regular mail addresses for sub-missions.

SECTION 3. BACKGROUND

Gross income does not include inter-est on any state or local bond that meetsthe requirements of section 103 and relatedprovisions of the Code. A credit againsttax is provided to a holder of a qualifiedtax credit bond issued under sections 54,1397E or 1400N that meets the require-ments of those sections and related pro-visions of the Code. Under certain cir-cumstances, an issuer may take remedialaction under provisions such as sections1.141–12, 1.142–2, 1.144–2, 1.145–2, and1.147–2 of the Income Tax Regulationsand similar provisions that are applicableto tax credit bonds in order to cure a viola-tion of the Code.

The Service has previously providedformal tax-exempt bond closing agree-ment programs such as the program de-scribed in Rev. Proc. 97–15, 1997–1C.B. 635. Violations of section 103 andrelated provisions of the Code that cannotbe remediated under existing remedial ac-tion provisions or other tax-exempt bondclosing agreement programs contained inregulations or other published guidancemay be resolved by entering into a closingagreement under TEB VCAP.

Section 7121 of the Code and the regu-lations thereunder authorize the Commis-sioner to enter into written closing agree-ments with any person in connection withthe tax liability of such person (or of theperson or estate for which he acts). Section301.7121–1 of the Income Tax Regulationsprovides, in part, that a closing agreementmay be entered into in any case in whichthere appears to be an advantage in hav-ing the case permanently and conclusivelyclosed, or if good and sufficient reasons areshown by the taxpayer for desiring a clos-ing agreement and it is determined by theCommissioner that the United States will

sustain no disadvantage through consum-mation of such an agreement.

SECTION 4. SCOPE OF TEB VCAP

Under TEB VCAP, an issuer may re-quest a closing agreement with respect toits bonds to resolve violations of sections103, 54, 1397E, 1400N and related provi-sions of the Code. TEB VCAP is not avail-able when:

(a) Absent extraordinary circum-stances, the violation can be remediatedunder existing remedial action provisionsor tax-exempt bond closing agreementprograms contained in regulations or otherpublished guidance.

(b) The bond issue is under examina-tion. A bond issue is generally treatedas under examination on the date a letteropening an examination on the bond issueis sent.

(c) The tax-exempt status of the bondsor qualified status of tax credit bonds is atissue in any court proceeding or is beingconsidered by the IRS Office of Appeals.

(d) The Service determines that the vi-olation was due to willful neglect.

SECTION 5. PROCEDURESFOR REQUESTING A CLOSINGAGREEMENT UNDER TEB VCAP

(a) Information Required in Requests.An issuer or its authorized representativerequesting a closing agreement must sub-mit the information specified in IRM 7.2.3and the information reporting return forthe applicable bonds on IRS Form 8038 orother comparable form that was filed withrespect to the issue. (For convenience ofreference, the relevant portions of the In-ternal Revenue Manual (IRM) are avail-able on the IRS website, at www.irs.gov, inthe section on the Tax-Exempt Bond Com-munity, under the subheading of PublishedGuidance.) All information concerningthe closing agreement must be submittedunder penalty of perjury signed by an of-ficial of the issuer with knowledge of theissue and authorized to make the submis-sions on behalf of the issuer. The re-quest may also contain a Form 2848 withthe name, address, phone number, and faxnumber of an authorized contact person.

2008–11 I.R.B. 592 March 17, 2008

(b) Additional Information for Re-quests. CPM staff may require additionalinformation depending on the facts andcircumstances. All additional informationmust be submitted under penalty of per-jury signed by the person who initiallysigned the submission or who would havebeen authorized to make the original sub-mission.

(c) Electronic Format. All informa-tion submitted in support of a closingagreement request must be provided in anelectronic format that is either emailed inPDF format or provided on a compact disc(“CD”) sent via regular mail to the addressprovided by this notice. Hard copies ofthe submissions can be provided but arenot required.

(d) Anonymous Closing AgreementRequests. An issuer or its authorizedrepresentative may initiate discussionsregarding the appropriate terms of a clos-ing agreement on an anonymous basis.An anonymous request may be made onbehalf of a group of similarly situated is-suers. However, the execution of a closingagreement must be between the Serviceand a disclosed issuer, and all terms ofa closing agreement must be consistentwith section 7121 of the Code. Until thename of the bond issue is disclosed to theService, a request for a closing agreementunder TEB VCAP will not prevent theService from beginning an examinationof the bond issue. An issue for whicha request has been submitted under thisparagraph (d) that has been placed underexamination prior to the date the issue isidentified to the Service will no longer beeligible for TEB VCAP.

(e) TEB VCAP Mailing Address. TEBVCAP submissions should be mailed to:

Internal Revenue ServiceAttn: TEB VCAP1122 Town & Country CommonsSt. Louis, MO 63017

(f) TEB VCAP E-Mail Address.In the alternative, VCAP informationmay be submitted in PDF format [email protected]. TEB CPM willprovide an acknowledgement of receipt ofan email request.

SECTION 6. CLOSING AGREEMENTTERMS

Closing agreements under TEB VCAPwill generally follow the model closingagreement in IRM 4.81.1, Exhibit 9, as thesame may be modified or changed. Spe-cific closing agreement terms will dependon the facts and circumstances of the case,including the degree of diligence exercisedby the issuer and any conduit borrower.Any standardized closing agreement termsthat are developed for TEB VCAP will beset forth in the Internal Revenue Manualand/or other published guidance.

SECTION 7. EFFECT OF CLOSINGAGREEMENT EXECUTED UNDERTEB VCAP

A closing agreement properly executedby the issuer and the Service will protectbondholders from including in their grossincome any interest on the bonds or fromrecapturing tax credits during the periodspecified in the agreement for any viola-tion described in the agreement. A closingagreement executed under section 7121 ofthe Code shall be final and conclusive ex-cept that: (1) the matter it relates to maybe reopened in the event of fraud, malfea-sance, or misrepresentation of a materialfact; (2) it is subject to the sections ofthe Code that expressly provide that ef-fect be given to their provisions (includingany stated exception for section 7122 ofthe Code) notwithstanding any other lawor rule of law; and (3) it is subject to anylaw, enacted after the date of the agree-ment, that applies to a tax period endingafter the date of the agreement covered bythe agreement.

SECTION 8. REQUESTS FORCOMMENTS

We anticipated that TEB VCAP willcontinue to be expanded and refined overtime based on experience and public com-ment. The Service welcomes commentsregarding the format and operation ofTEB VCAP, and suggestions with re-gard to the general framework of closingagreement terms including standardizedclosing agreement terms and amountsthat may be specified for particular vi-olations. Comments should be submit-ted in writing and should be emailed to

[email protected] or mailedto the following address:

Steven A. ChamberlinManager, Tax Exempt Bonds

Compliance & ProgramManagement

SE:T:GE:TEB:CPM1122 Town & Country CommonsSt. Louis, MO 63017

SECTION 9. EFFECT ON OTHERDOCUMENTS

Notice 2001–60, 2001–2 C.B. 304, ismodified and superseded.

SECTION 10. EFFECTIVE DATE

TEB VCAP is effective February 27,2008.

SECTION 11. DRAFTINGINFORMATION

The principal authors of this noticeare Steven A. Chamberlin of Tax ExemptBonds Compliance & Program Manage-ment, Tax Exempt & Government Entities,and Carla Young of the Office of AssociateChief Counsel (Financial Institutions &Products). For further information regard-ing this notice, contact Steven Chamberlinat (636) 255–1290 or Carla Young at (202)622–3980 (not toll-free calls).

Section 67 Limitations onEstates or Trusts for BundledInvestment Management andAdvisory Costs

Notice 2008–32

This notice provides interim guidanceon the treatment under § 67 of the Inter-nal Revenue Code of investment advisorycosts and other costs subject to the 2-per-cent floor under § 67(a) that are bundledas part of one commission or fee paid tothe trustee or executor (“Bundled Fidu-ciary Fee”) and are incurred by a trust otherthan a grantor trust (nongrantor trust) or anestate.

BACKGROUND

On January 16, 2008, the SupremeCourt of the United States issued its de-cision in Michael J. Knight, Trustee of

March 17, 2008 593 2008–11 I.R.B.

William L. Rudkin Testamentary Trustv. Commissioner, 552 U.S. , 128S. Ct. 782 (2008), holding that costs paidto an investment advisor by a nongrantortrust or estate generally are subject to the2-percent floor for miscellaneous itemizeddeductions under § 67(a). The IRS and theTreasury Department expect to issue finalregulations under § 1.67–4 of the IncomeTax Regulations consistent with theSupreme Court’s holding in Knight. Thefinal regulations also will address the issueraised when a nongrantor trust or estatepays a Bundled Fiduciary Fee for costsincurred in-house by the fiduciary, someof which are subject to the 2-percent floorand some of which are fully deductiblewithout regard to the 2-percent floor. Thefinal regulations, however, will not beissued prior to the due date for filing 2007income tax returns (determined withoutregard to extensions), and will apply onlyprospectively. Accordingly, in light ofthe Supreme Court’s decision in Knight,the IRS and the Treasury Departmentare providing interim guidance thatspecifically addresses the treatment of aBundled Fiduciary Fee.

INTERIM GUIDANCE

Taxpayers will not be required to deter-mine the portion of a Bundled FiduciaryFee that is subject to the 2-percent floorunder § 67 for any taxable year beginningbefore January 1, 2008. Instead, for eachsuch taxable year, taxpayers may deductthe full amount of the Bundled FiduciaryFee without regard to the 2-percent floor.Payments by the fiduciary to third par-ties for expenses subject to the 2-percentfloor are readily identifiable and must betreated separately from the otherwise Bun-dled Fiduciary Fee.

The IRS and the Treasury Departmentanticipate that final regulations under§ 1.67–4 will be published without delayafter the extended comment period grantedin this notice. The final regulations maycontain one or more safe harbors for theallocation of fees and expenses betweenthose costs that are subject to the 2-per-cent floor and those that are not. Anysafe harbors in the final regulations fordetermining the allocation of a bundledfiduciary fee between costs subject to the2-percent floor and those not subject to the2-percent floor may be available for tax-

payers to use for taxable years beginningon or after January 1, 2008.

REQUESTS FOR COMMENTS

Interested parties are invited to submitcomments on this notice and § 1.67–4of the proposed regulations published inthe Federal Register of July 27, 2007(REG–128224–06, 2007–36 I.R.B. 551[72 FR 41243–01]) by May 27, 2008.

The IRS and the Treasury Departmentare considering various modifications to§ 1.67–4 of the proposed regulations thatmay include safe harbors for determin-ing the allocation of a Bundled FiduciaryFee between costs subject to the 2-per-cent floor and those that are not. The IRSand the Treasury Department request com-ments on whether safe harbors would behelpful and request suggestions on how thesafe harbors may be formulated. Com-ments are specifically requested on reason-able estimates of the percentage(s) of thetotal costs of administering a nongrantortrust or estate that is attributable to costssubject to the 2-percent floor including,but not limited to, costs for investmentmanagement and advice. Comments arealso requested on whether the safe har-bors should reflect the nature or value ofthe assets in the nongrantor trust or estate,and/or the number of beneficiaries of thenongrantor trust or estate.

Comments should be submitted to: In-ternal Revenue Service, CC:PA:LPD:PR(Notice 2008–32), Room 5203, P.O.Box 7604, Ben Franklin Station, Wash-ington, DC 20224. Alternatively,comments may be hand deliveredMonday through Friday between thehours of 8:00 a.m. to 4:00 p.m. to:CC:PA:LPD:PR (Notice 2008–32),Courier’s Desk, Internal RevenueService, 1111 Constitution Avenue,N.W., Washington, DC. Commentsmay also be submitted electronicallyvia the following e-mail address:[email protected] include Notice 2008–32 in thesubject line of any electronic submissions.

EFFECTIVE DATE

This notice is effective February 27,2008.

CONTACT INFORMATION

The principal author of this noticeis Jennifer N. Keeney of the Office ofAssociate Chief Counsel (Passthroughs& Special Industries). For further in-formation regarding this notice, contactJennifer N. Keeney at (202) 622–3060(not a toll-free call).

26 CFR 601.601: Rules and regulations.(Also Part I, §§ 25, 103, 143; 1.25–4T, 1.103–1,6a.103A–2.)

Rev. Proc. 2008–19

SECTION 1. PURPOSE

This revenue procedure provides guid-ance with respect to the United States andarea median gross income figures that areto be used by issuers of qualified mortgagebonds, as defined in § 143(a) of the Inter-nal Revenue Code, and issuers of mortgagecredit certificates, as defined in § 25(c), incomputing the housing cost/income ratiodescribed in § 143(f)(5).

SECTION 2. BACKGROUND

.01 Section 103(a) provides that, ex-cept as provided in § 103(b), gross incomedoes not include interest on any state orlocal bond. Section 103(b)(1) providesthat § 103(a) shall not apply to any pri-vate activity bond that is not a qualifiedbond (within the meaning of § 141). Sec-tion 141(e) provides that the term “qual-ified bond” includes any private activitybond that (1) is a qualified mortgage bond,(2) meets the applicable volume cap re-quirements under § 146, and (3) meets theapplicable requirements under § 147.

.02 Section 143(a)(1) provides that theterm “qualified mortgage bond” means abond that is issued as part of a “qualifiedmortgage issue”. Section 143(a)(2)(A)provides that the term “qualified mort-gage issue” means an issue of one or morebonds by a state or political subdivisionthereof, but only if (i) all proceeds of theissue (exclusive of issuance costs and areasonably required reserve) are to be usedto finance owner-occupied residences; (ii)the issue meets the requirements of sub-sections (c), (d), (e), (f), (g), (h), (i), and(m)(7) of § 143; (iii) the issue does not

2008–11 I.R.B. 594 March 17, 2008

meet the private business tests of para-graphs (1) and (2) of § 141(b); and (iv)with respect to amounts received morethan 10 years after the date of issuance,repayments of $250,000 or more of prin-cipal on financing provided by the issueare used not later than the close of the firstsemi-annual period beginning after thedate the prepayment (or complete repay-ment) is received to redeem bonds that arepart of the issue.

.03 Section 143(f) imposes eligibilityrequirements concerning the maximumincome of mortgagors for whom financingmay be provided by qualified mortgagebonds. Section 25(c)(2)(A)(iii)(IV) pro-vides that recipients of mortgage creditcertificates must meet the income re-quirements of § 143(f). Generally, under§§ 143(f)(1) and 25(c)(2)(A)(iii)(IV),these income requirements are met onlyif all owner-financing under a qualifiedmortgage bond and all certified indebt-edness amounts under a mortgage creditcertificate program are provided to mort-gagors whose family income is 115 percentor less of the applicable median familyincome. Under § 143(f)(6), the incomelimitation is reduced to 100 percent of theapplicable median family income if thereare fewer than three individuals in thefamily of the mortgagor.

.04 Section 143(f)(4) provides that theterm “applicable median family income”means the greater of (A) the area mediangross income for the area in which the res-idence is located, or (B) the statewide me-dian gross income for the state in which theresidence is located.

.05 Section 143(f)(5) provides for anupward adjustment of the income limita-tions in certain high housing cost areas.Under § 143(f)(5)(C), a high housingcost area is a statistical area for whichthe housing cost/income ratio is greaterthan 1.2. The housing cost/income ratiois determined under § 143(f)(5)(D) bydividing (a) the applicable housing priceratio by (b) the ratio that the area mediangross income bears to the median grossincome for the United States. The applica-

ble housing price ratio is the new housingprice ratio (new housing average purchaseprice for the area divided by the new hous-ing average purchase price for the UnitedStates) or the existing housing price ratio(existing housing average area purchaseprice divided by the existing housing aver-age purchase price for the United States),whichever results in the housing cost/in-come ratio being closer to 1. This incomeadjustment applies only to bonds issued,and nonissued bond amounts elected, afterDecember 31, 1988. See § 4005(h) of theTechnical and Miscellaneous Revenue Actof 1988, 1988–3 C.B. 1, 311 (1988).

.06 The Department of Housing andUrban Development (HUD) has com-puted the median gross income for theUnited States, the states, and statisti-cal areas within the states. The incomeinformation was released to the HUDregional offices on February 13, 2008,and may be obtained by calling the HUDreference service at 1–800–245–2691.The income information is also avail-able at HUD’s World Wide Web site,http:huduser.org/datasets/il.html, whichprovides a menu from which you mayselect the year and type of data of interest.The Internal Revenue Service annuallypublishes the median gross income for theUnited States.

.07 The most recent nationwide averagepurchase prices and average area purchaseprice safe harbor limitations were pub-lished on March 10, 2008, in Rev. Proc.2008–17, 2008–10 I.R.B. 549.

SECTION 3. APPLICATION

.01 When computing the housingcost/income ratio under § 143(f)(5), is-suers of qualified mortgage bonds andmortgage credit certificates must use$61,500 as the median gross income forthe United States. See § 2.06 of this rev-enue procedure.

.02 When computing the housingcost/income ratio under § 143(f)(5), is-suers of qualified mortgage bonds andmortgage credit certificates must use thearea median gross income figures released

by HUD on February 13, 2008. See § 2.06of this revenue procedure.

SECTION 4. EFFECT ON OTHERREVENUE PROCEDURES

.01 Rev. Proc. 2007–31, 2007–19I.R.B. 1225, is obsolete except as providedin § 5.02 of this revenue procedure.

.02 This revenue procedure does not af-fect the effective date provisions of Rev.Rul. 86–124, 1986–2 C.B. 27. Those ef-fective date provisions will remain opera-tive at least until the Service publishes anew revenue ruling that conforms the ap-proach to effective dates set forth in Rev.Rul. 86–124 to the general approach takenin this revenue procedure.

SECTION 5. EFFECTIVE DATES

.01 Issuers must use the United Statesand area median gross income figuresspecified in § 3 of this revenue procedurefor commitments to provide financing thatare made, or (if the purchase precedes thefinancing commitment) for residences thatare purchased, in the period that begins onFebruary 13, 2008, and ends on the datewhen these United States and area mediangross income figures are rendered obsoleteby a new revenue procedure.

.02 Notwithstanding § 5.01 of this rev-enue procedure, issuers may continue torely on the United States and area me-dian gross income figures specified in Rev.Proc. 2007–31 with respect to bonds orig-inally sold and nonissued bond amountselected not later than March 30, 2008, ifthe commitments or purchases describedin § 5.01 are made not later than May 29,2008.


The principal author of this revenueprocedure is David White of the Officeof Associate Chief Counsel (FinancialInstitutions & Products). For further infor-mation regarding this revenue procedure,contact Mr. White at (202) 622–3980 (nota toll-free call).

March 17, 2008 595 2008–11 I.R.B.

Part IV. Items of General InterestNotice of ProposedRulemaking

Hybrid Retirement Plans

REG–104946–07


ACTION: Notice of proposed rulemaking.

SUMMARY: This document containsproposed regulations providing guid-ance relating to sections 411(a)(13) and411(b)(5) of the Internal Revenue Code(Code) concerning certain hybrid definedbenefit plans. These regulations provideguidance on changes made by the PensionProtection Act of 2006. These regulationsaffect sponsors, administrators, partici-pants, and beneficiaries of hybrid definedbenefit plans.

DATES: Written or electronic commentsand requests for a public hearing must bereceived by March 27, 2008.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–104946–07),Room 5203, Internal Revenue Service, POBox 7604, Ben Franklin Station, Wash-ington, DC 20044. Submissions may behand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.to: CC:PA:LPD:PR (REG–104946–07),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW,Washington, DC, or sent electroni-cally via the Federal eRulemaking Por-tal at http://www.regulations.gov (IRSREG–104946–07).

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,Lauson C. Green or Linda S. F. Marshallat (202) 622–6090; concerning submis-sions of comments or to request a publichearing, Funmi Taylor at (202) 622–7180(not toll-free numbers).


Background

This document contains amendments tothe Income Tax Regulations (26 CFR part

1) under sections 411(a)(13) and 411(b)(5)of the Code. Generally, a defined benefitpension plan must satisfy the minimumvesting standards of section 411(a) and theaccrual requirements of section 411(b) inorder to be qualified under section 401(a)of the Code. Sections 411(a)(13) and411(b)(5), which were added to the Codeby section 701(b) of the Pension Protec-tion Act of 2006, Public Law 109–280,120 Stat. 780 (PPA ’06), modify the min-imum vesting standards of section 411(a)and the accrual requirements of section411(b).

Section 411(a)(13)(A) provides that anapplicable defined benefit plan (which isdefined in section 411(a)(13)(C)) is nottreated as failing to meet either (i) Therequirements of section 411(a)(2) (sub-ject to a special vesting rule in section411(a)(13)(B) with respect to benefitsderived from employer contributions) or(ii) The requirements of section 411(c)or 417(e) with respect to contributionsother than employee contributions, merelybecause the present value of the accruedbenefit (or any portion thereof) of anyparticipant is, under the terms of the plan,equal to the amount expressed as the bal-ance in a hypothetical account or as anaccumulated percentage of the partici-pant’s final average compensation. Sec-tion 411(a)(13)(B) requires an applicabledefined benefit plan to provide that an em-ployee who has completed at least 3 yearsof service has a nonforfeitable right to 100percent of the employee’s accrued benefitderived from employer contributions.

Under section 411(a)(13)(C)(i), a planis an applicable defined benefit plan ifthe plan is a defined benefit plan underwhich the accrued benefit (or any portionthereof) of a participant is calculated as thebalance of a hypothetical account main-tained for the participant or as an accu-mulated percentage of the participant’s fi-nal average compensation. Under sec-tion 411(a)(13)(C)(ii), the Secretary of theTreasury is to issue regulations which in-clude in the definition of an applicable de-fined benefit plan any defined benefit plan(or portion of such a plan) which has an ef-fect similar to a plan described in section411(a)(13)(C)(i).

Section 411(b)(1)(H)(i) provides thata defined benefit plan fails to complywith section 411(b) if, under the plan,an employee’s benefit accrual is ceased,or the employee’s rate of benefit accrualis reduced, because of the attainment ofany age. Section 411(b)(5), which wasadded to the Code by section 701(b)(1)of PPA ’06, provides additional rules re-lated to section 411(b)(1)(H)(i). Section411(b)(5)(A) generally provides that aplan is not treated as failing to meet therequirements of section 411(b)(1)(H)(i)if a participant’s accrued benefit, as de-termined as of any date under the termsof the plan, would be equal to or greaterthan that of any similarly situated youngerindividual who is or could be a partic-ipant. Section 411(b)(5)(G) providesthat, for purposes of section 411(b)(5),any reference to the accrued benefit ofa participant shall be a reference to theparticipant’s benefit accrued to date. Forpurposes of section 411(b)(5)(A), section411(b)(5)(A)(iv) provides that the accruedbenefit may, under the terms of the plan,be expressed as an annuity payable atnormal retirement age, the balance of ahypothetical account, or the current valueof the accumulated percentage of the em-ployee’s final average compensation.

Section 411(b)(5)(B) imposes severalrequirements on an applicable definedbenefit plan as a condition of the plansatisfying section 411(b)(1)(H). Section411(b)(5)(B)(i) provides that such a plan istreated as failing to meet the requirementsof section 411(b)(1)(H) if the terms of theplan provide for an interest credit (or anequivalent amount) for any plan year at arate that is greater than a market rate ofreturn. Under section 411(b)(5)(B)(i)(I), aplan is not treated as having an above-mar-ket rate merely because the plan providesfor a reasonable minimum guaranteed rateof return or for a rate of return that isequal to the greater of a fixed or variablerate of return. Section 411(b)(5)(B)(i)(II)provides that an interest credit (or anequivalent amount) of less than zero canin no event result in the hypothetical ac-count balance or similar amount beingless than the aggregate amount of contri-butions credited to the account. Section411(b)(5)(B)(i)(III) specifies that the Sec-

2008–11 I.R.B. 596 March 17, 2008

retary of the Treasury may provide byregulation for rules governing the calcula-tion of a market rate of return for purposesof section 411(b)(5)(B)(i)(I) and for per-missible methods of crediting interest tothe account (including fixed or variableinterest rates) resulting in effective rates ofreturn meeting the requirements of section411(b)(5)(B)(i)(I).

Section 411(b)(5)(B)(ii), (iii), and (iv)contain minimum benefit rules that ap-ply if, after June 29, 2005, an applicableplan amendment is adopted. Section411(b)(5)(B)(v)(I) defines an applica-ble plan amendment as an amendmentto a defined benefit plan which has theeffect of converting the plan to an ap-plicable defined benefit plan. Undersection 411(b)(5)(B)(ii), if, after June29, 2005, an applicable plan amendmentis adopted, the plan is treated as fail-ing to meet the requirements of section411(b)(1)(H) unless the requirements ofsection 411(b)(5)(B)(iii) are met withrespect to each individual who was a par-ticipant in the plan immediately beforethe adoption of the amendment. Section411(b)(5)(B)(iii) specifies that, subject tosection 411(b)(5)(B)(iv), the requirementsof section 411(b)(5)(B)(iii) are met withrespect to any participant if the accruedbenefit of the participant under the termsof the plan as in effect after the amend-ment is not less than the sum of: (I) Theparticipant’s accrued benefit for years ofservice before the effective date of theamendment, determined under the termsof the plan as in effect before the amend-ment; plus (II) The participant’s accruedbenefit for years of service after the effec-tive date of the amendment, determinedunder the terms of the plan as in effect afterthe amendment. Section 411(b)(5)(B)(iv)provides that, for purposes of section411(b)(5)(B)(iii)(I), the plan must creditthe participant’s account or similar amountwith the amount of any early retirementbenefit or retirement-type subsidy for theplan year in which the participant retiresif, as of such time, the participant has metthe age, years of service, and other re-quirements under the plan for entitlementto such benefit or subsidy.

