Internal Revenue Service, Treasury § 301.7654–1
(Miscellaneous Stamp Tax Regula- consisting of compensation for mili- tions). For regulations relating to the tary or naval service shall be taken manufacture of opium suitable for into account notwithstanding section smoking purposes, see 26 CFR (1939) 150 514 of the Soldiers’ and Sailors’ Civil (Narcotics Regulations 3, 3 FR 1402) as Relief Act of 1940 (50 App. U.S.C. 574). made applicable to section 7641 by However, see paragraph (e) of this sec- Treasury Decision 6091, approved Au- tion. gust 16, 1954 (19 FR 5167). (b) Allocation of tax. (1) Net collec- tions of income taxes imposed for each POSSESSIONS taxable year beginning after December 31, 1972, with respect to each individual § 301.7654–1 Coordination of U.S. and described in paragraph (a)(2) of this Guam individual income taxes. section for such year shall be divided (a) Application of section—(1) Scope. between the United States and Guam Section 7654 and this section set forth by the Commissioner of Internal Rev- the general procedures to be followed enue and the Commissioner of Revenue by the Government of the United and Taxation of Guam as follows: States and the Government of Guam in (i) Net collections attributable to in- the division between the two govern- come from sources within the United ments of revenue derived from collec- States shall be covered into the Treas- tions of the income taxes imposed for ury of the United States. any taxable year beginning after De- (ii) Net collections attributable to in- cember 31, 1972, with respect to any in- come from sources within Guam shall dividual described in subparagraph (2) be covered into the treasury of Guam, of this paragraph (a), and paragraph (e) and of this section. To the extent that sec- (iii) Net collections not described in tion 7654 and this section are incon- subdivision (i) or (ii) of this subpara- sistent with the provisions of section 30 graph (i.e., net collections attributable of the Organic Act of Guam (48 U.S.C. to income from sources other than 1421h), relating to duties and taxes to within the United States or Guam) be covered into the treasury of Guam shall be covered into the treasury of and held in account for the Govern- the jurisdiction (either the United ment of Guam, such section 30 is super- States or Guam) with which the indi- seded. vidual is required to file his return (2) Individuals covered. Paragraph (b) under paragraph (b) of § 1.935–1 of this of this section applies only to an indi- chapter for such year. vidual who, for a taxable year, is de- (2) The amount of tax of any indi- scribed in paragraph (a)(2) of § 1.935–1 of vidual for a taxable year which shall be this chapter (Income Tax Regulations) allocated to Guam for purposes of de- and has (or in the case of a joint re- termining the portion of the net collec- turn, such individual and his spouse tions from such individual which shall have)— be covered into the treasury of Guam (i) Adjusted gross income of $50,000 or by the United States for such year more, and shall be that amount which bears the (ii) Gross income of $5,000 or more same ratio to such amount of tax as from sources within the jurisdiction the adjusted gross income of that indi- (either the United States or Guam) vidual for such year which is allocable other than the jurisdiction with which to sources in Guam bears to the total the individual is required to file his in- adjusted gross income of such indi- come tax return under paragraph (b) of vidual for such year. For purposes of § 1.935–1 of this chapter. such allocation by the United States, For the determination of gross income the adjusted gross income of the tax- and adjusted gross income see sections payer shall be determined by taking 61 and 62, and the regulations there- into account any compensation of any under, or, when applicable, the cor- member of the Armed Forces for serv- responding provisions as made applica- ices performed in Guam the withheld ble in Guam by the Guam Territorial tax on which is paid into the treasury income tax (48 U.S.C. 1421i). For pur- of Guam pursuant to paragraph (e) of poses of this paragraph, gross income this section. The amount of tax of any
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individual for any taxable year which (ii) Tax withheld from the compensa- shall be allocated to the United States tion of any member of the Armed for purposes of determining the portion Forces described in paragraph (a)(2) of of the net collections from such indi- this section which is paid to Guam pur- vidual which shall be covered into the suant to section 7654(d) and paragraph Treasury of the United States by Guam (e) of this section shall be taken into for such year shall be that amount account in determining the amount re- which bears the same ratio to such quired to be covered into the treasury amount of tax as the adjusted gross in- of Guam under paragraph (b)(1)(ii) of come of that individual for such year this section. which is allocable to sources in the (iii) For purposes of this subpara- United States bears to the total ad- graph, any underpayment of tax is justed gross income of such individual treated as attributable on a pro rata for such year. basis to income from sources within (c) Definitions and special rules. For the United States, Guam, and sources purposes of this section— other than within the United States or (1) Net collections. (i) In determining Guam, respectively, and is divided be- net collections for a taxable year, ap- tween the United States and Guam propriate adjustment between the two under the rules in paragraph (b) of this jurisdictions shall be made on a propor- section. tionate basis for underpayments of in- (2) Income taxes. The term ‘‘income come taxes for such taxable year, cred- taxes’’ means— its allowed against the income tax for (i) With respect to taxes imposed by such taxable year (other than the cred- the United States, the income taxes it for taxes withheld under section 3402 on wages), and refunds made of income imposed by chapter 1 of the Code, and taxes paid with respect to such taxable (ii) With respect to taxes imposed by year. Thus, if a net operating loss re- Guam, the Guam Territorial income sults in a carryback to an earlier tax- tax (48 U.S.C. 1421i). able year which gives rise to a refund (3) Source rules. The determination of for that earlier year, an adjustment the source of income shall be based on must be made based upon the propor- the principles contained in sections 861 tion which the amount of tax covered through 863, and the regulations there- by one jurisdiction into the treasury of under, or, when applicable, in those the other jurisdiction for that earlier sections as made applicable in Guam year bears to the total amount of tax by the Guam Territorial income tax. paid for that earlier year, even though For such purposes the provisions of the loss may have resulted from activi- section 514 of the Soldiers’ and Sailors’ ties in one jurisdiction and the income, Civil Relief Act of 1940 (50 App. U.S.C. against which the loss was offset, was 574) relating to the determination of earned in the other jurisdiction. Simi- the source of income of members of the lar adjustments must be made for for- Armed Forces shall not be taken into eign tax credit carrybacks even though account. For purposes of this subpara- different jurisdictions are involved. If, graph, the provisions in section 935(c) for example, an individual pays income treating Guam as part of the United tax of $30,000 to the United States for States, and vice versa, do not apply. 1974 and $10,000 of such tax is covered For definition of the terms ‘‘United into the treasury of Guam, and if for States’’ and ‘‘Guam’’ (see section 1975 such individual has a net operating 7701(a)(9) of the Code and section 2 of loss attributable to a trade or business the Organic Act of Guam (48 U.S.C. carried on in the United States which 1421). loss is carried back to 1974 and gives (d) Information return. Each indi- rise to a refund of $15,000 by the United States, Guam must cover into the vidual described in paragraph (a)(2) of Treasury of the United States the this section for a taxable year who is amount of $5,000 which is the adjust- required by paragraph (b)(1) of § 1.935–1 ment based upon the refund of this chapter to file his return of in- ($15,000×$10,000/$30,000=$5,000). come for such year with the United
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States shall timely file a properly exe- Guam under this paragraph with re- cuted Form 5074 (Allocation of Indi- spect to remuneration for services per- vidual Income Tax to Guam) by attach- formed in Guam by members of the ing such form to his income tax return. Armed Forces of the United States, the Each individual described in paragraph special procedure agreed upon with the (a)(2) of this section for a taxable year Department of Defense in 1951 shall not who is required by paragraph (b)(1) of apply to remuneration paid after De- § 1.935–1 of this chapter to file his re- cember 31, 1974. Under that procedure turn of income for such year with the tax withheld under section 3402 Guam shall timely file such informa- upon such remuneration for services tion as may be required by the Com- performed in Guam during April and missioner of Revenue and Taxation October of each year was to be pro- with respect to his income derived jected for the appropriate six-month from sources within the United States. period of which the base month is a See section 6688 and § 301.6688–1 for the part, thereby arriving at an estimated penalty for failure to comply with this figure for semiannual withholding tax paragraph. to be covered over. (e) Military personnel in Guam. The (f) Transfers of funds. The transfers of Commissioner of Internal Revenue funds between the United States and shall arrange to pay to Guam the Guam required to effectuate the provi- amount of the taxes deducted and with- sions of this section shall be made held by the United States under sec- when convenient for the two govern- tion 3402 from wages paid to members ments, but not less frequently than of the Armed Forces who are stationed once in each calendar year. In com- in Guam but who have no income tax plying with paragraph (b) of this sec- liability to Guam with respect to such tion, only net balances will be trans- wages by reason of section 514 of the ferred between the two governments. Soldiers’ and Sailors’ Civil Relief Act Further, amounts transferred pursuant of 1940 (50 App. U.S.C. 574). Section 514 to paragraph (b) of this section may be of that Act provides in effect that for determined on the basis of estimates purposes of the taxation of income by rather than the actual amounts derived Guam a person shall not be deemed to from information furnished by tax- have lost a residence or domicile in the payers, except that the net collections United States solely by reason of being for 1973 and every third calendar year absent therefrom in compliance with thereafter are to be transferred on the military or naval orders and the com- basis of the information furnished by pensation for military or naval service taxpayers pursuant to paragraph (d) of of such a person who is not a resident this section. In order to facilitate the of, or domiciled in, Guam shall not be transfer of funds pursuant to this sec- deemed income for services performed tion, the Commissioner of Internal within, or from sources within, Guam. Revenue and the Commissioner of Rev- Any amount paid to Guam under this enue and Taxation of Guam shall ex- paragraph in respect of a member of change such information, including the Armed Forces described in para- copies of income tax returns, as will graph (a)(2) of this section shall be ensure that the provisions of section taken into account in determining the 7654 and this section are being properly amount required to be covered into the implemented. treasury of Guam under paragraph [T.D. 7385, 40 FR 50265, Oct. 29, 1975] (b)(1)(ii) of this section. For purposes of this paragraph, the term ‘‘Armed DEFINITIONS Forces of the United States’’ has the meaning provided by § 301.7701–8 of this § 301.7701–1 Classification of organiza- chapter. This paragraph does not apply tions for federal tax purposes. to wages for services performed in (a) Organizations for federal tax pur- Guam by members of the Armed Forces poses—(1) In general. The Internal Rev- of the United States which are not enue Code prescribes the classification compensation for military or naval of various organizations for federal tax service. In determining the amount of purposes. Whether an organization is tax to be covered into the treasury of an entity separate from its owners for
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federal tax purposes is a matter of fed- 301.7701–4 unless a provision of the In- eral tax law and does not depend on ternal Revenue Code (such as section whether the organization is recognized 860A addressing Real Estate Mortgage as an entity under local law. Investment Conduits (REMICs)) pro- (2) Certain joint undertakings give rise vides for special treatment of that or- to entities for federal tax purposes. A ganization. For the classification of or- joint venture or other contractual ar- ganizations as trusts, see § 301.7701–4. rangement may create a separate enti- That section provides that trusts gen- ty for federal tax purposes if the par- erally do not have associates or an ob- ticipants carry on a trade, business, fi- jective to carry on business for profit. nancial operation, or venture and di- Sections 301.7701–2 and 301.7701–3 pro- vide the profits therefrom. For exam- vide rules for classifying organizations ple, a separate entity exists for federal that are not classified as trusts. tax purposes if co- owners of an apart- (c) Qualified cost sharing arrangements. ment building lease space and in addi- A qualified cost sharing arrangement tion provide services to the occupants that is described in § 1.482–7 of this either directly or through an agent. chapter and any arrangement that is Nevertheless, a joint undertaking treated by the Commissioner as a merely to share expenses does not cre- qualified cost sharing arrangement ate a separate entity for federal tax under § 1.482–7 of this chapter is not purposes. For example, if two or more recognized as a separate entity for pur- persons jointly construct a ditch mere- poses of the Internal Revenue Code. ly to drain surface water from their See § 1.482–7 of this chapter for the properties, they have not created a sep- proper treatment of qualified cost shar- arate entity for federal tax purposes. ing arrangements. Similarly, mere co-ownership of prop- (d) Domestic and foreign entities. For erty that is maintained, kept in repair, purposes of this section and §§ 301.7701– and rented or leased does not con- 2 and 301.7701–3, an entity is a domestic stitute a separate entity for federal tax entity if it is created or organized in purposes. For example, if an individual the United States or under the law of owner, or tenants in common, of farm the United States or of any State; an property lease it to a farmer for a cash entity is foreign if it is not domestic. rental or a share of the crops, they do See sections 7701(a)(4) and (a)(5). not necessarily create a separate enti- (e) State. For purposes of this section ty for federal tax purposes. and § 301.7701–2, the term State includes (3) Certain local law entities not recog- the District of Columbia. nized. An entity formed under local law (f) Effective date. The rules of this sec- is not always recognized as a separate tion are effective as of January 1, 1997. entity for federal tax purposes. For ex- [T.D. 8697, 61 FR 66588, Dec. 18, 1996] ample, an organization wholly owned by a State is not recognized as a sepa- § 301.7701–2 Business entities; defini- rate entity for federal tax purposes if it tions. is an integral part of the State. Simi- (a) Business entities. For purposes of larly, tribes incorporated under section this section and § 301.7701–3, a business 17 of the Indian Reorganization Act of entity is any entity recognized for fed- 1934, as amended, 25 U.S.C. 477, or under eral tax purposes (including an entity section 3 of the Oklahoma Indian Wel- with a single owner that may be dis- fare Act, as amended, 25 U.S.C. 503, are regarded as an entity separate from its not recognized as separate entities for owner under § 301.7701–3) that is not federal tax purposes. properly classified as a trust under (4) Single owner organizations. Under § 301.7701–4 or otherwise subject to spe- §§ 301.7701–2 and 301.7701–3, certain orga- cial treatment under the Internal Rev- nizations that have a single owner can enue Code. A business entity with two choose to be recognized or disregarded or more members is classified for fed- as entities separate from their owners. eral tax purposes as either a corpora- (b) Classification of organizations. The tion or a partnership. A business entity classification of organizations that are with only one owner is classified as a recognized as separate entities is deter- corporation or is disregarded; if the en- mined under §§ 301.7701–2, 301.7701–3, and tity is disregarded, its activities are
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treated in the same manner as a sole Finland, Julkinen Osakeyhtio/Publikt proprietorship, branch, or division of Aktiebolag the owner. France, Societe Anonyme (b) Corporations. For federal tax pur- Germany, Aktiengesellschaft Greece, Anonymos Etairia poses, the term corporation means— Guam, Corporation (1) A business entity organized under Guatemala, Sociedad Anonima a Federal or State statute, or under a Guyana, Public Limited Company statute of a federally recognized Indian Honduras, Sociedad Anonima tribe, if the statute describes or refers Hong Kong, Public Limited Company to the entity as incorporated or as a Hungary, Reszvenytarsasag corporation, body corporate, or body Iceland, Hlutafelag politic; India, Public Limited Company (2) An association (as determined Indonesia, Perseroan Terbuka Ireland, Public Limited Company under § 301.7701–3); Israel, Public Limited Company (3) A business entity organized under Italy, Societa per Azioni a State statute, if the statute describes Jamaica, Public Limited Company or refers to the entity as a joint-stock Japan, Kabushiki Kaisha company or joint-stock association; Kazakstan, Ashyk Aktsionerlik Kogham (4) An insurance company; Republic of Korea, Chusik Hoesa (5) A State-chartered business entity Liberia, Corporation conducting banking activities, if any of Luxembourg, Societe Anonyme Malaysia, Berhad its deposits are insured under the Fed- Malta, Public Limited Company eral Deposit Insurance Act, as amend- Mexico, Sociedad Anonima ed, 12 U.S.C. 1811 et seq., or a similar Morocco, Societe Anonyme federal statute; Netherlands, Naamloze Vennootschap (6) A business entity wholly owned by New Zealand, Limited Company a State or any political subdivision Nicaragua, Compania Anonima thereof; Nigeria, Public Limited Company (7) A business entity that is taxable Northern Mariana Islands, Corporation as a corporation under a provision of Norway, Allment Aksjeselskap Pakistan, Public Limited Company the Internal Revenue Code other than Panama, Sociedad Anonima section 7701(a)(3); and Paraguay, Sociedad Anonima (8) Certain foreign entities—(i) In gen- Peru, Sociedad Anonima eral. Except as provided in paragraphs Philippines, Stock Corporation (b)(8)(ii) and (d) of this section, the fol- Poland, Spolka Akcyjna lowing business entities formed in the Portugal, Sociedade Anonima following jurisdictions: Puerto Rico, Corporation Romania, Societe pe Actiuni American Samoa, Corporation Russia, Otkrytoye Aktsionernoy Argentina, Sociedad Anonima Obshchestvo Australia, Public Limited Company Saudi Arabia, Sharikat Al-Mossahamah Austria, Aktiengesellschaft Singapore, Public Limited Company Barbados, Limited Company Slovak Republic, Akciova Spolocnost Belgium, Societe Anonyme South Africa, Public Limited Company Belize, Public Limited Company Spain, Sociedad Anonima Bolivia, Sociedad Anonima Surinam, Naamloze Vennootschap Brazil, Sociedade Anonima Sweden, Publika Aktiebolag Canada, Corporation and Company Switzerland, Aktiengesellschaft Chile, Sociedad Anonima Thailand, Borisat Chamkad (Mahachon) People’s Republic of China, Gufen Youxian Trinidad and Tobago, Limited Company Gongsi Tunisia, Societe Anonyme Republic of China (Taiwan), Ku-fen Yu-hsien Turkey, Anonim Sirket Kung-szu Ukraine, Aktsionerne Tovaristvo Vidkritogo Colombia, Sociedad Anonima Tipu Costa Rica, Sociedad Anonima United Kingdom, Public Limited Company Cyprus, Public Limited Company United States Virgin Islands, Corporation Czech Republic, Akciova Spolecnost Uruguay, Sociedad Anonima Denmark, Aktieselskab Venezuela, Sociedad Anonima or Compania Ecuador, Sociedad Anonima or Compania Anonima Anonima Egypt, Sharikat Al-Mossahamah (ii) Clarification of list of corporations El Salvador, Sociedad Anonima in paragraph (b)(8)(i) of this section—(A)
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Exceptions in certain cases. The fol- treated in the same manner as an Akti- lowing entities will not be treated as engesellschaft. corporations under paragraph (b)(8)(i) (c) Other business entities. For federal of this section: tax purposes— (1) With regard to Canada, a Nova (1) The term partnership means a Scotia Unlimited Liability Company business entity that is not a corpora- (or any other company or corporation tion under paragraph (b) of this section all of whose owners have unlimited li- and that has at least two members. ability pursuant to federal or provin- (2) Wholly owned entities—(i) In gen- cial law). eral. A business entity that has a single (2) With regard to India, a company owner and is not a corporation under deemed to be a public limited company paragraph (b) of this section is dis- solely by operation of section 43A(1) regarded as an entity separate from its (relating to corporate ownership of the owner. company), section 43A(1A) (relating to (ii) Special rule for certain business en- annual average turnover), or section tities. If the single owner of a business 43A(1B) (relating to ownership inter- entity is a bank (as defined in section ests in other companies) of the Compa- 581), then the special rules applicable nies Act, 1956 (or any combination of to banks will continue to apply to the these), provided that the organiza- single owner as if the wholly owned en- tional documents of such deemed pub- tity were a separate entity. lic limited company continue to meet (d) Special rule for certain foreign busi- the requirements of section 3(1)(iii) of ness entities—(1) In general. Except as the Companies Act, 1956. provided in paragraph (d)(3) of this sec- (3) With regard to Malaysia, a tion, a foreign business entity de- Sendirian Berhad. scribed in paragraph (b)(8)(i) of this (B) Inclusions in certain cases. With re- section will not be treated as a cor- gard to Mexico, the term Sociedad poration under paragraph (b)(8)(i) of Anonima includes a Sociedad Anonima this section if— that chooses to apply the variable cap- (i) The entity was in existence on ital provision of Mexican corporate law May 8, 1996; (Sociedad Anonima de Capital Vari- (ii) The entity’s classification was able). relevant (as defined in § 301.7701–3(d)) on (iii) Public companies. For purposes of May 8, 1996; paragraph (b)(8)(i) of this section, with (iii) No person (including the entity) regard to Cyprus, Hong Kong, and Ja- for whom the entity’s classification maica, the term Public Limited Com- was relevant on May 8, 1996, treats the pany includes any Limited Company entity as a corporation for purposes of that is not defined as a private com- filing such person’s federal income tax pany under the corporate laws of those returns, information returns, and with- jurisdictions. In all other cases, where holding documents for the taxable year the term Public Limited Company is including May 8, 1996; not defined, that term shall include (iv) Any change in the entity’s any Limited Company defined as a pub- claimed classification within the sixty lic company under the corporate laws months prior to May 8, 1996, occurred of the relevant jurisdiction. solely as a result of a change in the or- (iv) Limited companies. For purposes ganizational documents of the entity, of this paragraph (b)(8), any reference and the entity and all members of the to a Limited Company includes, as the entity recognized the federal tax con- case may be, companies limited by sequences of any change in the entity’s shares and companies limited by guar- classification within the sixty months antee. prior to May 8, 1996; (v) Multilingual countries. Different (v) A reasonable basis (within the linguistic renderings of the name of an meaning of section 6662) existed on entity listed in paragraph (b)(8)(i) of May 8, 1996, for treating the entity as this section shall be disregarded. For other than a corporation; and example, an entity formed under the (vi) Neither the entity nor any mem- laws of Switzerland as a Societe ber was notified in writing on or before Anonyme will be a corporation and May 8, 1996, that the classification of
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the entity was under examination (in entity as a result of paragraph (b)(8)(i) which case the entity’s classification of this section in effect on November will be determined in the examina- 29, 1999 may elect by February 14, 2000 tion). to be classified for federal tax purposes (2) Binding contract rule. If a foreign as an entity other than a corporation business entity described in paragraph retroactive to any period from and in- (b)(8)(i) of this section is formed after cluding January 1, 1997. Any Finnish May 8, 1996, pursuant to a written bind- entity that becomes an eligible entity ing contract (including an accepted bid as a result of paragraph (b)(8)(i) of this to develop a project) in effect on May 8, section in effect on November 29, 1999 1996, and all times thereafter, in which may elect by February 14, 2000 to be the parties agreed to engage (directly classified for federal tax purposes as an or indirectly) in an active and substan- entity other than a corporation retro- tial business operation in the jurisdic- tion in which the entity is formed, active to any period from and including paragraph (d)(1) of this section will be September 1, 1997. applied to that entity by substituting [T.D. 8697, 61 FR 66589, Dec. 18, 1996, as the date of the entity’s formation for amended by T.D. 8844, 64 FR 66583, Nov. 29, May 8, 1996. 1999] (3) Termination of grandfather status— (i) In general. An entity that is not § 301.7701–3 Classification of certain treated as a corporation under para- business entities. graph (b)(8)(i) of this section by reason (a) In general. A business entity that of paragraph (d)(1) or (d)(2) of this sec- is not classified as a corporation under tion will be treated permanently as a § 301.7701–2(b) (1), (3), (4), (5), (6), (7), or corporation under paragraph (b)(8)(i) of (8) (an eligible entity) can elect its clas- this section from the earliest of: sification for federal tax purposes as (A) The effective date of an election provided in this section. An eligible en- to be treated as an association under tity with at least two members can § 301.7701–3; elect to be classified as either an asso- (B) A termination of the partnership under section 708(b)(1)(B) (regarding ciation (and thus a corporation under sale or exchange of 50 percent or more § 301.7701–2(b)(2)) or a partnership, and of the total interest in an entity’s cap- an eligible entity with a single owner ital or profits within a twelve month can elect to be classified as an associa- period); or tion or to be disregarded as an entity (C) A division of the partnership separate from its owner. Paragraph (b) under section 708(b)(2)(B). of this section provides a default clas- (ii) Special rule for certain entities. For sification for an eligible entity that purposes of paragraph (d)(2) of this sec- does not make an election. Thus, elec- tion, paragraph (d)(3)(i)(B) of this sec- tions are necessary only when an eligi- tion shall not apply if the sale or ex- ble entity chooses to be classified ini- change of interests in the entity is to a tially as other than the default classi- related person (within the meaning of fication or when an eligible entity sections 267(b) and 707(b)) and occurs no chooses to change its classification. An later than twelve months after the entity whose classification is deter- date of the formation of the entity. mined under the default classification (e) Effective date. Except as otherwise retains that classification (regardless provided in this paragraph (e), the of any changes in the members’ liabil- rules of this section apply as of Janu- ity that occurs at any time during the ary 1, 1997. The reference to the Finn- time that the entity’s classification is ish, Maltese, and Norwegian entities in relevant as defined in paragraph (d) of paragraph (b)(8)(i) of this section is ap- this section) until the entity makes an plicable on November 29, 1999. The ref- erence to the Trinidadian entity in election to change that classification paragraph (b)(8)(i) of this section ap- under paragraph (c)(1) of this section. plies to entities formed on or after No- Paragraph (c) of this section provides vember 29, 1999. Any Maltese or Nor- rules for making express elections. wegian entity that becomes an eligible Paragraph (d) of this section provides
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special rules for foreign eligible enti- (3) Existing eligible entities—(i) In gen- ties. Paragraph (e) of this section pro- eral. Unless the entity elects otherwise, vides special rules for classifying enti- an eligible entity in existence prior to ties resulting from partnership termi- the effective date of this section will nations and divisions under section have the same classification that the 708(b). Paragraph (f) of this section sets entity claimed under §§ 301.7701–1 forth the effective date of this section through 301.7701–3 as in effect on the and a special rule relating to prior pe- date prior to the effective date of this riods. section; except that if an eligible enti- (b) Classification of eligible entities that ty with a single owner claimed to be a do not file an election—(1) Domestic eligi- partnership under those regulations, ble entities. Except as provided in para- the entity will be disregarded as an en- graph (b)(3) of this section, unless the tity separate from its owner under this entity elects otherwise, a domestic eli- paragraph (b)(3)(i). For special rules re- gible entity is— garding the classification of such enti- (i) A partnership if it has two or ties for periods prior to the effective more members; or date of this section, see paragraph (f)(2) (ii) Disregarded as an entity separate of this section. from its owner if it has a single owner. (ii) Special rules. For purposes of (2) Foreign eligible entities—(i) In gen- paragraph (b)(3)(i) of this section, a for- eral. Except as provided in paragraph eign eligible entity is treated as being (b)(3) of this section, unless the entity in existence prior to the effective date elects otherwise, a foreign eligible en- of this section only if the entity’s clas- tity is— sification was relevant (as defined in (A) A partnership if it has two or paragraph (d) of this section) at any more members and at least one mem- time during the sixty months prior to ber does not have limited liability; the effective date of this section. If an (B) An association if all members entity claimed different classifications have limited liability; or prior to the effective date of this sec- (C) Disregarded as an entity separate tion, the entity’s classification for pur- from its owner if it has a single owner poses of paragraph (b)(3)(i) of this sec- that does not have limited liability. tion is the last classification claimed (ii) Definition of limited liability. For by the entity. If a foreign eligible enti- purposes of paragraph (b)(2)(i) of this ty’s classification is relevant prior to section, a member of a foreign eligible the effective date of this section, but entity has limited liability if the mem- no federal tax or information return is ber has no personal liability for the filed or the federal tax or information debts of or claims against the entity by return does not indicate the classifica- reason of being a member. This deter- tion of the entity, the entity’s classi- mination is based solely on the statute fication for the period prior to the ef- or law pursuant to which the entity is fective date of this section is deter- organized, except that if the under- mined under the regulations in effect lying statute or law allows the entity on the date prior to the effective date to specify in its organizational docu- of this section. ments whether the members will have (c) Elections—(1) Time and place for fil- limited liability, the organizational ing—(i) In general. Except as provided documents may also be relevant. For in paragraphs (c)(1) (iv) and (v) of this purposes of this section, a member has section, an eligible entity may elect to personal liability if the creditors of the be classified other than as provided entity may seek satisfaction of all or under paragraph (b) of this section, or any portion of the debts or claims to change its classification, by filing against the entity from the member as Form 8832, Entity Classification Elec- such. A member has personal liability tion, with the service center designated for purposes of this paragraph even if on Form 8832. An election will not be the member makes an agreement under accepted unless all of the information which another person (whether or not a required by the form and instructions, member of the entity) assumes such li- including the taxpayer identifying ability or agrees to indemnify that number of the entity, is provided on member for any such liability. Form 8832. See § 301.6109–1 for rules on
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applying for and displaying Employer sidiary, an election under paragraph Identification Numbers. (c)(1)(i) of this section for the acquired (ii) Further notification of elections. An subsidiary can be effective no earlier eligible entity required to file a federal than the day after the acquisition date tax or information return for the tax- (within the meaning of section able year for which an election is made 338(h)(2)). under paragraph (c)(1)(i) of this section (iv) Limitation. If an eligible entity must attach a copy of its Form 8832 to makes an election under paragraph its federal tax or information return (c)(1)(i) of this section to change its for that year. If the entity is not re- classification (other than an election quired to file a return for that year, a made by an existing entity to change copy of its Form 8832 must be attached its classification as of the effective to the federal income tax or informa- date of this section), the entity cannot tion return of any direct or indirect change its classification by election owner of the entity for the taxable again during the sixty months suc- year of the owner that includes the ceeding the effective date of the elec- date on which the election was effec- tion. However, the Commissioner may tive. An indirect owner of the entity permit the entity to change its classi- does not have to attach a copy of the fication by election within the sixty Form 8832 to its return if an entity in months if more than fifty percent of which it has an interest is already fil- the ownership interests in the entity as ing a copy of the Form 8832 with its re- of the effective date of the subsequent turn. If an entity, or one of its direct or election are owned by persons that did indirect owners, fails to attach a copy not own any interests in the entity on of a Form 8832 to its return as directed the filing date or on the effective date in this section, an otherwise valid elec- of the entity’s prior election. An elec- tion under paragraph (c)(1)(i) of this tion by a newly formed eligible entity section will not be invalidated, but the that is effective on the date of forma- non-filing party may be subject to pen- tion is not considered a change for pur- alties, including any applicable pen- poses of this paragraph (c)(1)(iv). alties if the federal tax or information (v) Deemed elections—(A) Exempt orga- returns are inconsistent with the enti- nizations. An eligible entity that has ty’s election under paragraph (c)(1)(i) been determined to be, or claims to be, of this section. exempt from taxation under section (iii) Effective date of election. An elec- 501(a) is treated as having made an tion made under paragraph (c)(1)(i) of election under this section to be classi- this section will be effective on the fied as an association. Such election date specified by the entity on Form will be effective as of the first day for 8832 or on the date filed if no such date which exemption is claimed or deter- is specified on the election form. The mined to apply, regardless of when the effective date specified on Form 8832 claim or determination is made, and can not be more than 75 days prior to will remain in effect unless an election the date on which the election is filed is made under paragraph (c)(1)(i) of this and can not be more than 12 months section after the date the claim for ex- after the date on which the election is empt status is withdrawn or rejected or filed. If an election specifies an effec- the date the determination of exempt tive date more than 75 days prior to status is revoked. the date on which the election is filed, (B) Real estate investment trusts. An el- it will be effective 75 days prior to the igible entity that files an election date it was filed. If an election speci- under section 856(c)(1) to be treated as fies an effective date more than 12 a real estate investment trust is treat- months from the date on which the ed as having made an election under election is filed, it will be effective 12 this section to be classified as an asso- months after the date it was filed. If an ciation. Such election will be effective election specifies an effective date be- as of the first day the entity is treated fore January 1, 1997, it will be effective as a real estate investment trust. as of January 1, 1997. If a purchasing (vi) Examples. The following examples corporation makes an election under illustrate the rules of this paragraph section 338 regarding an acquired sub- (c)(1):
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Example 1. On July 1, 1998, X, a domestic an election under paragraph (c)(1)(i) of corporation, purchases a 10% interest in Y, this section is to be effective for any an eligible entity formed under Country A period prior to the time that it is filed, law in 1990. The entity’s classification was not relevant to any person for federal tax or each person who was an owner between information purposes prior to X’s acquisition the date the election is to be effective of an interest in Y. Thus, Y is not considered and the date the election is filed, and to be in existence on the effective date of who is not an owner at the time the this section for purposes of paragraph (b)(3) election is filed, must also sign the of this section. Under the applicable Country election. A statute, all members of Y have limited li- ability as defined in paragraph (b)(2)(ii) of (iii) Changes in classification. For this section. Accordingly, Y is classified as paragraph (c)(2)(i) of this section, if an an association under paragraph (b)(2)(i)(B) of election under paragraph (c)(1)(i) of this section unless it elects under this para- this section is made to change the clas- graph (c) to be classified as a partnership. To sification of an entity, each person who be classified as a partnership as of July 1, was an owner on the date that any 1998, Y must file a Form 8832 by September 14, 1998. See paragraph (c)(1)(i) of this sec- transactions under paragraph (g) of tion. Because an election cannot be effective this section are deemed to occur, and more than 75 days prior to the date on which who is not an owner at the time the it is filed, if Y files its Form 8832 after Sep- election is filed, must also sign the tember 14, 1998, it will be classified as an as- election. This paragraph (c)(2)(iii) ap- sociation from July 1, 1998, until the effec- plies to elections filed on or after No- tive date of the election. In that case, it could not change its classification by elec- vember 29, 1999. tion under this paragraph (c) during the (d) Special rules for foreign eligible enti- sixty months succeeding the effective date of ties—(1) Definition of relevance. For pur- the election. poses of this section, a foreign eligible Example 2. (i) Z is an eligible entity formed entity’s classification is relevant when under Country B law and is in existence on its classification affects the liability of the effective date of this section within the meaning of paragraph (b)(3) of this section. any person for federal tax or informa- Prior to the effective date of this section, Z tion purposes. For example, a foreign claimed to be classified as an association. entity’s classification would be rel- Unless Z files an election under this para- evant if U.S. income was paid to the graph (c), it will continue to be classified as entity and the determination by the an association under paragraph (b)(3) of this withholding agent of the amount to be section. (ii) Z files a Form 8832 pursuant to this withheld under chapter 3 of the Inter- paragraph (c) to be classified as a partner- nal Revenue Code (if any) would vary ship, effective as of the effective date of this depending upon whether the entity is section. Z can file an election to be classified classified as a partnership or as an as- as an association at any time thereafter, but sociation. Thus, the classification then would not be permitted to change its might affect the documentation that classification by election during the sixty months succeeding the effective date of that the withholding agent must receive subsequent election. from the entity, the type of tax or in- formation return to file, or how the re- (2) Authorized signatures—(i) In gen- turn must be prepared. The date that eral. An election made under paragraph the classification of a foreign eligible (c)(1)(i) of this section must be signed entity is relevant is the date an event by— (A) Each member of the electing en- occurs that creates an obligation to tity who is an owner at the time the file a federal tax return, information election is filed; or return, or statement for which the (B) Any officer, manager, or member classification of the entity must be de- of the electing entity who is authorized termined. Thus, the classification of a (under local law or the entity’s organi- foreign entity is relevant, for example, zational documents) to make the elec- on the date that an interest in the en- tion and who represents to having such tity is acquired which will require a authorization under penalties of per- U.S. person to file an information re- jury. turn on Form 5471. (ii) Retroactive elections. For purposes (2) Special rule when classification is no of paragraph (c)(2)(i) of this section, if longer relevant. If the classification of a
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foreign eligible entity which was pre- Example 1. A, a U.S. person, owns a domes- viously relevant for federal tax pur- tic eligible entity that is disregarded as an poses ceases to be relevant for sixty entity separate from its owner. On January 1, 1998, B, a U.S. person, buys a 50 percent in- consecutive months, the entity’s clas- terest in the entity from A. Under this para- sification will initially be determined graph (f), the entity is classified as a part- under the default classification when nership when B acquires an interest in the the classification of the foreign eligible entity. However, A and B elect to have the entity again becomes relevant. The entity classified as an association effective date that the classification of a foreign on January 1, 1998. Thus, B is treated as buy- entity ceases to be relevant is the date ing shares of stock on January 1, 1998. (Under paragraph (c)(1)(iv) of this section, this elec- an event occurs that causes the classi- tion is treated as a change in classification fication to no longer be relevant, or, if so that the entity generally cannot change no event occurs in a taxable year that its classification by election again during causes the classification to be relevant, the sixty months succeeding the effective then the date is the first day of that date of the election.) Under paragraph (g)(1) taxable year. of this section, A is treated as contributing the assets and liabilities of the entity to the (e) Coordination with section 708(b). newly formed association immediately be- Except as provided in § 301.7701–2(d)(3) fore the close of December 31, 1997. Because (regarding termination of grandfather A does not retain control of the association status for certain foreign business enti- as required by section 351, A’s contribution ties), an entity resulting from a trans- will be a taxable event. Therefore, under sec- action described in section 708(b)(1)(B) tion 1012, the association will take a fair market value basis in the assets contributed (partnership termination due to sales by A, and A will have a fair market value or exchanges) or section 708(b)(2)(B) basis in the stock received. A will have no (partnership division) is a partnership. additional gain upon the sale of stock to B, (f) Changes in number of members of an and B will have a cost basis in the stock pur- entity—(1) Associations. The classifica- chased from A. tion of an eligible entity as an associa- Example 2. (i) On April 1, 1998, A and B, U.S. persons, form X, a foreign eligible entity. X tion is not affected by any change in is treated as an association under the default the number of members of the entity. provisions of paragraph (b)(2)(i) of this sec- (2) Partnerships and single member enti- tion, and X does not make an election to be ties. An eligible entity classified as a classified as a partnership. A subsequently partnership becomes disregarded as an purchases all of B’s interest in X. entity separate from its owner when (ii) Under paragraph (f)(1) of this section, X continues to be classified as an association. the entity’s membership is reduced to X, however, can subsequently elect to be dis- one member. A single member entity regarded as an entity separate from A. The disregarded as an entity separate from sixty month limitation of paragraph its owner is classified as a partnership (c)(1)(iv) of this section does not prevent X when the entity has more than one from making an election because X has not member. If an elective classification made a prior election under paragraph change under paragraph (c) of this sec- (c)(1)(i) of this section. Example 3. (i) On April 1, 1998, A and B, U.S. tion is effective at the same time as a persons, form X, a foreign eligible entity. X membership change described in this is treated as an association under the default paragraph (f)(2), the deemed trans- provisions of paragraph (b)(2)(i) of this sec- actions in paragraph (g) of this section tion, and X does not make an election to be resulting from the elective change pre- classified as a partnership. On January 1, empt the transactions that would re- 1999, X elects to be classified as a partnership sult from the change in membership. effective on that date. Under the sixty month limitation of paragraph (c)(1)(iv) of (3) Effect on sixty month limitation. A this section, X cannot elect to be classified change in the number of members of an as an association until January 1, 2004 (i.e., entity does not result in the creation sixty months after the effective date of the of a new entity for purposes of the election to be classified as a partnership). sixty month limitation on elections (ii) On June 1, 2000, A purchases all of B’s under paragraph (c)(1)(iv) of this sec- interest in X. After A’s purchase of B’s inter- tion. est, X can no longer be classified as a part- nership because X has only one member. (4) Examples. The following examples Under paragraph (f)(2) of this section, X is illustrate the application of this para- disregarded as an entity separate from A graph (f): when A becomes the only member of X. X,
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however, is not treated as a new entity for (c)(1)(i) of this section is determined purposes of paragraph (c)(1)(iv) of this sec- under all relevant provisions of the In- tion. As a result, the sixty month limitation ternal Revenue Code and general prin- of paragraph (c)(1)(iv) of this section con- tinues to apply to X, and X cannot elect to ciples of tax law, including the step be classified as an association until January transaction doctrine. 1, 2004 (i.e., sixty months after January 1, (3) Timing of election—(i) In general. 1999, the effective date of the election by X An election under paragraph (c)(1)(i) of to be classified as a partnership). this section that changes the classi- (5) Effective date. This paragraph (f) fication of an eligible entity for federal applies as of November 29, 1999. tax purposes is treated as occurring at (g) Elective changes in classification— the start of the day for which the elec- (1) Deemed treatment of elective change— tion is effective. Any transactions that (i) Partnership to association. If an eligi- are deemed to occur under this para- ble entity classified as a partnership graph (g) as a result of a change in elects under paragraph (c)(1)(i) of this classification are treated as occurring section to be classified as an associa- immediately before the close of the day tion, the following is deemed to occur: before the election is effective. For ex- The partnership contributes all of its assets and liabilities to the association ample, if an election is made to change in exchange for stock in the associa- the classification of an entity from an tion, and immediately thereafter, the association to a partnership effective partnership liquidates by distributing on January 1, the deemed transactions the stock of the association to its part- specified in paragraph (g)(1)(ii) of this ners. section (including the liquidation of (ii) Association to partnership. If an el- the association) are treated as occur- igible entity classified as an associa- ring immediately before the close of tion elects under paragraph (c)(1)(i) of December 31 and must be reported by this section to be classified as a part- the owners of the entity on December nership, the following is deemed to 31. Thus, the last day of the associa- occur: The association distributes all tion’s taxable year will be December 31 of its assets and liabilities to its share- and the first day of the partnership’s holders in liquidation of the associa- taxable year will be January 1. tion, and immediately thereafter, the (ii) Coordination with section 338 elec- shareholders contribute all of the dis- tion. A purchasing corporation that tributed assets and liabilities to a makes a qualified stock purchase of an newly formed partnership. eligible entity taxed as a corporation (iii) Association to disregarded entity. If an eligible entity classified as an as- may make an election under section sociation elects under paragraph 338 regarding the acquisition if it satis- (c)(1)(i) of this section to be dis- fies the requirements for the election, regarded as an entity separate from its and may also make an election to owner, the following is deemed to change the classification of the target occur: The association distributes all corporation. If a taxpayer makes an of its assets and liabilities to its single election under section 338 regarding its owner in liquidation of the association. acquisition of another entity taxable (iv) Disregarded entity to an associa- as a corporation and makes an election tion. If an eligible entity that is dis- under paragraph (c) of this section for regarded as an entity separate from its the acquired corporation (effective at owner elects under paragraph (c)(1)(i) the earliest possible date as provided of this section to be classified as an as- by paragraph (c)(1)(iii) of this section), sociation, the following is deemed to the transactions under paragraph (g) of occur: The owner of the eligible entity this section are deemed to occur imme- contributes all of the assets and liabil- diately after the deemed asset purchase ities of the entity to the association in by the new target corporation under exchange for stock of the association. section 338. (2) Effect of elective changes. The tax (iii) Application to successive elections treatment of a change in the classifica- in tiered situations. When elections tion of an entity for federal tax pur- poses by election under paragraph under paragraph (c)(1)(i) of this section
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for a series of tiered entities are effec- (ii) The entity and all members of the tive on the same date, the eligible enti- entity recognized the federal tax con- ties may specify the order of the elec- sequences of any change in the entity’s tions on Form 8832. If no order is speci- classification within the sixty months fied for the elections, any transactions prior to January 1, 1997; and that are deemed to occur in this para- (iii) Neither the entity nor any mem- graph (g) as a result of the classifica- ber was notified in writing on or before tion change will be treated as occur- May 8, 1996, that the classification of ring first for the highest tier entity’s the entity was under examination (in classification change, then for the next which case the entity’s classification highest tier entity’s classification will be determined in the examina- change, and so forth down the chain of tion). entities until all the transactions under this paragraph (g) have occurred. [T.D. 8697, 61 FR 66590, Dec. 18, 1996; 62 FR For example, Parent, a corporation, 11769, Mar. 13, 1997, as amended by T.D. 8767, wholly owns all of the interest of an el- 63 FR 14619, Mar. 26, 1998; T.D. 8827, 64 FR igible entity classified as an associa- 37678, July 13, 1999; 64 FR 58782, Nov. 1, 1999; tion (S1), which wholly owns another T.D. 8844, 64 FR 66583, Nov. 29, 1999] eligible entity classified as an associa- tion (S2), which wholly owns another § 301.7701–4 Trusts. eligible entity classified as an associa- (a) Ordinary trusts. In general, the tion (S3). Elections under paragraph term ‘‘trust’’ as used in the Internal (c)(1)(i) of this section are filed to clas- Revenue Code refers to an arrangement sify S1, S2, and S3 each as disregarded created either by a will or by an inter as an entity separate from its owner ef- vivos declaration whereby trustees fective on the same day. If no order is take title to property for the purpose specified for the elections, the fol- of protecting or conserving it for the lowing transactions are deemed to beneficiaries under the ordinary rules occur under this paragraph (g) as a re- applied in chancery or probate courts. sult of the elections, with each succes- Usually the beneficiaries of such a sive transaction occurring on the same trust do no more than accept the bene- day immediately after the preceding fits thereof and are not the voluntary transaction S1 is treated as liquidating planners or creators of the trust ar- into Parent, then S2 is treated as liqui- rangement. However, the beneficiaries dating into Parent, and finally S3 is of such a trust may be the persons who treated as liquidating into Parent. create it and it will be recognized as a (4) Effective date. This paragraph (g) trust under the Internal Revenue Code applies to elections that are filed on or if it was created for the purpose of pro- after November 29, 1999. Taxpayers may tecting or conserving the trust prop- apply this paragraph (g) retroactively erty for beneficiaries who stand in the to elections filed before November 29, 1999 if all taxpayers affected by the same relation to the trust as they deemed transactions file consistently would if the trust had been created by with this paragraph (g). others for them. Generally speaking, (h) Effective date—(1) In general. Ex- an arrangement will be treated as a cept as otherwise provided in this sec- trust under the Internal Revenue Code tion, the rules of this section are appli- if it can be shown that the purpose of cable as of January 1, 1997. the arrangement is to vest in trustees (2) Prior treatment of existing entities. responsibility for the protection and In the case of a business entity that is conservation of property for bene- not described in § 301.7701–2(b) (1), (3), ficiaries who cannot share in the dis- (4), (5), (6), or (7), and that was in exist- charge of this responsibility and, there- ence prior to January 1, 1997, the enti- fore, are not associates in a joint enter- ty’s claimed classification(s) will be re- prise for the conduct of business for spected for all periods prior to January profit. 1, 1997, if— (b) Business trusts. There are other ar- (i) The entity had a reasonable basis rangements which are known as trusts (within the meaning of section 6662) for because the legal title to property is its claimed classification; conveyed to trustees for the benefit of
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beneficiaries, but which are not classi- Example 1. A corporation purchases a port- fied as trusts for purposes of the Inter- folio of residential mortgages and transfers nal Revenue Code because they are not the mortgages to a bank under a trust agree- ment. At the same time, the bank as trustee simply arrangements to protect or con- delivers to the corporation certificates evi- serve the property for the beneficiaries. dencing rights to payments from the pooled These trusts, which are often known as mortgages; the corporation sells the certifi- business or commercial trusts, gen- cates to the public. The trustee holds legal erally are created by the beneficiaries title to the mortgages in the pool for the simply as a device to carry on a profit- benefit of the certificate holders but has no making business which normally would power to reinvest proceeds attributable to have been carried on through business the mortgages in the pool or to vary invest- ments in the pool in any other manner. organizations that are classified as cor- There are two classes of certificates. Holders porations or partnerships under the In- of class A certificates are entitled to all pay- ternal Revenue Code. However, the fact ments of mortgage principal, both scheduled that the corpus of the trust is not sup- and prepaid, until their certificates are re- plied by the beneficiaries is not suffi- tired; holders of class B certificates receive cient reason in itself for classifying the payments of principal only after all class A arrangement as an ordinary trust rath- certificates have been retired. The different rights of the class A and class B certificates er than as an association or partner- serve to shift to the holders of the class A ship. The fact that any organization is certificates, in addition to the earlier sched- technically cast in the trust form, by uled payments of principal, the risk that conveying title to property to trustees mortgages in the pool will be prepaid so that for the benefit of persons designated as the holders of the class B certificates will beneficiaries, will not change the real have ‘‘call protection’’ (freedom from pre- character of the organization if the or- mature termination of their interests on ac- count of prepayments). The trust thus serves ganization is more properly classified to create investment interests with respect as a business entity under § 301.7701–2. to the mortgages held by the trust that dif- (c) Certain investment trusts—(1) An fer significantly from direct investment in ‘‘investment’’ trust will not be classi- the mortgages. As a consequence, the exist- fied as a trust if there is a power under ence of multiple classes of trust ownership is the trust agreement to vary the invest- not incidental to any purpose of the trust to ment of the certificate holders. See facilitate direct investment, and, accord- ingly, the trust is classified as a business en- Commissioner v. North American Bond tity under § 301.7701–2. Trust, 122 F. 2d 545 (2d Cir. 1941), cert. Example 2. Corporation M is the originator denied, 314 U.S. 701 (1942). An invest- of a portfolio of residential mortgages and ment trust with a single class of own- transfers the mortgages to a bank under a ership interests, representing undi- trust agreement. At the same time, the bank vided beneficial interests in the assets as trustee delivers to M certificates evidenc- of the trust, will be classified as a trust ing rights to payments from the pooled mortgages. The trustee holds legal title to if there is no power under the trust the mortgages in the pool for the benefit of agreement to vary the investment of the certificate holders, but has no power to the certificate holders. An investment reinvest proceeds attributable to the mort- trust with multiple classes of owner- gages in the pool or to vary investments in ship interests ordinarily will be classi- the pool in any other manner. There are two fied as a business entity under classes of certificates. Holders of class C cer- § 301.7701–2; however, an investment tificates are entitled to receive 90 percent of trust with multiple classes of owner- the payments of principal and interest on the mortgages; class D certificate holders ship interests, in which there is no are entitled to receive the other ten percent. power under the trust agreement to The two classes of certificates are identical vary the investment of the certificate except that, in the event of a default on the holders, will be classified as a trust if underlying mortgages, the payment rights of the trust is formed to facilitate direct class D certificate holders are subordinated investment in the assets of the trust to the rights of class C certificate holders. M and the existence of multiple classes of sells the class C certificates to investors and ownership interests is incidental to retains the class D certificates. The trust has multiple classes of ownership interests, that purpose. given the greater security provided to hold- (2) The provisions of paragraph (c)(1) ers of class C certificates. The interests of of this section may be illustated by the certificate holders, however, are substan- following examples: tially equivalent to undivided interests in
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the pool of mortgages, coupled with a lim- (d) Liquidating trusts. Certain organi- ited recourse guarantee running from M to zations which are commonly known as the holders of class C certificates. In such liquidating trusts are treated as trusts circumstances, the existence of multiple for purposes of the Internal Revenue classes of ownership interests is incidental to the trust’s purpose of facilitating direct Code. An organization will be consid- investment in the assets of the trust. Ac- ered a liquidating trust if it is orga- cordingly, the trust is classified as a trust. nized for the primary purpose of liqui- Example 3. A promoter forms a trust in dating and distributing the assets which shareholders of a publicly traded cor- transferred to it, and if its activities poration can deposit their stock. For each are all reasonably necessary to, and share of stock deposited with the trust, the consistent with, the accomplishment of participant receives two certificates that are that purpose. A liquidating trust is initially attached, but may be separated and treated as a trust for purposes of the traded independently of each other. One cer- tificate represents the right to dividends and Internal Revenue Code because it is the value of the underlying stock up to a formed with the objective of liqui- specified amount; the other certificate rep- dating particular assets and not as an resents the right to appreciation in the organization having as its purpose the stock’s value above the specified amount. carrying on of a profit-making business The separate certificates represent two dif- which normally would be conducted ferent classes of ownership interest in the through business organizations classi- trust, which effectively separate dividend fied as corporations or partnerships. rights on the stock held by the trust from a portion of the right to appreciation in the However, if the liquidation is unreason- value of such stock. The multiple classes of ably prolonged or if the liquidation ownership interests are designed to permit purpose becomes so obscured by busi- investors, by transferring one of the certifi- ness activities that the declared pur- cates and retaining the other, to fulfill their pose of liquidation can be said to be varying investment objectives of seeking pri- lost or abandoned, the status of the or- marily either dividend income or capital ap- ganization will no longer be that of a preciation from the stock held by the trust. liquidating trust. Bondholders’ protec- Given that the trust serves to create invest- tive committees, voting trusts, and ment interests with respect to the stock held by the trust that differ significantly from di- other agencies formed to protect the rect investment in such stock, the trust is interests of security holders during in- not formed to facilitate direct investment in solvency, bankruptcy, or corporate re- the assets of the trust. Accordingly, the organization proceedings are analogous trust is classified as a business entity under to liquidating trusts but if subse- § 301.7701–2. quently utilized to further the control Example 4. Corporation N purchases a port- or profitable operation of a going busi- folio of bonds and transfers the bonds to a ness on a permanent continuing basis, bank under a trust agreement. At the same time, the trustee delivers to N certificates they will lose their classification as evidencing interests in the bonds. These cer- trusts for purposes of the Internal Rev- tificates are sold to public investors. Each enue Code. certificate represents the right to receive a (e) Environmental remediation trusts. particular payment with respect to a specific (1) An environmental remediation trust bond. Under section 1286, stripped coupons is considered a trust for purposes of the and stripped bonds are treated as separate Internal Revenue Code. For purposes of bonds for federal income tax purposes. Al- this paragraph (e), an organization is though the interest of each certificate holder is different from that of each other certifi- an environmental remediation trust if cate holder, and the trust thus has multiple the organization is organized under classes of ownership, the multiple classes state law as a trust; the primary pur- simply provide each certificate holder with a pose of the trust is collecting and dis- direct interest in what is treated under sec- bursing amounts for environmental re- tion 1286 as a separate bond. Given the simi- mediation of an existing waste site to larity of the interests acquired by the cer- resolve, satisfy, mitigate, address, or tificate holders to the interests that could be prevent the liability or potential liabil- acquired by direct investment, the multiple classes of trust interests merely facilitate ity of persons imposed by federal, direct investment in the assets held by the state, or local environmental laws; all trust. Accordingly, the trust is classified as contributors to the trust have (at the a trust. time of contribution and thereafter)