Section 411(b)(5)(B)(v) sets forthcertain provisions related to an ap-

plicable plan amendment. Section411(b)(5)(B)(v)(II) provides that if thebenefits under two or more defined ben-efit plans of an employer are coordinatedin such a manner as to have the effect ofadoption of an applicable plan amend-ment, the plan sponsor is treated as havingadopted an applicable plan amendmentas of the date the coordination begins.Section 411(b)(5)(B)(v)(III) directs theSecretary of the Treasury to issue regu-lations to prevent the avoidance of thepurposes of section 411(b)(5)(B) throughthe use of two or more plan amendmentsrather than through a single plan amend-ment.

Section 411(b)(5)(B)(vi) provides aspecial rule for converting a variable in-terest crediting rate to a fixed rate forpurposes of determining plan benefits inthe case of a terminating applicable de-fined benefit plan.

Section 411(b)(5)(C) provides that aplan is not treated as failing to meet therequirements of section 411(b)(1)(H)(i)solely because the plan provides offsetsagainst benefits under the plan to the ex-tent the offsets are allowable in applyingthe requirements of section 401(a). Sec-tion 411(b)(5)(D) provides that a planis not treated as failing to meet the re-quirements of section 411(b)(1)(H) solelybecause the plan provides a disparity incontributions or benefits with respect towhich the requirements of section 401(l)(relating to permitted disparity for SocialSecurity benefits and related matters) aremet.

Section 411(b)(5)(E) provides that aplan is not treated as failing to meet the re-quirements of section 411(b)(1)(H) solelybecause the plan provides for indexing ofaccrued benefits under the plan. Undersection 411(b)(5)(E)(iii), indexing meansthe periodic adjustment of the accruedbenefit by means of the application of arecognized investment index or methodol-ogy. Section 411(b)(5)(E)(ii) requires that,except in the case of a variable annuity,the indexing not result in a smaller benefitthan the accrued benefit determined with-out regard to the indexing.

Section 701(a) of PPA ’06 added provi-sions to the Employee Retirement IncomeSecurity Act of 1974, Public Law 93–406

(88 Stat. 829) (ERISA), that are paral-lel to the above-described sections of theCode that were added by section 701(b) ofPPA ’06. The guidance provided in theseproposed regulations with respect to theCode would also apply for purposes of theparallel amendments to ERISA made bysection 701(a) of PPA ’06.1

Section 701(c) of PPA ’06 added pro-visions to the Age Discrimination in Em-ployment Act of 1967, Public Law 90–202(81 Stat. 602) (ADEA), that are parallelto section 411(b)(5) of the Code. Exec-utive Order 12067 requires all Federaldepartments and agencies to advise andoffer to consult with the Equal Employ-ment Opportunity Commission (EEOC)during the development of any proposedrules, regulations, policies, proceduresor orders concerning equal employmentopportunity. The IRS and the Treasury De-partment have consulted with the EEOCprior to the issuance of these proposedregulations.

Section 701(d) of PPA ’06 providesthat nothing in the amendments made bysection 701 should be construed to createan inference concerning the treatment ofapplicable defined benefit plans or conver-sions of plans into applicable defined ben-efit plans under section 411(b)(1)(H), orconcerning the determination of whetheran applicable defined benefit plan fails tomeet the requirements of section 411(a)(2),411(c), or 417(e) as in effect before suchamendments solely because the presentvalue of the accrued benefit (or any por-tion thereof) of any participant is, underthe terms of the plan, equal to the amountexpressed as the balance in a hypotheticalaccount or as an accumulated percentageof the participant’s final average compen-sation.

Section 701(e) of PPA ’06 sets forththe effective date provisions with respectto amendments made by section 701 ofPPA ’06. Section 701(e)(1) specifies thatthe amendments made by section 701generally apply to periods beginning onor after June 29, 2005. Thus, the agediscrimination safe harbors under section411(b)(5)(A) and section 411(b)(5)(E) areeffective for periods beginning on or afterJune 29, 2005. Section 701(e)(2) pro-vides that the special present value rules

1 Under section 101 of Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of the Treasury has interpretive jurisdiction over the subject matter addressed by these proposedregulations for purposes of ERISA, as well as the Code.

March 17, 2008 597 2008–11 I.R.B.

of section 411(a)(13)(A) are effective fordistributions made after August 17, 2006.

Under section 701(e)(3) of PPA ’06, inthe case of a plan in existence on June 29,2005, the 3-year vesting rule under section411(a)(13)(B) and the market rate of returnlimitation under section 411(b)(5)(B)(i)are generally effective for years beginningafter December 31, 2007. In the case ofa plan not in existence on June 29, 2005,those sections are effective for periodsbeginning on or after June 29, 2005. Sec-tion 701(e)(4) of PPA ’06 contains specialeffective date provisions for collectivelybargained plans that modify these effec-tive dates.

Under section 701(e)(5) of PPA ’06,sections 411(b)(5)(B)(ii), (iii), and (iv)apply to a conversion amendment that isadopted after, and takes effect after, June29, 2005.

Section 702 of PPA ’06 provides forregulations to be prescribed by August 16,2007, addressing the application of rulesset forth in section 701 of PPA ’06 wherethe conversion of a defined benefit pensionplan into an applicable defined benefit planis made with respect to a group of employ-ees who become employees by reason of amerger, acquisition, or similar transaction.

Proposed regulations (EE–184–86,1988–1 C.B. 881) under sections411(b)(1)(H) and 411(b)(2) were pub-lished by the Treasury Department and theIRS in the Federal Register on April 11,1988 (53 FR 11876), as part of a packageof regulations that also included pro-posed regulations under sections 410(a),411(a)(2), 411(a)(8), and 411(c) (relatingto the maximum age for participation,vesting, normal retirement age, and actu-arial adjustments after normal retirementage, respectively).2

Notice 96–8, 1996–1 C.B. 359, see§601.601(d)(2)(ii)(b) of this chapter, de-scribed the application of sections 411and 417(e) to a single sum distributionunder a cash balance plan where inter-est credits under the plan are frontloaded(that is, where future interest credits to anemployee’s hypothetical account balanceare not conditioned upon future serviceand thus accrue at the same time that the

benefits attributable to a hypothetical al-location to the account accrue). Underthe analysis set forth in Notice 96–8, inorder to comply with sections 411(a) and417(e) in calculating the amount of a sin-gle sum distribution under a cash balanceplan, the balance of an employee’s hy-pothetical account must be projected tonormal retirement age and converted to anannuity under the terms of the plan, andthen the employee must be paid at leastthe present value of the projected annuity,determined in accordance with section417(e). Under that analysis, where a cashbalance plan provides frontloaded interestcredits using an interest rate that is higherthan the section 417(e) applicable interestrate, payment of a single sum distributionequal to the current hypothetical accountbalance as a complete distribution of theemployee’s accrued benefit may result ina violation of section 417(e) or a forfeiturein violation of section 411(a). In addi-tion, Notice 96–8 proposed a safe harborwhich provided that, if frontloaded inter-est credits are provided under a plan at arate no greater than the sum of identifiedstandard indices and associated margins,no violation of section 411(a) or 417(e)would result if the employee’s entire ac-crued benefit is distributed in the formof a single sum distribution equal to theemployee’s hypothetical account balance,provided the plan uses appropriate annuityconversion factors. Since the issuance ofNotice 96–8, four federal appellate courtshave followed the analysis set out in theNotice: Esden v. Bank of Boston, 229F.3d 154 (2d Cir. 2000), cert. dismissed,531 U.S. 1061 (2001); West v. AK SteelCorp. Ret. Accumulation Pension Plan,484 F.3d 395 (6th Cir. 2007), reh’g andreh’g en banc denied, No. 06–3442, 2007U.S. App. LEXIS 20447 (6th Cir. Aug. 8,2007); Berger v. Xerox Corp. Ret. IncomeGuarantee Plan, 338 F.3d 755 (7th Cir.2003), reh’g and reh’g en banc denied,No. 02–3674, 2003 U.S. App. LEXIS19374 (7th Cir. Sept. 15, 2003); Lyons v.Georgia-Pacific Salaried Employees Ret.Plan, 221 F.3d 1235 (11th Cir. 2000), cert.denied, 532 U.S. 967 (2001).

Notice 2007–6, 2007–3 I.R.B.272 (January 16, 2007), see§601.601(d)(2)(ii)(b) of this chapter,provides transitional guidance with re-spect to certain requirements of sections411(a)(13) and 411(b)(5) and section701(b) of PPA ’06. Notice 2007–6includes certain special definitions, in-cluding: accumulated benefit, which isdefined as a participant’s benefit accruedto date under a plan; lump sum-basedplan, which is defined as a definedbenefit plan under the terms of which theaccumulated benefit of a participant isexpressed as the balance of a hypotheticalaccount maintained for the participant oras the current value of the accumulatedpercentage of the participant’s final aver-age compensation; and statutory hybridplan, which is a lump sum-based planor a plan which has an effect similar toa lump sum-based plan. Notice 2007–6provides guidance on a number of issues,including a rule under which a plan thatprovides for indexed benefits described insection 411(b)(5)(E) is a statutory hybridplan (because it has an effect similar toa lump sum-based plan), unless the planeither solely provides for post-retirementadjustment of the amounts payable to aparticipant or is a variable annuity planunder which the assumed interest rateused to determine adjustments is at least 5percent. The notice provides a safe harborfor applying the rules set forth in section701 of PPA ’06 where the conversion ofa defined benefit pension plan into anapplicable defined benefit plan is madewith respect to a group of employees whobecome employees by reason of a merger,acquisition, or similar transaction. Thistransitional guidance, along with otherguidance provided in Part III of Notice2007–6, applies pending the issuance offurther guidance and, thus, will cease toapply when these regulations are finalizedand become effective.

Explanation of Provisions

Overview

In general, these proposed regula-tions would incorporate the transitional

2 On December 11, 2002, the Treasury Department and the IRS issued proposed regulations regarding the age discrimination requirements of section 411(b)(1)(H) that specifically addressedcash balance plans as part of a package of regulations that also addressed section 401(a)(4) nondiscrimination cross-testing rules applicable to cash balance plans (67 FR 76123). The 2002proposed regulations were intended to replace the 1988 proposed regulations. In Ann. 2003–22, 2003–1 C.B. 847, see §601.601(d)(2)(ii)(b) of this chapter, the Treasury Department andthe IRS announced the withdrawal of the 2002 proposed regulations under section 401(a)(4), and in Ann. 2004–57, 2004–2 C.B. 15, see §601.601(d)(2)(ii)(b) of this chapter, the TreasuryDepartment and the IRS announced the withdrawal of the 2002 proposed regulations relating to age discrimination.

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guidance provided under Notice 2007–6.However, the proposed regulations wouldutilize new terminology (such as statu-tory hybrid benefit formula and lumpsum-based benefit formula) to take intoaccount situations where plans providemore than one benefit formula. Theseproposed regulations would also provideadditional guidance with respect to sec-tions 411(a)(13) and 411(b)(5), taking intoaccount comments received in response toNotice 2007–6.

Section 411(a)(13): Special vesting rulesfor applicable defined benefit plans andapplicable definitions

The proposed regulations would reflectnew section 411(a)(13)(A) by providingthat an applicable defined benefit plandoes not violate the requirements of sec-tion 411(a)(2), or the requirements ofsection 411(c) or 417(e), with respect toa participant’s accrued benefit derivedfrom employer contributions, merely be-cause the plan determines the presentvalue of benefits determined under a lumpsum-based benefit formula as the amountof the hypothetical account maintained forthe participant or as the current value ofthe accumulated percentage of the partic-ipant’s final average compensation underthat formula. However, section 411(a)(13)does not alter the definition of an accruedbenefit under section 411(a)(7)(A) (whichgenerally defines a participant’s accruedbenefit as the annual benefit commencingat normal retirement age), nor does it al-ter the definition of a normal retirementbenefit under section 411(a)(9) (whichgenerally defines a participant’s normalretirement benefit as the benefit under theplan commencing at normal retirementage).

Section 411(b)(5)(G) provides that, forpurposes of section 411(b)(5), any ref-erence to the accrued benefit means thebenefit accrued to date. The proposedregulations refer to this as the accumu-lated benefit, which is distinct from theparticipant’s accrued benefit under sec-tion 411(a)(7) (an annuity beginning atnormal retirement age that is actuariallyequivalent to the participant’s accumu-lated benefit).

The regulations define a lumpsum-based benefit formula as a benefitformula used to determine all or any part

of a participant’s accumulated benefit un-der which the benefit provided under theformula is expressed as the balance of ahypothetical account maintained for theparticipant or as the current value of theaccumulated percentage of the partici-pant’s final average compensation. Underthe proposed regulations, whether a ben-efit formula is a lump sum-based benefitformula would be determined based onhow the accumulated benefit of a partic-ipant is expressed under the terms of theplan, and would not depend on whetherthe plan provides an optional form of ben-efit in the form of a single sum payment.Similarly, a formula would not fail to bea lump sum-based benefit formula merelybecause the plan’s terms state that theaccrued benefit is an annuity at normalretirement age that is actuarially equiva-lent to a hypothetical account balance. Inaddition, the regulations would providethat a participant is not treated as havinga lump sum-based benefit formula merelybecause the participant is entitled to a ben-efit under a defined benefit plan that is notless than the benefit properly attributableto after-tax employee contributions.

Section 411(a)(13)(A) applies onlywith respect to a benefit provided under alump sum-based benefit formula. Accord-ingly, if the present value rules of section417(e) apply to a form of benefit undera plan and the plan provides benefits un-der a benefit formula that is not a lumpsum-based benefit formula (including, forexample, a plan that provides for indexingas described in section 411(b)(5)(E)), thenthe plan must set forth a methodologyto determine the projected benefit underthat formula at normal retirement age forpurposes of applying the rules of section417(e), as described in the “Analysis” sec-tion of Notice 96–8.

The proposed regulations use the termstatutory hybrid benefit formula to de-scribe the portion of a defined benefit planthat is an applicable defined benefit plandescribed in section 411(a)(13)(C)(i) orthe portion of the plan that has a similareffect. Specifically, the proposed regu-lations would define a statutory hybridbenefit formula as a benefit formula that iseither a lump sum-based benefit formulaor a formula that has an effect similar toa lump sum-based benefit formula. Forthis purpose, under the proposed regula-tions, a benefit formula under a defined

benefit plan has an effect similar to alump sum-based benefit formula if the for-mula provides that a participant’s accruedbenefit payable at normal retirement age(or at benefit commencement, if later) isexpressed as a benefit that includes peri-odic adjustments (including a formula thatprovides for indexed benefits describedin section 411(b)(5)(E)) that are reason-ably expected to result in a smaller annualbenefit at normal retirement age (or atcommencement of benefits, if later) forthe participant, when compared to a sim-ilarly situated, younger individual who isor could be a participant in the plan. Thus,a benefit formula under a plan has an ef-fect similar to a lump sum-based benefitformula if the right to future adjustmentsaccrues at the same time as the benefit thatis subject to the adjustments.

The proposed regulations would setforth certain additional rules that are usedin determining whether a benefit formulahas an effect similar to a lump sum-basedbenefit formula. For example, the pro-posed regulations provide that a benefitformula that does not include periodic ad-justments is treated as a formula with aneffect similar to a lump sum-based ben-efit formula if the formula is otherwisedescribed in the preceding paragraph andthe adjustments are provided pursuant to apattern of repeated plan amendments. See§1.411(d)–4, A–1(c)(1). The proposedregulations would provide that, for pur-poses of determining whether a benefitformula has an effect similar to a lumpsum-based benefit formula, indexing thatapplies to adjust benefits after the annuitystarting date (for example, cost-of-livingincreases) is disregarded. In addition, theproposed regulations would provide thata benefit formula under a defined benefitplan that provides for a benefit properlyattributable to after-tax employee contri-butions does not have an effect similar toa lump sum-based benefit formula. Theproposed regulations would also providethat adjustments under a variable annuitydo not have an effect similar to a lumpsum-based benefit formula if the assumedinterest rate used to determine the ad-justments is at least 5 percent. Such anannuity does not have an effect similar toa lump sum-based benefit formula even ifpost-annuity starting date adjustments aremade using a specified assumed interestrate that is less than 5 percent.

March 17, 2008 599 2008–11 I.R.B.

Pursuant to new section 411(a)(13)(B),the proposed regulations would providethat, in the case of a participant whose ac-crued benefit (or any portion thereof) un-der a defined benefit plan is determinedunder a statutory hybrid benefit formula,the plan is not treated as meeting the re-quirements of section 411(a)(2) unless theplan provides that the participant has anonforfeitable right to 100 percent of theparticipant’s accrued benefit if the partici-pant has 3 or more years of service. Thisrequirement would apply on a participant-by-participant basis and would apply tothe participant’s entire benefit (not just theportion of the participant’s benefit that isdetermined under a statutory hybrid ben-efit formula). Furthermore, if the par-ticipant is entitled to the greater of twobenefits under a plan, one of which is abenefit calculated under a statutory hy-brid benefit formula, the proposed regula-tions would provide that the 3-year vest-ing requirement applies to that participanteven if the participant’s benefit under thestatutory hybrid benefit formula is ulti-mately smaller than under the other for-mula. The proposed regulations do not ad-dress how the 3-year vesting requirementapplies in the case of floor-offset arrange-ments.3 See the discussion in this pream-ble under the heading “Comments and Re-quests for Public Hearing.”

Section 411(b)(5): Safe harbor for agediscrimination, conversion protection,and market rate of return limitation

A. Safe harbor for age discrimination

The proposed regulations under newsection 411(b)(5)(A) would provide that aplan is not treated as failing to meet the re-quirements of section 411(b)(1)(H)(i) withrespect to certain benefit formulas if, asdetermined as of any date, a participant’saccumulated benefit expressed under oneof those formulas would not be less thanany similarly situated, younger partic-ipant’s accumulated benefit expressedunder the same formula. A plan that doesnot satisfy this test is required to satisfy thegeneral nondiscrimination test of section411(b)(1)(H)(i).

Under the proposed regulations, thesafe harbor standard for satisfying sec-tion 411(b)(5)(A) would be available onlywhere a participant’s accumulated benefitunder the terms of the plan is expressed asan annuity payable at normal retirementage (or current age, if later), the balance ofa hypothetical account, or the current valueof the accumulated percentage of the em-ployee’s final average compensation. Forthis purpose, if the accumulated benefitof a participant is expressed as an annu-ity payable at normal retirement age (orcurrent age, if later) under the plan terms,then the comparison of benefits is madeusing such an annuity. If the accumulatedbenefit of a participant is expressed underthe plan terms as the balance of a hypo-thetical account or the current value ofan accumulated percentage of the partic-ipant’s final average compensation, thenthe comparison of benefits is made usingthe balance of a hypothetical account orthe current value of the accumulated per-centage of the participant’s final averagecompensation, respectively.

The proposed regulations would requirea comparison of the accumulated benefitof each possible participant in the plan tothe accumulated benefit of each other simi-larly situated, younger individual who is orcould be a participant in the plan. For thispurpose, the proposed regulations wouldprovide that an individual is similarly situ-ated to another individual if the individualis identical to that other individual in ev-ery respect that is relevant in determininga participant’s benefit under the plan (in-cluding but not limited to period of service,compensation, position, date of hire, workhistory, and any other respect) except forage.4 In determining whether an individualis similarly situated to another individual,any characteristic that is relevant for deter-mining benefits under the plan and that isbased directly or indirectly on age is disre-garded. For example, if a particular benefitformula applies to a participant on accountof the participant’s age, an individual towhom the benefit formula does not applyand who is identical to a participant in allrespects other than age is similarly situatedto the participant. By contrast, an individ-ual is not similarly situated to a participant

if a different benefit formula applies to theindividual and the application of the dif-ferent formula is based neither directly norindirectly on age.

The comparison of accumulated bene-fits is made without regard to any subsi-dized portion of any early retirement ben-efit that is included in a participant’s accu-mulated benefit. For this purpose, the sub-sidized portion of an early retirement bene-fit is the retirement-type subsidy within themeaning of §1.411(d)–3(g)(6) that is con-tingent on a participant’s severance fromemployment and commencement of bene-fits before normal retirement age.

In addition, the comparison of accumu-lated benefits generally must be made us-ing the same form of benefit. Thus, thesafe harbor is not available for compar-ing the accumulated benefit of a partici-pant expressed as an annuity at normal re-tirement age with the accumulated benefitof a similarly situated, younger participantexpressed as a hypothetical account bal-ance. Nevertheless, the proposed regula-tions would permit a plan that provides thesum of benefits that are expressed in twoor more different forms of benefit to sat-isfy the safe harbor if the plan would sepa-rately satisfy the safe harbor for each sep-arate form of benefit. Similarly, the pro-posed regulations would permit a plan thatprovides the greater of benefits that are ex-pressed in two or more different forms ofbenefit to satisfy the safe harbor if the planwould separately satisfy the safe harbor foreach separate form of benefit. For this pur-pose, a similarly situated, younger partic-ipant is treated as having an accumulatedbenefit of zero with respect to a benefit for-mula that does not apply to the participant.Thus, the safe harbor would be available ifan older participant is entitled to benefitsunder more than one type of benefit for-mula, even if not all of those types of ben-efit formulas are available to every simi-larly situated participant who is younger.

The proposed regulations would reflectnew section 411(b)(5)(C), which providesthat a plan is not treated as failing to meetthe requirements of section 411(b)(1)(H)solely because the plan provides offsetsof benefits under the plan to the extentsuch offsets are allowable in applying

3 See Rev. Rul. 76–259, 1976–2 C.B. 111, see §601.601(d)(2)(ii)(b) of this chapter, for certain standards applicable to floor-offset arrangements.

4 For example, if a plan provides for an election extended to all participants that affects a participant’s accumulated benefit, then someone who makes such an election is similarly situated toa participant who makes such an election, and someone who does not make an election is similarly situated to a participant who does not make such an election.

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the requirements under section 401 andthe applicable requirements of the Em-ployee Retirement Income Security Actof 1974, Public Law 93–406 (88 Stat.829) (ERISA) and the Age Discrimina-tion in Employment Act of 1967, PublicLaw 90–202 (81 Stat. 602) (ADEA). Theproposed regulations incorporate the pro-visions of section 411(b)(5)(D) (relating topermitted disparity under section 401(l))without providing additional guidance.

The proposed regulations would reflectnew section 411(b)(5)(E), which providesfor the disregard of certain indexing ofbenefits for purposes of the age discrimi-nation rules of section 411(b)(1)(H). Theproposed regulations limit the disregard ofindexing to formulas under defined benefitplans other than lump sum-based formulas.In addition, the proposed regulations limitthe disregard of indexing to situations inwhich the extent of the indexing for a par-ticipant would not be less than the indexingapplicable to a similarly situated, youngerparticipant. Thus, the disregard of index-ing is only available if the indexing is nei-ther terminated nor reduced on account ofthe attainment of any age.

Section 411(b)(5)(E) requires that theindexing methodology be a recognizedmethodology. The proposed regulationswould treat only the following index-ing methodologies as recognized forthis purpose: indexing using an eligi-ble cost-of-living index as described in§1.401(a)(9)–6, A–14(b); indexing usingthe rate of return on the aggregate assetsof the plan; and indexing using the rateof return on the annuity contract for theemployee issued by an insurance companylicensed under the laws of a State.

Under the proposed regulations, thesection 411(b)(5)(E)(ii) protection againstloss (“no-loss”) requirement for an in-dexed plan (which provides that the index-ing not result in a smaller accrued benefit)would be implemented by applying the“preservation of capital” rule of section411(b)(5)(B)(i)(II) to indexed plans. (Thepreservation of capital rule is discussedin this preamble paragraph heading “C.Market rate of return limitation.”) Forthis purpose, the exemption from the ap-plication of the no-loss rule for variableannuities would be limited to situationsin which the variable annuity adjustmentis based on the rate of return on the ag-gregate assets of the plan or the annuity

contract. Thus, the exemption from theapplication of the no-loss rule would notapply if the variable annuity adjustmentis based on the rate of return of a portionof the assets of the plan. In addition, thisexemption would also apply for purposesof the preservation of capital requirementthat applies to statutory hybrid plans.