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actual or potential liability or a rea- also furnish to each grantor a state- sonable expectation of liability under ment that shows all items of income, federal, state, or local environmental deduction, and credit of the trust for laws for environmental remediation of the grantor’s taxable year attributable the waste site; and the trust is not a to the portion of the trust treated as qualified settlement fund within the owned by the grantor. The statement meaning of § 1.468B–1(a) of this chapter. must provide the grantor with the in- An environmental remediation trust is formation necessary to take the items classified as a trust because its pri- into account in computing the mary purpose is environmental remedi- grantor’s taxable income, including in- ation of an existing waste site and not formation necessary to determine the the carrying on of a profit-making federal tax treatment of the items (for business that normally would be con- example, whether an item is a deduct- ducted through business organizations ible expense under section 162(a) or a classified as corporations or partner- capital expenditure under section ships. However, if the remedial purpose 263(a)) and how the item should be is altered or becomes so obscured by taken into account under the economic business or investment activities that performance rules of section 461(h) and the declared remedial purpose is no the regulations thereunder. See § 1.461– longer controlling, the organization 4 of this chapter for rules relating to will no longer be classified as a trust. economic performance. For purposes of this paragraph (e), en- (3) All amounts contributed to an en- vironmental remediation includes the vironmental remediation trust by a costs of assessing environmental condi- grantor (cash-out grantor) who, pursu- tions, remedying and removing envi- ant to an agreement with the other ronmental contamination, monitoring grantors, contributes a fixed amount to remedial activities and the release of the trust and is relieved by the other substances, preventing future releases grantors of any further obligation to of substances, and collecting amounts make contributions to the trust, but from persons liable or potentially lia- remains liable or potentially liable ble for the costs of these activities. For under the applicable environmental purposes of this paragraph (e), persons laws, will be considered amounts con- have potential liability or a reasonable tributed for remediation. An environ- expectation of liability under federal, mental remediation trust agreement state, or local environmental laws for may direct the trustee to expend remediation of the existing waste site amounts contributed by a cash-out if there is authority under a federal, grantor (and the earnings thereon) be- state, or local law that requires or fore expending amounts contributed by could reasonably be expected to require other grantors (and the earnings there- such persons to satisfy all or a portion on). A cash-out grantor will cease to be of the costs of the environmental reme- treated as an owner of a portion of the diation. trust when the grantor’s portion is (2) Each contributor (grantor) to the fully expended by the trust. trust is treated as the owner of the por- (4) The provisions of this paragraph tion of the trust contributed by that (e) may be illustrated by the following grantor under rules provided in section example: 677 and § 1.677(a)–1(d) of this chapter. Example. (a) X, Y, and Z are calendar year Section 677 and § 1.677(a)–1(d) of this corporations that are liable for the remedi- chapter provide rules regarding the ation of an existing waste site under applica- treatment of a grantor as the owner of ble federal environmental laws. On June 1, a portion of a trust applied in dis- 1996, pursuant to an agreement with the gov- charge of the grantor’s legal obliga- erning federal agency, X, Y, and Z create an tion. Items of income, deduction, and environmental remediation trust within the credit attributable to an environ- meaning of paragraph (e)(1) of this section to mental remediation trust are not re- collect funds contributed to the trust by X, Y, and Z and to carry out the remediation of ported by the trust on Form 1041, but the waste site to the satisfaction of the fed- are shown on a separate statement to eral agency. X, Y, and Z are jointly and sev- be attached to that form. See § 1.671– erally liable under the federal environmental 4(a) of this chapter. The trustee must laws for the remediation of the waste site,
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and the federal agency will not release X, Y, sioner may permit by letter ruling, in or Z from liability until the waste site is re- appropriate circumstances, this para- mediated to the satisfaction of the agency. graph (e) to be applied subject to ap- (b) The estimated cost of the remediation is $20,000,000. X, Y, and Z agree that, if Z con- propriate terms and conditions. tributes $1,000,000 to the trust, Z will not be (f) Effective date. The rules of this sec- required to make any additional contribu- tion generally apply to taxable years tions to the trust, and X and Y will complete beginning after December 31, 1960. the remediation of the waste site and make Paragraph (e)(5) of this section con- additional contributions if necessary. tains rules of applicability for para- (c) On June 1, 1996, X, Y, and Z each con- tribute $1,000,000 to the trust. The trust graph (e) of this section. In addition, agreement directs the trustee to spend Z’s the last sentences of paragraphs (b), contributions to the trust and the income al- (c)(1), and (c)(2) Example 1 and Example locable to Z’s portion before spending X’s 3 of this section are effective as of Jan- and Y’s portions. On November 30, 1996, the uary 1, 1997. trustee disburses $2,000,000 for remediation work performed from June 1, 1996, through [32 FR 15241, Nov. 3, 1967, as amended by T.D. September 30, 1996. For the six-month period 8080, 51 FR 9952, Mar. 24, 1986; T.D. 8668, 61 FR ending November 30, 1996, the interest earned 19191, May 1, 1996; T.D. 8697, 61 FR 66592, Dec. on the funds in the trust was $75,000, which 18, 1996] is allocated in equal shares of $25,000 to X’s, Y’s, and Z’s portions of the trust. § 301.7701–5 Domestic, foreign, resi- (d) Z made no further contributions to the dent, and nonresident persons. trust. Pursuant to the trust agreement, the trustee expended Z’s portion of the trust be- A domestic corporation is one orga- fore expending X’s and Y’s portion. There- nized or created in the United States, fore, Z’s share of the remediation disburse- including only the States (and during ment made in 1996 is $1,025,000 ($1,000,000 con- the periods when not States, the Terri- tribution by Z plus $25,000 of interest allo- cated to Z’s portion of the trust). Z takes the tories of Alaska and Hawaii), and the $1,025,000 disbursement into account under District of Columbia, or under the law the appropriate federal tax accounting rules. of the United States or of any State or In addition, X’s share of the remediation dis- Territory. A foreign corporation is one bursement made in 1996 is $487,500, and Y’s which is not domestic. A domestic cor- share of the remediation disbursement made in 1996 is $487,500. X and Y take their respec- poration is a resident corporation even tive shares of the disbursement into account though it does no business and owns no under the appropriate federal tax accounting property in the United States. A for- rules. eign corporation engaged in trade or (e) The trustee made no further remedi- business within the United States is re- ation disbursements in 1996, and X and Y ferred to in the regulations in this made no further contributions in 1996. From December 1, 1996, to December 31, 1996, the chapter as a resident foreign corpora- interest earned on the funds remaining in tion, and a foreign corporation not en- the trust was $5,000, which is allocated $2,500 gaged in trade or business within the to X’s portion and $2,500 to Y’s portion. Ac- United States, as a nonresident foreign cordingly, for 1996, X and Y each had interest corporation. A partnership engaged in income of $27,500 from the trust and Z had in- trade or business within the United terest income of $25,000 from the trust. States is referred to in the regulations (5) This paragraph (e) is applicable to in this chapter as a resident partner- trusts meeting the requirements of ship, and a partnership not engaged in paragraph (e)(1) of this section that are trade or business within the United formed on or after May 1, 1996. This States, as a nonresident partnership. paragraph (e) may be relied on by Whether a partnership is to be regarded trusts formed before May 1, 1996, if the as resident or nonresident is not deter- trust has at all times met all require- mined by the nationality or residence ments of this paragraph (e) and the of its members or by the place in which grantors have reported items of it was created or organized. ,income and deduction consistent with this paragraph (e) on original or [32 FR 15231, Nov. 3, 1967, as amended by T.D. amended returns. For trusts formed be- 8813, 64 FR 4970, Feb. 2, 1999] fore May 1, 1996, that are not described in the preceding sentence, the Commis-
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§ 301.7701–6 Definitions; person, fidu- (ii) One or more United States per- ciary. sons have the authority to control all (a) Person. The term person includes substantial decisions of the trust (con- an individual, a corporation, a partner- trol test). ship, a trust or estate, a joint-stock (2) A trust is a United States person company, an association, or a syn- for purposes of the Internal Revenue Code (Code) on any day that the trust dicate, group, pool, joint venture, or meets both the court test and the con- other unincorporated organization or trol test. For purposes of the regula- group. The term also includes a guard- tions in this chapter, the term domestic ian, committee, trustee, executor, ad- trust means a trust that is a United ministrator, trustee in bankruptcy, re- States person. The term foreign trust ceiver, assignee for the benefit of credi- means any trust other than a domestic tors, conservator, or any person acting trust. in a fiduciary capacity. (3) Except as otherwise provided in (b) Fiduciary—(1) In general. Fidu- part I, subchapter J, chapter 1 of the ciary is a term that applies to persons Code, the taxable income of a foreign who occupy positions of peculiar con- trust is computed in the same manner fidence toward others, such as trustees, as the taxable income of a nonresident executors, and administrators. A fidu- alien individual who is not present in ciary is a person who holds in trust an the United States at any time. Section estate to which another has a bene- 641(b). Section 7701(b) is not applicable ficial interest, or receives and controls to trusts because it only applies to in- income of another, as in the case of re- dividuals. In addition, a foreign trust is ceivers. A committee or guardian of not considered to be present in the the property of an incompetent person United States at any time for purposes is a fiduciary. of section 871(a)(2), which deals with (2) Fiduciary distinguished from agent. capital gains of nonresident aliens There may be a fiduciary relationship present in the United States for 183 between an agent and a principal, but days or more. the word agent does not denote a fidu- (b) Applicable law. The terms of the ciary. An agent having entire charge of trust instrument and applicable law property, with authority to effect and must be applied to determine whether execute leases with tenants entirely on the court test and the control test are his own responsibility and without con- met. sulting his principal, merely turning (c) The court test—(1) Safe harbor. A over the net profits from the property trust satisfies the court test if— periodically to his principal by virtue (i) The trust instrument does not di- of authority conferred upon him by a rect that the trust be administered power of attorney, is not a fiduciary outside of the United States; within the meaning of the Internal (ii) The trust in fact is administered Revenue Code. In cases when no legal exclusively in the United States; and trust has been created in the estate (iii) The trust is not subject to an controlled by the agent and attorney, automatic migration provision de- the liability to make a return rests scribed in paragraph (c)(4)(ii) of this with the principal. section. (c) Effective date. The rules of this (2) Example. The following example il- section are effective as of January 1, lustrates the rule of paragraph (c)(1) of 1997. this section: [T.D. 8697, 61 FR 66593, Dec. 18, 1996] Example. A creates a trust for the equal benefit of A’s two children, B and C. The § 301.7701–7 Trusts—domestic and for- trust instrument provides that DC, a State Y eign. corporation, is the trustee of the trust. State (a) In general. (1) A trust is a United Y is a state within the United States. DC ad- States person if— ministers the trust exclusively in State Y and the trust instrument is silent as to (i) A court within the United States where the trust is to be administered. The is able to exercise primary supervision trust is not subject to an automatic migra- over the administration of the trust tion provision described in paragraph (court test); and (c)(4)(ii) of this section. The trust satisfies
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the safe harbor of paragraph (c)(1) of this ministration, of the Uniform Probate section and the court test. Code, 8 Uniform Laws Annotated 1 (3) Definitions. The following defini- (West Supp. 1998), available from the tions apply for purposes of this section: National Conference of Commissioners (i) Court. The term court includes any on Uniform State Laws, 676 North St. federal, state, or local court. Clair Street, Suite 1700, Chicago, Illi- (ii) The United States. The term the nois 60611. United States is used in this section in (B) Testamentary trust. In the case of a geographical sense. Thus, for pur- a trust created pursuant to the terms poses of the court test, the United of a will probated within the United States includes only the States and the States (other than an ancillary pro- District of Columbia. See section bate), if all fiduciaries of the trust have 7701(a)(9). Accordingly, a court within a been qualified as trustees of the trust territory or possession of the United by a court within the United States, States or within a foreign country is the trust meets the court test. not a court within the United States. (C) Inter vivos trust. In the case of a (iii) Is able to exercise. The term is able trust other than a testamentary trust, to exercise means that a court has or if the fiduciaries and/or beneficiaries would have the authority under appli- take steps with a court within the cable law to render orders or judg- United States that cause the adminis- ments resolving issues concerning ad- tration of the trust to be subject to the ministration of the trust. primary supervision of the court, the (iv) Primary supervision. The term pri- trust meets the court test. mary supervision means that a court has (D) A United States court and a foreign or would have the authority to deter- court are able to exercise primary super- mine substantially all issues regarding vision over the administration of the trust. the administration of the entire trust. If both a United States court and a for- A court may have primary supervision eign court are able to exercise primary under this paragraph (c)(3)(iv) notwith- supervision over the administration of standing the fact that another court the trust, the trust meets the court has jurisdiction over a trustee, a bene- test. ficiary, or trust property. (ii) Automatic migration provisions. (v) Administration. The term adminis- Notwithstanding any other provision tration of the trust means the carrying in this section, a court within the out of the duties imposed by the terms United States is not considered to have of the trust instrument and applicable primary supervision over the adminis- law, including maintaining the books tration of the trust if the trust instru- and records of the trust, filing tax re- ment provides that a United States turns, managing and investing the as- court’s attempt to assert jurisdiction sets of the trust, defending the trust or otherwise supervise the administra- from suits by creditors, and deter- tion of the trust directly or indirectly mining the amount and timing of dis- would cause the trust to migrate from tributions. the United States. However, this para- (4) Situations that cause a trust to sat- graph (c)(4)(ii) will not apply if the isfy or fail to satisfy the court test. (i) Ex- trust instrument provides that the cept as provided in paragraph (c)(4)(ii) trust will migrate from the United of this section, paragraphs (c)(4)(i) (A) States only in the case of foreign inva- through (D) of this section set forth sion of the United States or widespread some specific situations in which a confiscation or nationalization of prop- trust satisfies the court test. The four erty in the United States. situations described are not intended (5) Examples. The following examples to be an exclusive list. illustrate the rules of this paragraph (A) Uniform Probate Code. A trust (c): meets the court test if the trust is reg- istered by an authorized fiduciary or fi- Example 1. A, a United States citizen, cre- ates a trust for the equal benefit of A’s two duciaries of the trust in a court within children, both of whom are United States the United States pursuant to a state citizens. The trust instrument provides that statute that has provisions substan- DC, a domestic corporation, is to act as tially similar to Article VII, Trust Ad- trustee of the trust and that the trust is to
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be administered in Country X, a foreign (C) The selection of a beneficiary; country. DC maintains a branch office in (D) Whether a receipt is allocable to Country X with personnel authorized to act income or principal; as trustees in Country X. The trust instru- (E) Whether to terminate the trust; ment provides that the law of State Y, a state within the United States, is to govern (F) Whether to compromise, arbi- the interpretation of the trust. Under the trate, or abandon claims of the trust; law of Country X, a court within Country X (G) Whether to sue on behalf of the is able to exercise primary supervision over trust or to defend suits against the the administration of the trust. Pursuant to trust; the trust instrument, the Country X court (H) Whether to remove, add, or re- applies the law of State Y to the trust. Under place a trustee; the terms of the trust instrument the trust (I) Whether to appoint a successor is administered in Country X. No court with- in the United States is able to exercise pri- trustee to succeed a trustee who has mary supervision over the administration of died, resigned, or otherwise ceased to the trust. The trust fails to satisfy the court act as a trustee, even if the power to test and therefore is a foreign trust. make such a decision is not accom- Example 2. A, a United States citizen, cre- panied by an unrestricted power to re- ates a trust for A’s own benefit and the ben- move a trustee, unless the power to efit of A’s spouse, B, a United States citizen. make such a decision is limited such The trust instrument provides that the trust that it cannot be exercised in a manner is to be administered in State Y, a state within the United States, by DC, a State Y that would change the trust’s resi- corporation. The trust instrument further dency from foreign to domestic, or vice provides that in the event that a creditor versa; and sues the trustee in a United States court, the (J) Investment decisions; however, if trust will automatically migrate from State a United States person under section Y to Country Z, a foreign country, so that no 7701(a)(30) hires an investment advisor United States court will have jurisdiction for the trust, investment decisions over the trust. A court within the United made by the investment advisor will be States is not able to exercise primary super- vision over the administration of the trust considered substantial decisions con- because the United States court’s jurisdic- trolled by the United States person if tion over the administration of the trust is the United States person can terminate automatically terminated in the event the the investment advisor’s power to court attempts to assert jurisdiction. There- make investment decisions at will. fore, the trust fails to satisfy the court test (iii) Control. The term control means from the time of its creation and is a foreign having the power, by vote or otherwise, trust. to make all of the substantial decisions (d) Control test—(1) Definitions—(i) of the trust, with no other person hav- United States person. The term United ing the power to veto any of the sub- States person means a United States stantial decisions. To determine person within the meaning of section whether United States persons have 7701(a)(30). For example, a domestic control, it is necessary to consider all corporation is a United States person, persons who have authority to make a regardless of whether its shareholders substantial decision of the trust, not are United States persons. only the trust fiduciaries. (ii) Substantial decisions. The term (iv) Treatment of certain employee ben- substantial decisions means those deci- efit trusts. Provided that United States sions that persons are authorized or re- fiduciaries control all of the substan- quired to make under the terms of the tial decisions made by the trustees or trust instrument and applicable law fiduciaries, the following types of and that are not ministerial. Decisions trusts are deemed to satisfy the con- that are ministerial include decisions trol test set forth in paragraph (a)(1)(ii) regarding details such as the book- of this section— keeping, the collection of rents, and (A) A qualified trust described in sec- the execution of investment decisions. tion 401(a); Substantial decisions include, but are (B) A trust described in section not limited to, decisions concerning— 457(g); (A) Whether and when to distribute (C) A trust that is an individual re- income or corpus; tirement account described in section (B) The amount of any distributions; 408(a);
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(D) A trust that is an individual re- power to make a substantial decision tirement account described in section of the trust that would cause the do- 408(k) or 408(p); mestic or foreign residency of the trust (E) A trust that is a Roth IRA de- to change, the trust is allowed 12 scribed in section 408A; months from the date of the change to (F) A trust that is an education indi- make necessary changes either with re- vidual retirement account described in spect to the persons who control the section 530; substantial decisions or with respect to (G) A trust that is a voluntary em- the residence of such persons to avoid a ployees’ beneficiary association de- change in the trust’s residency. For scribed in section 501(c)(9); purposes of this section, an inadvertent (H) Such additional categories of change means the death, incapacity, trusts as the Commissioner may des- resignation, change in residency or ignate in revenue procedures, notices, other change with respect to a person or other guidance published in the In- that has a power to make a substantial ternal Revenue Bulletin (see decision of the trust that would cause § 601.601(d)(2)(ii)(b)). a change to the residency of the trust (v) Examples. The following examples but that was not intended to change illustrate the rules of paragraph (d)(1) the residency of the trust. If the nec- of this section: essary change is made within 12 Example 1. Trust has three fiduciaries, A, B, months, the trust is treated as retain- and C. A and B are United States citizens and ing its pre-change residency during the C is a nonresident alien. No persons except 12-month period. If the necessary the fiduciaries have authority to make any change is not made within 12 months, decisions of the trust. The trust instrument the trust’s residency changes as of the provides that no substantial decisions of the date of the inadvertent change. trust can be made unless there is unanimity (ii) Request for extension of time. If among the fiduciaries. The control test is reasonable actions have been taken to not satisfied because United States persons do not control all the substantial decisions make the necessary change to prevent of the trust. No substantial decisions can be a change in trust residency, but due to made without C’s agreement. circumstances beyond the trust’s con- Example 2. Assume the same facts as in Ex- trol the trust is unable to make the ample 1, except that the trust instrument modification within 12 months, the provides that all substantial decisions of the trust may provide a written statement trust are to be decided by a majority vote to the district director having jurisdic- among the fiduciaries. The control test is satisfied because a majority of the fidu- tion over the trust’s return setting ciaries are United States persons and there- forth the reasons for failing to make fore United States persons control all the the necessary change within the re- substantial decisions of the trust. quired time period. If the district di- Example 3. Assume the same facts as in Ex- rector determines that the failure was ample 2, except that the trust instrument di- due to reasonable cause, the district di- rects that C is to make all of the trust’s in- rector may grant the trust an exten- vestment decisions, but that A and B may veto C’s investment decisions. A and B can- sion of time to make the necessary not act to make the investment decisions on change. Whether an extension of time their own. The control test is not satisfied is granted is in the sole discretion of because the United States persons, A and B, the district director and, if granted, do not have the power to make all of the sub- may contain such terms with respect stantial decisions of the trust. to assessment as may be necessary to Example 4. Assume the same facts as in Ex- ensure that the correct amount of tax ample 3, except A and B may accept or veto C’s investment decisions and can make in- will be collected from the trust, its vestments that C has not recommended. The owners, and its beneficiaries. If the dis- control test is satisfied because the United trict director does not grant an exten- States persons control all substantial deci- sion, the trust’s residency changes as sions of the trust. of the date of the inadvertent change. (2) Replacement of any person who had (iii) Examples. The following exam- authority to make a substantial decision ples illustrate the rules of paragraphs of the trust—(i) Replacement within 12 (d)(2)(i) and (ii) of this section: months. In the event of an inadvertent Example 1. A trust that satisfies the court change in any person that has the test has three fiduciaries, A, B, and C. A and
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B are United States citizens and C is a non- Example 3. A trust, Trust T, has two fidu- resident alien. All decisions of the trust are ciaries, A and B. Both A and B are United made by majority vote of the fiduciaries. States persons. A and B hire C, an invest- The trust instrument provides that upon the ment advisor who is a foreign person, and death or resignation of any of the fidu- may terminate C’s employment at will. The ciaries, D, is the successor fiduciary. A dies investment advisor makes the investment and D automatically becomes a fiduciary of decisions for the trust. A and B control all the trust. When D becomes a fiduciary of the other decisions of the trust. Although C has trust, D is a nonresident alien. Two months the power to make investment decisions, A after A dies, B replaces D with E, a United and B are treated as controlling these deci- States person. Because D was replaced with sions. Therefore, the control test is satisfied. E within 12 months after the date of A’s Example 4. G, a United States citizen, cre- death, during the period after A’s death and ates a trust. The trust provides for income to before E begins to serve, the trust satisfies A and B for life, remainder to A’s and B’s de- the control test and remains a domestic trust. scendants. A is a nonresident alien and B is Example 2. Assume the same facts as in Ex- a United States person. The trustee of the ample 1 except that at the end of the 12- trust is a United States person. The trust in- month period after A’s death, D has not been strument authorizes A to replace the trustee. replaced and remains a fiduciary of the The power to replace the trustee is a sub- trust. The trust becomes a foreign trust on stantial decision. Because A, a nonresident the date A died unless the district director alien, controls a substantial decision, the grants an extension of the time period to control test is not satisfied. make the necessary change. (e) Effective date—(1) General rule. Ex- (3) Automatic migration provisions. cept for the election to remain a do- Notwithstanding any other provision mestic trust provided in paragraph (f) in this section, United States persons of this section, this section is applica- are not considered to control all sub- ble to trusts for taxable years ending stantial decisions of the trust if an at- after February 2, 1999. This section tempt by any governmental agency or may be relied on by trusts for taxable creditor to collect information from or years beginning after December 31, assert a claim against the trust would 1996, and also may be relied on by cause one or more substantial decisions trusts whose trustees have elected to of the trust to no longer be controlled apply sections 7701(a)(30) and (31) to the by United States persons. trusts for taxable years ending after (4) Examples. The following examples August 20, 1996, under section illustrate the rules of this paragraph 1907(a)(3)(B) of the Small Business Job (d): Protection Act of 1996, (the SBJP Act) Example 1. A, a nonresident alien indi- Public Law 104–188, 110 Stat. 1755 (26 vidual, is the grantor and, during A’s life- U.S.C. 7701 note). time, the sole beneficiary of a trust that (2) Trusts created after August 19, 1996. qualifies as an individual retirement account If a trust is created after August 19, (IRA). A has the exclusive power to make de- 1996, and before April 5, 1999, and the cisions regarding withdrawals from the IRA and to direct its investments. The IRA’s sole trust satisfies the control test set forth trustee is a United States person within the in the regulations project REG–251703– meaning of section 7701(a)(30). The control 96 published under section 7701(a)(30) test is satisfied with respect to this trust be- and (31) (1997–1 C.B. 795) (See cause the special rule of paragraph (d)(1)(iv) § 601.601(d)(2) of this chapter), but does of this section applies. not satisfy the control test set forth in Example 2. A, a nonresident alien indi- paragraph (d) of this section, the trust vidual, is the grantor of a trust and has the power to revoke the trust, in whole or in may be modified to satisfy the control part, and revest assets in A. A is treated as test of paragraph (d) by December 31, the owner of the trust under sections 672(f) 1999. If the modification is completed and 676. A is not a fiduciary of the trust. The by December 31, 1999, the trust will be trust has one trustee, B, a United States per- treated as satisfying the control test of son, and the trust has one beneficiary, C. B paragraph (d) for taxable years begin- has the discretion to distribute corpus or in- ning after December 31, 1996, (and for come to C. In this case, decisions exercisable by A to have trust assets distributed to A are taxable years ending after August 20, substantial decisions. Therefore, the trust is 1996, if the election under section a foreign trust because B does not control all 1907(a)(3)(B) of the SBJP Act has been substantial decisions of the trust. made for the trust).
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(f) Election to remain a domestic trust— come is not required to file a Form (1) Trusts eligible to make the election to 1041. Section 6012(a)(4). For purposes of remain domestic. A trust that was in ex- the election, a trust that filed neither istence on August 20, 1996, and that was a Form 1041 nor a Form 1040NR for the treated as a domestic trust on August period that includes August 19, 1996, 19, 1996, as provided in paragraph (f)(2) will be considered to have been treated of this section, may elect to continue as a domestic trust on August 19, 1996, treatment as a domestic trust notwith- if the trust had a reasonable basis standing section 7701(a)(30)(E). This (within the meaning of section 6662) election is not available to a trust that under prior law for being treated as a was wholly-owned by its grantor under domestic trust for that period and for subpart E, part I, subchapter J, chapter filing neither a Form 1041 nor a Form 1, of the Code on August 20, 1996. The 1040NR for that period. election is available to a trust if only a (3) Procedure for making the election to portion of the trust was treated as remain domestic—(i) Required Statement. owned by the grantor under subpart E To make the election, a statement on August 20, 1996. If a partially-owned must be filed with the Internal Rev- grantor trust makes the election, the enue Service in the manner and time election is effective for the entire described in this section. The state- trust. Also, a trust may not make the ment must be entitled ‘‘Election to Re- election if the trust has made an elec- main a Domestic Trust under Section tion pursuant to section 1907(a)(3)(B) of 1161 of the Taxpayer Relief Act of the SBJP Act to apply the new trust 1997,’’ be signed under penalties of per- criteria to the first taxable year of the jury by at least one trustee of the trust ending after August 20, 1996, be- trust, and contain the following infor- cause that election, once made, is ir- mation— revocable. (A) A statement that the trust is (2) Determining whether a trust was electing to continue to be treated as a treated as a domestic trust on August 19, domestic trust under section 1161 of the 1996—(i) Trusts filing Form 1041 for the Taxpayer Relief Act of 1997; taxable year that includes August 19, (B) A statement that the trustee had 1996. For purposes of the election, a a reasonable basis (within the meaning trust is considered to have been treated of section 6662) under prior law for as a domestic trust on August 19, 1996, treating the trust as a domestic trust if: the trustee filed a Form 1041, ‘‘U.S. on August 19, 1996. (The trustee need Income Tax Return for Estates and not explain the reasonable basis on the Trusts,’’ for the trust for the period election statement.); that includes August 19, 1996 (and did (C) A statement either that the trust not file a Form 1040NR, ‘‘U.S. Non- filed a Form 1041 treating the trust as resident Alien Income Tax Return,’’ for a domestic trust for the period that in- that year); and the trust had a reason- cludes August 19, 1996, (and that the able basis (within the meaning of sec- trust did not file a Form 1040NR for tion 6662) under section 7701(a)(30) prior that period), or that the trust was not to amendment by the SBJP Act (prior required to file a Form 1041 or a Form law) for reporting as a domestic trust 1040NR for the period that includes Au- for that period. gust 19, 1996, with an accompanying (ii) Trusts not filing a Form 1041. Some brief explanation as to why a Form 1041 domestic trusts are not required to file was not required to be filed; and Form 1041. For example, certain group (D) The name, address, and employer trusts described in Rev. Rul. 81–100 identification number of the trust. (1981–1 C.B. 326) (See § 601.601(d)(2) of (ii) Filing the required statement with this chapter) consisting of trusts that the Internal Revenue Service. (A) Except are parts of qualified retirement plans as provided in paragraphs (f)(3)(ii)(E) and individual retirement accounts are through (G) of this section, the trust not required to file Form 1041. Also, a must attach the statement to a Form domestic trust whose gross income for 1041. The statement may be attached to the taxable year is less than the either the Form 1041 that is filed for amount required for filing an income the first taxable year of the trust be- tax return and that has no taxable in- ginning after December 31, 1996 (1997
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taxable year), or to the Form 1041 filed application of section 7701(a)(30)(E) to for the first taxable year of the trust the trust, but has not yet filed a Form beginning after December 31, 1997 (1998 1040NR for the 1997 taxable year, when taxable year). The statement, however, the trust files its Form 1041 for the 1997 must be filed no later than the due taxable year it must note on its Form date for filing a Form 1041 for the 1998 1041 that it made estimated tax pay- taxable year, plus extensions. The elec- ments based on treatment as a foreign tion will be effective for the 1997 tax- trust. The Form 1041 must be filed with able year, and thereafter, until revoked the Philadelphia Service Center (and or terminated. If the trust filed a Form not with the service center where the 1041 for the 1997 taxable year without trust ordinarily would file its Form the statement attached, the statement 1041). should be attached to the Form 1041 (E) If a trust forms part of a qualified filed for the 1998 taxable year. stock bonus, pension, or profit sharing (B) If the trust has insufficient gross plan, the election provided by this income and no taxable income for its paragraph (f) must be made by attach- 1997 or 1998 taxable year, or both, and ing the statement to the plan’s annual therefore is not required to file a Form return required under section 6058 (in- 1041 for either or both years, the trust formation return) for the first plan must make the election by filing a year beginning after December 31, 1996, Form 1041 for either the 1997 or 1998 or to the plan’s information return for taxable year with the statement at- the first plan year beginning after De- tached (even though not otherwise re- cember 31, 1997. The statement must be quired to file a Form 1041 for that attached to the plan’s information re- year). The trust should only provide on turn that is filed no later than the due the Form 1041 the trust’s name, name date for filing the plan’s information and title of fiduciary, address, em- return for the first plan year beginning ployer identification number, date cre- after December 31, 1997, plus exten- ated, and type of entity. The statement sions. The election will be effective for must be attached to a Form 1041 that is the first plan year beginning after De- filed no later than October 15, 1999. cember 31, 1996, and thereafter, until (C) If the trust files a Form 1040NR for the 1997 taxable year based on ap- revoked or terminated. plication of new section 7701(a)(30)(E) (F) Any other type of trust that is to the trust, and satisfies paragraph not required to file a Form 1041 for the (f)(1) of this section, in order for the taxable year, but that is required to trust to make the election the trust file an information return (for exam- must file an amended Form 1040NR re- ple, Form 5227) for the 1997 or 1998 tax- turn for the 1997 taxable year. The able year must attach the statement to trust must note on the amended Form the trust’s information return for the 1040NR that it is making an election 1997 or 1998 taxable year. However, the under section 1161 of the Taxpayer Re- statement must be attached to an in- lief Act of 1997. The trust must attach formation return that is filed no later to the amended Form 1040NR the state- than the due date for filing the trust’s ment required by paragraph (f)(3)(i) of information return for the 1998 taxable this section and a completed Form 1041 year, plus extensions. The election will for the 1997 taxable year. The items of be effective for the 1997 taxable year, income, deduction and credit of the and thereafter, until revoked or termi- trust must be excluded from the nated. amended Form 1040NR and reported on (G) A group trust described in Rev. the Form 1041. The amended Form Rul. 81–100 consisting of trusts that are 1040NR for the 1997 taxable year, with parts of qualified retirement plans and the statement and the Form 1041 at- individual retirement accounts (and tached, must be filed with the Philadel- any other trust that is not described phia Service Center no later than the above and that is not required to file a due date, plus extensions, for filing a Form 1041 or an information return) Form 1041 for the 1998 taxable year. need not attach the statement to any (D) If a trust has made estimated tax return and should file the statement payments as a foreign trust based on with the Philadelphia Service Center.
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The trust must make the election pro- date of the termination of the election. vided by this paragraph (f) by filing the See sections 684, 6048, and 6677 for the statement by October 15, 1999. The elec- federal tax consequences and reporting tion will be effective for the 1997 tax- requirements related to the change in able year, and thereafter, until revoked trust residence. or terminated. (5) Effective date. This paragraph (f) is (iii) Failure to file the statement in the applicable beginning on February 2, required manner and time. If a trust fails 1999. to file the statement in the manner or [T.D. 8813, 64 FR 4970, Feb. 2, 1999] time provided in paragraphs (f)(3)(i) and (ii) of this section, the trustee may § 301.7701–8 Military or naval forces provide a written statement to the dis- and Armed Forces of the United trict director having jurisdiction over States. the trust setting forth the reasons for The term ‘‘military or naval forces of failing to file the statement in the re- the United States’’ and the term quired manner or time. If the district ‘‘Armed Forces of the United States’’ director determines that the failure to each includes all regular and reserve file the statement in the required man- components of the uniformed services ner or time was due to reasonable which are subject to the jurisdiction of cause, the district director may grant the Secretary of Defense, the Secretary the trust an extension of time to file of the Army, the Secretary of the the statement. Whether an extension of Navy, or the Secretary of the Air time is granted shall be in the sole dis- Force. The terms also include the cretion of the district director. How- Coast Guard. The members of such ever, the relief provided by this para- forces include commissioned officers graph (f)(3)(iii) is not ordinarily avail- and the personnel below the grade of able if the statute of limitations for commissioned officer in such forces. the trust’s 1997 taxable year has ex- pired. Additionally, if the district di- § 301.7701–9 Secretary or his delegate. rector grants an extension of time, it (a) The term Secretary or his delegate may contain terms with respect to as- means the Secretary of the Treasury, sessment as may be necessary to en- or any officer, employee, or agency of sure that the correct amount of tax the Treasury Department duly author- will be collected from the trust, its ized by the Secretary (directly, or indi- owners, and its beneficiaries. rectly by one or more redelegations of (4) Revocation or termination of the authority) to perform the function election—(i) Revocation of election. The mentioned or described in the context, election provided by this paragraph (f) and the term ‘‘or his delegate’’ when to be treated as a domestic trust may used in connection with any other offi- only be revoked with the consent of the cial of the United States shall be simi- Commissioner. See sections 684, 6048, larly construed. and 6677 for the federal tax con- (b) In any case in which a function is sequences and reporting requirements vested by the Internal Revenue Code of related to the change in trust resi- 1954 or any other statute in the Sec- dence. retary or his delegate, and Treasury (ii) Termination of the election. An regulations or Treasury decisions ap- election under this paragraph (f) to re- proved by the Secretary or his delegate main a domestic trust terminates if provide that such function may be per- changes are made to the trust subse- formed by the Commissioner, assistant quent to the effective date of the elec- commissioner, regional commissioner, tion that result in the trust no longer assistant regional commissioner, dis- having any reasonable basis (within trict director, director of a regional the meaning of section 6662) for being service center, or by a designated offi- treated as a domestic trust under sec- cer or employee in the office of any tion 7701(a)(30) prior to its amendment such officer, such provision in the regu- by the SBJP Act. The termination of lations or Treasury decision shall con- the election will result in the trust stitute a delegation by the Secretary of changing its residency from a domestic the authority to perform such function trust to a foreign trust on the effective to the designated officer or employee.
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If such authority is delegated to any responding provisions of prior law, or officer or employee performing services pursuant to section 6109, and in which under the supervision and control of nine digits are separated by hyphens as the Commissioner, such provision in follows: 000-00-0000. Such term does not the regulations or Treasury decision include a number with a letter as a suf- shall constitute a delegation by the fix which is used to identify an auxil- Secretary to the Commissioner of the iary beneficiary under the social secu- authority to perform such function and rity program. The terms ‘‘account a redelegation thereof by the Commis- number’’ and ‘‘social security number’’ sioner to the designated officer or em- refer to the same number. ployee. (c) An officer or employee, including [T.D. 7306, 39 FR 9947, Mar. 15, 1974] the Commissioner, authorized by regu- lations or Treasury decision to perform § 301.7701–12 Employer identification a function shall have authority to re- number. delegate the performance of such func- For purposes of this chapter, the tion to any officer or employee per- term employer identification number forming services under his supervision means the taxpayer identifying number and control, unless such power to so re- of an individual or other person delegate is prohibited or restricted by (whether or not an employer) which is proper order or directive. The Commis- assigned pursuant to section 6011 (b) or sioner may also redelegate authority corresponding provisions of prior law, to perform such function to other offi- or pursuant to section 6109, and in cers or employees under his supervision which nine digits are separated by a and control and, to the extent he hyphen, as follows: 00–0000000. The deems proper, may authorize further terms ‘‘employer identification num- redelegation of such authority. ber’’ and ‘‘identification number’’ (de- (d) The Commissioner may prescribe fined in § 31.0–2(a)(11) of this chapter such limitations as he deems proper on (Employment Tax Regulations)) refer the extent to which any officer or em- to the same number. ployee under his supervision and con- trol shall perform any such function, [T.D. 7306, 39 FR 9947, Mar. 15, 1974] but, in the case of an officer or em- ployee designated in regulations or § 301.7701–13 Pre-1970 domestic build- Treasury decision as authorized to per- ing and loan association. form such function, such limitations (a) In general. For taxable years be- shall not render invalid any perform- ginning after October 16, 1962, and be- ance by such officer or employee of the fore July 12, 1969, the term ‘‘domestic function which, except for such limita- building and loan association’’ means a tions, such officer or employee is au- domestic building and loan association, thorized to perform by such regula- a domestic savings and loan associa- tions or Treasury decision in effect at tion, a Federal savings and loan asso- the time the function is performed. ciation, and any other savings institu- tion chartered and supervised as a sav- § 301.7701–10 District director. ings and loan or similar association The term district director means the under Federal or State law which district director of internal revenue for meets supervisory test (described in an internal revenue district. The term paragraph (b) of this section), the busi- also includes the Assistant Commis- ness operations test (described in para- sioner (International). graph (c) of this section), and each of [32 FR 15241, Nov. 3, 1967, as amended by T.D. the various assets tests (described in 8411, 57 FR 15241, Apr. 27, 1992] paragraphs (d), (e), (f), and (h) of this section). For the definition of the term § 301.7701–11 Social security number. ‘‘domestic building and loan associa- For purposes of this chapter, the tion’’, for taxable years beginning after term social security number means the July 11, 1969, see §301.7701–13A. taxpayer identifying number of an indi- (b) Supervisory test. A domestic build- vidual or estate which is assigned pur- ing and loan association must be either suant to section 6011(b) or cor- (1) an insured institution within the
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meaning of section 401(a) of the Na- thority. In addition, such requirement tional Housing Act (12 U.S.C. 1724 (a)) will be considered to be met if more or (2) subject by law to supervision and than 85 percent of the dollar amount of examination by State or Federal au- the total deposits and withdrawable thority having supervision over such shares of the association are held dur- associations. An ‘‘insured institution’’ ing the taxable year by the general is one the accounts of which are in- public as opposed to amounts deposited sured by the Federal Savings and Loan by family or related business groups or Insurance Corporation. persons who are officers or directors of (c) Business operations test—(1) In gen- the association. The percentage speci- eral. An association must utilize its as- fied in this subparagraph shall be com- sets so that substantially all of its puted as of the close of the taxable business consists of acquiring the sav- year, or at the option of the taxpayer, ings of the public and investing in the on the basis of the average of the loans described in subparagraphs (6) amounts of deposits held during the through (10) of paragraph (d) of this year. Such average shall be determined section. The requirement of this para- by computing the percentage specified graph is referred to in this section as either as of the close of each month, as the business operations test. The busi- of the close of each quarter, or semi- ness of acquiring the savings of the annually during the taxable year and public and investing in the prescribed by using the yearly average of the loans includes ancillary or incidental monthly, quarterly, or semiannual per- activities which are directly and pri- centages obtained. marily related to such acquisition and investment, such as advertising for (3) Investing in loans—(i) In general. savings, appraising property on which The requirement that substantially all loans are to be made by the associa- of an association’s business (other than tion, and inspecting the progress of acquiring the savings of the public) construction in connection with con- must consist of investing in the loans struction loans. Even though an asso- described in subparagraphs (6) through ciation meets the supervisory test in (10) of paragraph (d) of this section or- paragraph (b) and all the assets tests dinarily will be considered to be met described in paragraphs (d) through (h) for a taxable year if the association of this section, it will nevertheless not meets both the gross income test de- qualify as a domestic building and loan scribed in subdivision (ii) of this sub- association if any substantial part of paragraph, and the sales activity test its business consists of activities which described in subdivision (iii) of this are not directly and primarily related subparagraph. However, if an associa- to such acquisition and investment, tion does not meet the requirements of such as brokering mortgage paper, sell- both subdivisions (ii) and (iii) of this ing insurance, or subdividing real es- subparagraph, it will nevertheless meet tate. However, an association will meet the investing in loans requirement if it the business operations test for a tax- is able to demonstrate that substan- able year if it meets the requirements tially all its business (other than ac- of both subparagraphs (2) and (3) of this quiring the savings of the public) con- paragraph (c), relating respectively to sisted of investing in the prescribed acquiring the savings of the public, and loans. Transactions which are neces- investing in loans. sitated by exceptional circumstances (2) Acquiring the savings of the public. and which are not undertaken as recur- The requirement that substantially all ring business activities for profit will of an association’s business (other than not be considered a substantial part of investing in loans) must consist of ac- an association’s business. Thus, for ex- quiring the savings of the public ordi- ample, an association would meet the narily will be considered to be met if investing in loans requirement if it can savings are acquired in all material re- establish that it failed to meet the spects in conformity with the rules and gross income test because of receipt of regulations of the Federal Home Loan a non-recurring item of income due to Bank Board or substantially equivalent exceptional circumstances, or it failed rules of a State law or supervisory au- to meet the sales activity test because
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of sales made to achieve necessary li- fail to meet the gross income test, if in quidity to meet abnormal withdrawals the aggregate they exceed 15 percent of from savings accounts. For the pur- gross income, are the excess of gains poses of this subparagraph, however, over losses on sale of real estate (other the acquisition of loans in anticipation than foreclosed property); rental in- of their sale to other financial institu- come (other than on foreclosed prop- tions does not constitute ‘‘investing’’ erty and the portion of property used in loans, even though such acquisition in the association’s business); pre- and sale resulted from an excess of de- miums, commissions, and fees (other mand for loans over savings capital in than commitment fees) on loans which the association’s area. have never been held by the associa- (ii) Gross income test. The gross in- tion; and insurance brokerage fees. come test is met if more than 85 per- (iii) Sales activity test: in general. The cent of the gross income of an associa- sales activity test is met for a taxable tion consists of: year if the association meets both the (a) Interest or dividends on assets de- sales of whole loans test described in fined in subparagraph (2), (3), or (4) of subdivision (iv) of this subparagraph, paragraph (d) of this section, and the sales of whole loans and par- (b) Interest on loans defined in sub- ticipations test described in subdivi- paragraphs (6) through (10) of para- sion (v) of this subparagraph. For the graph (d) of this section, purposes of this subdivision and sub- (c) Income attributable to the por- divisions (iv), (v), and (vi) of this sub- tion of property used in the associa- paragraph: tion’s business as defined in paragraph (a) The term loan means loan as de- (d)(5) of this section, fined in paragraph (j)(1) of this section, (d) Premiums, discounts, commis- other than foreclosed property defined sions, or fees (including late charges in such paragraph and governmental and penalties) on loans defined in sub- obligations defined in paragraph (d)(3) paragraphs (6) through (10) of para- of this section. graph (d) of this section which have at (b) The amount of a loan shall be de- some time been held by the associa- termined in accordance with the rules tion, or for which firm commitments contained in paragraph (l) (1) and (2)(ii) have been issued, of this section. (e) Gain or loss on the sale of govern- (c) The term loans acquired for invest- mental obligations defined in para- ment during the taxable year means the graph (d)(3) of this section, or amount of loans outstanding as of the ( f ) Income, gain, or loss attributable close of the taxable year, reduced (but to foreclosed property (as defined in not below zero) by the amount of loans paragraph (j)(1) of this section), but not outstanding as of the beginning of such including such income, gain, or loss year, and increased by the lesser of (1) which, pursuant to section 595 and the the amount of repayments made on regulations thereunder, is not included loans during the taxable year or (2) an in gross income. amount equal to 20 percent of the For the purposes of this subparagraph, amount of loans outstanding as of the gross income shall be computed with- beginning of the taxable year. For this out regard to gains or losses on the purpose, repayments do not include re- sale of the portion of property used in payments on loans to the extent such the association’s business (described in loans are refinanced by the association. paragraph (d)(5) of this section), with- (d) The term sales of participations out regard to gains or losses on the means sales by an association of inter- rented portion of property used as the ests in loans, which sales meet the re- principal or branch office of the asso- quirements of the regulations of the ciation (described in such paragraph), Federal Home Loan Bank Board relat- and without regard to gains or losses ing to sales of participations, or which on the sale of participations and loans meet substantially equivalent require- (other than governmental obligations ments of State law or regulations re- defined in paragraph (d)(3) of this sec- lating to sales of participations. tion). Examples of types of income (e) The term sales of whole loans which would cause an association to means sales of loans other than sales of
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participations as defined in subdivision (v) Sales of whole loans and participa- (d) of this subdivision, but in deter- tions test. The sales of whole loans and mining the amount of sales of whole participations test is met if the sum of loans, the following sales shall be dis- the amount of sales of whole loans and regarded: Sales of loans made to other the amount of sales of participations financial institutions pursuant to an during the taxable year does not exceed arrangement whereunder the associa- 100 percent of the amount of loans ac- tion simultaneously enters in a bona quired for investment during the tax- fide agreement to repurchase such able year. loans within a period of 18 months from (vi) Sales activity tests: special rules— the time of sale if such arrangement (a) Carryover of sales. The amount spec- conforms to the rules and regulations ified in subdivision (iv)(a) of this sub- of applicable supervisory authorities; paragraph as the maximum amount of sales made to the Federal Savings and sales of whole loans shall be increased Loan Insurance Corporation or to a by the amount by which 15 percent of corporation defined in paragraph (d)(4) the amount of loans acquired for in- of this section (relating to deposit in- vestment by the association during the surance company securities); and sales 2 preceding taxable years exceeds the made in the course of liquidation of the amount of sales of whole loans made association pursuant to Federal or during such preceding taxable years; State law. and the amount specified in subdivision (iv) Sales of whole loans test. The sales (v) of this subparagraph as the max- of whole loans test is met for a taxable imum amount of sales of whole loans year if the amount of sales of whole and participations shall be increased loans during the taxable year does not by the amount by which the amount of exceed the greater of (a) 15 percent of the amount of loans acquired for in- loans acquired for investment by the vestment during the taxable year, or association during the 2 preceding tax- (b) 20 percent of the amount of loans able years exceeds the sum of the outstanding at the beginning of the amount of sales of whole loans and par- taxable year. However, the 20 percent ticipations made during such preceding of beginning loans limitation specified taxable years. For example, if 15 per- in subdivision (b) of the previous sen- cent of the amount of loans acquired tence shall be reduced by the number for investment in 1965 and 1966 exceed- of percentage points (rounded to the ed the amount of sales of whole loans nearest one hundredth of a percentage during such years by $250,000, the point) which is equal to the sum of the amount of sales of whole loans per- 2 percentages obtained by dividing, for mitted in 1967 under subdivision (iv)(a) each of the 2 preceding taxable years, of this subparagraph would be in- the amount of sales of whole loans dur- creased by $250,000. ing each such taxable year by the (b) Use of preceding year’s base. If the amount of loans outstanding at the be- amount of loans acquired for invest- ginning of such taxable year. For ex- ment by the association during the pre- ample, if the amounts of sales of whole ceding taxable year exceeds such loans made by a calendar year associa- amount for the current taxable year, tion in 1965 and 1966 were 3 percent and the 15 percent limitation provided in 4 percent, respectively, of loans out- subdivision (iv)(a) of this subparagraph standing at the beginning of each such and the 100 percent limitation provided year, the amount of sales of whole in subdivision (v) of this subparagraph loans allowed under such subdivision shall be based upon such preceding tax- (b) for 1967 would be an amount equal able year’s amount. However, the max- to 13 percent (20 percent minus 7 per- imum amount of sales of whole loans centage points) of loans outstanding at permitted under subdivision (iv)(a) and the beginning of 1967. In computing the the maximum amount of sales of whole reduction to the 20 percent of begin- loans and participations permitted ning loans limitation specified in such under subdivision (v) in any taxable subdivision (b), sales of whole loans year shall be reduced by the amount of made before January 1, 1964, shall not the increase in such sales allowed for be taken into account. the preceding taxable year solely by