B. Conversion protection

The regulations would provide guid-ance on the new conversion protectionsunder section 411(b)(5)(B)(ii), (iii), and(iv). Under the proposed regulations, aparticipant whose benefits are affected bya conversion amendment which occurredafter June 29, 2005, must generally beprovided with a benefit after the conver-sion that is at least equal to the sum ofthe benefits accrued through the date ofthe conversion and benefits earned afterthe conversion, with no permitted inter-action between these two portions. Thiswould assure participants that there will beno “wear-away” as a result of a conver-sion, both with respect to the participant’saccrued benefits and any early retirementsubsidy to which the participant is entitledbased on the pre-conversion benefits.

The proposed regulations would pro-vide an alternative mechanism underwhich the plan provides for the establish-ment of an opening hypothetical accountbalance as part of the conversion andkeeps separate track of (1) The openinghypothetical account balance and inter-est credits attributable thereto, and (2)The post-conversion hypothetical contri-butions and interest credits attributablethereto. Under this alternative, the planmust provide that, when a participant com-mences benefits, the plan will determinewhether the benefit attributable to theopening hypothetical account payable inthe particular optional form of benefit se-lected is greater than or equal to the benefitaccrued under the plan prior to the date ofconversion and payable in the same gen-eralized optional form of benefit (withinthe meaning of §1.411(d)–3(g)(8)) at thesame annuity starting date. For example,if a participant elects a straight life annuitypayable at age 60, the plan must deter-mine if the straight life annuity payable atage 60 that is attributable to the openinghypothetical account balance is greaterthan or equal to the straight life annuity

payable at age 60 based on service priorto the conversion and determined underthe terms of the pre-conversion plan. Ifthe benefit attributable to the opening hy-pothetical account balance is greater, thenthe plan must provide that such benefit ispaid in lieu of the pre-conversion bene-fit together with the benefit attributableto post-conversion contribution credits.If the benefit attributable to the openinghypothetical account balance is less, thenthe plan must provide that such benefitwill be increased sufficiently to providethe pre-conversion benefit. In such a case,the participant must also be entitled tothe benefit attributable to post-conversioncontribution credits.

The proposed regulations would pro-vide that, if an optional form of benefitis available on the annuity starting datewith respect to the benefit attributable tothe opening hypothetical account balanceor opening accumulated percentage, but nooptional form within the same generalizedoptional form of benefit was available atthat annuity starting date under the termsof a plan as in effect immediately prior tothe effective date of the conversion amend-ment, then the comparison must still bemade by assuming that the pre-conversionplan had such an optional form of bene-fit. For example, if the pre-conversion plandid not provide for a single sum distribu-tion option, the alternative would requirethat any single sum distribution option thatis attributable to the opening hypotheticalaccount balance be greater than or equalto the present value of the pre-conversionbenefit, where present value is determinedin accordance with section 417(e).

The IRS and the Treasury Departmentare seeking comments on another alter-native means of satisfying the conversionrequirements that would involve estab-lishing an opening hypothetical accountbalance, but in limited situations wouldnot require the subsequent comparison.Any such alternative would be permittedonly if it were designed to provide ade-quate protection to participants in plansthat adopt conversion amendments. Forexample, such an alternative might belimited to situations in which the partici-pant elects a single sum distribution, andwhere the pre-conversion plan either didnot provide a single sum option or had asingle sum option that was based on thebenefit payable at normal retirement age

March 17, 2008 601 2008–11 I.R.B.

(rather than the benefit payable at earlyretirement age). In those situations, thealternative might provide that the compar-ison is not necessary if (1) The openinghypothetical account balance is equal tothe present value of the pre-conversionbenefit determined in accordance withsection 417(e), (2) The interest credits onthe opening hypothetical account balanceare reasonably expected to be no lowerthan the interest rate used to determine theopening hypothetical account balance, and(3) Either the plan provides a death benefitequal to the hypothetical account balanceor no pre-retirement mortality decrementis applied in establishing the openinghypothetical account balance. Such analternative could result in a single sumdistribution attributable to the pre-conver-sion benefit that is lower, or higher, thanthe present value of the pre-conversionbenefit, depending on whether the actualinterest credits applicable to the openinghypothetical account balance during theinterim are lower, or higher, than the inter-est rate used in determining the openinghypothetical account balance and whetherthe applicable interest rate and applicablemortality table under section 417(e)(3)have changed in the interim.

The proposed regulations also wouldprovide guidance on what constitutesa conversion amendment under section411(b)(5)(B)(v). Under the proposedregulations, whether an amendment is aconversion amendment is determined ona participant-by-participant basis. Theproposed regulations would provide thatan amendment (or amendments) is a con-version amendment with respect to aparticipant if it meets two criteria: (1)The amendment reduces or eliminates thebenefits that, but for the amendment, theparticipant would have accrued after theeffective date of the amendment under abenefit formula that is not a statutory hy-brid benefit formula and under which theparticipant was accruing benefits prior tothe amendment, and (2) After the effectivedate of the amendment, all or a portionof the participant’s benefit accruals underthe plan are determined under a statutoryhybrid benefit formula.

The proposed regulations would pro-vide that only amendments that reduce oreliminate accrued benefits described insection 411(a)(7), or retirement-type sub-sidies described in section 411(d)(6)(B)(i),

that would otherwise accrue as a result offuture service are treated as amendmentsthat reduce or eliminate the participant’sbenefits that would have accrued after theeffective date of the amendment undera benefit formula that is not a statutoryhybrid benefit formula. Under the pro-posed regulations, a plan is treated ashaving been amended for this purpose if,under the terms of the plan, a change inthe conditions of a participant’s employ-ment results in a reduction or eliminationof the benefits that the participant wouldhave accrued in the future under a benefitformula that is not a statutory hybrid ben-efit formula (for example, a job transferfrom an operating division covered by anon-statutory hybrid defined benefit planto an operating division that is coveredby a cash balance formula). However,in the absence of coordination betweenthe formulas, the special requirements forconversion amendments typically will besatisfied automatically.

The proposed regulations would pro-vide rules prohibiting the avoidance of theconversion protections through the use ofmultiple plans or multiple employers. Un-der the proposed regulations, an employeris treated as having adopted a conversionamendment if the employer adopts anamendment under which a participant’sbenefits under a plan that is not a statutoryhybrid plan are coordinated with a sepa-rate plan that is a statutory hybrid plan,such as through a reduction (offset) of thebenefit under the plan that is not a statutoryhybrid plan. In addition, if an employee’semployer changes as a result of a merger,acquisition, or other transaction describedin §1.410(b)–2(f), then the two employerswould be treated as a single employer forthis purpose. Thus, for example, in anacquisition, if the buyer adopts an amend-ment to its statutory hybrid plan underwhich a participant’s benefits under theseller’s plan (that is not a statutory hybridplan) are coordinated with benefits underthe buyer’s plan, such as through a reduc-tion (offset) of the buyer’s plan benefits,the seller and buyer would be treated as asingle employer and as having adopted aconversion amendment. However, if thereis no coordination between the plans, thereis no conversion amendment.

The proposed regulations would pro-vide that a conversion amendment alsoincludes multiple amendments that result

in a conversion amendment, even if theamendments would not be conversionamendments individually. Under the pro-posed regulations, if an amendment toprovide a benefit under a statutory hybridbenefit formula is adopted within 3 yearsafter adoption of an amendment to re-duce non-statutory hybrid benefit formulabenefits, then those amendments wouldbe consolidated in determining whether aconversion amendment has been adopted.In the case of an amendment to providea benefit under a statutory hybrid benefitformula that is adopted more than 3 yearsafter adoption of an amendment to reducenon-statutory hybrid benefit formula ben-efits, there would be a presumption thatthe amendments are not consolidated un-less the facts and circumstances indicatethat adoption of an amendment to providea statutory hybrid benefit formula wasintended at the time of the reduction in thenon-statutory hybrid benefit formula.

The proposed regulations would pro-vide that the effective date of a conver-sion amendment is, with respect to a par-ticipant, the date as of which the reduc-tion occurs of the benefits that the partic-ipant would have accrued after the effec-tive date of the amendment under a benefitformula that is not a statutory hybrid ben-efit formula. In accordance with section411(d)(6), the proposed regulations wouldprovide that the date of a reduction of thosebenefits cannot be earlier than the date ofadoption of the conversion amendment.

C. Market rate of return limitation

The proposed regulations would reflectthe rule in section 411(b)(5)(B)(i)(I) underwhich a statutory hybrid plan is treated asfailing to satisfy section 411(b)(1)(H) if itprovides an interest crediting rate that isin excess of a market rate of return. Theproposed regulations would define an in-terest crediting rate as the rate by whicha participant’s benefit is increased underthe ongoing terms of a plan to the ex-tent the amount of the increase is not con-ditioned on current service, regardless ofhow the amount of that increase is calcu-lated. Thus, whether the amount is an in-terest credit for this purpose is determinedwithout regard to whether the amount iscalculated by reference to a rate of inter-est, a rate of return, an index, or otherwise.

2008–11 I.R.B. 602 March 17, 2008

The proposed regulations would requirea plan to specify the timing for determin-ing the plan’s interest crediting rate thatwill apply for each plan year (or portionof a plan year) using one of two permit-ted methods — either pursuant to a dailyinterest crediting rate based on permis-sible interest crediting rates specified inthe proposed regulations, or pursuant to aspecified lookback month and stability pe-riod. For this purpose, the plan’s lookbackmonth and stability period must satisfy therules for selecting the lookback month andstability period under §1.417(e)–1(d)(4).However, the stability period and look-back month need not be the same as thoseused under the plan for purposes of section417(e)(3).

In addition, the proposed regulationswould require a plan to specify the peri-odic (at least annual) frequency at whichinterest credits are made under the plan.If, under a plan, interest is credited morefrequently than annually (for example,monthly or quarterly), then the interestcredit for that period must be a pro rataportion of the annual interest credit. Thus,for example, in the case of a plan the termsof which provide for interest to be creditedat an interest crediting rate that would bepermitted under the proposed regulations,if the plan provides for monthly interestcredits and if the interest rate for a planyear has a value of 6 percent, then theaccumulated benefits at the beginning ofeach month would be increased by 0.5percent per month during the plan year.The proposed regulations would providethat interest credits are not treated as cre-ating an effective rate of return in excessof a market rate of return merely becausean otherwise permissible interest creditingrate is compounded more frequently thanannually.

The proposed regulations would pro-vide that an interest crediting rate for a planyear is not in excess of a market rate of re-turn if it is based on specified indices. Asin Notice 2007–6, these include the safeharbor rates described in Notice 96–8, theinterest rates on 30-Year Treasury securi-ties, and the rate of interest on long-terminvestment grade corporate bonds (as de-scribed in section 412(b)(5)(B)(ii)(II) prior

to amendment by PPA ’06 for plan yearsbeginning before January 1, 2008, and thethird-segment bond rate used under sec-tion 430 for subsequent plan years). Forthis purpose, the third-segment bond rateis permitted to be determined with or with-out regard to the transition rules of section430(h)(2)(G).

These rates would be required to changeon at least an annual basis.5 These rates aremarket yields to maturity on outstandingbonds and do not reflect the change in themarket value of an outstanding bond as aresult of future changes in the interest rateenvironment or in a bond issuer’s risk pro-file.6 As noted in the preceding paragraph,the proposed rules generally are similar tothose described in Notice 2007–6 but donot provide guidance on a number of issuesrelated to market rate of return. It is ex-pected that these issues will be addressedin the first part of 2008.

The proposed regulations would reflectthe preservation of capital rule in section411(b)(5)(B)(i)(II) that requires a statutoryhybrid plan to provide that interest cred-its will not result in a hypothetical accountbalance (or similar amount) being less thanthe aggregate amount of the hypotheticalallocations. Under the proposed regula-tions, this requirement would be applied atthe participant’s annuity starting date. Inaddition, the proposed regulations wouldprovide that the combination of this preser-vation of capital protection with a rate ofreturn which otherwise satisfies the mar-ket rate of return limitation will not resultin an effective interest crediting rate that isin excess of a market rate of return.

While the second sentence of section411(b)(5)(B)(i)(I) provides that a statutoryhybrid plan is not treated as having anabove-market rate merely because the planprovides for a reasonable minimum guar-anteed rate of return or for a rate of returnthat is equal to the greater of a fixed orvariable rate of return, these proposed reg-ulations do not provide guidance for thesealternatives. Moreover, the presence of apreservation of capital requirement indi-cates that Congress considered that a rateof return that could be negative in someyears (such as a rate of return on an eq-uity portfolio) could be permissible. How-

ever, as discussed in the following para-graphs, the Treasury Department and theIRS have concerns that the use of a mini-mum guaranteed rate of return or the useof the greater of a fixed and a variablerate could result in effective interest cred-iting rates that are above market rates ofreturn and are soliciting comments on howto avoid that result.

Some commentators have suggestedthat it should be acceptable for a plan toadopt a fixed interest crediting rate thatwould apply without regard to changesin the interest rate environment. This isparticularly important where the plan pro-vides for hypothetical contributions thatincrease with age or service and the planneeds a minimum interest crediting rate inorder to satisfy the accrual rules of section411(b). While this issue is reserved underthese proposed regulations, the approachsuggested by commentators could be ac-complished in two different ways. Underone possibility, the regulations might setforth a specific interest crediting rate (suchas 4 percent or 5 percent) that a plan maybe permitted to use. Under an alternativeapproach, the regulations might set fortha permitted methodology under which aplan would be permitted to establish afixed interest crediting rate based on thethen-applicable level of a permissible rate,such as the 3rd segment rate. For example,if the 3rd segment rate were 5.5 percentat the time the fixed rate is establishedunder the plan, then under the alternativeapproach the plan might be permitted tofix the interest crediting rate at 5.5 per-cent. Comments are requested on thesealternatives. In particular, comments arerequested as to rules that the regulationscould set forth that would avoid the po-tential for the fixed rate to be establishedat a time when interest rates are unusuallyhigh, such as occurred in the early 1980s.

With respect to the option for a planto use an interest crediting rate that is thegreater of a fixed or variable interest rate,the Treasury Department and the IRS be-lieve that the interaction between the twointerest rates must be taken into account indetermining whether the effective interestcrediting rate under a plan which providesan interest crediting rate that is equal to the

5 The requirement that an interest crediting rate change not less frequently than annually is intended to distinguish these rates from fixed rates, which are discussed later in this preamble. Seealso §31.3121(v)(2)–1(d)(2)(i)(C)(2) of the Employment Tax Regulations, which permits a rate to be fixed for up to 5 years.

6 Because this interest rate does not reflect the change in the market value of an outstanding bond when an issuer becomes higher risk or the bond goes into default, the bonds have been limitedto investment grade bonds in the top three quality levels where the risk of default is small.

March 17, 2008 603 2008–11 I.R.B.

greater of a fixed or variable interest rateis above a market rate of return. Whethera statutory hybrid plan that is providinginterest credits based on the greater of afixed or variable interest rate effectivelyprovides an interest crediting rate that ex-ceeds a market rate of return depends ona number of factors, including how highthe fixed interest rate is, how frequently the“greater of” determination is applied, andthe volatility of the variable interest rate.

As noted earlier, the proposed regu-lations would provide that including thepreservation of capital rule does not causethe plan’s effective interest crediting rate tobe in excess of a market rate of return. Thisrule reflects the fact that the minimum rateunder the preservation of capital rule is aninterest rate of 0 percent which is appliedon a one-time basis at the annuity start-ing date, and is premised on the expecta-tion that the variable rate would rarely benegative for extended periods of time (sothat the inclusion of the capital preserva-tion rule should not significantly increasethe effective rate of return under the plan).If the variable rate is the rate of interest onbonds that would be permitted under theproposed regulations, then that expectationis easily met.

By contrast, if the variable interestrate is the rate of return on an equity in-vestment, the expectation that the capitalpreservation rule does not significantly in-crease the effective interest crediting rateis only applicable if the equity investmentis a well-diversified portfolio. This is be-cause a well-diversified portfolio shouldhave sufficiently limited volatility so thatthe inclusion of the preservation of capi-tal rule should not significantly increasethe effective rate of return resulting frominterest credits that are based on that port-folio. Accordingly, if the regulations wereto permit the use of an interest creditingrate based on an asset portfolio as an in-terest credit, the regulations might limitthe choice of portfolio to the actual planassets (relying on the fiduciary rules toensure that the portfolio is adequately di-versified). Of course, any such regulationswould only permit the use of an interestcrediting rate based on an asset portfolioif the use of such a rate is prospective andis selected before the period during whichthe rate is determined.

Comments are requested on what otherasset portfolios have sufficiently con-

strained volatility that they should bepermitted to form the basis of a marketrate of return for interest crediting undera statutory hybrid plan and whether it isappropriate to base an interest creditingrate on the value of an index. For ex-ample, are the assets under a regulatedinvestment company (RIC) described insection 851 sufficiently diversified suchthat a statutory hybrid plan will not betreated as providing an effective interestcrediting rate in excess of a market rateof return where it credits interest basedon the rate of return on the RIC and alsoprovides for the preservation of capital (asrequired for a statutory hybrid plan undersection 411(b)(5)(B)(i)(II))? Similarly, if astatutory hybrid plan credits interest basedon the rate of return on an equity indexthat is not a narrow-based equity index(as defined under section 3(a)(55) of theSecurities Exchange Act of 1934) andwhich also provides for the preservationof capital, is the plan providing an interestcrediting rate that is not in excess of amarket rate of return?

If the determination of the greater ofa fixed interest crediting rate and a vari-able interest crediting rate is made morefrequently than required to comply withthe capital preservation rule, the added fre-quency is more likely to result in an effec-tive interest crediting rate that is in excessof a market rate of return. For example, ifa statutory hybrid plan were to credit in-terest each day based on the greater of theactual rate of return on the plan assets forthat day or 0 percent, the effective interestcrediting rate would be far in excess of amarket rate of return.

The Treasury Department and the IRSare considering providing that a plan willnot have an effective interest crediting ratein excess of a market rate of return merelybecause it provides annual interest creditsbased on the greater of a reasonable fixedrate (such as 3 percent or 4 percent) andone of the rates of interest set forth in theproposed regulations. However, if a statu-tory hybrid plan were to provide interestcredits based on the greater of a fixed rate(including a fixed rate of 0 percent) and therate of return on plan assets or the valueof an equity-based index, determined onan annual basis, then the effective interestcrediting rate would typically be in excessof a market interest rate. Comments arerequested on what types of reductions to

the variable rate would be appropriate inorder to ensure that the effective interestcrediting rate under these situations doesnot exceed a market rate of return. In ad-dition, comments are requested on whetherregulations should establish reductions inthese situations where the determinationof whether the fixed or variable interestcrediting rate is greater is made more fre-quently than annually.

Pending issuance of guidance address-ing this issue, plan sponsors should becautious in adopting interest creditingrates other than those explicitly permittedin these proposed regulations. If such arate were adopted, and it did not satisfythe requirement not to be in excess of amarket rate of return under rules providedin future guidance, the rate would have tobe reduced in order to satisfy the require-ment.

The proposed regulations would pro-vide that, to the extent that interest credits(or equivalent amounts) have accrued un-der the terms of a statutory hybrid plan,section 411(d)(6) is violated by a planamendment that changes the interest cred-iting rate if the revised rate under anycircumstances could result in a lower rateof return after the applicable amendmentdate of the plan amendment. An excep-tion is provided that would permit certainchanges in a plan’s interest crediting ratewithout violating section 411(d)(6). Underthis exception, the proposed regulationswould permit an amendment to changethe plan’s interest crediting rate for futureperiods from the safe harbor market ratesof interest (for example, rates based on el-igible cost-of-living indices, or rates basedon Treasury bonds with the margins speci-fied in the proposed regulations) to the rateof interest on long-term investment gradecorporate bonds. Such a change would notconstitute a reduction in accrued benefitsin violation of section 411(d)(6) becauseit is expected that the change would resultin a reduction only in rare and unusualcircumstances, and the change would bepermitted only if the amendment is effec-tive not less than 30 days after adoptionand, on the effective date of the amend-ment, the new interest crediting rate isnot less than the interest crediting ratethat would have applied in the absenceof the amendment. In addition, the IRSand the Treasury Department may provideadditional guidance regarding changes to

2008–11 I.R.B. 604 March 17, 2008

the ongoing interest crediting rate under aplan that would or would not constitute areduction of accrued benefits in violationof section 411(d)(6).

Pension Equity Plans (PEPs)

These proposed regulations do not in-clude any rules specifically relating toplans that are often referred to as pensionequity plans, or PEPs (other than defininga participant’s accumulated benefit under aPEP as the accumulated percentage of finalaverage compensation). Notice 2007–6requested comments on the applicationof qualification requirements other thansections 411(b)(1)(H) and 417(e) to suchplans, including the treatment of interestcredited with respect to terminated vestedparticipants. See §601.601(d)(2)(ii)(b) ofthis chapter. The IRS and the TreasuryDepartment have received a number ofcomments pursuant to this request. Thesecomments indicate that, apart from de-termining the accumulated benefit as apercentage of final average compensa-tion, this design often provides explicitor implicit interest credits by determiningthe normal retirement benefit to be: (1)The accumulated percentage of final av-erage compensation divided by a deferredannuity factor (thus implicitly providinginterest and mortality credits for deferredbenefits); or (2) The lesser of (a) the cur-rent single sum benefit projected to normalretirement age and using an interest rate setforth in the plan or (b) the projected singlesum benefit based on projected service tonormal retirement age (taking into accountthe plan’s formula for the accumulatedpercentage of final average compensationwithout salary increases), with the lesserof these two amounts converted to an an-nuity. The right to future interest creditsunder these designs is earned at the sametime as the related percentage of finalaverage compensation; however, the com-ments indicated that the interest typicallycommences only after active participationceases.

The IRS and the Treasury Departmentwill continue to evaluate comments re-ceived regarding PEPs and are focusing onthe following questions in situations where

the interest credit is credited only after ac-tive participation ceases:

• Are these designs properly treated asplans under which the accrued benefitis expressed “as an accumulated per-centage of the participant’s final aver-age compensation” within the meaningof section 411(a)(13)(A)? After thedate on which interest credits com-mence, should these designs be treatedas plans under which the accrued ben-efit is expressed “as the balance ofa hypothetical account” within themeaning of section 411(a)(13)(A)?

• Do any of the designs in (1) or (2) ofthe preceding paragraph provide fora lower rate of accrual for additionalyears of service (because no interest iscredited if service is continued)? Seesection 411(b)(1)(G). Alternatively,can this issue be avoided by treatingthe annual rate at which the normalretirement benefit accrues as decliningwith each additional year of service?

• How should the backloading rulesof section 411(b)(1)(A)-(C) apply tothese designs and do they raise issueson which comments were requested inNotice 2007–14, 2007–7 I.R.B. 501?See §601.601(d)(2)(ii)(b) of this chap-ter.

Section 1107 of PPA ’06 and CodeSection 411(d)(6)

Under section 1107 of PPA ’06, a plansponsor is permitted to delay adoptinga plan amendment pursuant to statutoryprovisions under PPA ’06 (or pursuantto any regulation issued under PPA ’06)until the last day of the first plan yearbeginning on or after January 1, 2009(January 1, 2011 in the case of govern-mental plans). As described in Rev. Proc.2007–44, 2007–28 I.R.B. 54, this amend-ment deadline applies to both interim anddiscretionary amendments that are madepursuant to PPA ’06 statutory provisionsor any regulation issued under PPA ’06.See §601.601(d)(2)(ii)(b) of this chapter.If section 1107 of PPA ’06 applies to an

amendment of a plan, section 1107 pro-vides that the plan does not fail to meetthe requirements of section 411(d)(6) byreason of such amendment, except as pro-vided by the Secretary of the Treasury.7

The IRS and the Treasury Departmentare considering whether relief from section411(d)(6) should be provided for particularamendments that would be made pursuantto section 701 of PPA ’06 or these pro-posed regulations. In the following provi-sions of this section of the preamble, theIRS and the Treasury Department have setforth a description of amendments that areand are not entitled to section 411(d)(6) re-lief. Comments are requested on whethersection 411(d)(6) relief is or is not appro-priate for any additional amendments re-lated to section 701 of PPA ’06 or theseproposed regulations.

Until further guidance is provided bythe IRS and the Treasury Department, sec-tion 411(d)(6) relief is not available for thefollowing amendments that are describedin section 1107 of PPA ’06:

• A conversion amendment where theeffective date of the reduction in ben-efits that a participant, but for theamendment, would have accrued un-der a benefit formula that is not astatutory hybrid benefit formula is ear-lier than the date of adoption of thereduction amendment.

• An amendment that reduces a partici-pant’s hypothetical account balance oraccumulated percentage of final aver-age compensation below the amounton the date the amendment is adopted.

• An amendment to change the interestcrediting rate from one of the ratesspecified in Notice 96–8 using a mar-gin that is less than or equal to themaximum margin for that rate to thesame or another rate specified in No-tice 96–8 with an associated marginwhere the excess (if any) of the max-imum margin under the second rateover the margin used for that secondrate exceeds the excess (if any) of themaximum margin under the first rateover the margin used for that first rate.

7 Except to the extent permitted under section 411(d)(6) and §§1.411(d)–3 and 1.411(d)–4, or under a statutory provision such as section 1107 of PPA ’06, section 411(d)(6) prohibits a planamendment that decreases a participant’s accrued benefits or that has the effect of eliminating or reducing an early retirement benefit or retirement-type subsidy, or eliminating an optionalform of benefit, with respect to benefits attributable to service before the amendment. However, an amendment that eliminates or decreases benefits that have not yet accrued does not violatesection 411(d)(6), provided that the amendment is adopted and effective before the benefits accrue.

March 17, 2008 605 2008–11 I.R.B.

Until further guidance is provided bythe IRS and the Treasury Department, sec-tion 411(d)(6) relief is available for the fol-lowing amendments that are described insection 1107 of PPA ’06:

• As provided in Notice 2007–6, in thecase of a plan that provides for a singlesum distribution to a participant thatexceeds the participant’s hypotheti-cal account balance or accumulatedpercentage of final average compen-sation, the plan may be amended toeliminate the excess for distributionsmade after August 17, 2006. See§601.601(d)(2)(ii)(b) of this chapter.

• An amendment to change the interestcrediting rate from one of the ratesspecified in Notice 96–8 using a mar-gin that is less than or equal to the max-imum margin for that rate to one ofthe other rates specified in Notice 96–8with an associated margin where theexcess (if any) of the maximum mar-gin under the second rate over the mar-gin used for that second rate does notexceed the excess (if any) of the max-imum margin under the first rate overthe margin used for that first rate.

These rules under section 1107 ofPPA ’06 will be reflected in futureguidance on the market rate of returnrules under section 411(b)(5)(B)(i). TheIRS and the Treasury Department expectthat section 411(d)(6) relief under section1107 of PPA ’06 will be available inthe case of an amendment pursuant tothat future guidance to change a plan’sinterest crediting rate (including creditson pre-August 18, 2006 accruals) from aninterest rate that is above a market rate ofreturn to an interest rate that constitutesa market rate of return, provided that anyretroactive change in the crediting ratedoes not apply for periods before the datethat section 411(b)(5)(B)(i) first appliesto the plan. In addition, to the extentpermitted under future guidance, the IRSand the Treasury Department expect thatsection 411(d)(6) relief under section 1107of PPA ’06 will be available in the case ofan amendment to change the plan’s interestcrediting rate to a rate that is expected

to be higher than the plan’s current rate(such as an amendment to change to anequity-based rate of return).

Effective/Applicability Dates

Pursuant to section 701(e)(1) ofPPA ’06, the amendments made by section701 of PPA ’06 are generally effectivefor periods beginning on or after June29, 2005. However, sections 701(e)(2)through 701(e)(5) of PPA ’06 set forth anumber of special effective/applicabilitydate rules that are described earlier in theBackground section of the preamble ofthese proposed regulations.

These proposed regulations reflectthe statutory effective dates set forth insection 701(e) of PPA ’06. Thus, theproposed regulations would reflect thatsection 411(a)(13)(A) applies to distri-butions made after August 17, 2006. Inaddition, the proposed regulations wouldreflect that, in the case of a plan that isin existence on June 29, 2005, section411(a)(13)(B) applies to plan years be-ginning on or after January 1, 2008. Atthe date of issuance of these proposedregulations, bills have been introducedin the House of Representatives and theSenate which provide that (1) section411(a)(13)(B) only applies to a participantwho performs at least one hour of serviceon or after the effective date of section411(a)(13)(B) with respect to the plan, and(2) in the case of a plan other than a plandescribed in section 701(e)(3) or 701(e)(4)of PPA ’06, section 411(a)(13)(B) appliesto years ending on or after June 29, 2005.8

Proposed §1.411(a)(13)–1(e)(1)(iii)(A)(2)and §1.411(a)(13)–1(e)(1)(iii)(B)(2) havebeen reserved in order to accommodatethese changes.

These regulations are proposed to beeffective for plan years beginning on orafter January 1, 2009 (or, if later, the datethat applies to certain collectively bar-gained plans pursuant to section 701(e)(4)of PPA ’06). For periods after the statutoryeffective date and before the regulatoryeffective date set forth in the precedingsentence, a plan must comply with sec-tions 411(a)(13) and 411(b)(5). Duringthese periods, a plan is permitted to relyon the provisions set forth in the proposed

regulations for purposes of satisfying therequirements of sections 411(a)(13) and411(b)(5).

These regulations should not be con-strued to create any inference concerningthe applicable law prior to the effectivedates of sections 411(a)(13) and 411(b)(5).See also section 701(d) of PPA ’06.

Special Analyses

It has been determined that these pro-posed regulations are not a significant reg-ulatory action as defined in Executive Or-der 12866. Therefore, a regulatory assess-ment is not required. It also has been deter-mined that section 553(b) of the Adminis-trative Procedure Act (5 U.S.C. chapter 5)does not apply to these regulations, and be-cause the regulation does not impose a col-lection of information on small entities, theRegulatory Flexibility Act (5 U.S.C. chap-ter 6) does not apply. Pursuant to section7805(f) of the Code, these regulations willbe submitted to the Chief Counsel for Ad-vocacy of the Small Business Administra-tion for comment on its impact on smallbusiness.

Comments and Requests for PublicHearing

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

The IRS and the Treasury Departmentspecifically request comments on the clar-ity of the proposed regulations and howthey may be made easier to understand.

In addition to the comments requestedunder the “Conversion protection” and“Market rate of return limitation” headingsof this preamble (and in Part V of Notice2007–6), comments are also requested onissues not addressed in these proposedregulations, including:

• The application of the 3-year vestingrequirement in section 411(a)(13)(B)to a plan that is not a statutory hy-brid plan when the plan is part of afloor-offset arrangement with a planthat includes a lump sum-based benefitformula.

8 H.R. 3361 (Aug. 3, 2007) and S. 1974 (Aug. 2, 2007), at section 8(3)(B)(iv).

2008–11 I.R.B. 606 March 17, 2008

• Whether guidance should be issued un-der section 411(b)(5) as to whether acharacteristic is indirectly on accountof age.

• Whether the age discrimination safeharbor in section 411(b)(5)(A) shouldbe available in the case of any planthat does not express a participant’s ac-cumulated benefit as either an annu-ity payable at normal retirement age(or current age, if later), the balance ofa hypothetical account, or the currentvalue of the accumulated percentage ofa participant’s final average compensa-tion.

All comments will be available forpublic inspection and copying. A publichearing will be scheduled if requested inwriting by any person who timely submitswritten comments. If a public hearing isscheduled, notice of the date, time, andplace of the public hearing will be pub-lished in the Federal Register.


The principal authors of these reg-ulations are Lauson C. Green andLinda S. F. Marshall, Office of DivisionCounsel/Associate Chief Counsel (TaxExempt and Government Entities).However, other personnel from the IRSand the Treasury Department participatedin the development of these regulations.

* * * * *

Proposed Amendments to theRegulations

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


Paragraph 1. The authority citation forpart 1 is amended by adding entries as fol-lows:

Authority: 26 U.S.C. 7805 * * *Section 1.411(a)(13)–1 also issued un-

der 26 U.S.C. 411(a)(13).Section 1.411(b)(5)–1 also issued under

26 U.S.C. 411(b)(5). * * *Par. 2. Section 1.411(a)(13)–1 is added

to read as follows:

§1.411(a)(13)–1 Statutory hybrid plans.

(a) In general. This section sets forthcertain rules that apply to statutory hybridplans under section 411(a)(13). Paragraph(b) of this section describes special rulesfor certain statutory hybrid plans that de-termine benefits under a lump sum-basedbenefit formula. Paragraph (c) of this sec-tion describes the vesting requirement forstatutory hybrid plans. Paragraphs (d) and(e) of this section contain definitions andeffective/applicability dates, respectively.

(b) Calculation of benefit by referenceto hypothetical account balance or accu-mulated percentage. Pursuant to section411(a)(13)(A), a statutory hybrid plan thatdetermines any portion of a participant’sbenefits under a lump sum-based benefitformula is not treated as failing to meet therequirements of section 411(a)(2), or therequirements of section 411(c) or 417(e)with respect to the participant’s accruedbenefit derived from employer contribu-tions, solely because, with respect to ben-efits determined under that formula, thepresent value of those benefits is, underthe terms of the plan, equal to the balanceof the hypothetical account maintained forthe participant or to the current value ofthe accumulated percentage of the partic-ipant’s final average compensation underthat formula.

(c) Three-year vesting require-ment—(1) In general. Pursuant to section411(a)(13)(B), if any portion of the par-ticipant’s accrued benefit under a definedbenefit plan is determined under a statu-tory hybrid benefit formula, the plan isnot treated as meeting the requirements ofsection 411(a)(2) unless the plan providesthat the participant has a nonforfeitableright to 100 percent of the participant’saccrued benefit if the participant has 3 ormore years of service. Thus, this 3-yearvesting requirement applies with respectto the entire accrued benefit of a partici-pant under a defined benefit plan even ifonly a portion of the participant’s accruedbenefit under the plan is determined undera statutory hybrid benefit formula. Sim-ilarly, if the participant’s accrued benefitunder a defined benefit plan is, under theplan’s terms, the larger of two (or more)benefit amounts, where each amount is de-termined under a different benefit formula(including a benefit determined pursuantto an offset among formulas within the

plan) and at least one of those formulas isa statutory hybrid benefit formula, the par-ticipant’s entire accrued benefit under thedefined benefit plan is subject to the 3-yearvesting rule of section 411(a)(13)(B) andthis paragraph (c). The rule describedin the preceding sentence applies even ifthe larger benefit is ultimately the benefitdetermined under a formula that is not astatutory hybrid benefit formula.

(2) Floor-offset arrangements involvinga statutory hybrid plan. [Reserved]

(3) Examples. The provisions of thisparagraph (c) are illustrated by the follow-ing examples:

Example 1. Employer M sponsors Plan X, pur-suant to which each participant’s accrued benefit isequal to the sum of the benefit provided under twobenefit formulas. The first benefit formula is a statu-tory hybrid benefit formula, and the second formula isnot. Because a portion of each participant’s accruedbenefit provided under Plan X is determined under astatutory hybrid benefit formula, the 3-year vestingrequirement described in paragraph (c)(1) of this sec-tion applies to each participant’s entire accrued ben-efit provided under Plan X.

Example 2. The facts are the same as in Exam-ple 1, except that the benefit formulas described inExample 1 only apply to participants for service per-formed in Division A of Employer M and a differ-ent benefit formula applies to participants for serviceperformed in Division B of Employer M. Pursuantto the terms of Plan X, the accrued benefit of a par-ticipant attributable to service performed in DivisionB is equal to the benefit provided by a benefit for-mula that is not a statutory hybrid benefit formula.Therefore, the 3-year vesting requirement describedin paragraph (c)(1) of this section does not apply toa participant with an accrued benefit under Plan X ifthe participant’s benefit is solely attributable to ser-vice performed in Division B.

(d) Definitions—(1) In general. Thedefinitions in this paragraph (d) apply forpurposes of this section.

(2) Lump sum-based benefit formula.The term lump sum-based benefit formulameans a lump sum-based benefit formulaas defined in §1.411(b)(5)–1(e)(3).

(3) Statutory hybrid benefit for-mula—(i) In general. A statutory hybridbenefit formula means a benefit formulathat is either a lump sum-based benefitformula or a formula that is not a lumpsum-based benefit formula but that has aneffect similar to a lump sum-based benefitformula.

(ii) Effect similar to a lump sum-basedbenefit formula. Except as provided inparagraph (d)(3)(iii) of this section, abenefit formula under a defined bene-fit plan that is not a lump sum-basedbenefit formula has an effect similar to

March 17, 2008 607 2008–11 I.R.B.

a lump sum-based benefit formula ifthe formula provides that a participant’saccumulated benefit (within the mean-ing of §1.411(b)(5)–1(e)(2)) payable atnormal retirement age (or benefit com-mencement, if later) is expressed as abenefit that includes the right to peri-odic adjustments (including a formulathat provides for indexed benefits under§1.411(b)(5)–1(b)(2)) that are reason-ably expected to result in a smaller an-nual benefit at normal retirement age (orbenefit commencement, if later) for theparticipant than for a similarly situated,younger individual (within the meaningof §1.411(b)(5)–1(b)(5)) who is or couldbe a participant in the plan. A benefitformula that does not include periodic ad-justments is treated as a formula with aneffect similar to a lump sum-based ben-efit formula if the formula is otherwisedescribed in the preceding sentence andthe adjustments are provided pursuant to apattern of repeated plan amendments. See§1.411(d)–4, A–1(c)(1).

(iii) Exceptions—(A) Post-retirementbenefit adjustments. Post-annuity startingdate adjustments of the amounts payableto a participant (such as cost-of-livingincreases) are disregarded in determiningwhether a benefit formula under a definedbenefit plan has an effect similar to a lumpsum-based benefit formula.

(B) Certain variable annuity benefitformulas. If the assumed interest rateused for purposes of the adjustment ofamounts payable to a participant under avariable annuity benefit formula is at least5 percent, then the adjustments under thevariable annuity benefit formula are nottreated as being reasonably expected toresult in a smaller annual benefit at normalretirement age (or benefit commencement,if later) for the participant than for a sim-ilarly situated, younger individual (withinthe meaning of §1.411(b)(5)–1(b)(5)) whois or could be a participant in the plan,and thus such a variable annuity benefitformula does not have an effect similar toa lump sum-based benefit formula.

(C) Contributory plans. A benefit for-mula under a defined benefit plan thatprovides for a benefit equal to the benefitproperly attributable to after-tax employeecontributions does not have an effect sim-ilar to a lump sum-based benefit formula.See section 411(c)(2) for rules for deter-

mining benefits attributable to after-taxemployee contributions.

(4) Variable annuity benefit formula.A variable annuity benefit formula meansany benefit formula under a defined ben-efit plan which provides that the amountpayable is periodically adjusted by refer-ence to the difference between the rate ofreturn of plan assets (or specified marketindices) and a specified assumed interestrate.

(e) Effective/applicability date—(1)Statutory effective/applicability date—(i)In general. Except as provided in para-graphs (e)(1)(ii) and (e)(1)(iii) of thissection, section 411(a)(13) applies for pe-riods beginning on or after June 29, 2005.

(ii) Calculation of benefits. Section411(a)(13)(A) applies to distributionsmade after August 17, 2006.

(iii) Vesting—(A) Plans in existence onJune 29, 2005—(1) General rule. In thecase of a plan that is in existence on June29, 2005 (regardless of whether the planis a statutory hybrid plan on that date),section 411(a)(13)(B) applies to plan yearsbeginning on or after January 1, 2008.

(2) Hour of service required. [Re-served]

(3) Exception for plan sponsor elec-tion. See §1.411(b)(5)–1(f)(1)(iii)(A)(2)for a special election for early applicationof section 411(a)(13)(B).

(B) Plans not in existence on June 29,2005—(1) In general. In the case of aplan not in existence on June 29, 2005,section 411(a)(13)(B) applies for periodsbeginning on or after June 29, 2005.

(2) Hour of service required. [Re-served]

(C) Collectively bargained plans.Notwithstanding paragraphs (e)(1)(iii)(A)and (B) of this section, in the case of acollectively bargained plan maintainedpursuant to one or more collective bar-gaining agreements between employeerepresentatives and one or more employersratified on or before August 17, 2006, therequirements of section 411(a)(13)(B) donot apply for plan years beginning beforethe earlier of—

(1) The later of—(i) The date on which the last of those

collective bargaining agreements termi-nates (determined without regard to anyextension thereof on or after August 17,2006), or

(ii) January 1, 2008; or

(2) January 1, 2010.(D) Treatment of plans with both collec-

tively bargained and non-collectively bar-gained employees. In the case of a planwhere a collective bargaining agreementapplies to some, but not all, of the plan par-ticipants, the plan is considered a collec-tively bargained plan for purposes of para-graph (e)(1)(iii)(C) of this section if at least25 percent of the participants in the planare members of collective bargaining unitsfor which the benefit levels under the planare specified under a collective bargainingagreement.

(2) Effective/applicability date of regu-lations. This section applies for plan yearsbeginning on or after January 1, 2009 (or,if later, the date applicable under para-graph (e)(1)(iii)(C) of this section). Forthe periods after the statutory effective dateset forth in paragraph (e)(1) of this sectionand before the regulatory effective date setforth in the preceding sentence, a plan mustcomply with section 411(a)(13). Duringthese periods, a plan is permitted to relyon the provisions of this section for pur-poses of satisfying the requirements of sec-tion 411(a)(13).

Par. 3. Section 1.411(b)(5)–1 is addedto read as follows:

§1.411(b)(5)–1 Reduction in rate ofbenefit accrual under a defined benefitplan.

(a) In general. This section sets forthcertain rules related to reduction in therate of benefit accrual under a definedbenefit plan. Paragraph (b) of this sectiondescribes certain plan design-based safeharbors (including statutory hybrid plans)that are deemed to satisfy the age discrim-ination rules under section 411(b)(1)(H).Paragraph (c) of this section describesrules relating to statutory hybrid plan con-version amendments. Paragraph (d) of thissection describes rules restricting interestcredits (or equivalent amounts) under astatutory hybrid plan to a market rate of re-turn. Paragraphs (e) and (f) of this sectioncontain definitions and effective/applica-bility dates, respectively.

(b) Safe harbors for certain plandesigns—(1) Accumulated benefit test-ing—(i) In general. Pursuant to section411(b)(5)(A), and subject to paragraph(b)(1)(ii) of this section, a plan is nottreated as failing to meet the requirements

2008–11 I.R.B. 608 March 17, 2008

of section 411(b)(1)(H)(i) if, as of any date,the accumulated benefit of a participantwould not be less than the accumulatedbenefit of any similarly situated, youngerparticipant. This test requires a compar-ison of the accumulated benefit of eachindividual who is or could be a participantin the plan with the accumulated benefitof each other similarly situated, youngerindividual who is or could be a participantin the plan. See paragraph (b)(5) of thissection for rules regarding whether eachyounger individual who is or could be aparticipant is similarly situated to a partic-ipant. The comparison described in thisparagraph (b)(1)(i) is based on—

(A) The annuity payable at normal re-tirement age (or current age, if later) if theaccumulated benefit of the participant un-der the terms of the plan is expressed as anannuity payable at normal retirement age(or current age, if later);

(B) The balance of a hypothetical ac-count if the accumulated benefit of the par-ticipant under the terms of the plan is ex-pressed as a hypothetical account balance;or

(C) The current value of an accumu-lated percentage of the participant’s finalaverage compensation if the accumulatedbenefit of the participant under the termsof the plan is expressed as an accumulatedpercentage of final average compensation.

(ii) Benefit formulas for compari-son—(A) In general. The safe harborprovided by section 411(b)(5)(A) andparagraph (b)(1)(i) of this section does notapply to a plan if the accumulated bene-fit of a participant under the plan is notdescribed in paragraph (b)(1)(i)(A), (B)or (C) of this section. In addition, exceptas provided in paragraph (b)(1)(ii)(B) ofthis section, that safe harbor also doesnot apply to a plan if the comparison re-quired under paragraph (b)(1)(i) of thissection involves comparing accumulatedbenefits that are described in differentsubparagraphs of paragraph (b)(1)(i) ofthis section. Thus, for example, if a planprovides an accumulated benefit that isexpressed under the terms of the plan asan annuity payable at normal retirementage as described in paragraph (b)(1)(i)(A)of this section for participants who areage 55 or over, and the plan provides anaccumulated benefit that is expressed asthe balance of a hypothetical account asdescribed in paragraph (b)(1)(i)(B) of this

section for participants who are youngerthan age 55, the safe harbor describedin section 411(b)(5)(A) and paragraph(b)(1)(i) of this section does not apply tothe plan.

(B) Greater-of and sum-of benefit for-mulas. If a plan provides that a partici-pant’s accumulated benefit is equal to thesum of accumulated benefits that are de-scribed in different subparagraphs of para-graph (b)(1)(i) of this section, then the planis deemed to satisfy paragraph (b)(1)(i) ofthis section if the plan satisfies the compar-ison described in paragraph (b)(1)(i) of thissection separately for each of the differentaccumulated benefits. Similarly, if a planprovides that a participant’s accumulatedbenefit is equal to the greater of accumu-lated benefits that are described in differ-ent subparagraphs of paragraph (b)(1)(i) ofthis section, then the plan is deemed to sat-isfy paragraph (b)(1)(i) of this section ifthe plan satisfies the comparison describedin paragraph (b)(1)(i) of this section sepa-rately for each of the different accumulatedbenefits. For purposes of this paragraph(b)(1)(ii)(B), a similarly situated, youngerparticipant is treated as having an accumu-lated benefit of zero under a benefit for-mula if the benefit formula does not applyto the participant.

(iii) Disregard of certain subsidizedbenefits. For purposes of paragraph(b)(1)(i) of this section, any subsidizedportion of any early retirement benefit thatis included in a participant’s accumulatedbenefit is disregarded. For this purpose,the subsidized portion of an early retire-ment benefit is the retirement-type subsidywithin the meaning of §1.411(d)–3(g)(6)that is contingent on a participant’s sev-erance from employment and commence-ment of benefits before normal retirementage.

(2) Indexed benefits—(i) In gen-eral. Except as provided in paragraph(b)(2)(iv) of this section, pursuant tosection 411(b)(5)(E) and this paragraph(b)(2)(i), a defined benefit plan is nottreated as failing to meet the requirementsof section 411(b)(1)(H) solely becausea benefit formula under the plan (otherthan a lump sum-based benefit formula)provides for the periodic adjustment ofaccrued benefits under the plan, but onlyif the adjustment is by means of the appli-cation of a recognized investment indexor methodology described in paragraph

(b)(2)(ii) of this section and the plan satis-fies paragraph (b)(2)(iii) of this section. Astatutory hybrid plan that is not treated asfailing to satisfy section 411(b)(1)(H) pur-suant to the preceding sentence must nev-ertheless satisfy the qualification require-ments otherwise applicable to statutoryhybrid plans, including the requirementsof §1.411(a)(13)–1(c) (relating to mini-mum vesting standards), paragraph (c) ofthis section (relating to plan conversionamendments), and paragraph (d) of thissection (relating to market rates of return).

(ii) Recognized investment index ormethodology. An adjustment is made pur-suant to a recognized investment index ormethodology if it is made pursuant to—

(A) An eligible cost-of-living index asdescribed in §1.401(a)(9)–6, A–14(b);

(B) The rate of return on the aggregateassets of the plan; or

(C) The rate of return on the annuitycontract for the employee issued by an in-surance company licensed under the lawsof a State.

(iii) Similarly situated participant test.A plan satisfies this paragraph (b)(2)(iii)if the aggregate periodic adjustments ofeach participant’s accrued benefit underthe plan (determined as a percentage ofthe unadjusted accrued benefit) would notbe less than the aggregate periodic adjust-ments of any similarly situated, youngerparticipant. This test requires a compari-son of the aggregate periodic adjustmentsof each individual who is or could be a par-ticipant in the plan for any specified periodwith the aggregate periodic adjustments ofeach other similarly situated, younger in-dividual who is or could be a participantin the plan for the same period. See para-graph (b)(5) of this section for rules re-garding whether each younger individualwho is or could be a participant is similarlysituated to a participant.

(iv) Protection against loss—(A) Ingeneral. Paragraph (b)(2)(i) of this sectiondoes not apply unless the plan satisfiessection 411(b)(5)(E)(ii) and paragraph(d)(2)(ii) of this section (relating to preser-vation of capital).

(B) Exception for variable annuity ben-efit formulas. The requirement to satisfysection 411(b)(5)(E)(ii) and paragraph(d)(2)(ii) of this section does not applyin the case of a benefit provided undera variable annuity benefit formula, butonly if the adjustments under the variable

March 17, 2008 609 2008–11 I.R.B.

annuity benefit formula are based on therate of return on the aggregate assets ofthe plan or the rate of return on the annuitycontract for the employee issued by an in-surance company licensed under the lawsof a State.

(3) Certain offsets permitted. A plan isnot treated as failing to meet the require-ments of section 411(b)(1)(H) solely be-cause the plan provides offsets against ben-efits under the plan to the extent the off-sets are allowable in applying the require-ments of section 401(a) and the applicablerequirements of the Employee RetirementIncome Security Act of 1974, Public Law93–406 (88 Stat. 829), and the Age Dis-crimination in Employment Act of 1967,Public Law 90–202 (81 Stat. 602).

(4) Permitted disparities in plan contri-butions or benefits. A plan is not treated asfailing to meet the requirements of section411(b)(1)(H) solely because the plan pro-vides a disparity in contributions or bene-fits with respect to which the requirementsof section 401(l) are met.

(5) Definition of similarly situated. Forpurposes of paragraphs (b)(1) and (b)(2) ofthis section, an individual is similarly situ-ated to another individual if the individualis identical to that other individual in ev-ery respect that is relevant in determininga participant’s benefit under the plan (in-cluding period of service, compensation,position, date of hire, work history, andany other respect) except for age. In deter-mining whether an individual is similarlysituated to another individual, any char-acteristic that is relevant for determiningbenefits under the plan and that is baseddirectly or indirectly on age is disregarded.For example, if a particular benefit formulaapplies to a participant on account of theparticipant’s age, an individual to whomthe benefit formula does not apply and whois identical to the participant in all other re-spects is similarly situated to the partici-pant. By contrast, an individual is not sim-ilarly situated to a participant if a differ-ent benefit formula applies to the individ-ual and the application of the different for-mula is not based directly or indirectly onage.