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reason of the application of the provi- of loans acquired for investment in 1966, X sions of the previous sentence. For ex- may base its 15 percent limitation for 1966 on ample, assuming no carryover of sales the $320,000 amount and sell whole loans in an amount up to $48,000 (15 percent of under subdivision (a) of this subdivi- $320,000) and still meet the sales of whole sion, if the amount of loans acquired loans test. However, to the extent that the for investment by a calendar year asso- amount of sales of whole loans exceeds ciation was $1,000,000 in 1965, under sub- $45,000 (15 percent of the $300,000 amount of division (iv)(a) of this subparagraph the loans acquired for investment in 1966), the association could make sales of whole maximum amount of sales computed under loans in 1966 of $150,000 (15 percent of the percentage of loans acquired for invest- $1,000,000) even though the amount of ment limitation (but not the 20 percent of beginning loans limitation) for 1967 must be its loans acquired for investment dur- reduced. ing 1966 was only $800,000. However, the Example 3. Y Association made no sales of amount of sales of whole loans per- whole loans in 1964 and 1965, and made sales mitted in 1967 under subdivision (iv)(a) of participations in the 2 years in amounts of this subparagraph would be reduced which, in the aggregate, were $50,000 less to the extent that the amount of the than the amounts of loans acquired for in- sales of whole loans made by the asso- vestment for such years. At the beginning of ciation during 1966 exceeded $120,000 (15 1966 the amount of Y’s loans outstanding was $1 million, and the amount of its loans ac- percent of $800,000). quired for investment in such year was (vii) Examples illustrating sales activity $100,000. Although the maximum amount of test. The provisions of subdivisions (iii) sales of whole loans which Y could make through (vi) of this subparagraph may under the sales of whole loans test is $200,000 be illustrated by the following exam- (20 percent of $1 million), nevertheless, in ples in each of which it is assumed that order to meet the sales of whole loans and the association is a calendar year tax- participations test, the sum of the amounts payer which is operated in all material of sales of whole loans and sales of participa- tions may not exceed $150,000 (100 percent of respects in conformity with applicable the $100,000 amount of loans acquired for in- rules and regulations of Federal or vestment in 1966 plus a carryover of sales State supervisory authorities. from the previous two years of $50,000). It is assumed that the amount of loans acquired Example 1. X Association made sales of for investment in 1965 did not exceed $100,000, whole loans in 1964 and 1965 which were 10 so that the preceding year’s base cannot be percent and 7 percent, respectively, of the used to increase the amount of sales per- amounts of loans outstanding at the begin- mitted in 1966. ning of each such year, and which were 25 percent and 17 percent, respectively, of the (viii) Reporting requirements. In the amounts of loans acquired for investment in case of income tax returns for taxable each such year. The amount of X’s loans out- years ending after October 31, 1964, standing at the beginning of 1966 was $1 mil- there shall be filed with the return a lion, and the amount of its loans acquired for investment for such year was $300,000. The statement showing the amount of gross maximum amount of sales of whole loans income for the taxable year in each of which X may make under the percentage of the categories described in subdivision beginning loans limitation for 1966 is $30,000, (ii) of this subparagraph; and, for the which is 3 percent (20 percent reduced by the taxable year and the two preceding sum of 10 percent and 7 percent) of $1 mil- taxable years, the amount of loans (de- lion. The maximum amount of sales of whole scribed in subdivision (iii) (a) of this loans permitted under the percentage of subparagraph) outstanding at the be- loans acquired for investment limitation for 1966 is $45,000 (15 percent of $300,000). X may ginning of the year and at the end of therefore sell whole loans in an amount up the year, the amount of repayments on to $45,000 in 1966 and meet the sales of whole loans (not including repayments on loans test. It is assumed that the amount of loans to the extent such loans are refi- loans acquired for investment in 1965 did not nanced by the association), the amount exceed $300,000, so that the preceding year’s of sales of whole loans, and the amount base cannot be used to increase the amount of sales of participations. of sales permitted in 1966. (4) Effective date. The provisions of Example 2. Assume the same facts as in the previous example, except that the amount of subparagraphs (1) through (3) of this loans acquired for investment in the pre- paragraph (c), are applicable to taxable ceding year (1965) was $320,000. Since such years ending after October 31, 1964. amount is greater than the $300,000 amount However, at the option of the taxpayer,
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for a taxable year beginning before No- ing and loan association must consist vember 1, 1964, and ending after Octo- of the assets defined in subparagraphs ber 31, 1964, the provisions of subpara- (2) through (10) of this paragraph (d). graphs (1) through (3) of this paragraph For purposes of this paragraph, it is (except the 20 percent of beginning immaterial whether the association loans limitation specified in subdivi- originated the loans defined in sub- sion (iv)(b) of subparagraph (3) of this paragraphs (6) through (10) of this para- paragraph (c)) shall apply only to the graph (d), or purchased or otherwise ac- part year falling after October 31, 1964, quired them in whole or in part from as if such part year constituted a tax- another. See paragraph (j) of this sec- able year. In such case, the following tion for definition of certain terms rules shall apply: used in this paragraph, and paragraph (i) The amount of the ‘‘loans acquired (k) of this section for the determina- for investment’’ for such part year tion of amount and character of loans. shall be equal to the loans acquired for (2) Cash. The term ‘‘cash’’ means investment during the entire taxable cash on hand, and time or demand de- year within which falls such part year, posits with, or withdrawable accounts multiplied by a fraction the numerator in, other financial institutions. of which is the number of days in such (3) Governmental obligations. The term part year and the denominator of ‘‘governmental obligations’’ means ob- which is the number of days in such en- ligations of the United States, a State tire taxable year. or political subdivision of a State, and (ii) The increase in sales of whole stock or obligations of a corporation loans and participations permitted by which is an instrumentality of the subdivision (vi) of subparagraph (3) of United States, a State, or political sub- this paragraph (c), (relating to carry- division of a State. over of sales and use of preceding (4) Deposit insurance company securi- year’s base) shall be the amount of ties. The term ‘‘deposit insurance com- such increase computed under such pany securities’’ means certificates of subdivision, multiplied by the fraction deposit in, or obligations of, a corpora- specified in subdivision (i) of this sub- tion organized under a State law which paragraph. specifically authorizes such corpora- If, treating the part year as a taxable tion to insure the deposits or share ac- year, the association meets all the re- counts of member associations. quirements of this paragraph for such (5) Property used in the association’s part year it will be considered to have business—(i) In general. The term met the business operations test for ‘‘property used in the association’s the entire taxable year, providing it business’’ means land, buildings, fur- operated in all material respects in niture, fixtures, equipment, leasehold conformity with applicable rules and interests, leasehold improvements, and regulations of Federal or State super- other assets used by the association in visory authorities for the entire tax- the conduct of its business of acquiring able year. The 20 percent of beginning the savings of the public and investing loans limitation specified in subdivi- in the loans defined in subparagraphs sion (iv)(b) of subparagraph (3) of this (6) through (10) of this paragraph (d). paragraph (c), shall be applied only on Real property held for the purpose of the basis of a taxable year and not the being used primarily as the principal or part year. For taxable years beginning branch office of the association con- after October 16, 1962, and ending be- stitutes property used in the associa- fore November 1, 1964, an association tion’s business so long as it is reason- will be considered to have met the ably anticipated that such property business operations test if it operated will be occupied for such use by the as- in all material respects in conformity sociation, or that construction work with applicable rules and regulations of preparatory to such occupancy will be Federal or State supervisory authori- commenced thereon, within 2 years ties. after acquisition of the property. Stock (d) 90 percent of assets test—(1) In gen- of a wholly owned subsidiary corpora- eral. At least 90 percent of the amount tion which has as its exclusive activity of the total assets of a domestic build- the ownership and management of
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property more than 50 percent of the secured by a deposit, withdrawable fair rental value of which is used as the share, or savings account in the asso- principal or branch office of the asso- ciation, or share of a member of the as- ciation constitutes property used in sociation, with respect to which a dis- such business. Real property held by an tribution is allowable as a deduction association for investment or sale, under section 591. even for the purpose of obtaining mort- (7) Home loan. The term ‘‘home loan’’ gage loans thereon, does not constitute means a loan secured by an interest property used in the association’s busi- in— ness. (i) Improved residential real property (ii) Property rented to others. Except consisting of a structure or structures as provided in the second sentence of containing, in the aggregate, no more subdivision (i) of this subparagraph, than 4 family units. property or a portion thereof rented by (ii) An individually owned family the association to others does not con- unit in a multiple-unit structure, the stitute property used in the associa- owner of which unit owns an undivided tion’s business. However, if the fair interest in the underlying real estate rental value of the rented portion of a and the common elements of such single piece of real property (including structure (so-called condominium appurtenant parcels) used as the prin- type). cipal or branch office of the association Or a construction loan or improvement constitutes less than 50 percent of the loan for such property. A construction fair rental value of such piece of prop- loan made for the purpose of financing erty, or if such property has an ad- more than one structure (so-called justed basis of not more than $150,000, tract financing) constitutes a home the entire property shall be considered loan, providing no individual structure used in such business. If such rented contains more than 4 family units and portion constitutes 50 percent or more it is contemplated that, as soon as pos- of the fair rental value of such piece of sible after completion of construction, property, and such property has an ad- the structures will become property de- justed basis of more than $150,000, an scribed in subdivision (i) of this sub- allocation of its adjusted basis is re- paragraph. A construction loan secured quired. The portion of the total ad- by a structure containing more than 4 justed basis of such piece of property family units constitutes a home loan which is deemed to be property used in only if the structure has been com- the association’s business shall be mitted to a plan of individual apart- equal to an amount which bears the ment ownership described in subdivi- same ratio to such total adjusted basis sion (ii) of this subparagraph and such as the amount of the fair rental value plan is held out and advertised as such. of the portion used as the principal or A loan secured by a cooperative apart- branch office of the association bears ment building containing more than 4 to the total fair rental value of such family units does not constitute a property. In the case of all property home loan. other than real property used or to be (8) Church loan. The term ‘‘church used as the principal or branch office of loan’’ means a loan secured by an in- the association, if the fair rental value terest in real property which is used of the rented portion thereof con- primarily for church purposes, or a stitutes less than 15 percent of the fair construction loan or improvement loan rental value of such property, the en- for such property. For the purposes of tire property shall be considered used this subparagraph, the term ‘‘church in the association’s business. If such purposes’’ means the ministration of rented portion constitutes 15 percent sacerdotal functions, the conduct of re- or more of the fair rental value of such ligious worship and closely associated property, an allocation of its adjusted activities designed primarily to pro- basis (in the same manner as required vide fellowship among members of the for real property used as the principal congregation, or the instruction of reli- or branch office) is required. gion. Thus, a parish hall would nor- (6) Passbook loan. The term ‘‘pass- mally qualify as property used pri- book loan’’ means a loan to the extent marily for church purposes, whereas a
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building used primarily to furnish edu- sets other than those defined in para- cation, other than the instruction of graph (d) of this section may not ex- religion, would not. ceed 41 percent of total assets. See sec- (9) Multifamily loan. The term ‘‘multi- tion 593(b)(5) and the regulations there- family loan’’ means a loan, other than under for the effect of application of one defined in subparagraph (7) of this this subparagraph on the allowable ad- paragraph (d), (relating to a home dition to the reserves for bad debts. loan), secured by an interest in im- (g) Taxable years for which 41 percent proved residential real property or a of assets test applies—(1) First taxable construction loan or improvement loan year. For an association’s first taxable for such property. year beginning after October 16, 1962, (10) Nonresidential real property loan. subparagraph (2) of paragraph (f) ap- The term ‘‘nonresidential real property plies. loan’’ means a loan, other than one de- (2) Second taxable year. For an asso- fined in subparagraph (7), (8), or (9) of ciation’s second taxable year beginning this paragraph (d), (relating respec- after October 16, 1962, subparagraph (2) tively to a home loan, church loan, and of paragraph (f) applies if such associa- multifamily loan) secured by an inter- tion met all the requirements of para- est in real property, or a construction graphs (b) through (e), (h), and either loan or improvement loan for such subparagraph (1) or (2) of paragraph (f) property. for its first taxable year. (e) 18 percent of assets test. Not more (3) Years other than first and second than 18 percent of the amount of the taxable years. For any taxable year of total assets of a domestic building and an association beginning after October loan association may consist of assets 16, 1962, other than its first and second other than those defined in subpara- taxable years beginning after such graphs (2) through (9) of paragraph (d) date, subparagraph (2) of paragraph (f) of this section. Thus, the sum of the applies if such association met either— amounts of the nonresidential real (i) The requirements of paragraphs property loans and the assets other (b) through (e), (f)(1), and (h) of this than those defined in paragraph (d) of section for the immediately preceding this section may not exceed 18 percent taxable year, or of total assets. (ii) The requirements of paragraphs (f) 36 or 41 percent of assets test—(1) 36 (b) through (e), (f)(2), and (h) of this percent test. Unless subparagraph (2) of section for the immediately preceding this paragraph (f), applies, not more taxable year, and the requirements of than 36 percent of the amount of the paragraphs (b) through (e), (f)(1), and total assets of a domestic building and (h) of this section for the second pre- loan association may consist of assets ceding taxable year. other than those defined in subpara- Thus, in years other than its first and graphs (2) through (8) of paragraph (d) second taxable years beginning after of this section. Thus, unless subpara- October 16, 1962, an association may graph (2) of this paragraph (f), applies, apply the 41 percent of assets test for 2 the sum of the amounts of multifamily consecutive years, but only if it met loans, nonresidential real property the 36 percent test (and all other tests) loans, and assets other than those de- for the year previous to the 2 consecu- fined in paragraph (d) of this section tive years. may not exceed 36 percent of total as- (4) Examples. The provisions of para- sets. graph (f) and this paragraph may be il- (2) 41 percent test. If this subpara- lustrated by the following examples in graph applies, not more than 41 percent each of which it is assumed that the as- of the amount of the total assets of a sociation at all times meets all the re- domestic building and loan association quirements of paragraphs (b) through may consist of assets other than those (e) and (h) of this section and files its defined in subparagraphs (2) through (8) returns on a calendar year basis. of paragraph (d) of this section. Thus, Example 1. An association has 41 percent of if this subparagraph applies, the sum of its assets invested in assets other than those the amounts of multifamily loans, non- defined in subparagraphs (2) through (8) of residential real property loans, and as- paragraph (d) of this section as of the close
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of 1963 and 1964. Because 1963 is its first tax- (3) Stock which was security for a able year beginning after October 16, 1962, loan and which, by reason of having the 41 percent of assets test applies, and the been bid in at foreclosure or otherwise association therefore qualifies as a domestic having been reduced to ownership or building and loan association for 1963. Be- cause 1964 is its second taxable year begin- possession of the association, is a loan ning after such date and the 41 percent of as- within the definition of such term in sets test applied for its first taxable year, paragraph (j)(1) of this section; and the 41 percent of assets test applies for 1964 (4) Stock of a wholly owned sub- and it therefor qualifies for such year. sidiary corporation which has as its ex- Example 2. An association has 36 percent of clusive activity the ownership and its assets invested in assets other than those management of property more than 50 defined in subparagraphs (2) through (8) of percent of the fair rental value of paragraph (d) of this section as of the close of 1964, and 41 percent as of the close of 1965, which is used as the principal or 1966, and 1967. The association qualifies in branch office of the association. 1965 because, as a result of having met the 36 (i) [Reserved] percent of assets test for the immediately (j) Definition of certain terms. For pur- preceding taxable year (1964), the 41 percent poses of this section— of assets test applies to 1965. It qualifies in (1) Loan. The term ‘‘loan’’ means 1966 because as a result of having met the 41 percent of assets test in the immediately debt, as the term ‘‘debt’’ is used in sec- preceding taxable year (1965) and the 36 per- tion 166 and the regulations there- cent of assets test in the second preceding under. The term ‘‘loan’’ also includes a taxable year (1964), the 41 percent of assets redeemable ground rent (as defined in test applies to 1966. The association would section 1055(c)) which is owned by the not qualify in 1967, however, because, al- taxpayer, and any property (referred to though it met the 41 percent of assets test in this section as ‘‘foreclosed prop- for the immediately preceding taxable year erty’’) which was security for the pay- (1966), it did not meet the 36 percent of assets test in the second preceding taxable year ment of any indebtedness and which (1965), and therefore the 41 percent of assets has been bid in at foreclosure, or other- test does not apply to 1967. wise been reduced to ownership or pos- Example 3. An association has more than 41 session of the association by agreement percent of its assets invested in assets other or process of law, whether or not such than those defined in subparagraphs (2) property was acquired subsequent to through (8) of paragraph (d) of this section as December 31, 1962. of the close of 1963, and 41 percent invested (2) Secured. A loan will be considered in such assets as of the close of 1964. The as- sociation does not qualify in either year. It as ‘‘secured’’ only if the loan is on the does not qualify in 1963 because it exceeded security of any instrument (such as a the 41 percent limitation, and it does not mortgage, deed of trust, or land con- qualify in 1964 because the 41 percent of as- tract) which makes the interest of the sets test does not apply to 1964 since the as- debtor in the property described there- sociation did not meet either the 41 percent in specific security for the payment of of assets test or the 36 percent of assets test the loan, provided that such instru- in the prior year (1963). ment is of such a nature that, in the (h) 3 percent of assets test. Not more event of default, the interest of the than 3 percent of the amount of the debtor in such property could be sub- total assets of a domestic building and jected to the satisfaction of the loan loan association may consist of stock with the same priority as a mortgage of any corporation, unless such stock is or deed of trust in the jurisdiction in property which is defined in paragraph which the property is situated. (d) of this section. The stock which (3) Interest. The word ‘‘interest’’ constitutes property defined in such means an interest in real property paragraph (d) is: which, under the law of the jurisdiction (1) Stock representing a in which such property is situated, con- withdrawable account in another finan- stitutes either (i) an interest in fee in cial institution; such property, (ii) a leasehold interest (2) Stock of a corporation which is an in such property extending or renew- instrumentality of the United States able automatically for a period of at or of a State or political subdivision least 30 years, or at least 10 years be- thereof; yond the date scheduled for the final
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payment on a loan secured by an inter- be used for such purposes, the entire est in such property, (iii) a leasehold loan will qualify. If 85 percent or less of interest in property described in para- the proceeds of a loan are to be used for graph (d)(7)(i) of this section (relating such purposes, an allocation of its ad- to certain home loans) extending for a justed basis is required. Examples of period of at least 2 years beyond the loans which constitute improvement date scheduled for the final payment loans are loans made for the purpose of on a loan secured by an interest in painting a house, adding a new room to such property or (iv) a leasehold inter- a house, remodeling the lobby of an est in such property held subject to a apartment building, and purchasing redeemable ground rent defined in sec- and installing storm windows, storm tion 1055(c). doors, and awnings. Examples of loans (4) Real property. The term ‘‘real which do not constitute improvement property’’ means any property which, loans are loans made for the purpose of under the law of the jurisdiction in purchasing draperies, and removable which such property is situated, con- appliances, such as refrigerators, stitutes real property. ranges, and washing machines. It is not (5) Improved real property. The term necessary that a loan be secured by the ‘‘improved real property’’ means— real property which is altered, re- (i) Land on which is located any paired, or improved. building of a permanent nature (such (8) Residential real property. The term as a house, apartment house, office ‘‘residential real property’’ means real building, hospital, shopping center, property which consists of one or more warehouse, garage, or other similar family units. A family unit is a build- permanent structure), provided that ing or portion thereof which contains the value of such building is substan- complete living facilities which are to tial in relation to the value of such be used on other than a transient basis land; by only one family consisting of one or (ii) Any building lot or site which, by more persons. Thus, an apartment reason of installations and improve- which is to be used on other than a ments that have been completed in transient basis by one family, which keeping with applicable governmental contains complete facilities for living, requirements and with general practice sleeping, eating, cooking, and sanita- in the community, is a building lot or tion constitutes a family unit. Hotels, site ready for the construction of any motels, dormitories, fraternity and so- building of a permanent nature within rority houses, rooming houses, hos- the meaning of subdivision (i) of this pitals, sanitariums, rest homes, and subparagraph; or parks and courts for mobile homes do (iii) Real property which, because of not normally constitute residential its state of improvement, produces suf- real property. ficient income to maintain such real (k) Amount and character of loans—(1) property and retire the loan in accord- Treatment at time of determination—(i) In ance with the terms thereof. general. The amount of a loan, as of the (6) Construction loan. The term ‘‘con- time the determination required by struction loan’’ means a loan, the pro- subparagraph (3) of this paragraph (k), ceeds of which are to be disbursed to is made, shall be treated for the pur- the borrower (either by the association poses of this section as being secured: or a third party) as construction work (a) First by the portion of property, progresses on real property which is se- if any, defined in subparagraph (6), (7), curity for the loan, which property is, or (8) of paragraph (d) of this section to or from the proceeds of such loan will the extent of the loan value thereof; become, improved real property. (b) Next by the portion of property, if (7) Improvement loan. The term ‘‘im- any, defined in subparagraph (9) of provement loan’’ means a loan which, paragraph (d) of this section to the ex- by its terms and conditions, requires tent of the loan value thereof; and that the proceeds of the loan be used (c) Next by the portion of property, if for altering, repairing, or improving any, defined in subparagraph (10) of real property. If more than 85 percent paragraph (d) of this section to the ex- of the proceeds of a single loan are to tent of the loan value thereof.