(c) Special rules for plan conversionamendments—(1) In general. Pursuant tosection 411(b)(5)(B)(ii), (iii), and (iv), ifthere is a conversion amendment withinthe meaning of paragraph (c)(4) of this sec-tion with respect to a defined benefit plan,

then the plan is treated as failing to meetthe requirements of section 411(b)(1)(H)unless the plan, after the amendment, sat-isfies the requirements of paragraph (c)(2)of this section.

(2) Separate calculation of post-conver-sion benefit—(i) In general. A statutoryhybrid plan satisfies the requirements ofthis paragraph (c)(2) if the plan providesthat, in the case of an individual who wasa participant in the plan immediately be-fore the date of adoption of the conversionamendment, the participant’s benefit at anysubsequent annuity starting date is not lessthan the sum of:

(A) The participant’s section 411(d)(6)protected benefit (as defined in§1.411(d)–3(g)(14)) with respect to ser-vice before the effective date of the con-version amendment, determined under theterms of the plan as in effect immediatelybefore the effective date of the amend-ment; and

(B) The participant’s section 411(d)(6)protected benefit with respect to serviceon and after the effective date of the con-version amendment, determined under theterms of the plan as in effect after the ef-fective date of the amendment.

(ii) Rules of application. For purposesof this paragraph (c)(2), except as pro-vided in paragraph (c)(3) of this section,the benefits under paragraph (c)(2)(i)(A)and (B) of this section must each be deter-mined in the same manner as if they wereprovided under separate plans that areindependent of each other (for example,without any benefit offsets), and, exceptto the extent permitted under §1.411(d)–3or §1.411(d)–4 (or other applicable law),each optional form of payment providedunder the terms of the plan with respect toa participant’s section 411(d)(6) protectedbenefit as in effect before the amendmentmust be available thereafter to the extentof the plan’s benefits for service prior tothe effective date of the amendment.

(3) Establishment of opening hypothet-ical account balance—(i) In general. Pro-vided that the requirements of paragraph(c)(3)(ii) of this section are satisfied, astatutory hybrid plan under which an open-ing hypothetical account balance or open-ing accumulated percentage of the partici-pant’s final average compensation is estab-lished as of the effective date of the con-version amendment does not fail to satisfythe requirements of paragraph (c)(2) of this

section merely because benefits attribut-able to that opening hypothetical accountbalance or opening accumulated percent-age (that is, benefits that are not describedin paragraph (c)(2)(i)(B) of this section)are substituted for benefits described inparagraph (c)(2)(i)(A) of this section.

(ii) Comparison of benefits—(A) Test-ing requirement. For any optional formof benefit payable at an annuity startingdate where there was an optional form ofbenefit within the same generalized op-tional form of benefits (within the meaning1.411(d)–3(g)(8)) that would have beenavailable to the participant at that annuitystarting date under the terms of the plan asin effect immediately before the effectivedate of the conversion amendment, the re-quirements of this paragraph (c)(3)(ii) aresatisfied only if the plan provides that theamount of the benefit under that optionalform of benefit available to the partici-pant under the lump sum-based benefitformula that is attributable to the openinghypothetical account balance or openingaccumulated percentage as described inparagraph (c)(3)(i) of this section, deter-mined under the terms of the plan as of theannuity starting date (including actuarialconversion factors), is not less than thebenefit under that optional form of benefitdescribed in paragraph (c)(2)(i)(A) of thissection. To satisfy this requirement, if thebenefit under an optional form attribut-able to the opening hypothetical accountbalance or opening accumulated percent-age is less than the benefit described inparagraph (c)(2)(i)(A) of this section, thenthe benefit attributable to the openinghypothetical account balance or openingaccumulated percentage must be increasedto the extent necessary to provide the min-imum benefit described in this paragraph(c)(3)(ii)(A). Thus, if a plan is using theoption under this paragraph (c)(3) to sat-isfy paragraph (c)(2) of this section withrespect to a participant, the participantmust receive a benefit equal to not lessthan the sum of:

(1) The greater of the benefit attribut-able to the opening hypothetical accountbalance as described in this paragraph(c)(3)(ii) and the benefit described in para-graph (c)(2)(i)(A) of this section, and

(2) The benefit described in paragraph(c)(2)(i)(B) of this section.

(B) Special rule for post-conversionoptional forms of benefit. If an optional

2008–11 I.R.B. 610 March 17, 2008

form of benefit is available on the annuitystarting date with respect to the benefitattributable to the opening hypotheticalaccount balance or opening accumulatedpercentage, but no optional form within thesame generalized optional form of benefit(within the meaning of §1.411(d)–3(g)(8))was available at that annuity starting dateunder the terms of a plan as in effect im-mediately prior to the effective date of theconversion amendment, then, for purposesof this paragraph (c)(3)(ii), the plan istreated as if such an optional form of bene-fit were available immediately prior to theeffective date of the conversion amend-ment. In that event, paragraph (c)(3)(ii)(A)of this section must be applied by takinginto account the optional form of benefitthat is treated as if it were available onthe annuity starting date under the termsof the plan as in effect immediately priorto the effective date of the conversionamendment. Thus, for example, if a singlesum optional form of payment is not avail-able under the plan terms applicable tothe accrued benefit described in paragraph(c)(2)(i)(A) of this section, but a singlesum form of payment is available withrespect to the benefit attributable to theopening hypothetical account balance oropening accumulated percentage as of theannuity starting date, then, for purposes ofparagraph (c)(3)(ii)(A) of this section, theplan is treated as if a single sum (to whichsection 417(e)(3) applies) were availableunder the terms of the plan as in effectimmediately prior to the effective date ofthe conversion amendment.

(4) Conversion amendment—(i) Ingeneral. An amendment is a conversionamendment that is subject to the require-ments of this paragraph (c) with respect toa participant if—

(A) The amendment reduces or elimi-nates the benefits that, but for the amend-ment, the participant would have accruedafter the effective date of the amendmentunder a benefit formula that is not a statu-tory hybrid benefit formula (and underwhich the participant was accruing bene-fits prior to the amendment); and

(B) After the effective date of theamendment, all or a portion of the par-ticipant’s benefit accruals under the planare determined under a statutory hybridbenefit formula.

(ii) Rules of application—(A) In gen-eral. Paragraphs (c)(4)(iii), (iv), and (v)

of this section describe special rules thattreat certain arrangements as conversionamendments. The rules described in thoseparagraphs apply both separately and incombination. Thus, for example, in anacquisition described in §1.410(b)–2(f),if the buyer adopts an amendment underwhich a participant’s benefits under theseller’s plan that is not a statutory hybridplan are coordinated with a separate planof the buyer that is a statutory hybrid plan,such as through an offset of the partici-pant’s benefit under the buyer’s plan bythe participant’s benefit under the seller’splan, the seller and buyer are treated as asingle employer under paragraph (c)(4)(iv)of this section and they are treated ashaving adopted a conversion amendmentunder paragraph (c)(4)(iii) of this section.However, pursuant to paragraph (c)(4)(iii)of this section, if there is no coordinationbetween the two plans, there is no conver-sion amendment.

(B) Covered amendments. Onlyamendments that eliminate or reduceaccrued benefits described in section411(a)(7), or a retirement-type subsidydescribed in section 411(d)(6)(B)(i), thatwould otherwise accrue as a result of fu-ture service are treated as amendmentsdescribed in paragraph (c)(4)(i)(A) of thissection.

(C) Operation of plan terms treated ascovered amendment. If, under the termsof a plan, a change in the conditions of aparticipant’s employment results in a re-duction of the participant’s benefits thatwould have accrued in the future under abenefit formula that is not a statutory hy-brid benefit formula, the plan is treatedfor purposes of this paragraph (c)(4) as ifsuch plan terms constitute an amendmentthat reduces the participant’s benefits thatwould have accrued after the effective dateof the change under a benefit formula thatis not a statutory hybrid benefit formula.Thus, for example, if a participant trans-fers from an operating division that is cov-ered by a non-statutory hybrid benefit for-mula to an operating division that is cov-ered by a statutory hybrid benefit formula,there has been a conversion amendment asof the date of the transfer.

(iii) Multiple plans. An employer istreated as having adopted a conversionamendment if the employer adopts anamendment under which a participant’sbenefits under a plan that is not a statutory

hybrid plan are coordinated with a separateplan that is a statutory hybrid plan, such asthrough a reduction (offset) of the benefitunder the plan that is not a statutory hybridplan.

(iv) Multiple employers. If the em-ployer of an employee changes as aresult of a transaction described in§1.410(b)–2(f), then the two employersare treated as a single employer for pur-poses of this paragraph (c)(4).

(v) Multiple amendments—(A) In gen-eral—(1) General rule. For purposes ofthis paragraph (c)(4), a conversion amend-ment includes multiple amendments thatresult in a conversion amendment evenif the amendments are not conversionamendments individually. For example,an employer is treated as having adopteda conversion amendment if the employerfirst adopts an amendment described inparagraph (c)(4)(i)(A) of this section and,at a later date, adopts an amendment thatadds a benefit under a statutory hybridbenefit formula as described in paragraph(c)(4)(i)(B) of this section, if they are con-solidated under paragraph (c)(4)(v)(A)(2)of this section.

(2) Delay between plan amendments. Inthe case of an amendment to provide a ben-efit under a statutory hybrid benefit for-mula that is adopted within three years af-ter adoption of an amendment to reducenon-statutory hybrid benefit formula bene-fits, those amendments are consolidated indetermining whether a conversion amend-ment has been adopted. Thus, the lateradoption of the statutory hybrid benefitformula will cause the earlier amendmentto be treated as a conversion amendment.In the case of an amendment to provide abenefit under a statutory hybrid benefit for-mula that is adopted more than three yearsafter adoption of an amendment to reducebenefits under a non-statutory hybrid ben-efit formula, there is a presumption thatthe amendments are not consolidated un-less the facts and circumstances indicatethat adoption of the amendment to providea benefit under a statutory hybrid benefitformula was intended at the time of reduc-tion in the non-statutory hybrid benefit for-mula.

(B) Multiple conversion amendments.If an employer adopts multiple amend-ments reducing benefits described in para-graph (c)(4)(i)(A) of this section, eachamendment is treated as a separate conver-

March 17, 2008 611 2008–11 I.R.B.

sion amendment, provided that paragraph(c)(4)(i)(B) of this section is applicableat the time of the amendment (taking intoaccount the rules of this paragraph (c)(4)).

(vi) Effective date of a conversionamendment. The effective date of a con-version amendment is, with respect toa participant, the date as of which thereduction of the participant’s benefits de-scribed in paragraph (c)(4)(i)(A) of thissection occurs. In accordance with section411(d)(6), the date of a reduction of thosebenefits cannot be earlier than the date ofadoption of the conversion amendment.

(5) Examples. The following examplesillustrate the application of paragraph (c)of this section:

Example 1. (i) Facts where plan does not estab-lish opening hypothetical account balance for partic-ipants and participant elects life annuity at normalretirement age. Employer N sponsors Plan E, a de-fined benefit plan that provides an accumulated ben-efit, payable as a straight life annuity commencingat age 65 (which is Plan E’s normal retirement age),based on a percentage of highest average compen-sation times the participant’s years of service. PlanE permits any participant who has had a severancefrom employment to elect payment in the followingoptional forms of benefit (with spousal consent if ap-plicable), with any payment not made in a straight lifeannuity converted to an equivalent form based on rea-sonable actuarial assumptions: a straight life annuity;and a 50 percent, 75 percent, or 100 percent joint andsurvivor annuity. The payment of benefits may com-mence at any time after attainment of age 55, withan actuarial reduction if the commencement is beforenormal retirement age. In addition, the plan offers asingle sum payment after attainment of age 55 equalto the present value of the normal retirement benefitusing the applicable interest rate and mortality tableunder section 417(e)(3) in effect under the terms ofthe plan on the annuity starting date.

(ii) Facts relating to the conversion amendment.On January 1, 2010, Plan E is amended to eliminatefuture accruals under the highest average compensa-tion benefit formula and to base future benefit accru-als on a hypothetical account balance. For service onor after January 1, 2010, each participant’s hypothet-ical account balance is credited monthly with a paycredit equal to a specified percentage of the partici-pant’s compensation during the month and also withinterest based on the third segment rate described insection 430(h)(2)(C)(iii). With respect to benefits un-der the hypothetical account balance attributable toservice on and after January 1, 2010, a participant ispermitted to elect (with spousal consent if applica-ble) payment in the same generalized optional formsof benefit (even though different actuarial factors ap-ply) as under the terms of the plan in effect beforeJanuary 1, 2010, and also as a single sum distribu-tion. The plan provides for the benefits attributableto service before January 1, 2010, to be determinedunder the terms of the plan as in effect immediatelybefore the effective date of the amendment, and thebenefits attributable to service on and after January

1, 2010 to be determined separately, under the termsof the plan as in effect after the effective date of theamendment, with neither benefit offsetting the otherin any manner. Thus, each participant’s benefits areequal to the sum of the benefits attributable to servicebefore January 1, 2010 (to be determined under theterms of the plan as in effect immediately before theeffective date of the amendment), plus the benefitsattributable to the participant’s hypothetical accountbalance.

(iii) Facts relating to an affected participant. Par-ticipant A is age 62 on January 1, 2010 and, on De-cember 31, 2009, A’s benefit for years of service be-fore January 1, 2010, payable as a straight life an-nuity commencing at A’s normal retirement age (age65) which is January 1, 2013, is $1,000 per month.Participant A has a severance from employment onJanuary 1, 2013, and, on January 1, 2013, the hypo-thetical account balance, with pay credits and interestfrom January 1, 2010, to January 1, 2013, has become$11,000. Using the conversion factors under the planas amended on January 1, 2013, that balance is equiv-alent to a straight life annuity of $100 per month com-mencing on January 1, 2013. This benefit is in addi-tion to the benefit attributable to service before Jan-uary 1, 2010. Participant A elects (with spousal con-sent) a straight life annuity of $1,100 per month com-mencing January 1, 2013.

(iv) Conclusion. Participant A’s benefit satisfiesthe requirements of paragraph (c)(3)(ii)(A) of thissection because Participant A’s benefit is not less thanthe sum of Participant A’s section 411(d)(6) protectedbenefit (as defined in §1.411(d)–3(g)(14)) with re-spect to service before the effective date of the con-version amendment, determined under the terms ofthe plan as in effect immediately before the effectivedate of the amendment, and Participant A’s section411(d)(6) protected benefit with respect to service onand after the effective date of the conversion amend-ment, determined under the terms of the plan as ineffect after the effective date of the amendment.

Example 2. (i) Facts involving plan’s establish-ment of opening hypothetical account balance andpayment of pre-conversion accumulated benefit in lifeannuity at normal retirement age. The facts in thisExample 2 are the same as the facts under paragraph(i) of Example 1.

(ii) Facts relating to the conversion amendment.On January 1, 2010, Plan E is amended to eliminatefuture accruals under the highest average compensa-tion benefit formula and to base future benefit accru-als on a hypothetical account balance. An openinghypothetical account balance is established for eachparticipant, and, under the plan’s terms, that balanceis equal to the present value of the participant’s accu-mulated benefit on December 31, 2009 (payable as astraight life annuity at normal retirement age or im-mediately, if later), using the applicable interest rateand applicable mortality table under section 417(e)(3)on January 1, 2010. Under Plan E, the account basedon this opening hypothetical account balance is main-tained as a separate account from the account for ac-cruals on or after January 1, 2010. The hypotheti-cal account balance maintained for each participantfor accruals on or after January 1, 2010, is creditedmonthly with a pay credit equal to a specified per-centage of the participant’s compensation during themonth. A participant’s hypothetical account balance(including both of the separate accounts) is credited

monthly with interest based on the third segment ratedescribed in section 430(h)(2)(C)(iii).

(iii) Facts relating to optional forms of benefit.Following severance from employment and attain-ment of age 55, a participant is permitted to elect(with spousal consent if applicable) payment in thesame generalized optional forms of benefit as underthe plan in effect prior to January 1, 2010, with theamount payable calculated based on the hypotheticalaccount balance on the annuity starting date and theapplicable interest rate and applicable mortality tableon the annuity starting date. The single sum distribu-tion is equal to the hypothetical account balance.

(iv) Facts relating to conversion protection. Theplan provides that, as of a participant’s annuity start-ing date, the plan will determine whether the ben-efit attributable to the opening hypothetical accountpayable in the particular optional form of benefit se-lected is greater than or equal to the benefit accruedunder the plan through the date of conversion andpayable in the same generalized optional form of ben-efit with the same annuity starting date. If the ben-efit attributable to the opening hypothetical accountbalance is greater, the plan provides that such ben-efit is paid in lieu of the pre-conversion benefit, to-gether with the benefit attributable to post-conver-sion contribution credits. If the benefit attributableto the opening hypothetical account balance is less,the plan provides that such benefit is increased suffi-ciently to provide the pre-conversion benefit, togetherwith the benefit attributable to post-conversion con-tribution credits.

(v) Facts relating to an affected participant. OnJanuary 1, 2010, the opening hypothetical accountbalance established for Participant A is $80,000,which is the present value of Participant A’s straightlife annuity of $1,000 per month commencing atJanuary 1, 2013, using the applicable interest rate andapplicable mortality table under section 417(e)(3) ineffect on January 1, 2010. On January 1, 2010, theapplicable interest rate for Participant A is equivalentto a level rate of 5.5 percent. Thereafter, ParticipantA’s hypothetical account balance for subsequent ac-cruals is credited monthly with a pay credit equal toa specified percentage of the participant’s compen-sation during the month. In addition, Participant A’shypothetical account balance (including both of theseparate accounts) is credited monthly with interestbased on the third segment rate described in section430(h)(2)(C)(iii).

(vi) Facts relating to calculation of the partici-pant’s benefit. Participant A has a severance fromemployment on January 1, 2013 at age 65, and elects(with spousal consent) a straight life annuity com-mencing January 1, 2013. On January 1, 2013, theopening hypothetical account balance, with interestcredits from January 1, 2010, to January 1, 2013, hasbecome $95,000, which, using the conversion factorsunder the plan on January 1, 2013, is equivalent to astraight life annuity of $1,005 per month commencingon January 1, 2013 (which is greater than the $1,000 amonth payable at age 65 under the terms of the plan ineffect before January 1, 2010). This benefit is in addi-tion to the benefit determined using the hypotheticalaccount balance for service after January 1, 2010.

(vii) Conclusion. The benefit satisfies the re-quirements of paragraph (c)(3)(ii)(A) of this sectionwith respect to Participant A because A’s benefit isnot less than the sum of (A) the greater of Participant

2008–11 I.R.B. 612 March 17, 2008

A’s benefits attributable to the opening hypotheticalaccount balance and A’s section 411(d)(6) protectedbenefit (as defined in §1.411(d)–3(g)(14)) withrespect to service before the effective date of theconversion amendment, determined under the termsof the plan as in effect immediately before the ef-fective date of the amendment, and (B) ParticipantA’s section 411(d)(6) protected benefit with respectto service on and after the effective date of the con-version amendment, determined under the terms ofthe plan as in effect after the effective date of theamendment.

Example 3. (i) Facts involving a subsequent de-crease in interest rates. The facts are the same asin Example 2, except that, because of a decrease inbond rates after January 1, 2010, and before January1, 2013, the rate of interest credited in that periodaverages less than 5.5 percent, and, on January 1,2013, the effective applicable interest rate under sec-tion 417(e)(3) under the plan’s terms is 4.7 percent.As a result, Participant A’s opening hypothetical ac-count balance plus attributable interest credits has in-creased to only $87,000 on January 1, 2013, and, us-ing the conversion factors under the plan on January1, 2013, is equivalent to a straight life annuity com-mencing on January 1, 2013, of $775 per month. Un-der the terms of Plan E, the benefit attributable toA’s opening account balance is increased so that A’sstraight life annuity commencing on January 1, 2013,is $1,000 per month. This benefit is in addition to thebenefit attributable to the hypothetical account bal-ance for service after January 1, 2010.

(ii) Conclusion. The benefit satisfies the require-ments of paragraph (c)(3)(ii)(A) of this section withrespect to Participant A because A’s benefit is not lessthan the sum of (A) the greater of A’s benefits attribut-able to the opening hypothetical account balance andA’s section 411(d)(6) protected benefit (as defined in§1.411(d)–3(g)(14)) with respect to service before theeffective date of the conversion amendment, deter-mined under the terms of the plan as in effect imme-diately before the effective date of the amendment,and (B) A’s section 411(d)(6) protected benefit withrespect to service on and after the effective date of theconversion amendment, determined under the termsof the plan as in effect after the effective date of theamendment.

Example 4. (i) Facts involving payment of a subsi-dized early retirement benefit. The facts are the sameas in Example 2, except that under the terms of PlanE on December 31, 2009, a participant who retiresbefore age 65 and after age 55 with 30 years of ser-vice has only a 3 percent per year actuarial reduction.Participant A has a severance from employment onJanuary 1, 2011, when A is age 63 and has 30 yearsof service. On January 1, 2011, A’s opening hypo-thetical account balance, with interest from January1, 2010, to January 1, 2011, has become $86,000,which, using the conversion factors under the plan(as amended) on January 1, 2011, is equivalent to astraight life annuity commencing on January 1, 2011,of $850 per month.

(ii) Facts relating to calculation of the partici-pant’s benefit. Under the terms of Plan E on Decem-ber 31, 2009, Participant A is entitled to a straight lifeannuity commencing on January 1, 2011, equal to atleast $940 per month ($1,000 reduced by 3 percentfor each of the 2 years that A’s benefits commence be-fore normal retirement age). Under the terms of Plan

E, the benefit attributable to A’s opening account bal-ance is increased so that A is entitled to a straight lifeannuity of $940 per month commencing on January1, 2013. This benefit is in addition to the benefit de-termined using the hypothetical account balance forservice after January 1, 2010.

(iii) Conclusion. The benefit satisfies the require-ments of paragraph (c)(3)(ii)(A) of this section withrespect to Participant A because A’s benefit is notless than the sum of (A) the greater of Participant A’sbenefits attributable to the opening hypothetical ac-count balance (increased by attributable interest cred-its) and A’s section 411(d)(6) protected benefit (as de-fined in §1.411(d)–3(g)(14)) with respect to servicebefore the effective date of the conversion amend-ment, determined under the terms of the plan as ineffect immediately before the effective date of theamendment, and (B) Participant A’s section 411(d)(6)protected benefit with respect to service on and afterthe effective date of the conversion amendment, de-termined under the terms of the plan as in effect afterthe effective date of the amendment.

Example 5. (i) Facts involving addition of a sin-gle sum payment option. The facts are the same asin Example 2, except that, before January 1, 2010,Plan E did not offer payment in a single sum dis-tribution for amounts in excess of $5,000. Plan E,as amended on January 1, 2010, offers payment inany of the available annuity distribution forms com-mencing at any time following severance from em-ployment as were provided under Plan E before Jan-uary 1, 2010. In addition, Plan E, as amended on Jan-uary 1, 2010, offers payment in the form of a singlesum attributable to service before January 1, 2010,which is the greater of the opening hypothetical ac-count balance (increased by attributable interest cred-its) or a single sum distribution of the straight life an-nuity payable at age 65 using the same actuarial fac-tors as are used for mandatory cashouts for amountsequal to $5,000 or less under the terms of the plan onDecember 31, 2009. Participant B is age 40 on Jan-uary 1, 2010, and B’s opening hypothetical accountbalance (increased by attributable interest credits) is$33,000 (which is the present value, using the con-version factors under the plan (as amended) on Jan-uary 1, 2010, of Participant B’s straight life annuityof $1,000 per month commencing at January 1, 2035,which is when B will be age 65). Participant B hasa severance from employment on January 1, 2013,and elects (with spousal consent) an immediate sin-gle sum distribution. Participant B’s opening hypo-thetical account balance (increased by attributable in-terest) on January 1, 2013, is $45,000. The presentvalue, on January 1, 2013, of Participant B’s benefitof $1,000 per month, commencing immediately usingthe actuarial factors for mandatory cashouts under theterms of the plan on December 31, 2009, would re-sult in a single sum payment of $44,750. ParticipantB is paid a single sum distribution equal to the sum of$45,000 plus an amount equal to B’s January 1, 2013,hypothetical account balance for benefit accruals forservice after January 1, 2010.

(ii) Conclusion. Because, under Plan E, Partici-pant B is entitled to the sum of (A) The greater of the$45,000 opening hypothetical account balance (in-creased by attributable interest credits) and $44,750(present value of the benefit with respect to serviceprior to January 1, 2010, using the actuarial factors formandatory cashout distributions under the terms of

the plan on December 31, 2009), plus (B) An amountequal to B’s hypothetical account balance for benefitaccruals for service after January 1, 2010, the benefitsatisfies the requirements of paragraph (c)(3)(ii)(A)of this section with respect to Participant B. If Par-ticipant B’s hypothetical account balance under PlanE was instead less than $44,750 on January 1, 2013,Participant B would be entitled to a single sum pay-ment equal to the sum of $44,750 and an amountequal to B’s hypothetical account balance for bene-fit accruals for service after January 1, 2010.

Example 6. (i) Facts involving addition of newannuity optional form of benefit. The facts are thesame as in Example 2, except that, after December 31,2009, and before January 1, 2013, Plan E is amendedto offer payment in a 5-, 10-, or 15-year term cer-tain and life annuity, using the same actuarial assump-tions that apply for other optional forms of distribu-tion. When Participant A has a severance from em-ployment on January 1, 2013, A elects (with spousalconsent) a 5-year term certain and life annuity com-mencing immediately equal to $935 per month. Ap-plication of the same actuarial assumptions to Par-ticipant A’s benefit of $1,000 per month (under PlanE as in effect on December 31, 2009), commencingimmediately on January 1, 2013, would result in a5-year term certain and life annuity commencing im-mediately equal to $955 per month. Under the termsof Plan E, the benefit attributable to A’s opening ac-count balance is increased so that, using the conver-sion factors under the plan (as amended) on January1, 2013, A’s opening hypothetical account balance(increased by attributable interest credits) produces a5-year term certain and life annuity commencing im-mediately equal to $955 per month commencing onJanuary 1, 2013. This benefit is in addition to thebenefit determined using the January 1, 2013, hypo-thetical account balance for service after January 1,2010.

(ii) Conclusion. This benefit satisfies the require-ments of paragraph (c)(3)(ii)(A) of this section withrespect to Participant A.

Example 7. (i) Facts involving addition of distri-bution option before age 55. The facts are the same asin Example 5, except that Participant B (age 43) elects(with spousal consent) a straight life annuity. UnderPlan E, the straight life annuity attributable to Partici-pant B’s opening hypothetical account balance at age43 is $221 per month. Application of the same actu-arial assumptions to Participant B’s benefit of $1,000per month (under Plan E as in effect on December 31,2009), commencing immediately on January 1, 2013,would result in a straight life annuity at age 43 equalto $219 per month.

(ii) Conclusion. Because, under its terms, Plan Eprovides that Participant B is entitled to an amountnot less than the present value (using the same ac-tuarial assumptions as apply on January 1, 2013, inconverting the $45,000 hypothetical account balanceattributable to the opening hypothetical account bal-ance to the $221 straight life annuity) of ParticipantB’s straight life annuity of $1,000 per month com-mencing at January 1, 2035, and the $221 straightlife annuity is in addition to the benefit accruals forservice after January 1, 2010, payment of the $221monthly annuity would satisfy the requirements ofparagraph (c)(3)(ii)(A) of this section with respect toParticipant B.

March 17, 2008 613 2008–11 I.R.B.

(d) Market rate of return—(1) In gen-eral—(i) Basic test. Subject to paragraph(d)(3) of this section, a statutory hybridplan satisfies the requirements of section411(b)(1)(H) and this paragraph (d) only if,for any plan year, the interest crediting rateunder the terms of the plan is no greaterthan a market rate of return.

(ii) Definition of interest crediting rateand interest credit. For purposes of thisparagraph (d), a plan’s interest creditingrate means the rate by which a partici-pant’s benefit is increased under the on-going terms of the plan to the extent theamount of the increase is not conditionedon current service, regardless of how theamount of that increase is calculated. Theamount of such an increase is an interestcredit. Thus, whether the amount is an in-terest credit for this purpose is determinedwithout regard to whether the amount iscalculated by reference to a rate of inter-est, a rate of return, an index, or otherwise.

(iii) Single rates. Except as is otherwiseprovided in this paragraph (d)(1), an inter-est crediting rate is not in excess of a mar-ket rate of return only if the plan providesan interest credit for the year at a rate thatis equal to one of the following rates thatis specified in the terms of the plan:

(A) The interest rate on long-term in-vestment grade corporate bonds (as de-scribed in paragraph (d)(4) of this section);

(B) An interest rate that is deemed tobe not in excess of a market rate of returnunder paragraph (d)(5) of this section; or

(C) An interest rate that is described inparagraph (d)(6) of this section.

(iv) Timing rules—(A) In general. Aplan must specify the timing for determin-ing the plan’s interest crediting rate thatwill apply for each plan year (or portionof a plan year) using either of the methodsdescribed in paragraph (d)(1)(iv)(B) of thissection and must specify the frequency ofinterest crediting under the plan pursuantto paragraph (d)(1)(iv)(C) of this section.

(B) Methods to determine interest cred-iting rate. A plan is permitted to providedaily interest credits using a daily inter-est crediting rate based on the permittedrates specified in paragraph (d)(1)(iii) ofthis section. Alternatively, a plan is per-mitted to provide an interest credit for astability period that is based on the inter-est crediting rate for a specified lookbackmonth with respect to that stability period.The stability period and lookback month

must satisfy the rules for selecting the sta-bility period and lookback month under§1.417(e)–1(d)(4). (However, the interestrates can be any of the rates in paragraph(d)(1)(iii) of this section and the stabilityperiod and lookback month need not be thesame as those used under the plan for pur-poses of section 417(e)(3).)

(C) Frequency of interest crediting. In-terest credits under a plan must be madeon an annual or more frequent periodic ba-sis. If a plan provides for the crediting ofinterest more frequently than annually (forexample, monthly or quarterly), then theinterest credit for that period must be a prorata portion of the annual interest credit.Thus, for example, if a plan’s terms pro-vide for interest to be credited monthly andfor the interest crediting rate to be equalto the interest rate on long-term invest-ment grade corporate bonds (as describedin paragraph (d)(4) of this section), andthat interest rate for a plan year is 6 per-cent, the accumulated benefits at the be-ginning of each month would be increasedby 0.5 percent per month during the planyear. Interest credits under the terms of aplan are not treated as creating an effectiverate of return that is in excess of a marketrate of return merely because an otherwisepermissible interest crediting rate is com-pounded more frequently than annually.

(v) Lesser rates. An interest creditingrate is not in excess of a market rate of re-turn if the plan provides an interest cred-iting rate that, under all circumstances, isalways less than one of the rates describedin paragraph (d)(1)(iii) of this section.

(vi) Greater-of rates. If a statutory hy-brid plan provides for an interest credit thatis equal to the interest credits determinedunder the greater of 2 or more different in-terest crediting rates, the effective interestcrediting rate is not in excess of a marketrate of return only if each of the differ-ent rates satisfies the requirements of para-graph (d)(1)(ii) of this section and the ad-ditional requirements of paragraph (d)(7)of this section are satisfied.

(2) Preservation of capital require-ment—(i) In general. A statutory hybridplan is treated as failing to meet the re-quirements of section 411(b)(1)(H) if therequirements of paragraph (d)(2)(ii) of thissection are not satisfied.

(ii) Preservation of capital de-fined—(A) In general. The requirementsof this paragraph (d)(2)(ii) are satisfied

if the plan provides that, as of the partic-ipant’s annuity starting date, the partic-ipant’s benefit under the plan is no lessthan the benefit determined as of thatdate based on the sum of the hypotheticalcontributions credited under the plan (orthe accumulated percentage of the partic-ipant’s final average compensation, or theparticipant’s accrued benefits determinedwithout regard to any indexing under sec-tion 411(b)(5)(E), as applicable).

(B) Hypothetical contributions defined.For purposes of this paragraph (d)(2)(ii),a hypothetical contribution is any amountcredited under a statutory hybrid plan otherthan an interest credit (as defined in para-graph (d)(1)(ii) of this section). Thus, ifan opening hypothetical account balanceor opening accumulated percentage of theparticipant’s final average compensation isestablished pursuant to paragraph (c)(3) ofthis section, that opening hypothetical ac-count balance or opening accumulated per-centage as of the date established is treatedas a hypothetical contribution and, thus,is taken into account for purposes of thepreservation of capital requirement of thisparagraph (d)(2)(ii).

(3) Plan termination—(i) In general.Except as provided in paragraph (d)(3)(ii)of this section, a statutory hybrid plan istreated as meeting the requirements ofparagraph (d)(1) of this section only ifthe terms of the plan provide that, upontermination of the plan, a participant’sbenefit as of the termination is determinedusing the interest rate and mortality tableotherwise applicable for determining thatbenefit under the plan (without regard totermination of the plan).

(ii) Variable interest rates. A statutoryhybrid plan is treated as meeting the re-quirements of paragraph (d)(1) of this sec-tion only if the terms of the plan providethat, upon termination of the plan, any in-terest rate used to determine a participant’sbenefits under the plan (including any in-terest crediting rate and any interest rateused to determine annuity benefits) that isa variable rate is determined as the averageof the rates of interest used under the planfor that purpose during the 5-year periodending on the termination date.

(4) Long-term investment grade corpo-rate bonds. For purposes of this para-graph (d), the rate of interest on long-terminvestment grade corporate bonds meansthe third segment rate described in sec-

2008–11 I.R.B. 614 March 17, 2008

tion 430(h)(2)(C)(iii) (determined with orwithout regard to the transition rules ofsection 430(h)(2)(G)), provided that suchrate floats on a periodic basis not less fre-quently than annually. However, for planyears beginning prior to January 1, 2008,the rate of interest on long-term investment

grade corporate bonds means the rate de-scribed in section 412(b)(5)(B)(ii)(II) priorto amendment by the Pension ProtectionAct of 2006, Public Law 109–280 (120Stat. 780) (PPA ’06).

(5) Safe harbor rates of interest—(i)Rates based on Treasury bonds with mar-

gins. An interest crediting rate is deemedto be not in excess of a market rate of re-turn if the rate is adjusted at least annuallyand is equal to the sum of any of the fol-lowing rates of interest for Treasury bondsand the associated margin for that interestrate:

Treasury bond interest rates Associated Margin

The discount rate on 3-month Treasury Bills 175 basis pointsThe discount rate on 12-month or shorter Treasury Bills 150 basis pointsThe yield on 1-year Treasury Constant Maturities 100 basis pointsThe yield on 3-year or shorter Treasury bonds 50 basis pointsThe yield on 7-year or shorter Treasury bonds 25 basis pointsThe yield on 30-year or shorter Treasury bonds 0 basis points

(ii) Eligible cost-of-living indices. Aninterest crediting rate is deemed to benot in excess of a market rate of re-turn if the rate is adjusted no less fre-quently than annually and is equal to therate of increase with respect to an eli-gible cost-of-living index described in§1.401(a)(9)–6, A–14(b), except that forpurposes of this paragraph (d)(5)(ii), theeligible cost-of-living index described in§1.401(a)(9)–6, A–14(b)(2), is increasedby 300 basis points.

(iii) Additional safe harbors. The Com-missioner may, in guidance of general ap-plicability, specify additional interest cred-iting rates that are deemed to be not inexcess of a market rate of return. See§601.601(d)(2)(ii)(b) of this chapter.

(6) Other interest rates—(i) Reason-able minimum guaranteed rate of return.[Reserved]

(ii) Equity-based rates. [Reserved](7) Combinations of rates of return—(i)

In general. If a plan provides an interestcrediting rate that is equal to the interestcredits determined under the greater of 2or more different interest crediting rateswhere each of the different rates satisfiesthe requirements of paragraph (d)(1)(iii)of this section, then the interest creditsprovided by the plan satisfy this paragraph(d)(7) only if one or more of the differ-ent interest crediting rates under the planare adjusted as provided in paragraphs(d)(7)(iii) or (d)(7)(iv) of this section inorder to provide that the effective interestcrediting rate resulting from the use ofthe greater of 2 or more rates does notexceed a market rate of return. This para-graph (d)(7) provides the exclusive rulesthat may be used for this purpose and,

therefore, a plan does not satisfy the re-quirements of this paragraph (d) if the planprovides for interest credits determinedusing the greater of 2 or more interestcrediting rates and that combination ofinterest crediting rates is not specificallypermitted by this paragraph (d)(7).

(ii) Coordination with preservation ofcapital rule. No adjustment under thisparagraph (d)(7) is required merely be-cause the plan satisfies the requirements ofparagraph (d)(2) of this section.

(iii) Combination of fixed and variableinterest rates. [Reserved]

(iv) Other combinations. [Reserved](8) Section 411(d)(6)—(i) General

rule. Except as provided in this paragraph(d)(8), to the extent that benefits have ac-crued under the terms of a statutory hybridplan that entitle the participant to futureinterest credits, an amendment to theplan to change the interest crediting ratefor such interest credits violates section411(d)(6) if the revised rate under any cir-cumstances could result in a lower interestcrediting rate as of any date after the appli-cable amendment date of the amendment(within the meaning of §1.411(d)–3(g)(4))changing the interest crediting rate. Foradditional rules, see §1.411(d)–3(a)(1).

(ii) Adoption of long-term investmentgrade corporate bond rate or safe har-bor rate. An amendment to a statutoryhybrid plan to change the interest credit-ing rate for future periods from an inter-est crediting rate described in paragraph(d)(5) of this section to the interest cred-iting rate described in paragraph (d)(4) ofthis section does not constitute a decreaseof an accrued benefit and, therefore, doesnot violate section 411(d)(6). However,

an amendment described in this paragraph(d)(8)(ii) cannot be effective less than 30days after adoption and, on the effectivedate of the amendment, the new interestcrediting rate cannot be less than the inter-est crediting rate that would have appliedin the absence of the amendment.

(iii) Other changes not treated as pro-hibited reduction of accrued benefit. [Re-served]

(e) Definitions—(1) In general. Thedefinitions in this paragraph (e) apply forpurposes of this section.

(2) Accumulated benefit. A partici-pant’s accumulated benefit at any datemeans the participant’s benefit, as ex-pressed under the terms of the plan, ac-crued to that date. For this purpose, theaccumulated benefit of a participant maybe expressed under the terms of the planas either the balance of a hypotheticalaccount or the current value of an accumu-lated percentage of the participant’s finalaverage compensation, even if the plandefines the participant’s accrued benefit asan annuity beginning at normal retirementage that is actuarially equivalent to thatbalance or value.

(3) Lump sum-based benefit for-mula—(i) In general. A lump sum-basedbenefit formula means a benefit formulaused to determine all or any part of aparticipant’s accumulated benefit under adefined benefit plan under which the bene-fit provided under the formula is expressedas the balance of a hypothetical accountmaintained for the participant or as thecurrent value of the accumulated per-centage of the participant’s final averagecompensation. Whether a benefit formulais a lump sum-based benefit formula is

March 17, 2008 615 2008–11 I.R.B.

determined based on how the accumulatedbenefit of a participant is expressed underthe terms of the plan, and does not dependon whether the plan provides an optionalform of benefit in the form of a single sumpayment.

(ii) Exception for contributory plans. Aparticipant is not treated as having a lumpsum-based benefit formula merely becausethe participant is entitled to a benefit undera defined benefit plan that is equal to thegreater of the otherwise applicable benefitformula and the benefit properly attribut-able to after-tax employee contributions.

(4) Statutory hybrid benefit formula. Astatutory hybrid benefit formula means astatutory hybrid benefit formula as definedin §1.411(a)(13)–1(d)(3).

(5) Statutory hybrid plan. A statutoryhybrid plan means a defined benefit planthat contains a statutory hybrid benefit for-mula.

(6) Variable annuity benefit formula. Avariable annuity benefit formula means avariable annuity benefit formula as definedin §1.411(a)(13)–1(d)(4).

(f) Effective/applicability date—(1)Statutory effective/applicability dates—(i)In general. Except as provided in para-graph (f)(1)(iii) of this section, section411(b)(5) applies for periods beginning onor after June 29, 2005.

(ii) Conversion amendments. The re-quirements of section 411(b)(5)(B)(ii),(iii), and (iv) apply to a conversion amend-ment (as defined in paragraph (c)(4) ofthis section) that is adopted after, and takeseffect after, June 29, 2005.

(iii) Market rate of return—(A) Plansin existence on June 29, 2005—(1) In gen-eral. In the case of a plan that is in ex-istence on June 29, 2005 (regardless ofwhether the plan is a statutory hybrid planon that date), section 411(b)(5)(B)(i) onlyapplies to plan years beginning on or afterJanuary 1, 2008.

(2) Exception for plan sponsorelection. Notwithstanding paragraph(f)(1)(iii)(A)(1) of this section, a plansponsor of a plan that is in existence onJune 29, 2005 (regardless of whetherthe plan is a statutory hybrid plan onthat date) may elect to have the require-ments of section 411(a)(13)(B) and section411(b)(5)(B)(i) apply for any period afterJune 29, 2005, and before the first planyear beginning after December 31, 2007.In accordance with section 1107 of the

PPA ’06, an employer is permitted to adoptan amendment to make this election as lateas the last day of the first plan year that be-gins on or after January 1, 2009 (January1, 2011, in the case of a governmental planas defined in section 414(d)) if the planoperates in accordance with the election.

(B) Plans not in existence on June 29,2005. In the case of a plan not in existenceon June 29, 2005, section 411(b)(5)(B)(i)applies to the plan on and after the laterof June 29, 2005, and the date the planbecomes a statutory hybrid plan.

(2) Effective/applicability date of regu-lations. This section applies for plan yearsbeginning on or after January 1, 2009 (or,if later, the date applicable under para-graph (f)(3) of this section). For the pe-riods after the statutory effective date setforth in paragraph (f)(1) or (f)(3) of thissection and before the regulatory effectivedate set forth in the preceding sentence, aplan must comply with section 411(b)(5).During these periods, a plan is permittedto rely on the provisions of this section forpurposes of satisfying the requirements ofsection 411(b)(5).

(3) Collectively bargained plans—(i)In general. Notwithstanding paragraph(f)(1)(iii) of this section, in the case ofa collectively bargained plan maintainedpursuant to one or more collective bar-gaining agreements between employeerepresentatives and one or more employersratified on or before August 17, 2006, therequirements of section 411(b)(5)(B)(i) donot apply to plan years beginning beforethe earlier of—

(A) The later of—(1) The date on which the last of those

collective bargaining agreements termi-nates (determined without regard to anyextension thereof on or after August 17,2006), or

(2) January 1, 2008; or(B) January 1, 2010.(ii) Treatment of plans with both collec-

tively bargained and non-collectively bar-gained employees. In the case of a planwhere a collective bargaining agreementapplies to some, but not all, of the plan par-ticipants, the plan is considered a collec-tively bargained plan for purposes of para-graph (f)(3)(i) of this section if at least 25percent of the participants in the plan aremembers of collective bargaining units forwhich the benefit levels under the plan are

specified under the collective bargainingagreement.


(Filed by the Office of the Federal Register on December 27,2007, 8:45 a.m., and published in the issue of the FederalRegister for December 28, 2007, 72 F.R. 73680)

Notice of ProposedRulemaking

Diversification Requirementsfor Certain DefinedContribution Plans

REG–136701–07


ACTION: Notice of Proposed Rulemak-ing.

SUMMARY: This document contains pro-posed regulations under section 401(a)(35)of the Internal Revenue Code (Code) re-lating to diversification requirements forcertain defined contribution plans and topublicly traded employer securities. Theseregulations will affect administrators of,employers maintaining, participants in,and beneficiaries of defined contributionplans that are invested in employer secu-rities.

DATES: Written or electronic commentsand requests for a public hearing must bereceived by April 2, 2008.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–136701–07), room5203, Internal Revenue Service, PO Box7604, Ben Franklin Station, Washing-ton, D.C. 20044. Submissions may behand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.to: CC:PA:LPD:PR (REG–136701–07),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, N.W.,Washington, D.C., or sent electroni-cally via the Federal eRulemaking Por-tal at http://www.regulations.gov (IRSREG–136701–07).

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,

2008–11 I.R.B. 616 March 17, 2008

R. Lisa Mojiri-Azad or Dana Barry at(202) 622–6060; concerning submissionof comments or to request a public hear-ing, Kelly Banks at (202) 622–7180 (nottoll-free numbers).


Background

This document contains proposed reg-ulations under section 401(a)(35) of theCode, which was added by section 901 ofthe Pension Protection Act of 2006, PublicLaw 109–280, 120 Stat. 780 (PPA ’06).1

Section 401(a)(35)(A) provides that atrust which is part of an applicable definedcontribution plan is not a qualified trustunder section 401(a) unless the plan sat-isfies the diversification requirements ofsections 401(a)(35)(B), (C), and (D). Un-der section 401(a)(35)(B), each individualmust have the right to direct the plan todivest employer securities allocated to theindividual’s account that are attributable toemployee contributions or elective defer-rals and to reinvest an equivalent amountin other investment options meeting the re-quirements of section 401(a)(35)(D).2

Under section 401(a)(35)(C), each indi-vidual who is a participant who has com-pleted at least three years of service, abeneficiary of a participant who has com-pleted at least three years of service, or abeneficiary of a deceased participant mustbe permitted to elect to direct the planto divest employer securities allocated tothe individual’s account and to reinvest anequivalent amount in other investment op-tions meeting the requirements of section401(a)(35)(D).

Section 401(a)(35)(D)(i) requires anapplicable defined contribution plan tooffer individuals not less than three in-vestment options, other than employersecurities, to which the individuals maydirect the proceeds from the divestmentof employer securities, each of which isdiversified and has materially differentrisk and return characteristics.

Under section 401(a)(35)(D)(ii)(I), aplan does not fail to meet the requirementsof section 401(a)(35)(D) if it allows in-dividuals to divest employer securitiesand reinvest the proceeds at periodic, rea-sonable opportunities occurring no lessfrequently than quarterly.

Under section 401(a)(35)(D)(ii)(II), aplan is not permitted to impose restrictionsor conditions with respect to the invest-ment of employer securities that are notimposed on the investment of other assetsof the plan. However, this rule does notapply to restrictions or conditions imposedto comply with securities laws. The Secre-tary is authorized to issue regulations pro-viding additional exceptions to the require-ments of section 401(a)(35)(D)(ii)(II).

An applicable defined contributionplan under section 401(a)(35) is a definedcontribution plan that holds any publiclytraded employer securities. A publiclytraded employer security is defined as anemployer security under section 407(d)(1)of the Employee Retirement Income Se-curity Act of 1974, Public Law 93–406,88 Stat. 829 (ERISA) which is readilytradable on an established securities mar-ket. Section 401(a)(35)(F)(i) provides thata plan that does not hold publicly tradedemployer securities is nevertheless treatedas holding publicly traded employer se-curities if any employer corporation orany member of a controlled group of cor-porations which includes the employer(determined by applying section 1563(a),except substituting 50 percent for 80 per-cent) has issued a class of stock that is apublicly traded employer security. How-ever, section 401(a)(35)(F) does not applyto a plan if no employer corporation, orparent corporation (as defined in section424(e)) of an employer corporation, hasissued any publicly traded employer secu-rity and no employer or parent corporationhas issued any special class of stock whichgrants particular rights to, or bears par-ticular risks for, the holder or issuer withrespect to any corporation described in

section 401(a)(35)(F)(i) which has issuedany publicly traded employer security.

Section 401(a)(35)(E) provides thatsection 401(a)(35) does not apply to anemployee stock ownership plan within themeaning of section 4975(e)(7) (ESOP)that holds no contributions (or earningsthereunder) that are subject to section401(k) or (m) (generally relating to elec-tive deferrals and matching and employeeafter-tax contributions) and the ESOP isa separate plan for purposes of section414(l) with respect to any other definedbenefit plan or defined contribution planmaintained by the same employer or em-ployers. Section 401(a)(35)(E) furtherprovides that section 401(a)(35) does notapply to one-participant retirement plans.

Section 401(a)(35) is generally effec-tive for plan years beginning after De-cember 31, 2006. Section 401(a)(35)(H)generally provides a three year phase-inrule with respect to an individual’s rightto direct the divestment of employer se-curities attributable to employer contribu-tions, except with respect to certain par-ticipants who have attained age 55. Sec-tion 901(c)(2) of PPA ’06 includes a spe-cial rule for a plan maintained pursuant toone or more collective bargaining agree-ments between employee representativesand one or more employers that was rat-ified on or before August 17, 2006. Un-der this rule, section 401(a)(35) is not ef-fective until plan years beginning after theearlier of (1) the later of (a) December 31,2007 or (b) the date on which the last ofsuch collective bargaining agreements ter-minates (determined without regard to anyextension thereof after August 17, 2006) or(2) December 31, 2008.

Notice 2006–107, 2006–2 C.B.1114 (December 18, 2006) (see§601.601(d)(2)(ii)(b) of this chapter), in-cludes guidance and transitional rules withrespect to the diversification requirementsof section 401(a)(35).3 Notice 2006–107provides that a plan (and an investment op-tion described in section 401(a)(35)(D)(i))is not treated as holding employer secu-

1 Section 901 of PPA ’06 also added a parallel provision at section 204(j) of the Employee Retirement Income Security Act of 1974, Public Law 93–406, 88 Stat. 829 (ERISA). Under section101 of Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of Treasury has interpretative jurisdiction over the subject matter addressed in these proposed regulations for purposesof section 204(j) of ERISA. Thus, the guidance provided in these proposed regulations with respect to section 401(a)(35) of the Code also applies for purposes of section 204(j) of ERISA.