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To the extent that the amount of a (3) Time of determination—(i) In gen- loan exceeds the amount treated as eral. The determination of the amount being secured by property defined in of a loan which is treated as being se- subparagraphs (6) through (10) of para- cured by each of the categories of prop- graph (d) of this section, such loan erty shall be made: shall be treated as property not defined (a) As of the time a loan is made; in paragraph (d) of this section. If the (b) As of the time a loan is increased; loan value of any one category of prop- (c) As of the time any portion of the erty defined in paragraph (d) of this property which was security for the section exceeds 85 percent of the loan is released; and amount of the loan for which it is secu- (d) As of any time required by appli- rity then the entire loan shall be treat- cable Federal or State regulatory au- ed as a loan secured by such property. thorities for reappraisal or reanalysis (ii) Loans of $40,000 or less. Notwith- of such loans. standing the provisions of subdivision (ii) Special rule. In the case of loans (i) of this subparagraph, in the case of loans amounting to $40,000 or less as of outstanding with respect to which no the time of a determination, made on event described in subdivision (i) of the security of property which is a this subparagraph has occurred in a combination of two or more categories taxable year beginning on or after Oc- or property defined in subparagraph (6) tober 17, 1962, the determination of the through (10) of paragraph (d) of this amounts of such loans which are treat- section, all such loans for any taxable ed as being secured by each of the cat- year may, at the option of the associa- egories of property may be made, at tion, be treated for the purposes of this the option of the association, as of the section as being secured by the cat- close of the first taxable year begin- egory of property the loan value of ning on or after such date, providing which constitutes the largest percent- the determinations with respect to all age of the total loan value of the prop- such loans are made as of such date. erty except to the extent that the loan (4) Loan value. The loan value of is treated as property not defined in property which is security for a loan is paragraph (d) of this section. the maximum amount at the time as of (iii) Home loans of $20,000 or less. Not- which the determination is made which withstanding the provisions of subdivi- the association is permitted to lend on sions (i) and (ii) of this subparagraph, if such property under the rules and regu- a loan amounting to $20,000 or less as of lations of applicable Federal and State the time of a determination, is secured regulatory authorities. Such loan value partly by property of a category de- shall not exceed the fair market value scribed in subparagraph (7) of para- of such property at such time as deter- graph (d) of this section (relating to a mined under such rules and regula- home loan), the amount of the loan tions. However, in the case of loans shall, for the purposes of this section, made incidentally with and as a part of be treated as a loan described in such a bona fide salvage operation, the loan subparagraph except to the extent that value of the security property shall be the loan is treated as property not de- considered to be the face amount of the fined in paragraph (d) of this section. loan where the loan can be shown by (2) Treatment subsequent to time of de- the association to have been made for termination. The amount of a loan out- the primary purpose of recovering the standing as of any time subsequent to investment of the association, and the time of a determination shall be where such salvage operation is in con- treated, for the purposes of this sec- formity with rules and regulations of tion, as being secured by each of the applicable Federal or State regulatory categories of property in the same authorities. ratio that the amount which was treat- (5) Examples. The following examples, ed as being secured by each category in each of which it is assumed that X bore to the total amount of the loan at Savings and Loan Association files its the time as of which the determination return on a calendar year basis, illus- was last made with respect to such trate the application of the rules in loan. this paragraph:
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Example 1. On July 1, 1963, X makes a single Amount Percent- loan of $1 million to M Corporation which Category of loan of loan age of loan is secured by real property which is a total combination of homes, apartments, and Home loan ...... $400,000 40 stores. As of the time the loan is made X de- Multifamily loan ...... 420,000 42 termines that the loan values of the cat- Nonresidential real property loan ...... 180,000 18 egories of property are as follows: Total ...... 1,000,000 100 Category of property Loan value Assuming that the $1 million loan to M was Home ...... $400,000 Multifamily ...... 420,000 reduced to $900,000 as of the close of 1963, Nonresidential real property ...... 240,000 that there were no increases in the amount of the loan and no releases of property which Total ...... 1,060,000 was security for the loan, and that there was no regulatory requirement to reappraise or As of the time the loan is made, therefore, reanalyze the loan, such loan will be consid- the $1,000,000 loan is treated under subpara- ered under subparagraph (2) of this para- graph (1)(i) of this paragraph as being se- graph to be secured, as of the close of 1963, as cured as follows: follows:
Percentage as of Amount as of Dec. 31, 1963 Category last determina- tion July 1, 1963
Home ...... 40 $360,000 (40%×$900,000) Multifamily ...... 42 378,000 (42%×$900,000) Nonresidential real property ...... 18 162,000 (18%×$900,000)
Total ...... 900,000
Example 2. X makes a loan of $40,000 se- method as is in accordance with sound cured by a building which contains a store accounting principles, provided such on the first floor and four family units on method is used in valuing all the assets the upper floors. The loan value of the part of the building used as a store is $21,000 and in a taxable year. the loan value of the residential portion is (2) Treatment of certain assets and re- $23,000. The loan will be treated under sub- serves. For purposes of this paragraph division (i) of subparagraph (1) of this para- (l): graph as a loan secured by residential real (i) Reserves for bad debts established property containing four or fewer family units to the extent of $23,000, and by nonresi- pursuant to section 593, or cor- dential property to the extent of $17,000, as of responding provisions of prior law, and the time the loan is made. However, if X ex- the regulations thereunder shall not ercises the option to treat all loans of $40,000 constitute a reduction of total assets, or less in accordance with subdivision (ii) of but shall be treated as a surplus or net subparagraph (1) of this paragraph, this loan worth item. would be treated as a home loan to the ex- tent of the full $40,000 because the loan value (ii) The adjusted basis of a ‘‘loan in of the residential portion is larger than the process’’ does not include the loan value of the nonresidential part. unadvanced portion of such loan. (l) Computation of percentages—(1) In (iii) Advances made by the associa- general. The percentages specified in tion for taxes, insurance, etc., on loans paragraphs (d) through (h) of this sec- shall be treated as being in the same tion shall, except as provided in sub- category as the loan with respect to paragraph (3) of this paragraph (l), be which the advances are made (irrespec- computed by comparing the amount of tive of whether the advances are se- the assets described in each paragraph cured by the property securing the as of the close of the taxable year with loan). the total amount of assets as of the (iv) Interest receivable included in close of the taxable year. The amount gross income shall be treated as being of the assets in any category and the in the same category as the loan or total amount of assets shall be deter- asset with respect to which it is mined with reference to their adjusted earned. basis under § 1.1011–1, or by such other
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(v) The unamortized portion of pre- paid or disposed of within such period, miums paid on mortgage loans ac- shall be considered assets other than quired by the association shall be con- those defined in paragraph (d) of this sidered part of the acquisition cost of section, unless both the acquisition such loans. and disposition are established to the (vi) Prepaid Federal Savings and satisfaction of the district director to Loan Insurance Corporation premiums have been for bona fide purposes; and shall be treated as being governmental (ii) The amount of cash shall not in- obligations defined in paragraph (d)(3) clude amounts received directly or in- of this section. directly from another financial institu- (vii) Accounts receivable (other than tion (other than a Federal Home Loan accrued interest receivable), and pre- Bank or a similar institution organized paid expenses and deferred charges under State law) to the extent of the other than those referred to in subdivi- amount of cash which an association sion (v) or (vi) of this subparagraph, has on deposit or holds as a shall be disregarded both as separate withdrawable account in such other fi- categories and in the computation of nancial institution. total assets. (viii) Foreclosed property (as defined (5) Reporting requirements. In the case in paragraph (j)(1) of this section) shall of income tax returns for taxable years be treated as having the same char- ending after October 31, 1964, there acter as the loan for which it was given shall be filed with the return a state- as security. ment showing the amount of assets as (3) Alternative method. At the option of the close of the taxable year in each of the taxpayer, the percentages speci- of the categories defined in paragraph fied in paragraphs (d) through (h) of (d), and in the category described in this section may be computed on the paragraph (h) of this section, and a basis of the average assets outstanding brief description and amount of all during the taxable year. Such average other assets. If the alternative method shall be determined by making the of computing percentages under sub- computation provided in subparagraph paragraph (3) of this paragraph (l) is se- (1) of this paragraph (l), either as of the lected, such statement shall show such close of each month, as of the close of information as of the end of each each quarter, or semiannually during month, each quarter, or semiannually the taxable year and by using the year- and the manner of calculating the ly average of the monthly, quarterly, averages. With respect to taxable years or semiannual percentages obtained for beginning after October 16, 1962, and each category. The method selected ending before November 1, 1964, tax- must be applied uniformly for the tax- payers shall maintain adequate records able year to all categories of assets, to establish to the satisfaction of the but the method may be changed from district director that it meets the var- year to year. ious assets tests specified in this sec- (4) Acquisition of certain assets. For tion. the purpose of the annual computation (6) Example. The principles of this of percentages under subparagraph (1) paragraph may be illustrated by the of this paragraph (l)— following example in which a descrip- (i) Assets which, within a 60-day pe- tion of the assets, the subparagraph of riod beginning in one taxable year of paragraph (d) in which the assets are the taxpayer and ending in the next defined, the amount of the assets, and year, are acquired directly or indi- the percentage of the total assets in- rectly through borrowing and then re- cluded in the calculation are set forth.
SAVINGS AND LOAN ASSOCIATION ASSETS AS OF DECEMBER 31, 1964
Described in Item paragraph (d), Amount Percentage subparagraph
1. Cash ...... (2) $1,000,000 1 2. Governmental obligations 1 ...... (3) 8,000,000 8 3. Deposit insurance company securities ...... (4) 1,000,000 1
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SAVINGS AND LOAN ASSOCIATION ASSETS AS OF DECEMBER 31, 1964—Continued
Described in Item paragraph (d), Amount Percentage subparagraph
Loans outstanding: 2 4. Home ...... (7) 59,000,000 59 5. Church ...... (8) 1,000,000 1 6. Multifamily ...... (9) 20,000,000 20 7. Nonresidential real property ...... (10) 5,000,000 5 8. Passbook ...... (6) 1,000,000 1 9. Other ...... 2,000,000 2 Fixed assets (less depreciation reserves): 10. Used in the association’s business ...... (5) 1,000,000 1 11. Rented to others ...... 500,000 .5 12. Land held for investment ...... 500,000 .5
13. Total assets included for purposes of this paragraph ...... 100,000,000 100.0%
14. Accounts receivable ...... 100,000 (disregarded) 15. Prepaid expenses (other than prepaid FSLIC premiums) ...... 1,000,000 (disregarded) 16. Deferred charges ...... 1,000,000 (disregarded)
17. Total assets ...... 102,100,000 1 Prepaid FSLIC premiums treated as governmental obligations. 2 Not including unadvanced portion of loans in process, but including interest receivable and advances with respect to loans. The computation of the percentages of assets in the various categories for the purpose of determining whether the percentage of assets tests in the paragraphs in this section are met as of the close of the year are as follows:
Test and paragraph Items considered Percentage
90 percent test (d) the sum of items 1 through 8 and 10 item—13 (total included assets) =97 percent 18 percent test (e) the sum of items 7, 9, 11, and 12—item 13 (total included assets) =8 percent 36 percent test (f) the sum of items 6, 7, 9, 11, and 12—item 13 (total included assets) =28 percent 3 percent test (h) 0—item 13 (total included assets) =0 percent
At the option of the association, the computations listed above could have been made as of the close of each month, each quarter, or semiannually, and averaged for the entire year.
(m) Taxable years beginning before Oc- (described in paragraph (b) of this sec- tober 17, 1962. For taxable years begin- tion), the business operations test (de- ning before October 17, 1962, the term scribed in paragraph (c) of this sec- ‘‘domestic building and loan associa- tion), and the assets test (described in tion’’ means a domestic building and paragraph (d) of this section). For the loan association, a domestic savings definition of the term ‘‘domestic build- and loan association, and a Federal ing and loan association’’ for taxable savings and loan association substan- years beginning after October 16, 1962, tially all the business of which is con- and before July 12, 1969, see § 301.7701– fined to making loans to members. 13. [32 FR 15241, Nov. 3, 1967, as amended by T.D. (b) Supervisory test. A domestic build- 7622, 44 FR 28661, May 16, 1979] ing and loan association must be either (1) an insured institution within the § 301.7701–13A Post-1969 domestic meaning of section 401(a) of the Na- building and loan association. tional Housing Act (12 U.S.C. 1724(a)) or (a) In general. For taxable years be- (2) subject by law to supervision and ginning after July 11, 1969, the term examination by State or Federal au- ‘‘domestic building and loan associa- thority having supervision over such tion’’ means a domestic building and associations. An ‘‘insured institution’’ loan association, a domestic savings is one the accounts of which are in- and loan association, a Federal savings sured by the Federal Savings and Loan and loan association, and any other Insurance Corporation. savings institution chartered and su- (c) Business operations test—(1) In gen- pervised as a savings and loan or simi- eral. An association must utilize its as- lar association under Federal or State sets so that its business consists prin- law which meets the supervisory test cipally of acquiring the savings of the
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public and investing in loans. The re- sociation in conformity with the rules quirement of this paragraph is referred and regulations of the Federal Home to in this section as the business oper- Loan Bank Board or substantially ations test. The business of acquiring equivalent rules of a State law or su- the savings of the public and investing pervisory authority. The term ‘‘other in loans includes ancillary or inci- obligations’’ does not include an ad- dental activities which are directly and vance made by a Federal Home Loan primarily related to such acquisition Bank under the authority of section 10 and investment, such as advertising for or 10b of the Federal Home Loan Bank savings, appraising property on which Act (12 U.S.C. 1430, 1430b) as amended loans are to be made by the associa- and supplemented. Both percentages tion, and inspecting the progress of specified in this paragraph shall be construction in connection with con- computed either as of the close of the struction loans. Even though an asso- taxable year or, at the option of the ciation meets the supervisory test de- taxpayer, on the basis of the average of scribed in paragraph (b) of this section the dollar amounts of the total depos- and the assets test described in para- its, withdrawable shares, and other ob- graph (d) of this section, it will never- ligations of the association held during theless not qualify as a domestic build- the taxable year. Such averages shall ing and loan association if it does not be determined by computing each per- meet the requirements of both para- centage specified either as of the close graphs (2) and (3) of this paragraph (c), of each month, as of the close of each relating, respectively, to acquiring the quarter, or semiannually during the savings of the public and investing in taxable year and by using the yearly loans. average of the monthly, quarterly, or (2) Acquiring the savings of the public. semiannual percentages obtained. The The requirement that an association’s method selected must be applied uni- business (other than investing in loans) formly for the taxable year to both per- must consist principally of acquiring centages, but the method may be the savings of the public ordinarily will changed from year to year. be considered to be met if savings are (3) Investing in loans—(i) In general. acquired in all material respects in The requirement that an association’s conformity with the rules and regula- business (other than acquiring the sav- tions of the Federal Home Loan Bank ings of the public) must consist prin- Board or substantially equivalent rules cipally of investing in loans will be of a State law or supervisory author- considered to be met for a taxable year ity. Alternatively, such requirement only if more than 75 percent of the will be considered to be met if more gross income of the association con- than 75 percent of the dollar amount of sists of— the total deposits, withdrawable shares, and other obligations of the as- (a) Interest or dividends on assets de- sociation are held during the taxable fined in paragraphs (1), (2), and (3) of year by the general public, as opposed paragraph (e) of this section, to amounts deposited or held by family (b) Interest on loans, or related business groups or persons (c) Income attributable to the por- who are officers or directors of the as- tion of property used in the associa- sociation. However, the preceding sen- tion’s business, as defined in paragraph tence shall not apply if the dollar (e)(11) of this section, amount of other obligations of the as- (d) So much of the amount of pre- sociation outstanding during the tax- miums, discounts, commissions, or fees able year exceeds 25 percent of the dol- (including late charges and penalties) lar amount of the total deposits, on loans which have at some time been withdrawable shares, and other obliga- held by the association, or for which tions of the association outstanding firm commitments have been issued, as during such year. For purposes of this is not in excess of 20 percent of the paragraph, the term ‘‘other obliga- gross income of the association, tions’’ means notes, bonds, debentures, (e) Net gain from sales and exchanges or other obligations, or other securities of governmental obligations, as defined (except capital stock), issued by an as- in paragraph (e)(2) of this section, or
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(f) Income, gain or loss attributable the term ‘‘sales of participations’’ to foreclosed property, as defined in means sales by an association of inter- paragraph (e)(9) of this section, but not ests in loans, which sales meet the re- including such income, gain or loss quirements of the regulations of the which, pursuant to section 595 and the Federal Home Loan Bank Board relat- regulations thereunder, is not included ing to sales of participations, or which in gross income. meet substantially equivalent require- Examples of types of income which ments of State law or regulations re- would cause an association to fail to lating to sales of participations. meet the requirements of this para- (iii) Reporting requirement. In the case graph if, in the aggregate, they equal of income tax returns for taxable years or exceed 25 percent of gross income, beginning after July 11, 1969, there is are: The excess of gains over losses required to be filed with the return a from sales of real property (other than statement showing the amount of gross foreclosed property); rental income income for the taxable year in each of (other than on foreclosed property and the categories described in paragraph the portion of property used in the as- (c)(3)(i) of this section. sociation’s business); premiums, com- (d) 60 percent of assets test. At least 60 missions, and fees (other than commit- percent of the amount of the total as- ment fees) on loans which have never sets of a domestic building and loan as- been held by the association; and insur- sociation must consist of the assets de- ance brokerage fees. fined in paragraph (e) of this section. (ii) Computation of gross income. For The percentage specified in this para- purposes of this paragraph, gross in- graph is computed as of the close of the come is computed without regard to— taxable year or, at the option of the (a) Gain or loss on the sale or ex- taxpayer, may be computed on the change of the portion of property used basis of the average assets outstanding in the association’s business as defined during the taxable year. Such average in paragraph (e)(11) of this section. is determined by making the appro- (b) Gain or loss on the sale or ex- priate computation described in this change of the rented portion of prop- section either as of the close of each erty used as the principal or branch of- month, as of the close of each quarter, fice of the association, as defined in or semiannually during the taxable paragraph (e)(11) of this section, and year and by using the yearly average of (c) Gains or losses on sales of partici- the monthly, quarterly, or semiannual pations, and loans, other than govern- percentage obtained for each category mental obligations defined in para- of assets defined in paragraph (e) of graph (e)(2) of this section. this section. The method selected must For purposes of this paragraph, gross be applied uniformly for the taxable income is also computed without re- year to all categories of assets, but the gard to items of income which an asso- method may be changed from year to ciation establishes arise out of trans- year. For purposes of this paragraph, it actions which are necessitated by ex- is immaterial whether the association ceptional circumstances and which are originated the loans defined in para- not undertaken as recurring business graphs (4) through (8) and (10) of para- activities for profit. Thus, for example, graph (e) of this section or purchased an association would meet the invest- or otherwise acquired them in whole or ing in loans requirement if it can es- in part from another. See paragraph (f) tablish that it would otherwise fail to of this section for definition of certain meet that requirement solely because terms used in this paragraph and in of the receipt of a nonrecurring item of paragraph (e) of this section, and for income due to exceptional cir- the determination of amount and char- cumstances. For this purpose, trans- acter of loans. actions necessitated by an excess of de- (e) Assets defined. The assets defined mand for loans over savings capital in in this paragraph are— the association’s area are not to be (1) Cash. The term ‘‘cash’’ means deemed to be necessitated by excep- cash on hand, and time or demand de- tional circumstances. For purposes of posits with, or withdrawable accounts paragraph (c)(3)(ii)(c) of this section, in, other financial institutions.
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(2) Governmental obligations. The term management of property more than 50 ‘‘governmental obligations’’ means— percent of the fair rental value of (i) Obligations of the United States, which is used as the principal or (ii) Obligations of a State or political branch office of the association con- subdivision of a State, and stitutes property used in such business. (iii) Stock or obligations of a cor- Real property held by an association poration which is an instrumentality for investment or sale, even for the of the United States, a State, or a po- purpose of obtaining mortgage loans litical subdivision of a State, thereon, does not constitute property other than obligations the interest on used in the association’s business. which is excludable from gross income (ii) Property rented to others. Except under section 103 and the regulations as provided in the second sentence of thereunder. paragraph (11)(i) of this paragraph (e), (3) Deposit insurance company securi- property or a portion thereof rented by ties. The term ‘‘deposit insurance com- the association to others does not con- pany securities’’ means certificates of stitute property used in the associa- deposit in, or obligations of, a corpora- tion’s business. However, if the fair tion organized under a State law which specifically authorizes such corpora- rental value of the rented portion of a tion to insure the deposits or share ac- single piece of real property (including counts of member associations. appurtenant parcels) used as the prin- (4) Passbook loan. The term ‘‘pass- cipal or branch office of the association book loan’’ means a loan to the extent constitutes less than 50 percent of the secured by a deposit, withdrawable fair rental value of such piece of prop- share, or savings account in the asso- erty, or if such property has an ad- ciation, or share of a member of the as- justed basis of not more than $150,000, sociation, with respect to which a dis- the entire property shall be considered tribution is allowable as a deduction used in such business. If such rented under section 591. portion constitutes 50 percent or more (5) Residential real property loan. [Re- of the fair rental value of such piece of served] property, and such property has an ad- (6) Church loan. [Reserved] justed basis of more than $150,000, an (7) Urban renewal loan. [Reserved] allocation of its adjusted basis is re- (8) Institutional loan. [Reserved] quired. The portion of the total ad- (9) Foreclosed property. [Reserved] justed basis of such piece of property (10) Educational loan. [Reserved] which is deemed to be property used in (11) Property used in the association’s the association’s business shall be business—(i) In general. The term ‘‘prop- equal to an amount which bears the erty used in the association’s business’’ same ratio to such total adjusted basis means land, buildings, furniture, fix- as the amount of the fair rental value tures, equipment, leasehold interests, of the portion used as the principal or leasehold improvements, and other branch office of the association bears assests used by the association in the to the total fair rental value of such conduct of its business of acquiring the property. In the case of all property savings of the public and investing in loans. Real property held for the pur- other than real property used or to be pose of being used primarily as the used as the principal or branch office of principal or branch office of the asso- the association, if the fair rental value ciation constitutes property used in of the rented portion thereof con- the association’s business so long as it stitutes less than 15 percent of the fair is reasonably anticipated that such rental value of such property, the en- property will be occupied for such use tire property shall be considered used by the association, or that construc- in the association’s business. If such tion work preparatory to such occu- rented portion constitutes 15 percent pancy will be commenced thereon, or more of the fair rental value of such within 2 years after acquisition of the property, an allocation of its adjusted property. Stock of a wholly owned sub- basis (in the same manner as required sidiary corporation which has as its ex- for real property used as the principal clusive activity the ownership and or branch office) is required.