2 Section 401(a)(28) provides certain diversification rights to participants in an employee stock ownership plan within the meaning of section 4975(e)(7) (ESOP). Section 401(a)(28)(B) alsogenerally requires that the plan offer at least three alternative investment options. Section 401(a)(28)(B) permits a plan to satisfy these diversification requirements by distributing, within 90days after the period during which the election may be made, the portion of the participant’s account that is subject to section 401(a)(28)(B). Section 401(a)(28)(B) was amended by section901(a)(2)(A) of PPA ’06 not to apply to a plan to which section 401(a)(35) applies.

3 Notice 2006–107 also includes guidance regarding the related notice requirements of section 101(m) of ERISA, including a model notice.

March 17, 2008 617 2008–11 I.R.B.

rities to which section 401(a)(35) applieswith respect to any securities held througheither an investment company registeredunder the Investment Company Act of1940 or a similar pooled investment vehi-cle that is regulated and subject to periodicexamination by a State or Federal agencyand with respect to which investment insecurities is made both in accordance withthe stated investment objectives of theinvestment vehicle and independent ofthe employer and any affiliate thereof,but only if the holdings of the investmentcompany or similar investment vehicleare diversified so as to minimize the riskof large losses. Notice 2006–107 alsoprovides that investment options satisfythe requirement that investment optionsbe diversified and have materially differ-ent risk and return characteristics undersection 401(a)(35)(D)(i) if the investmentoptions satisfy the requirements of section2550.404c–1(b)(3) of the Department ofLabor regulations.

Notice 2006–107 further provides that,for purposes of section 401(a)(35), thedate on which a participant completesthree years of service occurs immediatelyafter the end of the third vesting compu-tation period provided for under the planthat constitutes the completion of a thirdyear of service under section 411(a)(5).For a plan using the elapsed time methodof crediting service for vesting purposes(or a plan that provides for immediatevesting without using a vesting compu-tation period or elapsed time method ofdetermining vesting), the date on whicha participant completes three years ofservice is the third anniversary of the par-ticipant’s date of hire.

Notice 2006–107 includes special rulesregarding restrictions or conditions withrespect to employer securities under sec-tion 401(a)(35)(D)(ii)(II). An impermis-sible restriction or condition is either arestriction on an individual’s right to di-vest an investment in employer securitiesthat is not imposed on an investment thatis not in employer securities or a bene-fit that is conditioned on an investment inemployer securities. Examples of restric-tions or conditions that are prohibited bysection 401(a)(35)(D)(ii)(II) under Notice2006–107 include: (1) a plan allows an in-dividual the right to divest employer secu-rities on a quarterly basis but permits di-vestiture of another investment on a more

frequent basis; (2) a plan provides thata participant who divests his or her ac-count of employer securities receives lessfavorable treatment (such as a lower rateof matching contributions) than a partic-ipant whose account remains invested inemployer securities; and (3) a plan thatprovides if a participant divests his or heraccount balance with respect to investmentin a class of employer securities, the par-ticipant is not permitted for a period oftime to reinvest in that class of securi-ties where that restriction is not imposedon other investments. Notice 2006–107also provided examples of restrictions orconditions that are not prohibited by sec-tion 401(a)(35)(D)(ii)(II): (1) a provisionthat limits the extent to which an individ-ual’s account balance can be invested inemployer securities; (2) a provision un-der which an employer securities fund isclosed; (3) a restriction imposed by rea-son of application of securities laws or arestriction that is reasonably designed toensure compliance with such laws; (4) animposition of fees on other investment op-tions under the plan but not on investmentsin employer securities; and (5) a plan re-striction on the availability of otherwiseapplicable diversification rights under theplan for up to 90 days following an initialpublic offering of the employer’s stock.

Notice 2006–107 provides certain tran-sition rules. For example, for the periodprior to January 1, 2008, a plan does notimpose a restriction or condition pro-hibited by section 401(a)(35)(D)(ii)(II)merely because the plan, as in effect onDecember 18, 2006, (1) does not imposean otherwise applicable restriction on astable value fund or (2) allows individualsthe right to divest employer securities ona periodic basis (at least quarterly), butpermits divestiture of another investmenton a more frequent basis, provided thatthe other investment is not a generallyavailable investment.

Explanation of Provisions

Overview

The proposed regulations would pro-vide guidance with respect to the require-ments of section 401(a)(35) that incor-porates much of the guidance providedunder Notice 2006–107. The regulationswould clarify the scope of the rule in sec-

tion 401(a)(35)(D)(ii)(II) that generallyprohibits restrictions and conditions on in-vestment in employer securities, but wouldspecifically permit certain restrictions andconditions on such investment that areconsistent with the statute, and would alsodefine when employer securities are pub-licly traded on an established securitiesmarket under section 401(a)(35)(D).

Basic diversification rights

The proposed regulations incorporatethe guidance on the basic diversifica-tion rights of section 401(a)(35) that iscontained in Notice 2006–107. Thus, ifan applicable defined contribution planholds employee contributions (includingrollover contributions) or elective defer-rals with respect to an individual that areinvested in employer securities, the planmust provide that the individual is giventhe opportunity to divest the employer se-curities and reinvest an equivalent amountin another investment. These rights mustbe provided to each participant, to eachalternate payee who has an account underthe plan, and to each beneficiary of a de-ceased participant.

If employer contributions (other thanelective deferrals) are invested in em-ployer securities under the plan, the di-vestment right must be provided to eachparticipant who has completed at leastthree years of service, to each alternatepayee who has an account under the planwith respect to a participant who has atleast three years of service, and to eachbeneficiary of a deceased participant (re-gardless of whether the participant hadcompleted at least three years of service).For this purpose, the regulations wouldprovide that a participant has completedthree years of service on the last day ofthe vesting computation period as deter-mined under the plan that constitutes thecompletion of the third year of service (orthe third anniversary of hire for a plan thateither uses the elapsed time method or thatdoes not define the vesting computationperiod because the plan provides for fulland immediate vesting).

The regulations would require a planto provide individuals who have section401(a)(35) diversification rights the oppor-tunity to divest the employer securities andreinvest an equivalent amount in anotherinvestment at least quarterly. The individ-

2008–11 I.R.B. 618 March 17, 2008

uals must be permitted to select among noless than three investment options, eachof which is diversified and has materi-ally different risk and return characteris-tics. For this purpose, investment optionsthat constitute a broad range of invest-ment alternatives within the meaning ofDepartment of Labor Regulations section2550.404c–1(b)(3) are treated as being di-versified and having materially differentrisk and return characteristics.

Plans subject to section 401(a)(35)

Under the proposed regulations, a de-fined contribution plan which holds pub-licly-traded employer securities (referredto as an applicable defined contributionplan) is subject to the diversification re-quirements of section 401(a)(35), unless itis exempted under section 401(a)(35)(E)as a stand-alone ESOP or as a one-partici-pant retirement plan. For this purpose, anemployer security is defined by referenceto section 407(d)(1) of ERISA.

Under section 401(a)(35)(G)(v), an em-ployer security is a publicly traded em-ployer security if it is readily tradable onan established securities market. The reg-ulations would provide separate rules forsecurities traded on domestic securities ex-changes and foreign securities exchanges.

If a security is traded on a securities ex-change that is registered under section 6of the Securities Exchange Act of 1934,then the security would be deemed to bereadily tradable on an established secu-rities market. This definition is consis-tent with the definition of publicly tradedfound in §54.4975–7(b)(1)(iv), but deletesthe reference to a system sponsored by theNational Association of Securities Deal-ers (NASDAQ) registered under section15A(b) of the Act (15 U.S.C. 78o) becauseNASDAQ is now registered as a securitiesexchange under section 6 of the SecuritiesExchange Act of 1934. Thus, if a securityis not traded on a national securities ex-change that is registered under section 6 ofthe Securities Exchange Act of 1934, thenthe security would not be publicly tradedfor purposes of section 401(a)(35), (unlessit is traded on a foreign securities exchangeand has a “ready market” as described inthe next paragraph). This would apply toU.S. securities that are only traded on the

“Over-The-Counter Bulletin Board” andthe “pink sheets.”

Under the proposed regulations, if a se-curity is not listed on a securities exchangethat is registered under section 6 of theSecurities Exchange Act of 1934, but istraded on a foreign national securities ex-change that is officially recognized, sanc-tioned, or supervised by a governmentalauthority, then under the proposed regu-lations, the security would be traded onan established securities market. The pro-posed regulations would provide that sucha security is readily tradable if the secu-rity is deemed by the Securities and Ex-change Commission (SEC) as having a“ready market” under SEC Rule 15c3–1(17 CFR 240.15c3–1).4

The proposed regulations would reflectsection 401(a)(35)(F), which, subject tocertain exceptions, treats a plan holdingemployer securities that are not publiclytraded as nonetheless subject to the rules ofsection 401(a)(35) if any employer spon-soring the plan, or any member of the con-trolled group of corporations (determinedby applying section 1563(a), except substi-tuting 50 percent for 80 percent) has issueda class of stock which is publicly traded (asdefined above).

Section 401(a)(35)(E)(ii) provides thatan ESOP that is a separate plan holdingno contributions that are subject to section401(k) or section 401(m) is not an appli-cable defined contribution plan. (As notedearlier in this preamble, such a plan is sub-ject to the diversification requirements ofsection 401(a)(28)(B).) The proposed reg-ulations would clarify that a plan does notlose this exemption merely because it re-ceives rollover contributions of amountsfrom another plan that are held in a sep-arate account, even if those amounts wereattributable to contributions that were sub-ject to section 401(k) or 401(m) in theother plan. In addition, the proposed reg-ulations would reflect the exemption forone-participant retirement plans under sec-tion 401(a)(35)(E)(iv).

Notice 2006–107 provides that em-ployer securities held by an investmentcompany registered under the InvestmentCompany Act of 1940 or similar pooledinvestment vehicle are not treated as be-ing held by the plan. Some commentson Notice 2006–107 had recommended

a broader rule, under which a commin-gled fund that holds employer securitiesand other securities would not be treatedas holding employer securities that aresubject to the section 401(a)(35) diver-sification requirement. The proposedregulations would not adopt this broadexemption from the diversification rules.

The proposed regulations, however,clarify the types of pooled investmentvehicles that are exempt from the diversi-fication requirements. Under the proposedregulations, in order to be exempt from thediversification requirements, the pooledinvestment vehicle must be a commonor collective trust fund or pooled invest-ment fund maintained by a bank or trustcompany supervised by a State or Federalagency, a pooled investment fund of aninsurance company that is qualified to dobusiness in a State, or an investment funddesignated by the Commissioner in rev-enue rulings, notices, or other guidancepublished in the Internal Revenue Bulletin.As under Notice 2006–107, the regula-tions would include the requirement thatin order to be exempt from the diversifica-tion requirements the pooled investmentfund that holds the employer securitiesmust have stated investment objectivesand the investment must be independentof the employer and any affiliate thereof.The proposed regulations would add apercentage limitation rule to ensure thatthe investment in the employer securitiesthrough a pooled fund is not an attemptto evade the rules of section 401(a)(35).Under this rule, if the employer securitiesheld by such fund is more than 10 percentof the total value of all of the fund’s in-vestment, then the fund is not consideredto be independent of the employer.

Prohibition on restrictions or conditions

The proposed regulations would pro-vide that the section 401(a)(35)(D)(ii)(II)prohibition on restrictions or conditionswith respect to the investment of employersecurities which are not imposed on the in-vestment of other assets of the plan appliesto a direct or indirect restriction on an in-dividual’s rights to divest an investment inemployer securities that is not imposed onan investment that is not employer secu-rities as well as a direct or indirect ben-

4 Under the current SEC rules, a security is deemed to have a ready market if it is included on the FTSE Group (FTSE) World Index.

March 17, 2008 619 2008–11 I.R.B.

efit that is conditioned on investment inemployer securities. However, like Notice2006–107, the regulations would not ap-ply this prohibition to restrictions that areimposed by reason of the application of se-curities laws and in certain other situationsdescribed below.

Like Notice 2006–107, the proposedregulations would allow a plan to imposea restriction on divestiture that is reason-ably designed to comply with securitieslaw, even if the restriction is broader thanthe minimum restriction needed to complywith securities laws. The proposed reg-ulations incorporate the example of sucha restriction from Notice 2006–107. Thisis merely an example and broader restric-tions on divestiture are permitted, providedthey are reasonably designed to complywith securities law. For example, in somesmaller entities a broad restriction allow-ing divestiture to occur only once a quar-ter might be a restriction that is reasonablydesigned to comply with securities law.

Notice 2006–107 includes a rule thatpermits a plan to restrict the otherwise ap-plicable diversification rights under sec-tion 401(a)(35) for a period of up to 90days following an initial public offering ofthe employer’s stock. The proposed regu-lations would extend this rule to apply tothe first 90 days after the plan becomes anapplicable defined contribution plan. Thiscould happen, for example, when someother entity in the controlled group firstissues stock which is publicly traded orwhen a stand-alone ESOP first providesfor contributions that are subject to section401(k) or section 401(m).

Notice 2006–107 permits a plan toimpose a restriction on an investment inemployer securities that is not imposed ona stable value fund. The proposed regu-lations extend this rule to a fund that issimilar to a stable value fund. Specifically,the proposed regulations would providethat in the case of a plan that has sev-eral investment funds, including a fundinvested in employer securities, a fundwhich is a stable value or similar fund,and other funds which are not investedin employer securities, the plan does notimpose a restriction prohibited under sec-tion 401(a)(35)(D)(ii)(II) merely becausethe plan permits transfers to be made

into the stable value or similar fund morefrequently than into the fund invested inemployer securities (assuming the plandoes not impose a restriction on transfersto or from the employer securities fundthat it does not impose with respect to theother funds).

While the proposed regulations wouldgenerally prohibit indirect restrictions onan individual’s exercise of diversificationrights (such as a plan provision that lim-its the right of an individual who diversi-fies out of employer securities by provid-ing that such a participant is not permit-ted to reinvest in employer securities fora period of time), the rules would permitcertain indirect restrictions, as well as cer-tain indirect benefits that are conditionedon investment in employer securities. Un-der the proposed regulations, a plan wouldbe permitted to limit the extent to whichan individual’s account balance can be in-vested in employer securities. For exam-ple, a plan would not be treated as im-posing a restriction that violates section401(a)(35)(D)(ii)(II) merely because theplan prohibits a participant from investingadditional amounts in employer securitiesif more than 10 percent of that participant’saccount balance is (or would be after thechange) invested in employer securities.In addition, an applicable defined contri-bution plan does not violate a prohibitionagainst reinvestment in employer securi-ties if the plan has terminated any furtherinvestment in employer securities.

The proposed regulations would pro-vide that a plan is not providing an indirectbenefit that is conditioned on investmentin employer securities merely because theplan imposes fees on other investment op-tions that are not imposed on the invest-ment in employer securities. In addition,a plan is not providing a restriction on theright to divest an investment in employersecurities merely because the plan imposesa reasonable fee for the divestment of em-ployer securities.

The proposed regulations would per-mit a restriction on the frequency of in-vestment elections that was not in Notice2006–107. Under this rule, a plan wouldbe permitted to impose reasonable restric-tions on the timing and number of invest-ment elections that an individual can make

to invest in employer securities, providedthat the restrictions are designed to limitshort-term trading in the employer secu-rities. For example, a fund could limitthe purchase of employer securities if therehas been a sale within a short period oftime, such as 7 days. The regulations,however, would not permit a plan to limitan individual’s right to divest employer se-curities.

Proposed Effective Date

Section 401(a)(35) is applicable to planyears beginning on or after January 1,2007, subject to certain deferred effectivedates and transition rules. The proposedregulations would provide guidance onthese effective dates and transition rules.In particular, the regulations would pro-vide that a plan is eligible for the deferredeffective date applicable to collectivelybargained plans only if at least 25 percentof the participants in the plan are membersof collective bargaining units for which thecontributions under the plan are specifiedunder a collective bargaining agreement.

The regulations under section401(a)(35) are proposed to be effective forplan years beginning on or after January 1,2009. Until the regulations go into effect,Notice 2006–107 will continue to apply.For this purpose, the transitional reliefprovided for the period prior to January 1,2008, in paragraph 4 of Section III.D. ofNotice 2006–107 will continue to applyafter 2007 until the regulations go into ef-fect.5 In addition, plans are also permittedto apply the proposed regulations for planyears before the regulations go into effect.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in Exec-utive Order 12866. Therefore, a regula-tory assessment is not required. It also hasbeen determined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions, and, because §1.401(a)(35)–1 wouldnot impose a collection of information onsmall entities, the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Pursuant to section 7805(f) of the Code,

5 The Treasury and IRS are issuing a notice to reflect this extension. The notice is expected to be published as Notice 2008–7 in the 2008–3 issue of the I.R.B. on January 22, 2008, (see§601.601(d)(2)(ii)(b) of this chapter).

2008–11 I.R.B. 620 March 17, 2008

this notice of proposed rulemaking will besubmitted to the Chief Counsel for Advo-cacy of the Small Business Administrationfor comment on its impact on small busi-ness.

Comments and Requests for PublicHearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written (one signedand eight (8) copies) or electronic com-ments that are submitted timely to the IRS.The IRS and the Treasury Departmentspecifically request comments on the clar-ity of the proposed regulations and howthey can be made easier to understand.

In particular, the IRS and Treasury De-partment request comments on whetherthe determination of when an employer se-curity is readily tradable on an establishedsecurities market under these proposedregulations should also be applied forpurposes of determining whether an em-ployer security is readily tradable on anestablished securities market in apply-ing other provisions relating to qualifiedplans, given that the same words usedin interrelated provisions of the Codeare presumed to have the same meaning.These interrelated provisions include sec-tion 401(a)(28)(C) (requiring the use ofan independent appraiser for valuation ofemployer securities that are not readilytradable on an established securities mar-ket), section 409(h)(1)(B) (relating to putoptions for employer securities that are notreadily tradable on an established market),the definition of employer securities undersection 409(l)(1) (including regulationsunder section 4975), and the special rulesunder section 1042 (providing nonrecog-nition treatment for certain sales to anESOP).

All comments will be available forpublic inspection and copying. A publichearing will be scheduled if requested inwriting by any person who timely submitswritten comments. If a public hearing isscheduled, notice of the date, time, andplace of the public hearing will be pub-lished in the Federal Register.


The principal authors of theseregulations are Dana A. Barry andLisa Mojiri-Azad, Office of Division

Counsel/Associate Chief Counsel (TaxExempt and Government Entities).However, other personnel from the IRSand the Treasury participated in thedevelopment of these regulations.

* * * * *

Proposed Amendments to theRegulations

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

Part1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry innumerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.401(a)(35)–1 is also issued

under 26 U.S.C. 401(a)(35). * * *Par. 2. Section 1.401(a)(35)–1 is added

to read as follows:

§1.401(a)(35)–1 DiversificationRequirements for Certain DefinedContribution Plans.

(a) General rule—(1) Diversificationrequirements. Section 401(a)(35) imposesdiversification requirements on applicabledefined contribution plans. A trust that ispart of an applicable defined contributionplan is not a qualified trust under section401(a) unless the plan—

(i) Satisfies the diversification electionrequirements for elective deferrals and em-ployee contributions set forth in paragraph(b) of this section;

(ii) Satisfies the diversification electionrequirements for employer nonelectivecontributions set forth in paragraph (c) ofthis section;

(iii) Satisfies the investment option re-quirement set forth in paragraph (d) of thissection; and

(iv) Does not apply any restrictions orconditions on investments in employer se-curities that violate the requirements ofparagraph (e) of this section.

(2) Definitions, effective dates, andtransition rules. The definitions of appli-cable defined contribution plan, employersecurity, parent corporation, and publiclytraded are set forth in paragraph (f) of thissection. Effective/applicability dates andtransition rules are set forth in paragraph(g) of this section.

(b) Diversification requirements forelective deferrals and employee contribu-tions invested in employer securities—(1)General rule. With respect to any in-dividual described in paragraph (b)(2)of this section, if any portion of the in-dividual’s account under an applicabledefined contribution plan attributable toelective deferrals (as described in sec-tion 402(g)(3)(A)), after-tax employeecontributions, or rollover contributionsis invested in employer securities, thenthe plan satisfies the requirements of thisparagraph (b) if the individual may electto divest those employer securities andreinvest an equivalent amount in otherinvestment options. The plan may limitthe time for divestment and reinvestmentto periodic, reasonable opportunities oc-curring no less frequently than quarterly.

(2) Applicable individual with respectto elective deferrals and employee contri-butions. An individual is described in thisparagraph (b)(2) if the individual is—

(i) A participant;(ii) An alternate payee who has an ac-

count under the plan; or(iii) A beneficiary of a deceased partic-

ipant.(c) Diversification requirements for em-

ployer nonelective contributions investedin employer securities—(1) General rule.With respect to any individual described inparagraph (c)(2) of this section, if a por-tion of the individual’s account under anapplicable defined contribution plan attrib-utable to employer nonelective contribu-tions, other than elective deferrals, is in-vested in employer securities, then the plansatisfies the requirements of this paragraph(c) if the individual may elect to divestthose employer securities and reinvest anequivalent amount in other investment op-tions. The plan may limit the time fordivestment and reinvestment to periodic,reasonable opportunities occurring no lessfrequently than quarterly.

(2) Applicable individual with respectto employer nonelective contributions. Anindividual is described in this paragraph(c)(2) if the individual is—

(i) A participant who has completed atleast three years of service;

(ii) An alternate payee who has an ac-count under the plan with respect to a par-ticipant who has completed at least threeyears of service; or

March 17, 2008 621 2008–11 I.R.B.

(iii) A beneficiary of a deceased partic-ipant.

(3) Completion of 3 years of service.For purposes of paragraph (c)(2) of thissection, a participant completes three yearsof service on the last day of the vestingcomputation period provided for underthe plan that constitutes the completionof the third year of service under section411(a)(5). However, for a plan that usesthe elapsed time method of crediting ser-vice for vesting purposes (or a plan thatprovides for immediate vesting withoutusing a vesting computation period or theelapsed time method of determining vest-ing), a participant completes three years ofservice on the day immediately precedingthe third anniversary of the participant’sdate of hire.

(d) Investment option. An applicabledefined contribution plan must offer notless than three investment options, otherthan employer securities, to which an in-dividual who has the right to divest underparagraph (b)(1) or (c)(1) of this sectionmay direct the proceeds from the divest-ment of employer securities. Each of thethree investment options must be diversi-fied and have materially different risk andreturn characteristics. For this purpose, in-vestment options that constitute a broadrange of investment alternatives within themeaning of Department of Labor Regula-tion section 2550.404c–1(b)(3) are treatedas being diversified and having materiallydifferent risk and return characteristics.

(e) Restrictions or conditions on in-vestments in employer securities—(1) Im-permissible restrictions or conditions—(i)General rule. Except as provided in para-graph (e)(2) of this section, an applicabledefined contribution plan violates the re-quirements of this paragraph (e) if theplan imposes restrictions or conditionswith respect to the investment of employersecurities that are not imposed on the in-vestment of other assets of the plan. Arestriction or condition with respect toemployer securities means—

(A) A restriction on an individual’sright to divest an investment in employersecurities that is not imposed on an invest-ment that is not employer securities; and

(B) A benefit that is conditioned on in-vestment in employer securities.

(ii) Indirect restrictions or conditions.Except as provided in paragraph (e)(3) ofthis section, a plan violates the require-

ments of this paragraph (e) if the plan im-poses a restriction or condition in para-graph (e)(1)(i)(A) or (B) of this section ei-ther directly or indirectly. For example, aplan imposes an indirect restriction on anindividual’s right to divest an investmentin employer securities if the plan providesthat a participant who divests his or her ac-count balance with respect to investment inemployer securities is not permitted for aperiod of time thereafter to reinvest in em-ployer securities.

(2) Permitted restrictions or condi-tions—(i) In general. An applicable de-fined contribution plan does not violatethe requirements of this paragraph (e)merely because it imposes a restriction ora condition set forth in paragraph (e)(2)(ii)or (e)(2)(iii) of this section.

(ii) Securities laws. A plan is permit-ted to impose a restriction or condition onthe divestiture of employer securities thatis either required in order to ensure com-pliance with applicable securities laws oris reasonably designed to ensure compli-ance with applicable securities laws. Forexample, it is permissible for a plan tolimit divestiture rights for participants whoare subject to section 16(b) of the Secu-rities Exchange Act of 1934 to a reason-able period (such as 3 to 12 days) follow-ing publication of the employer’s quarterlyearnings statements because it is reason-ably designed to ensure compliance withRule 10b–5 of the Securities and ExchangeCommission.

(iii) Deferred application of the diver-sification requirements. An applicabledefined contribution plan is permitted torestrict the application of the diversifica-tion requirements of section 401(a)(35)and this section for up to 90 days afterthe plan becomes an applicable definedcontribution plan (for example, the date onwhich the employer securities held underthe plan become publicly traded).

(3) Permitted indirect restrictions orconditions—(i) In general. An applicabledefined contribution plan does not vio-late the requirements of this paragraph(e) merely because it imposes an indirectrestriction or condition set forth in para-graphs (e)(3)(ii) through (e)(3)(v) of thissection.