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(12) Regular or residual interest in a § 301.7701–15 Income tax return pre- REMIC—(i) In general. If for any cal- parer. endar quarter at least 95 percent of a (a) In general. An income tax return REMIC’s assets (as determined in ac- preparer is any person who prepares for cordance with § 1.860F–4(e)(1)(ii) or compensation, or who employs (or en- § 1.6049–7(f)(3) of this chapter) are assets gages) one or more persons to prepare defined in paragraph (e)(1) through for compensation, other than for the (e)(11) of this section, then for that cal- person, all or a substantial portion of endar quarter all the regular and resid- any return of tax under subtitle A of ual interests in that REMIC are treat- the Internal Revenue Code of 1954 or of ed as assets defined in this paragraph any claim for refund of tax under sub- (e). If less than 95 percent of a REMIC’s title A of the Internal Revenue Code of assets are assets defined in paragraph 1954. (e)(1) through (e)(11) of this section, the (1) A person who furnishes to a tax- payer or other preparer sufficient in- percentage of each REMIC regular or formation and advice so that comple- residual interest treated as an asset de- tion of the return or claim for refund is fined in this paragraph (e) is equal to largely a mechanical or clerical matter the percentage of the REMIC’s assets is considered an income tax return pre- that are assets defined in paragraph parer, even though that person does (e)(1) through (e)(11) of this section. not actually place or review placement See §§ 1.860F–4(e)(1)(ii)(B) and 1.6049– of information on the return or claim 7(f)(3) of this chapter for information for refund. See also paragraph (b) of required to be provided to regular and this section. residual interest holders if the 95 per- (2) A person who only gives advice on cent test is not met. specific issues of law shall not be con- (ii) Loans secured by manufactured sidered an income tax return preparer, housing. For purposes of paragraph unless— (e)(12)(i) of this section, a loan secured (i) The advice is given with respect to by manufactured housing treated as a events which have occurred at the time single family residence under section the advice is rendered and is not given 25(e)(10) is an asset defined in para- with respect to the consequences of graph (e)(1) through (e)(11) of this sec- contemplated actions; and tion. (ii) The advice is directly relevant to the determination of the existence, (f) Special rules. [Reserved] characterization, or amount of an [T.D. 7622, 44 FR 28661, May 16, 1979; 44 FR entry on a return or claim for refund. 29048, May 18, 1979, as amended by T.D. 8458, For example, if a lawyer gives an opin- 57 FR 61313, Dec. 24, 1992] ion on a transaction which a corpora- tion has consummated, solely to sat- § 301.7701–14 Cooperative bank. isfy an accountant (not at the time a For taxable years beginning after Oc- preparer of the corporation’s return) tober 16, 1962, the term ‘‘cooperative who is attempting to determine wheth- bank’’ means an institution without er the reserve for taxes set forth in the capital stock organized and operated corporation’s financial statement is for mutual purposes without profit reasonable, the lawyer shall not be which meets the supervisory test, the considered a tax return preparer solely by reason of rendering such opinion. business operations test, and the var- (3) A person may be an income tax re- ious assets tests specified in para- turn preparer without regard to edu- graphs (d) through (h) of § 301.7701–13, cational qualifications and professional employing the rules and definitions of status requirements. paragraphs (j) through (l) of that sec- (4) A person must prepare a return or tion. In applying paragraphs (b) claim for refund for compensation to through (l) of such section any ref- be an income tax return preparer. A erences to an ‘‘association’’ or to a person who prepares a return or claim ‘‘domestic building and loan associa- for refund for a taxpayer with no ex- tion’’ shall be deemed to be a reference plicit or implicit agreement for com- to a cooperative bank. pensation is not a preparer, even
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though the person receives a gift or re- Whether a schedule, entry, or other turn service or favor. portion of a return or claim for refund (5) A person who prepares a return or is a substantial portion is determined claim for refund outside the United by comparing the length and com- States is an income tax return pre- plexity of, and the tax liability or re- parer, regardless of his nationality, fund involved in, that portion to the residence, or the locations of his places length and complexity of, and tax li- of business, if the person otherwise sat- ability or refund involved in, the re- isfies the definition of income tax re- turn or claim for refund as a whole. turn preparer. Notwithstanding the (2) For purposes of applying the rule provisions of § 301.6109–1(g), the person of paragraph (b)(1) of this section, if shall secure an employer identification the schedule, entry, or other portion of number if he is an employer of another the return or claim for refund involves preparer, is a partnership in which one amounts of gross income, amounts of or more of the general partners is a deductions, or amounts on the basis of preparer, or is an individual not em- which credits are determined which ployed (or engaged) by another pre- are— parer. The person shall comply with (i) Less than $2,000; or the provisions of section 1203 of the (ii) Less than $100,000, and also less Tax Reform Act of 1976 and the regula- than 20 percent of the gross income (or tions thereunder. adjusted gross income if the taxpayer (6) An official or employee of the In- is an individual) as shown on the re- ternal Revenue Service performing his turn or claim for refund, official duties is not an income tax re- then the schedule or other portion is turn preparer. not considered to be a substantial por- (7) The following persons are not in- tion. If more than one schedule, entry come tax return preparers: or other portion is involved, they shall (i) Any individual who provides tax be aggregated in applying the rule of assistance under a Volunteer Income this paragraph (b)(2). Thus, if a person, Tax Assistance (VITA) program estab- for an individual taxpayer’s return, lished by the Internal Revenue Service; prepares a schedule for dividend in- (ii) Any organization sponsoring or come which totals $1,500 and gives ad- administering a Volunteer Income Tax vice making him a preparer of a sched- Assistance (VITA) program established ule of medical expenses which results by the Internal Revenue Service, but in a deduction for medical expenses of only with respect to that sponsorship $1,500, the person is not a preparer if or administration; the taxpayer’s adjusted gross income (iii) Any individual who provides tax shown on the return is more than counseling for the elderly under a pro- $15,000. This paragraph shall not apply gram established pursuant to section to a person who prepares all of a return 163 of the Revenue Act of 1978; and or claim for refund. (iv) Any organization sponsoring or (3) A preparer of a return is not con- administering a program to provide tax sidered to be a preparer of another re- counseling for the elderly established turn merely because an entry or en- pursuant to section 163 of the Revenue tries reported on the return may affect Act of 1978, but only with respect to an entry reported on the other return, that sponsorship or administration. unless the entry or entries reported on (b) Substantial preparation. (1) Only a the prepared return are directly re- person (or persons acting in concert) flected on the other return and con- who prepares all or a substantial por- stitute a substantial portion of the tion of a return or claim for refund other return. For example, the sole shall be considered to be a preparer (or preparer of a partnership return of in- preparers) of the return or claim for re- come or a small business corporation fund. A person who renders advice income tax return is considered a pre- which is directly relevant to the deter- parer of a partner’s or a shareholder’s mination of the existence, character- return if the entry or entries on the ization, or amount of an entry on a re- partnership or small business corpora- turn or claim for refund, will be re- tion return reportable on the partner’s garded as having prepared that entry. or shareholder’s return constitute a
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substantial portion of the partner’s or the person either is a fiduciary or is an shareholder’s return. officer, general partner, or employee of (c) Return and claim for refund—(1) Re- the fiduciary. turn. A return of tax under subtitle A is (4) Preparation of a claim for refund a return filed by or on behalf of a tax- for a taxpayer in response to— payer reporting the liability of the tax- (i) A notice of deficiency issued to payer for tax under subtitle A. A re- the taxpayer; or turn of tax under subtitle A also in- (ii) A waiver of restriction after initi- cludes an information return filed by ation of an audit of the taxpayer or an- or on behalf of a person or entity that other taxpayer if a determination in is not a taxable entity and which re- the audit of the other taxpayer affects, ports information which is or may be directly or indirectly, the liability of reported on the return of a taxpayer of the taxpayer for tax under subtitle A. tax under subtitle A. For purposes of paragraph (d)(2) of this (i) A return of tax under subtitle A section, the employee of a corporation includes an individual or corporation owning more than 50 percent of the income tax return, a fiduciary income voting power of another corporation, or tax return (for a trust or estate), a reg- the employee of a corporation more ulated investment company undistrib- than 50 percent of the voting power of uted capital gains tax return, a return which is owned by another corporation, of a charitable remainder trust, a re- is considered the employee of the other turn by a transferor of stock or securi- corporation as well. For purposes of ties to a foreign corporation, foreign paragraph (d)(3) of this section, an es- trust, or foreign partnership, a partner- tate, guardianship, conservatorship, ship return of income, a small business committee, and any similar arrange- corporation income tax return, and a ment for a taxpayer under a legal dis- DISC return. ability (such as a minor, an incom- (ii) A return of tax under subtitle A petent, or an infirm individual) is con- does not include an estate tax return, a sidered a trust or estate. gift tax return, any other return of ex- [T.D. 7675, 45 FR 11468, Feb. 21, 1980] cise taxes or income taxes collected at source on wages, an individual or cor- § 301.7701–16 Other terms. poration declaration of estimated tax, an application for an extension of time For a definition of the term ‘‘with- to file an individual or corporation in- holding agent’’ see § 1.1441–7(a). Any come tax return, or an information other terms that are defined in section statement on Form 990, any Form 1099, 7701 and that are not defined in or similar form. §§ 301.7701–1 to 301.7701–15, inclusive, (2) Claim for refund. A claim for re- shall, when used in this chapter, have fund of tax under subtitle A includes a the meanings assigned to them in sec- claim for credit against any tax under tion 7701. subtitle A. (Secs. 1441(c)(4) (80 Stat. 1553; 26 U.S.C. (d) Persons who are not preparers. A 1441(c)(4)), 3401(a)(6) (80 Stat. 1554; 26 U.S.C. person shall not be considered to be a 3401(a)(6)), and 7805 (68A Stat. 917; 26 U.S.C. preparer of a return or claim for refund 7805), Internal Revenue Code of 1954) if the person performs only one or more [T.D. 7977, 49 FR 36836, Sept. 20, 1984] of the following services: (1) Typing, reproduction, or other § 301.7701–17T Collective-bargaining mechanical assistance in the prepara- plans and agreements (temporary). tion of a return or claim for refund. Q–1: How did the Tax Reform Act of (2) Preparation of a return or claim 1984 (TRA of 1984) change the laws with for refund of a person, or an officer, a respect to plans that are maintained general partner, or employee of a per- pursuant to collective bargaining son, by whom the individual is regu- agreements? larly and continuously employed or in A–1: (a) Many of the requirements which the individual is a general part- and rules applicable to deferred com- ner. pensation and welfare benefit plans are (3) Preparation of a return or claim different for plans maintained pursuant for refund for a trust or estate of which to a collective bargaining agreement.
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Prior to the TRA of 1984, the Internal resentatives and one or more employ- Revenue Code provided no clear defini- ers. tion of an employee representative or (c) Even if (1) the finding in the ex- whether there is a collective bar- ample in the preceding paragraph (b) is gaining agreement between such em- made by the Secretary of Labor, (2) the ployee representative and one or more union has been recognized as exempt employers. under section 501(c)(5), and (3) the per- (b) Section 526(c) of the TRA of 1984 centage condition in section 7701(a)(46) added a new condition under a new sec- is satisfied, the Internal Revenue Serv- tion 7701(a)(46) that must be satisfied ice has the authority, pursuant to sec- in order for a plan to be considered to tion 7701(a)(46), to determine whether be a plan maintained pursuant to a col- there is a collective bargaining agree- lective bargaining agreement between ment under the Code. employee representatives and one or [T.D. 8073, 51 FR 4337, Feb. 4, 1986] more employers for purposes of the Code after March 31, 1984. If more than § 301.7701(b)–0 Outline of regulation one-half of the membership of an orga- provision for section 7701(b)–1 nization is comprised of owners, offi- through (b)–9. cers, and executives of employers cov- This section lists the paragraphs con- ered by the plan, then such organiza- tained in §§ 301.7701(b)–1 through tion is not an employee representative 301.7701(b)–9. for purposes of determining whether a § 301.7701(b)–1 Resident alien. plan is to be treated as maintained pur- suant to a collective bargaining agree- (a) Scope. ment between employee representa- (b) Lawful permanent resident. (1) Green card test. tives and one or more employers. (2) Rescission of resident status. Whether an individual is an owner, offi- (3) Administrative or judicial determina- cer or executive is to be determined tion of abandonment of resident status. separately with respect to each em- (c) Substantial presence test. ployer. Additionally, section 7701(a)(46) (1) In general. provides that the Internal Revenue (2) Determination of presence. Service shall make the determination (i) Physical presence. (ii) United States. for purposes of the Code as to whether (3) Current year. there is a collective bargaining agree- (4) Thirty-one day minimum. ment between employee representa- (d) Application of section 7701(b) to the pos- tives and one or more employers. sessions and territories. Q–2: If an organization does not fail (1) Application to aliens. to be an employee representative under (2) Non-application to citizens. (e) Examples. the 50 percent or less test of section 7701(a)(46), is a plan maintained pursu- § 301.7701(b)–2 Closer connection exception. ant to an agreement between such or- (a) In general. ganization and one or more employers (b) Foreign country. necessarily treated, under the Code, as (c) Tax home. a plan maintained pursuant to a collec- (1) Definition. tive bargaining agreement between an (2) Duration and nature of tax home. employee representative and one or (d) Closer connection to a foreign country. (1) In general. more employers? (2) Permanent home. A–2: (a) No. (e) Special rule. (b) Specific Code provisions generally (f) Closer connection exception unavailable. require other conditions than that in (g) Filing requirements. section 7701(a)(46) to be satisfied in § 301.7701(b)–3 Days of presence in the United order for a plan to be considered to be States that are excluded for purposes of sec- collectively-bargained. For example, in tion 7701(b). order for a plan to be described in sec- (a) In general. tion 413(a), the Secretary of Labor (b) Exempt individuals. must find that the plan is maintained (1) In general. pursuant to a collective bargaining (2) Foreign government-related individual. agreement between employee rep- (i) In general.
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(ii) Definition of international organiza- § 301.7701(b)–6 Taxable year. tion. (a) In general. (iii) Full-time diplomatic or consular sta- (b) Examples. tus. (3) Teacher or trainee. § 301.7701(b)–7 Coordination with income tax (4) Student. treaties. (5) Professional athlete. (6) Substantial compliance. (a) Consistency requirement. (7) Limitation on teacher or trainee and (1) Application. student exemptions. (2) Computation of tax liability. (i) Teacher or trainee limitation in gen- (3) Other Internal Revenue Code purposes. eral. (4) Special rules for S corporations. [Re- (ii) Special teacher or trainee limitation served] for section 872(b)(3) compensation. (b) Filing requirements. (iii) Limitation on student exemption. (c) Contents of statement. (iv) Transition rule. (1) In general. (v) Examples. (i) Returns due after December 15, 1997. (8) Immediate family. (ii) Earlier returns. (c) Medical condition. (2) Controlled foreign corporation share- (1) In general. holders. (2) lntent to leave the United States. (3) S corporation shareholders. [Reserved] (3) Preexisting medical condition. (d) Relationship to section 6114(a) treaty- (4) Examples. based return positions. (d) Days in transit. (e) Examples. (e) Regular commuters from Mexico or Can- ada. § 301.7701(b)–8 Procedural rules. (1) General rule. (a) Who must file. (2) Definitions. (1) Closer connection exception. (3) Examples. (2) Exempt individuals and individuals (f) Determination of excluded days applies with a medical condition. beyond year of determination. (3) De minimis presence and residency starting and termination dates. § 301.7701(b)–4 Residency time periods. (b) Contents of statement. (a) First year of residency. (1) Closer connection exception. (b) Last year of residency. (i) Returns due after December 15, 1997. (1) General rule. (ii) Earlier returns. (2) Exceptions. (2) Exempt individuals and individuals (c) Rules relating to residency starting date with a medical condition. and residency termination date. (i) Returns due after December 15, 1997. (1) De minimis presence. (ii) Earlier returns. (2) Proration. (3) De minimis presence and residency (3) Residency starting date for certain indi- starting and termination dates. viduals. (c) How to file. (i) In general. (d) Penalty for failure to file statement. (ii) Determination of presence. (1) General rule. (iii) Thirty-one day period. (2) Exception. (iv) Period of continuous presence. (e) Filing requirement disregarded. (v) Election procedure. (A) Filing requirements. § 301.7701(b)–9 Effective dates of §§ 301.7701(b)– (B) Election on behalf of a dependent child. 1 through 301.7701(b)–7. (C) Statement. (a) In general. (vi) Penalty for failure to comply with fil- (b) Special rules. ing requirements. (1) Green card test-residency starting date. (A) General rule. (2) Substantial presence test-years in- (B) Exception. cluded. (d) Examples. (3) Professional athletes. (e) No lapse. (4) Procedural rules and filing require- (1) Residency in prior year. ments. (2) Residency in following year. (3) Special rule. [T.D. 8411, 57 FR 15241, Apr. 27, 1992; 58 FR (4) Example. 17516, Apr. 5, 1993; as amended by T.D. 8733, 62 FR 53386, Oct. 14, 1997] § 301.7701(b)–5 Coordination with section 877. § 301.7701(b)–1 Resident alien. (a) General rule. (b) Tax imposed. (a) Scope. Section 301.7701(b)–1(b) pro- (c) Example. vides rules for determining whether an
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alien individual is a lawful permanent and (2) and § 25.2501–1(b) of this chapter, resident of the United States. Section respectively. 301.7701(b)–1(c) provides rules for deter- (b) Lawful permanent resident—(1) mining if an alien individual satisfies Green card test. An alien is a resident the substantial presence test. Section alien with respect to a calendar year if 301.7701(b)–2 provides rules for deter- the individual is a lawful permanent mining when an alien individual will be resident at any time during the cal- considered to maintain a tax home in a endar year. A lawful permanent resi- foreign country and to have a closer dent is an individual who has been law- connection to that foreign country. fully granted the privilege of residing Section 301.7701(b)–3 provides rules for permanently in the United States as an determining if an individual is an ex- immigrant in accordance with the im- empt individual because of his or her migration laws. Resident status is status as a foreign government-related deemed to continue unless it is re- individual, teacher, trainee, student, or scinded or administratively or judi- professional athlete. Section cially determined to have been aban- 301.7701(b)–3 also provides rules for de- doned. termining whether an individual may (2) Rescission of resident status. Resi- exclude days of presence in the United dent status is considered to be re- States because the individual was un- scinded if a final administrative or ju- able to leave the United States because dicial order of exclusion or deportation is issued regarding the alien individual. of a medical condition. Section For purposes of this paragraph, the 301.7701(b)–4 provides rules for deter- term ‘‘final judicial order’’ means an mining an individual’s residency start- order that is no longer subject to ap- ing and termination dates. Section peal to a higher court of competent ju- 301.7701(b)–5 provides rules for applying risdiction. section 877 to a nonresident alien indi- (3) Administrative or judicial determina- vidual. Section 301.7701(b)–6 provides tion of abandonment of resident status. rules for determining the taxable year An administrative or judicial deter- of an alien. Section 301.7701(b)–7 pro- mination of abandonment of resident vides rules for determining the effect status may be initiated by the alien in- of these regulations on rules in tax dividual, the Immigration and Natu- conventions to which the United States ralization Service (INS), or a consular is a party. Section 301.7701(b)–8 pro- officer. If the alien initiates this deter- vides procedural rules for establishing mination, resident status is considered that an individual is a nonresident to be abandoned when the individual’s alien. Section 301.7701(b)–9 provides the application for abandonment (INS effective dates of section 7701(b) and Form I–407) or a letter stating the the regulations under that section. Un- alien’s intent to abandon his or her less the context indicates otherwise, resident status, with the Alien Reg- the regulations under §§ 301.7701(b)–1 istration Receipt Card (INS Form I–151 through 301.7701(b)–9 apply for purposes or Form I–551) enclosed, is filed with of determining whether a United the INS or a consular officer. If INS re- States citizen is also a resident of the places any of the form numbers re- United States. (This determination ferred to in this paragraph or may be relevant, for example, to the § 301.7701(b)–2(f), refer to the com- application of section 861(a)(1) which parable INS replacement form number. treats income from interest-bearing For purposes of this paragraph, an obligations of residents as income from alien individual shall be considered to sources within the United States.) The have filed a letter stating the intent to regulations do not apply and §§ 1.871–2 abandon resident status with the INS and 1.871–5 of this chapter continue to or a consular office if such letter is apply for purposes of the bona fide resi- sent by certified mail, return receipt dence test of section 911. See § 1.911–2(c) requested (or a foreign country’s equiv- of this chapter. For purposes of deter- alent thereof). A copy of the letter, mining whether an individual is a resi- along with proof that the letter was dent of the United States for estate mailed and received, should be retained and gift tax purposes, see § 20.0–1(b)(1) by the alien individual. If the INS or a
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consular officer initiates this deter- an alien individual is determining his mination, resident status will be con- or her resident status. sidered to be abandoned upon the (4) Thirty-one day minimum. If an indi- issuance of a final administrative order vidual is not physically present for of abandonment. If an individual is more than 30 days during the current granted an appeal to a federal court of year, the substantial presence test will competent jurisdiction, a final judicial not be applied for that year even if the order is required. three-year total is 183 or more days. (c) Substantial presence test—(1) In For purposes of the substantial pres- general. An alien individual is a resi- ence test, it is irrelevant that an indi- dent alien if the individual meets the vidual was not present for more than 30 substantial presence test. An indi- days in the first or second year pre- vidual satisfies this test if he or she ceding the current year. has been present in the United States (d) Application of section 7701(b) to the on at least 183 days during a three year possessions and territories—(1) Applica- period that includes the current year. tion to aliens. Section 7701(b) provides For purposes of this test, each day of the basis for determining whether an presence in the current year is counted alien individual is a resident of a as a full day. Each day of presence in United States possession or territory the first preceding year is counted as that administers income tax laws that one-third of a day and each day of pres- are identical (except for the substi- ence in the second preceding year is tution of the name of the possession or counted as one-sixth of a day. For pur- territory for the term ‘‘United States’’ poses of this paragraph, any fractional where appropriate) to those in force in days resulting from the above calcula- the United States. If, after the applica- tions will not be rounded to the nearest tion of section 7701(b) and the regula- whole number. (See § 301.7701(b)–9(b)(2) tions thereunder, an alien individual is for transitional rules for calendar years 1985 and 1986.) a resident of the United States and a resident of a United States possession (2) Determination of presence—(i) Phys- or territory, the principles of ical presence. For purposes of the sub- stantial presence test, an individual § 301.7701(b)–2 (d) (relating to signifi- shall be treated as present in the cant contacts maintained by an indi- United States on any day that he or vidual with a foreign country) shall be she is physically present in the United applied in order to establish that the States at any time during the day. individual is a resident alien of either (But see § 301.7701(b)–3 relating to days the United States or a United States of presence that may be excluded.) possession or territory, but not both. (ii) United States. For purposes of sec- See § 1.933–1 (a) of this chapter for de- tion 7701(b) and the regulations there- termining whether an individual (in- under, the term United States when cluding a U.S. citizen or national) is a used in a geographical sense includes bona fide resident of Puerto Rico. See the states and the District of Colum- section 931 and the regulations there- bia. It also includes the territorial wa- under for the determination of whether ters of the United States and the sea- an individual (including a U.S. citizen bed and subsoil of those submarine or national) is a bona fide resident of areas which are adjacent to the terri- American Samoa. torial waters of the United States and (2) Non-application to citizens. Section over which the United States has ex- 7701(b) does not provide the basis for clusive rights, in accordance with determining whether a United States international law, with respect to the citizen or national is a bona fide resi- exploration and exploitation of natural dent of a United States possession or resources. It does not include the pos- territory. For example, a United States sessions and territories of the United citizen who is present in a United States or the air space over the United States possession or territory for 183 States. days during a calendar year will not (3) Current year. The term current automatically be a ‘‘bona fide resi- year means any calendar year for which dent’’ of that possession or territory.