(ii) Limitation on investment in em-ployer securities. The plan is permitted tolimit the extent to which an individual’saccount balance can be invested in em-

ployer securities, provided the limitationapplies without regard to a prior exerciseof rights to divest employer securities. Forexample, a plan does not impose a restric-tion that violates this paragraph (e) merelybecause the plan prohibits a participantfrom investing additional amounts in em-ployer securities if more than 10 percentof that participant’s account balance isinvested in employer securities.

(iii) Trading frequency. A plan is per-mitted to impose reasonable restrictionson the timing and number of investmentelections that an individual can make toinvest in employer securities, providedthat the restrictions are designed to limitshort-term trading in the employer secu-rities. For example, a plan could providethat a participant may not elect to investin employer securities if the employeehas elected to divest employer securitieswithin a short period of time, such as sevendays.

(iv) Frozen funds. A plan is permittedto prohibit any further investment in em-ployer securities.

(v) Fees. The plan has not provided anindirect benefit that is conditioned on in-vestment in employer securities merely be-cause the plan imposes fees on other in-vestment options that are not imposed onthe investment in employer securities. Inaddition, the plan has not provided a re-striction on the right to divest an invest-ment in employer securities merely be-cause the plan imposes a reasonable fee forthe divestment of employer securities.

(vi) Transfers to stable value fund. Inthe case of a plan that has several invest-ment funds, including one or more fundsinvested in employer securities, a fundwhich is a stable value or similar fund,and other funds which are not investedin employer securities, the plan does notimpose a restriction prohibited under thisparagraph (e) merely because the plan per-mits transfers to be made into the stablevalue or similar fund more frequently thanother funds (including funds invested inemployer securities).

(f) Definitions—(1) Application of def-initions. This paragraph (f) contains defi-nitions that are applicable for purposes ofthis section.

(2) Applicable defined contributionplan—(i) General rule. Except as pro-vided in this paragraph (f)(2), an applica-ble defined contribution plan means any

2008–11 I.R.B. 622 March 17, 2008

defined contribution plan which holds em-ployer securities that are publicly traded.See paragraph (f)(2)(iv) of this sectionfor a special rule that treats certain plansthat hold employer securities that are notpublicly traded as applicable defined con-tribution plans and paragraph (f)(3)(ii) ofthis section for a special rule that treatscertain plans as not holding publicly tradedemployer securities for purposes of thissection.

(ii) Exception for certain ESOPs. Anemployee stock ownership plan (ESOP),as defined in section 4975(e)(7), is notan applicable defined contribution plan ifthe plan is a separate plan for purposes ofsection 414(l) with respect to any other de-fined benefit plan or defined contributionplan maintained by the same employeror employers and holds no contributions(or earnings thereunder) that are (or wereever) subject to section 401(k) or 401(m).Thus, an employee stock ownership planis an applicable defined contribution planif that ESOP is a portion of a larger plan(whether or not that larger plan includescontributions that are subject to section401(k) or 401(m)). For purposes of thisparagraph (f)(2)(ii), a plan is not con-sidered to hold amounts ever subject tosection 401(k) or 401(m) merely becausethe plan holds amounts attributable torollover amounts in a separate account thatwere previously subject to section 401(k)or 401(m).

(iii) Exception for one-participantplans. A one-participant plan, as definedin section 401(a)(35)(E)(iv), is not an ap-plicable defined contribution plan.

(iv) Certain defined contribution planstreated as holding publicly traded em-ployer securities—(A) General rule. A de-fined contribution plan holding employersecurities that are not publicly traded istreated as an applicable defined contri-bution plan if any employer maintainingthe plan or any member of a controlledgroup of corporations that includes suchemployer has issued a class of stock whichis publicly traded. For purposes of thisparagraph (f)(2)(iv), a controlled group ofcorporation has the meaning given suchterm by section 1563(a), except that “50percent” is substituted for “80 percent”each place it appears.

(B) Exception for certain plans. Para-graph (f)(2)(iv)(A) of this section does notapply to a plan if—

(1) No employer maintaining the plan(or a parent corporation with respect tosuch employer) has issued stock that ispublicly traded; and

(2) No employer maintaining the plan(or parent corporation with respect to suchemployer) has issued any special class ofstock which grants to the holder or issuerparticular rights, or bears particular risksfor the holder or issuer, with respect toany employer maintaining the plan (or anymember of a controlled group of corpora-tions that includes such employer) whichhas issued any stock that is publicly traded.

(3) Employer security—(i) Generalrule. Employer security has the meaninggiven such term by section 407(d)(1) ofthe Employee Retirement Income SecurityAct of 1974, as amended.

(ii) Certain defined contribution plansor investment funds not treated as holdingemployer securities—(A) Exception forcertain flow-through investments. Subjectto paragraph (f)(3)(ii)(B) and (C) of thissection, a plan (and an investment optiondescribed in paragraph (d) of this section)is not treated as holding employer secu-rities for purposes of this section to theextent the employer securities are heldindirectly through—

(1) An investment company registeredunder the Investment Company Act of1940;

(2) A common or collective trust fundor pooled investment fund maintained bya bank or trust company supervised by aState or a Federal agency;

(3) A pooled investment fund of an in-surance company that is qualified to dobusiness in a State; or

(4) Any other investment fund desig-nated by the Commissioner in revenue rul-ings, notices, or other guidance publishedin the Internal Revenue Bulletin.

(B) Investment must be independent.The exception set forth in paragraph(f)(3)(ii)(A) of this section applies only ifthe investment in the employer securitiesare held in a fund under which—

(1) There are stated investment objec-tives of the fund; and

(2) The investment is independent ofthe employer and any affiliate thereof.

(C) Percentage limitation rule. For pur-poses of paragraph (f)(3)(ii)(B)(2) of thissection, an investment in employer secu-rities in a fund is considered to be inde-pendent of the employer and any affiliate

thereof only if the aggregate value of theemployer securities held in the fund is notin excess of 10 percent of the total value ofall of the fund’s investments.

(4) Parent corporation. Parent corpora-tion has the meaning given such term bysection 424(e).

(5) Publicly traded—(i) In general. Asecurity is publicly traded if it is readilytradable on an established securities mar-ket.

(ii) Established securities market. Forpurposes of this paragraph (f)(5), a secu-rity is traded on an established securitiesmarket if—

(A) The security is traded on a nationalsecurities exchange that is registered undersection 6 of the Securities and ExchangeAct of 1934 (15 U.S.C. 78f); or

(B) The security is traded on a for-eign national securities exchange that is of-ficially recognized, sanctioned, or super-vised by a governmental authority.

(iii) Readily tradable. For purposes ofthis paragraph (f)(5), except as provided bythe Commissioner in revenue rulings, no-tices, or other guidance published in the In-ternal Revenue Bulletin, a security is read-ily tradable if—

(A) The security is traded on a secu-rities exchange that is described in para-graph (f)(5)(ii)(A) of this section; or

(B) The security is traded on a secu-rities exchange that is described in para-graph (f)(5)(ii)(B) of this section and thesecurity is deemed by the Securities andExchange Commission (SEC) as having a“ready market” under SEC Rule 15c3–1(17 CFR 240.15c3–1).

(g) Effective date and transitionrules—(1) Statutory effective date—(i)General rule. Except as otherwise pro-vided in this paragraph (g), section401(a)(35) is effective for plan years be-ginning after December 31, 2006.

(ii) Collectively bargained plans—(A)Delayed effective date. In the case of aplan maintained pursuant to one or morecollective bargaining agreements betweenemployee representatives and one or moreemployers ratified on or before August 17,2006, section 401(a)(35) is effective forplan years beginning after the earlier of

(1) the later of—(i) December 31, 2007; or(ii) the date on which the last such col-

lective bargaining agreement terminates

March 17, 2008 623 2008–11 I.R.B.

(determined without regard to any exten-sion thereof); or

(2) December 31, 2008.(B) Definition of collectively bargained

plans. For purposes of this paragraph(g)(1)(ii), in the case of a plan for whichone or more collective bargaining agree-ments apply to some, but not all, of theplan participants, the plan is considered acollectively bargained plan if at least 25percent of the participants in the plan aremembers of collective bargaining unitsfor which the contributions under the plan

are specified under a collective bargainingagreement.

(iii) Special rule for certain employersecurities held in an ESOP. Section901(c)(3)(A) and (B) of the Pension Pro-tection Act of 2006, Public Law 109–280,120 Stat. 780 (PPA ’06), provides a spe-cial effective date for an employee stockownership plan that holds a class of pre-ferred stock with a guaranteed minimumvalue, as described in that section.

(2) Statutory transition rules—(i)General rule. Pursuant to section

401(a)(35)(H), in the case of the portionof an account to which paragraph (c) ofthis section applies and that consists ofemployer securities acquired in a plan yearbeginning before January 1, 2007, the re-quirements of paragraph (c) of this sectiononly apply to the applicable percentage ofsuch securities.

(ii) Applicable percentage—(A)Phase-in percentage. For purposes of thisparagraph (g)(2), the applicable percent-age is determined as follows—

Plan year to which paragraph (c) of this section applies: The applicable percentage is:

1st . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 332nd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 663rd and following . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

(B) Special rule. For a plan describedin paragraph (g)(1)(iii) of this section forwhich the special effective date undersection 901(c)(3) of PPA ’06 applies, theapplicable percentage under this paragraph(g)(2)(ii) is determined without regardto the delayed effective date in section901(c)(3)(A) and (B) of PPA ’06.

(iii) Nonapplication for participantsage 55 with three years of service. Para-graph (g)(2)(i) of this section does notapply to an individual who is a participantwho attained age 55 and had completed atleast three years of service (as defined inparagraph (c)(3) of this section) before thefirst day of the first plan year beginningafter December 31, 2005.

(iv) Separate application by class of se-curities. This paragraph (g)(2) applies sep-arately with respect to each class of secu-rities.

(3) Regulatory effective date. This sec-tion is effective for plan years beginningon or after January 1, 2009.



Update to Publication 1187,Specifications for Filing Form1042–S, Foreign Person’sU.S. Source Income Subjectto Withholding, Electronicallyor Magnetically, revisedSeptember 2006

Announcement 2008–19

This announcement supersedes An-nouncement 2008–6 and corrects a ty-pographical error. The reference to thestate code table in the second bullet waschanged to Sec. 17. Publicly TradedPartnership (PTP) was added the ‘Q’record descriptions below which referenceNQI/FLW-THR. Continue to use Publica-tion 1187, Specifications for Filing Form1042–S, Foreign Person’s U.S. SourceIncome Subject to Withholding, Electroni-cally or Magnetically, revised September2006 along with the changes listed belowfor your Tax Year 2007 filing. The fol-lowing changes are effective for Tax Year2007 filed in calendar year 2008.

• An explanatory note was added to theRecipient ‘Q’ Record which reads: Ifyou are a nominee that is the withhold-ing agent under Code Section 1446, en-ter the Publicly Traded Partnership’s(PTP) name and other information inthe NQI/FLW-THR/PTP fields; posi-tions 401–666.

• In the Recipient ‘Q’ Record, a newfield, NQI/FLW-THR/PTP StateCode, was added to positions 643–644.Enter the two-alpha character statecode (see table Part A, Sec. 17). If astate code or APO/FPO is not applica-ble then blank fill.

• Additional instructions were addedto the Recipient ‘Q’ Record,NQI/FLW-THR/PTP Country Code,positions 647–648. The instructionsread: Enter the two-character Coun-try Code abbreviation, where theNQI/FLW-THR/PTP is located. Enterblanks if the NQI/FLW-THR/PTP hasa U.S. address.

• The Field Title was changed andadditional instructions were addedto the Recipient ‘Q’ Record,NQI/FLW-THR/PTP Postal Code/ZIPCode, positions 649–657. The instruc-tions read: Enter the alpha/numericforeign postal code or U.S. ZIP Codefor all U.S. addresses including territo-ries, possessions and APO/FPO. Enterthe code in the left most position andblank fill the remaining positions. DONOT use hyphens or blanks betweennumbers or letters (e.g., if the postalcode is written as A6B 3C5 input asA6B3C5). Left-justify.

• Some of the Canadian Province codeschanged. Use the chart below to codeyour file.

2008–11 I.R.B. 624 March 17, 2008

Province Code Province

AB AlbertaBC British ColumbiaMB ManitobaNB New BrunswickNL Newfoundland & LabradorNS Nova ScotiaNT Northwest TerritoriesNU NunavutON OntarioPE Prince Edward IslandQC QuebecSK SaskatchewanYT Yukon Territory

If you have questions concerning thefiling of Form 1042–S, Foreign Per-son’s U.S. Source Income Subject toWithholding, please contact the InternalRevenue Service ECC-MTB toll-free at866–455–7438.

Deletions From CumulativeList of OrganizationsContributions to Whichare Deductible Under Section170 of the Code

Announcement 2008–20

The Internal Revenue Service has re-voked its determination that the organi-zations listed below qualify as organiza-tions described in sections 501(c)(3) and170(c)(2) of the Internal Revenue Code of1986.

Generally, the Service will not disallowdeductions for contributions made to alisted organization on or before the dateof announcement in the Internal RevenueBulletin that an organization no longerqualifies. However, the Service is notprecluded from disallowing a deductionfor any contributions made after an or-ganization ceases to qualify under section170(c)(2) if the organization has not timely

filed a suit for declaratory judgment undersection 7428 and if the contributor (1) hadknowledge of the revocation of the rulingor determination letter, (2) was aware thatsuch revocation was imminent, or (3) wasin part responsible for or was aware of theactivities or omissions of the organizationthat brought about this revocation.

If on the other hand a suit for declara-tory judgment has been timely filed, con-tributions from individuals and organiza-tions described in section 170(c)(2) thatare otherwise allowable will continue tobe deductible. Protection under section7428(c) would begin on March 17, 2008,and would end on the date the court firstdetermines that the organization is not de-scribed in section 170(c)(2) as more partic-ularly set forth in section 7428(c)(1). Forindividual contributors, the maximum de-duction protected is $1,000, with a hus-band and wife treated as one contributor.This benefit is not extended to any indi-vidual, in whole or in part, for the acts oromissions of the organization that were thebasis for revocation.

Drive for Youth 2020Missouri City, TX

Rise and Shine, Inc.Medical Lake, WA

Bluegrass Gymnastic Boosters, Inc.Lexington, KY

DebtTechColumbia, MD

Nexum Credit Counseling, Inc.Vero Beach, FL

New Home Gallery, Inc.Louisville, KY

Alban Community Services FoundationLititz, PA

Union Oaks, Inc.Omaha, NE

Shiloh Ministries of Hagerstown, Inc.Hagerstown, MD

Credicure, Inc.Martinsburg, WV

Newton Family FoundationWest Jordan, UT

Alliance to Rebuild LASanta Monica, CA

The Down Payment Assistance GroupSan Diego, CA

Phillip J. Kronzer Foundation forReligious ResearchLos Gatos, CA

Credit Success CompanyJacksonville, FL

Mario C. and Elva G. Rapanotti CharitableSupporting OrganizationSan Antonio, TX

Anthony & Megan Wolfenden CharitableSupporting OrganizationSanta Clara, CA

March 17, 2008 625 2008–11 I.R.B.

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

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position is be-ing extended to apply to a variation of thefact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds that thesame principle also applies to B, the earlierruling is amplified. (Compare with modi-fied, below).

Clarified is used in those instanceswhere the language in a prior ruling is be-ing made clear because the language hascaused, or may cause, some confusion.It is not used where a position in a priorruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and 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 used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe new ruling does nothing more than re-state the substance and situation of a previ-ously published ruling (or rulings). Thus,the term is used to republish under the1986 Code and regulations the same po-sition published under the 1939 Code andregulations. The term is also used whenit is desired to republish in a single rul-ing a series of situations, names, etc., thatwere previously published over a period oftime in separate rulings. If the new rul-ing does more than restate the substance

of a prior ruling, a combination of termsis used. For example, modified and su-perseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that is selfcontained. In this case, the previously pub-lished ruling is first modified and then, asmodified, is superseded.

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 names insubsequent rulings. After the original rul-ing has been supplemented several times, anew ruling may be published that includesthe list in the original ruling and the ad-ditions, and supersedes all prior rulings inthe 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 of casesin litigation, or the outcome of a Servicestudy.

AbbreviationsThe following abbreviations in current useand formerly used will appear in materialpublished 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.—Statement 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.

2008–11 I.R.B. i March 17, 2008

Numerical Finding List1

Bulletins 2008–1 through 2008–11

Announcements:

2008-1, 2008-1 I.R.B. 246

2008-2, 2008-3 I.R.B. 307

2008-3, 2008-2 I.R.B. 269

2008-4, 2008-2 I.R.B. 269

2008-5, 2008-4 I.R.B. 333

2008-6, 2008-5 I.R.B. 378

2008-7, 2008-5 I.R.B. 379

2008-8, 2008-6 I.R.B. 403

2008-9, 2008-7 I.R.B. 444

2008-10, 2008-7 I.R.B. 445

2008-11, 2008-7 I.R.B. 445

2008-12, 2008-7 I.R.B. 446

2008-13, 2008-8 I.R.B. 480

2008-14, 2008-8 I.R.B. 481

2008-15, 2008-9 I.R.B. 511

2008-16, 2008-9 I.R.B. 511

2008-17, 2008-9 I.R.B. 512

2008-19, 2008-11 I.R.B. 624

2008-20, 2008-11 I.R.B. 625

Notices:

2008-1, 2008-2 I.R.B. 251

2008-2, 2008-2 I.R.B. 252

2008-3, 2008-2 I.R.B. 253

2008-4, 2008-2 I.R.B. 253

2008-5, 2008-2 I.R.B. 256

2008-6, 2008-3 I.R.B. 275

2008-7, 2008-3 I.R.B. 276

2008-8, 2008-3 I.R.B. 276

2008-9, 2008-3 I.R.B. 277

2008-10, 2008-3 I.R.B. 277

2008-11, 2008-3 I.R.B. 279

2008-12, 2008-3 I.R.B. 280

2008-13, 2008-3 I.R.B. 282

2008-14, 2008-4 I.R.B. 310

2008-15, 2008-4 I.R.B. 313

2008-16, 2008-4 I.R.B. 315

2008-17, 2008-4 I.R.B. 316

2008-18, 2008-5 I.R.B. 363

2008-19, 2008-5 I.R.B. 366

2008-20, 2008-6 I.R.B. 406

2008-21, 2008-7 I.R.B. 431

2008-22, 2008-8 I.R.B. 465

2008-23, 2008-7 I.R.B. 433

2008-24, 2008-8 I.R.B. 466

2008-25, 2008-9 I.R.B. 484

2008-26, 2008-9 I.R.B. 487

2008-27, 2008-10 I.R.B. 543

2008-28, 2008-10 I.R.B. 546

2008-31, 2008-11 I.R.B. 592

2008-32, 2008-11 I.R.B. 593

Proposed Regulations:

REG-147290-05, 2008-10 I.R.B. 576

REG-104713-07, 2008-6 I.R.B. 409

REG-104946-07, 2008-11 I.R.B. 596

REG-111583-07, 2008-4 I.R.B. 319

REG-114126-07, 2008-6 I.R.B. 410

REG-136701-07, 2008-11 I.R.B. 616

REG-139236-07, 2008-9 I.R.B. 491

REG-141399-07, 2008-8 I.R.B. 470

REG-147832-07, 2008-8 I.R.B. 472

REG-149475-07, 2008-9 I.R.B. 510

Revenue Procedures:

2008-1, 2008-1 I.R.B. 1

2008-2, 2008-1 I.R.B. 90

2008-3, 2008-1 I.R.B. 110

2008-4, 2008-1 I.R.B. 121

2008-5, 2008-1 I.R.B. 164

2008-6, 2008-1 I.R.B. 192

2008-7, 2008-1 I.R.B. 229

2008-8, 2008-1 I.R.B. 233

2008-9, 2008-2 I.R.B. 258

2008-10, 2008-3 I.R.B. 290

2008-11, 2008-3 I.R.B. 301

2008-12, 2008-5 I.R.B. 368

2008-13, 2008-6 I.R.B. 407

2008-14, 2008-7 I.R.B. 435

2008-15, 2008-9 I.R.B. 489

2008-16, 2008-10 I.R.B. 547

2008-17, 2008-10 I.R.B. 549

2008-18, 2008-10 I.R.B. 573

2008-19, 2008-11 I.R.B. 594

Revenue Rulings:

2008-1, 2008-2 I.R.B. 248

2008-2, 2008-2 I.R.B. 247

2008-3, 2008-2 I.R.B. 249

2008-4, 2008-3 I.R.B. 272

2008-5, 2008-3 I.R.B. 271

2008-6, 2008-3 I.R.B. 271

2008-7, 2008-7 I.R.B. 419

2008-8, 2008-5 I.R.B. 340

2008-9, 2008-5 I.R.B. 342

2008-11, 2008-10 I.R.B. 541

2008-12, 2008-10 I.R.B. 520

2008-13, 2008-10 I.R.B. 518

2008-14, 2008-11 I.R.B. 578

2008-16, 2008-11 I.R.B. 585

Tax Conventions:

2008-8, 2008-6 I.R.B. 403

Treasury Decisions:

9368, 2008-6 I.R.B. 382

9369, 2008-6 I.R.B. 394

Treasury Decisions— Continued:

9370, 2008-7 I.R.B. 428

9371, 2008-8 I.R.B. 447

9372, 2008-8 I.R.B. 462

9373, 2008-8 I.R.B. 463

9374, 2008-10 I.R.B. 521

9375, 2008-5 I.R.B. 344

9376, 2008-11 I.R.B. 587

9377, 2008-11 I.R.B. 578

9382, 2008-9 I.R.B. 482

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2007–27 through 2007–52 is in Internal Revenue Bulletin2007–52, dated December 26, 2007.

March 17, 2008 ii 2008–11 I.R.B.

Finding List of Current Actions onPreviously Published Items1

Bulletins 2008–1 through 2008–11

Announcements:

2008-6

Superseded by

Ann. 2008-19, 2008-11 I.R.B. 624

Notices:

2001-16

Modified by

Notice 2008-20, 2008-6 I.R.B. 406

2001-60

Modified and superseded by

Notice 2008-31, 2008-11 I.R.B. 592

2006-77

Clarified and amplified by

Notice 2008-25, 2008-9 I.R.B. 484

2006-107

Modified by

Notice 2008-7, 2008-3 I.R.B. 276

2007-30

Modified and superseded by

Notice 2008-14, 2008-4 I.R.B. 310

2007-54

Clarified by

Notice 2008-11, 2008-3 I.R.B. 279

Proposed Regulations:

REG-209020-86

Corrected by

Ann. 2008-11, 2008-7 I.R.B. 445

REG-113891-07

Hearing scheduled by

Ann. 2008-4, 2008-2 I.R.B. 269

Revenue Procedures:

2002-9

Modified by

Rev. Proc. 2008-18, 2008-10 I.R.B. 573

2007-1

Superseded by

Rev. Proc. 2008-1, 2008-1 I.R.B. 1

2007-2

Superseded by

Rev. Proc. 2008-2, 2008-1 I.R.B. 90

2007-3

Superseded by

Rev. Proc. 2008-3, 2008-1 I.R.B. 110

Revenue Procedures— Continued:

2007-4

Superseded by

Rev. Proc. 2008-4, 2008-1 I.R.B. 121

2007-5

Superseded by

Rev. Proc. 2008-5, 2008-1 I.R.B. 164

2007-6

Superseded by

Rev. Proc. 2008-6, 2008-1 I.R.B. 192

2007-7

Superseded by

Rev. Proc. 2008-7, 2008-1 I.R.B. 229

2007-8

Superseded by

Rev. Proc. 2008-8, 2008-1 I.R.B. 233

2007-26

Obsoleted in part by

Rev. Proc. 2008-17, 2008-10 I.R.B. 549

2007-31

Obsoleted in part by

Rev. Proc. 2008-19, 2008-11 I.R.B. 594

2007-39

Superseded by

Rev. Proc. 2008-3, 2008-1 I.R.B. 110

2007-52

Superseded by

Rev. Proc. 2008-9, 2008-2 I.R.B. 258

2008-13

Corrected by

Ann. 2008-15, 2008-9 I.R.B. 511

Revenue Rulings:

2007-4

Supplemented and superseded by

Rev. Rul. 2008-3, 2008-2 I.R.B. 249

Treasury Decisions:

9362

Corrected by

Ann. 2008-9, 2008-7 I.R.B. 444Ann. 2008-12, 2008-7 I.R.B. 446

9363

Corrected by

Ann. 2008-10, 2008-7 I.R.B. 445

9375

Corrected by

Ann. 2008-16, 2008-9 I.R.B. 511

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2007–27 through 2007–52 is in Internal Revenue Bulletin 2007–52, dated December 26,2007.

2008–11 I.R.B. iii March 17, 2008

March 17, 2008 2008–11 I.R.B.

2008–11 I.R.B. March 17, 2008

March 17, 2008 2008–11 I.R.B.

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