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Whether a United States citizen or na- (1) The individual is present in the tional is a bona fide resident of a pos- United States for fewer than 183 days session or territory is determined in the current year; under sections 931 through 933 and (2) The individual maintains a tax § 1.935–1 to the extent it remains effec- home in a foreign country during the tive after December 31, 1984. current year; and (e) Examples. This section may be il- (3) Except as provided in paragraph lustrated by the following examples: (e) of this section, the individual has a closer connection during the current Example 1. B, an alien individual, is present year to a single foreign country in in the United States for 122 days in the cur- which he or she maintains a tax home rent year. He was present in the United States for 122 days in the first preceding cal- than to the United States. endar year and for 122 days in the second pre- (b) Foreign country. For purposes of ceding calendar year. In determining his sta- section 7701(b) and the regulations tus for the current year, B counts all 122 thereunder, the term ‘‘foreign coun- days in the United States in the current year try’’ when used in a geographical sense plus 1⁄3 of the 122 days in the United States in includes any territory under the sov- the first preceding calendar year (402⁄3 days) ereignty of the United Nations or a and 1⁄6 of the 122 days in the United States government other than that of the during the second preceding calendar year United States. It includes the terri- (201⁄3 days). The total of 122+402⁄3+201⁄3 equals 183 days. B meets the substantial presence torial waters of the foreign country test and is a resident alien for the current (determined in accordance with the year. laws of the United States), and the sea- Example 2. C, an alien individual, is present bed and subsoil of those submarine in the United States for 25 days during the areas which are adjacent to the terri- current year. She was present in the United torial waters of the foreign country States for 365 days during the first preceding and over which the foreign country has year and 365 days during the second pre- exclusive rights, in accordance with ceding year. The substantial presence test international law, with respect to the does not apply because C is present in the exploration and exploitation of natural United States for fewer than 31 days during the current year. resources. It also includes the posses- Example 3. D, an alien individual, is present sions and territories of the United in the United States for 170 days during the States. current year. He was present in the United (c) Tax home—(1) Definition. For pur- States for 30 days during the first preceding poses of section 7701 (b) and the regula- year and 30 days during the second preceding tions under that section, the term ‘‘tax year. In determining his status for the cur- home’’ has the same meaning that it rent year, D counts all 170 days in the United has for purposes of section 162(a)(2) (re- 1 States in the current year plus ⁄3 of the 30 lating to travel expenses while away days in the United States in the first pre- from home). Thus, an individual’s tax ceding calendar year (10 days) and 1⁄6 of the 30 days in the United States during the sec- home is considered to be located at the ond preceding calendar year (5 days). The individual’s regular or principal (if total of 170+10+5 equals 185 days. D meets the more than one regular) place of busi- substantial presence test and is a resident ness. If the individual has no regular or alien for the current year notwithstanding principal place of business because of the fact that he was present in the United the nature of the business, or because States for fewer than 31 days in each of the the individual is not engaged in car- two preceding years. rying on any trade or business within [T.D. 8411, 57 FR 15242, Apr. 27, 1992; 57 FR the meaning of section 162(a), then the 28612, June 26, 1992; 57 FR 37190, Aug. 18, 1992] individual’s tax home is the individ- ual’s regular place of abode in a real § 301.7701(b)–2 Closer connection ex- and substantial sense. ception. (2) Duration and nature of tax home. (a) In general. An alien individual The tax home maintained by the alien who meets the substantial presence individual must be in existence for the test may nevertheless be considered a entire current year. The tax home nonresident alien for the current year must be located in the same foreign if the following conditions are satis- country for which the individual is fied— claiming to have the closer connection
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described in paragraph (d) of this sec- whether the home is owned or rented tion. by the alien individual. It is material, (d) Closer connection to a foreign coun- however, that the dwelling be available try—(1) In general. For purposes of sec- at all times, continuously, and not tion 7701(b) and the regulations under solely for stays of short duration. that section, an alien individual will be (e) Special Rule. An alien individual considered to have a closer connection may demonstrate in one year that he to a foreign country than the United or she has a closer connection to two States if the individual or the Commis- foreign countries (but no more than sioner establishes that the individual two) if he or she satisfies all of the fol- has maintained more significant con- lowing conditions— tacts with the foreign country than (1) The individual maintains a tax with the United States. In determining home beginning on the first day of the whether an individual has maintained current year in one foreign country; more significant contacts with a for- (2) The individual changes his or her eign country than the United States, tax home during the current year to a the facts and circumstances to be con- second foreign country; sidered include, but are not limited to, (3) The individual continues to main- the following— tain his or her tax home in the second (i) The location of the individual’s foreign country for the remainder of permanent home; the current year; (ii) The location of the individual’s (4) The individual has a closer con- family; nection to each foreign country than to (iii) The location of personal belong- the United States for the period during ings, such as automobiles, furniture, which the individual maintains a tax clothing and jewelry owned by the indi- home in that foreign country; and vidual and his or her family; (iv) The location of social, political, (5) The individual is subject to tax- cultural or religious organizations with ation as a resident pursuant to the in- which the individual has a current re- ternal laws of either foreign country lationship; for the entire year or subject to tax- (v) The location where the individual ation as a resident in both foreign conducts his or her routine personal countries for the period during which banking activities; the individual maintains a tax home in (vi) The location where the indi- each foreign country. vidual conducts business activities (f) Closer connection exception unavail- (other than those that constitute the able. An alien individual who has per- individual’s tax home); sonally applied, or taken other affirm- (vii) The location of the jurisdiction ative steps, to change his or her status in which the individual holds a driver’s to that of a permanent resident during license; the current year or has an application (viii) The location of the jurisdiction pending for adjustment of status dur- in which the individual votes; ing the current year will not be eligible (ix) The country of residence des- for the closer connection exception. Af- ignated by the individual on forms and firmative steps to change status to documents; and that of a permanent resident include, (x) The types of official forms and but are not limited to, the following— documents filed by the individual, such (1) The filing of Immigration and as Form 1078 (Certificate of Alien Naturalization Form I–508 (Waiver of Claiming Residence in the United Immunities) by the alien; States), Form W–8 (Certificate of For- (2) The filing of Immigration and eign Status) or Form W–9 (Payer’s Re- Naturalization Form I–485 (Application quest for Taxpayer ldentification Num- for Status as Permanent Resident) by ber). the alien; (2) Permanent home. For purposes of (3) The filing of Immigration and paragraph (d)(1)(i) of this section, it is Naturalization Form I–130 (Petition for immaterial whether a permanent home Alien Relative) on behalf of the alien; is a house, an apartment, or a fur- (4) The filing of Immigration and nished room. It is also immaterial Naturalization Form I–140 (Petition for
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Prospective Immigrant Employee) on (iv) Professional athlete as defined in behalf of the alien; paragraph (b)(5) of this section. (5) The filing of Department of Labor (2) Foreign government-related indi- Form ETA–750 (Application for Alien vidual—(i) In general. A foreign govern- Employment Certification) on behalf of ment-related individual is an indi- the alien; or vidual (and that individual’s imme- (6) The filing of Department of State diate family) who is temporarily Form OF–230 (Application for Immi- present in the United States— grant Visa and Alien Registration) by (A) As a full-time employee of an the alien. international organization; (g) Filing requirements. See (B) By reason of diplomatic status; or § 3O1.7701(b)–8 with regard to the state- (C) By reason of a visa that the Sec- ment that must be filed by an alien in- retary of the Treasury or his or her dividual claiming the closer connection delegate (after consultation with the exception. Secretary of State when appropriate) determines represents full-time diplo- [T.D. 8411, 57 FR 15244, Apr. 27, 1992; 57 FR matic or consular status. An individual 28612, June 26, 1992; 57 FR 37190, Aug. 18, 1992; described in this paragraph shall be 58 FR 17516, Apr. 5, 1993] considered to be temporarily present in § 301.7701(b)–3 Days of presence in the the United States if the individual is United States that are excluded for not a lawful permanent resident as de- purposes of section 7701(b). scribed in § 301.7701(b)–1(b)(1), regard- less of the actual amount of time that (a) In general. In computing days of the individual is present in the United presence in the United States, an alien States. is considered to be present if the indi- (ii) Definition of international organi- vidual is physically present in the zation. The term ‘‘international organi- United States at any time during the zation’’ means any public international day (see § 301.7701(b)–1(c)(2)(i)). How- organization that has been designated ever, for purposes of section 7701(b) and by the President by Executive Order as the regulations under that section, the being entitled to enjoy the privileges, following days shall be excluded and exemptions, and immunities provided will not count as days of presence in for in the International Organizations the United States— Act (22 U.S.C. 288). An individual de- (1) Any day that an individual is scribed in paragraph (b)(2)(i) of this present in the United States as an ex- section will be a full-time employee of empt individual; an international organization if that (2) Any day that an individual is pre- individual’s employment with the orga- vented from leaving the United States nization is consistent with an employ- because of a medical condition that ment schedule of a person with a stand- arose while the individual was present ard full-time work schedule with the in the United States; organization. (3) Any day that an individual is in (iii) Full-time diplomatic or consular transit between two points outside the status. An individual is considered to United States; and have full-time diplomatic or consular (4) Any day on which a regular com- status if— muter residing in Canada or Mexico (A) The individual has been accred- commutes to and from employment in ited by a foreign government recog- the United States. nized de jure or de facto by the United (b) Exempt individuals—(1) In general. States; An exempt individual is an individual (B) The individual intends to engage who is either a— primarily in official activities for that (i) Foreign government-related indi- foreign government while in the United vidual as defined in paragraph (b)(2) of States; and this section; (C) The individual has been recog- (ii) Teacher or trainee as defined in nized by the President, or by the Sec- paragraph (b)(3) of this section; retary of State, or by a consular officer (iii) Student as defined in paragraph acting on behalf of the Secretary of (b)(4) of this section; or State, as being entitled to such status.
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(3) Teacher or trainee. A teacher or engaged in activities that are prohib- trainee includes any individual (and ited by the Immigration and Nation- that individual’s immediate family), ality Act and the regulations there- other than a student, who is admitted under and could result in the loss of F, temporarily to the United States as a J or M visa status. An individual will nonimmigrant under section 101(a)(15) not be deemed to comply substantially (J) (relating to the admission of teach- with the visa requirements relevant to ers and trainees into the United residence for tax purposes merely by States) or section 101(a)(15)(Q) (relating showing that the individual’s visa has to the admission of participants in not been revoked. An independent de- international cultural exchange pro- termination of substantial compliance grams) of the Immigration and Nation- may be made by the Internal Revenue ality Act (8 U.S.C. 1101(a)(15) (J), (Q)) Service for any individual claiming to and who substantially complies with be an exempt individual under para- the requirements of being admitted. graph (b) (3) or (4) of this section. For (4) Student. A student is any indi- example, if an individual with an F vidual (and that individual’s imme- visa (student visa) is found to have ac- diate family) who is admitted tempo- cepted unauthorized employment or to rarily to the United States as a non- have maintained a course of study that immigrant under section 101(a)(15)(F) is not considered by the Internal Rev- or (M) (relating to the admission of enue Service to be full-time, the indi- students into the United States) or as a vidual will not be considered to comply student under section 101(a)(15)(J) (re- substantially with the individual’s visa lating to the admission of teachers and requirements regardless of whether the trainees into the United States) or sec- individual’s visa has been revoked. tion 101(a)(15)(Q) (relating to the ad- (7) Limitation on teacher or trainee and mission of participants in inter- student exemptions—(i) Teacher or train- national cultural exchange programs) ee limitation in general. Except as other- of the Immigration and Nationality wise provided, an individual shall not Act (8 U.S.C. 1101(a)(15) (F), (J), (M), exclude days of presence as a teacher (Q)) who substantially complies with or trainee if the individual has been ex- the requirements of being admitted. empt as a teacher, trainee, or student For rules concerning taxation of cer- for any part of two of the six preceding tain nonresident students or trainees, calendar years. see section 871(c) and § 1.871–9(a) of this (ii) Special teacher or trainee limitation chapter. for section 872(b)(3) compensation. If— (5) Professional athlete. A professional (A) A teacher or trainee receives athlete is an individual who is tempo- compensation in the current year and rarily present in the United States to all of that compensation is described in compete in a charitable sports event section 872(b)(3); described in section 274(l)(1)(B). For (B) That individual was present in purposes of computing the days of pres- the United States as a teacher or train- ence in the United States, only days on ee in any prior year within the last 6 which the athlete actually competes in years; and a charitable sports event described in (C) During each prior year (within section 274(l)(1)(B) shall be excluded. the 6 year period) in which the indi- Thus, days on which the individual is vidual was present as a teacher or present to practice for the event, to trainee, the individual received com- perform promotional or other activi- pensation all of which was described in ties related to the event, or to travel section 872(b)(3); between events shall be included for Then that individual shall include days purposes of the substantial presence of presence as a teacher or trainee in test. the current year only if the individual (6) Substantial compliance. An indi- has been exempt as a teacher, trainee, vidual described in paragraph (b) (3) or or student for any part of four of the (4) of this section will be deemed to six preceding calendar years. comply substantially with the visa re- (iii) Limitation on student exemption. quirements relevant to residence for An individual will not be able to ex- tax purposes if the individual has not clude days of presence as a student if
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the individual has been exempt as a has been exempt as a teacher for at least two teacher, trainee, or student for any of the past six years. part of more than five calendar years, Example 3. The facts are the same as in Ex- unless it is established to the satisfac- ample 2, except that all of C’s compensation for the two preceding years was described in tion of the district director that the in- section 872(b)(3). C will be considered to be dividual does not intend to reside per- an exempt individual for the current year be- manently in the United States and has cause she has not been exempt as a student, substantially complied with the re- teacher or trainee for four of the six pre- quirements of the student visa pro- ceding calendar years. viding for the individual’s temporary Example 4. D is temporarily present in the presence in the United States. For pur- United States during the current year as a poses of this paragraph (b)(7), the facts teacher, within the meaning of section 101(a)(15)(J) of the Immigration and Nation- and circumstances to be considered in ality Act. D does not receive compensation determining if an individual has dem- described in section 872(b)(3) in the current onstrated an intent to reside perma- year. D entered the United States in Decem- nently in the United States include ber of the second preceding year and intends (but are not limited to)— to remain in the United States until June of (A) Whether the individual has main- the current year. D will not be considered an tained a closer connection with a for- exempt individual for the current year be- eign country as described in cause he has been exempt as a teacher for at § 301.7701(b)–2; and least two of the past six years. (B) Whether the individual has taken (8) Immediate family. The immediate affirmative steps within the meaning family of an exempt individual in- of paragraph (f) of § 301.7701(b)–2 to ad- cludes the individual’s spouse and un- just the individual’s status from non- married children (whether by blood or immigrant to lawful permanent resi- adoption) but only if the spouse’s or dent. unmarried children’s visa status are (iv) Transition rule. The rules in this derived from and dependent on the visa paragraph (b)(7) relating to stated peri- classification of the exempt individual. ods of exempt status apply only for For the purposes of this paragraph, the those stated periods that occur after term unmarried children means those 1984. Thus, for example, an alien who is children who are under 21 years of age, present as a student during the cal- who reside regularly in the household endar years 1982–1990 will not be sub- of the exempt individual, and who are ject to the five year rule for students not members of some other household. until 1990. The immediate family of an exempt in- (v) Examples. The following examples dividual does not include the attend- illustrate the application of paragraphs ants, servants, and personal employees (b)(7) (i) and (ii) of this section: of that individual. Example 1. B is temporarily present in the (c) Medical condition—(1) In general. United States during the current year as a An individual will not be considered teacher, within the meaning of section present on any day that the individual 101(a)(15)(J) of the Immigration and Nation- intends to leave and is unable to leave ality Act. B does not receive compensation the United States because of a medical described in section 872(b)(3) in the current condition or medical problem that year. B has been treated as an exempt stu- arose while the individual was present dent for the past three years. Although this in the United States. A day of presence is the first year that B is seeking to be ex- empt as a teacher, he will not be considered will not be excluded if the individual, an exempt individual for the year because he who was initially prevented from leav- has been exempt as a student for at least two ing, is subsequently able to leave the of the past six years. United States and then remains in the Example 2. C is temporarily present in the United States beyond a reasonable pe- United States during the current year as a riod for making arrangements to leave teacher and receives compensation described the United States. A day will also not in section 872(b)(3) in the current year. C has be excluded if the medical condition been treated as an exempt teacher for the past two years but C’s compensation for arose during a prior stay in the United those years was not described in section States (whether or not days of presence 872(b)(3). C will not be considered an exempt during the prior stay were excluded) individual for the current year because she and the alien returns to the United
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States for treatment of the medical gardless of whether the individual re- condition or medical problem that quired treatment for the condition or arose during the prior stay. problem when the individual entered (2) Intent to leave the United States. the United States. For purposes of paragraph (c)(1) of this (4) Examples. The following examples section, whether an individual intends illustrate the application of this para- to leave the United States on a par- graph (c): ticular day will be determined based on Example 1. B is in a serious automobile ac- all the facts and circumstances. Thus, cident in the United States on March 25. B if at the time an individual’s medical intended to leave the United States on condition or medical problem arose, March 31 (as evidenced by an airline ticket), the individual was present in the but was unable to leave on that date as a re- United States for a definite purpose sult of the injuries suffered in the accident. which by its nature could be accom- B recovered from the injuries and was able to plished within the United States dur- leave and did leave the United States on May ing a period of time that would not 31. B’s presence in the United States during the period from April 1 through May 31 will cause the individual to be a resident not be counted as days of presence in the under the substantial presence test, United States. the individual may be able to establish Example 2. The facts are the same as in Ex- that he or she intended to leave the ample 1, except that B’s return flight (as evi- United States. However, if the individ- denced by an airline ticket) was scheduled ual’s purpose is of such a nature that for May 31. Because B did not intend to leave an extended period of time would be re- the United States until May 31, B may not quired for its accomplishment (suffi- exclude any days of presence in the United States. cient to cause the individual to be a resident under the substanial presence (d) Days in transit. An alien indi- test), the individual would not be able vidual may exclude days of presence in to establish the requisite intent to the United States if the individual is in leave the United States. If the indi- transit between two foreign points, and vidual is present in the United States is physically present in the United for no particular purpose or a purpose States for fewer than 24 hours. For pur- by its nature that does not require a poses of this paragraph, an individual specific period of time to accomplish, will be considered to be in transit if the the determination of whether the indi- individual pursues activities that are vidual has the requisite intent to leave substantially related to completing his the United States will depend on all or her travel to a foreign point of des- the surrounding facts and cir- tination. For example, an alien who cumstances. In the case of an indi- travels between airports in the United vidual adjudicated mentally incom- States in order to change planes en petent, proof of intent to leave the route to the individual’s destination United States may be determined by will be considered to be in transit. analyzing the incompetent’s pattern of However, if the individual attends a behavior prior to the adjudication of business meeting while he or she is incompetence. Generally, an individual present in the United States, whether will be presumed to have intended to or not that meeting is within the con- leave during a period of illness if the fines of the airport, the individual will individual leaves the United States not be considered to be in transit. For within a reasonable period of time purposes of this paragraph, the term (time to make arrangements to leave) ‘‘foreign point’’ means any areas that after becoming physically able to are not included within the definition leave. of the term ‘‘United States’’ provided (3) Pre-existing medical condition. A in § 301.7701(b)–1(c)(2)(ii). medical condition or problem will not (e) Regular commuters from Mexico or be considered to arise while the indi- Canada—(1) General rule. An alien indi- vidual is present in the United States, vidual will not be considered to be if the condition or problem existed present in the United States on days prior to the individual’s arrival in the that the individual commutes to the United States, and the individual was United States from the individual’s aware of the condition or problem, re- residence in Mexico or Canada if the
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individual regularly commutes from ployment with X Corporation. B returned to Mexico or Canada. An alien individual his residence in Mexico on each of those eve- will be considered to commute regu- nings. On seven days in the period from Feb- larly if the individual commutes to the ruary 1, 1988, through June 1, 1988, B worked in X’s Mexico office. B is not considered to individual’s location of employment or have been present in the United States on self-employment in the United States any of the days that he travelled to X’s from his or her residence in Mexico or United States office for the purpose of engag- Canada on more than 75% of the work- ing in employment with Corporation X be- days during the working period. cause he commuted to his place of employ- (2) Definitions. (i) The term commutes ment within the United States on more than means to travel to employment or self- 75% of the workdays during the working pe- employment and to return to one’s res- riod (59 workdays in the United States/66 workdays in the working period=89.4%). idence within a 24-hour period. Example 2. C, who lives in Canada, con- (ii) The term workdays means days on tracted with a resort located in the United which the individual works in the States to provide snow-skiing instructions United States or Canada or Mexico. for the resort’s customers for two skiing sea- (iii) The term working period means sons, the first beginning on November 15, the period beginning with the first day 1987, and ending on March 15, 1988, and the in the current year on which the indi- second beginning on November 15, 1988, and ending on March 15, 1989. On 90 days in each vidual is physically present in the of the two skiing seasons, C travelled in the United States for purposes of engaging morning from Canada to the resort to pro- in employment or self-employment and vide skiing instructions pursuant to the con- ending on the last day in the current tract. C returned to Canada on each of those year on which the individual is phys- evenings. On 20 days during each of the two ically present in the United States for skiing seasons, C worked in Canada. C is not purposes of engaging in that employ- considered to have been present in the ment or self-employment. If the nature United States on any of the days that she travelled to the United States to provide ski of the employment or self-employment instructions in either the first working pe- is such that it requires the individual riod beginning on November 15, 1987, and to be present in the United States only ending on March 15, 1988, or the second work- on a seasonal or cyclical basis, the ing period beginning on November 15, 1988, working period will begin with the first and ending on March 15, 1989, because she day of the season or cycle on which the commuted to her employment within the individual is present in the United United States on more than 75% of the work- States for purposes of engaging in that days during each of the working periods (90 workdays in the United States/110 workdays employment or self-employment and in the working period=81.8%). end on the last day of the season or Example 3. D, who lives in Canada, is the cycle on which the individual is sole proprietor of a wholesale lumber busi- present in the United States for the ness with offices in both the United States purpose of engaging in that employ- and Canada. Beginning on January 4, 1988, ment or self-employment. Thus, there and ending on February 12, 1988, D commuted may be more than one working period to work in his United States office on 30 in a calendar year and a working pe- days. Beginning on February 15, 1988, and ending on March 25, 1988, D commuted to riod may begin in one calendar year work in his Canadian office on 30 days. Be- and end in the following calendar year. ginning on March 28, 1988, and ending on May (3) Examples. The following examples 27, 1988, D commuted to work in his United illustrate the operation of this para- States office on 45 days. Subsequent to May graph (e): 27, D did not commute to the United States on any other days in 1988. D is considered to Example 1. B lives in Mexico and is em- have been present in the United States on ployed by Corporation X in its office in Mex- each day that he travelled to his office in the ico. B was temporarily assigned to X’s office United States because D did not commute to in the United States. B’s employment in the the United States office on more than 75% of United States office began on February 1, the workdays during the working period be- 1988, and continued through June 1, 1988. On ginning on January 4, 1988, and ending on June 2, B resumed his employment in Mex- May 27, 1988 (75 workdays in the United ico. On 59 days in the period beginning on States/105 workdays in the working pe- February 1, 1988, and ending on June 1, 1988, riod=71.4%). B travelled each morning from his residence in Mexico to X Corporation’s United States (f) Determination of excluded days ap- office for the purpose of engaging in his em- plies beyond year of determination. If a
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day of presence is excluded under this dividual who meets the substantial section, then that day shall not be presence test is the last day during the taken into account in the current year calendar year that the individual is or the first or second preceding year. physically present in the United States [T.D. 8411, 57 FR 15245, Apr. 27, 1992; 57 FR if the individual establishes that, for 28612, June 26, 1992; 57 FR 37190, Aug. 18, 1992; the remainder of the calendar year, the as amended by T.D. 8733, 62 FR 53386, Oct. 14, individual’s tax home was in a foreign 1997] country and he or she maintained a closer connection (within the meaning § 301.7701(b)–4 Residency time periods. of § 301.7701(b)–2(d)) to that foreign (a) First year of residency. An alien in- country than to the United States. dividual who was not a United States Similarly, the residency termination resident during the preceding calendar date for an alien who meets the green year and who is a United States resi- card test is the first day during the cal- dent for the current year will begin to endar year that the alien is no longer a be a resident for tax purposes on the lawful permanent resident if the indi- alien’s residency starting date. The vidual establishes that, for the remain- residency starting date for an alien der of the calendar year, his or her tax who meets the substantial presence home was in a foreign country and he test is the first day during the calendar or she maintained a closer connection year on which the individual is present to that foreign country than to the in the United States. The residency United States. The residency termi- starting date for an alien who meets nation date for an alien who satisfies the lawful permanent resident test both the substantial presence test and (green card test), described in para- the green card test for the current graph (b)(1) of § 301.7701(b)–1, is the first year, will be the later of the first day day during the calendar year in which the individual is no longer a lawful per- the individual is physically present in manent resident of the United States the United States as a lawful perma- or the last day the individual was phys- nent resident. The residency starting date for an alien who satisfies both the ically present in the United States if substantial presence test and the green the alien establishes that, for the re- card test will be the earlier of the first mainder of the calendar year, his or day the individual is physically present her tax home was in a foreign country in the United States as a lawful perma- and he or she maintained a closer con- nent resident of the United States or nection to that foreign country than to the first day during the year that the the United States. It is immaterial individual is present for purposes of the whether the individual’s tax home was substantial presence test. (See in the United States, or that the indi- § 301.7701(b)–9(b)(1) for the transitional vidual had a closer connection to the rule relating to the residency starting United States than to the foreign coun- date of an alien individual who was a try, prior to the date of his or her de- lawful permanent resident in 1984. See parture from the United States or the also § 301.7701(b)–3 for days that may be date on which the individual was no excluded.) longer a lawful permanent resident, (b) Last year of residency—(1) General whichever is applicable. rule. An alien individual who is a (c) Rules relating to residency starting United States resident during the cur- date and residency termination date—(1) rent year but who is not a United De minimis presence. An alien individual States resident at any time during the may be present in the United States for following calendar year will cease to be up to 10 days without triggering the a resident for tax purposes on the indi- residency starting date (for purposes of vidual’s residency termination date. the substantial presence test) or ex- Generally, the residency termination tending the residency termination date date will be the last day of the cal- (for purposes of the substantial pres- endar year. ence test) if the individual is able to (2) Exceptions. Notwithstanding para- establish that, during that period, the graph (b)(1) of this section, the resi- individual’s tax home was in a foreign dency termination date for an alien in- country and he or she maintained a
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closer connection to that foreign coun- (ii) Determination of presence. Except try than to the United States. Days as otherwise provided in paragraph from more than one period of presence (c)(3)(iii) of this section, an individual may be disregarded for purposes of de- shall be treated as present in the termining an individual’s residency United States on any day that the indi- starting date or termination date so vidual is physically present in the long as the total is not more than 10 United States at any time during the days. However, an individual may not day. disregard any days that occur in a pe- (iii) Thirty-one day period. For pur- riod of consecutive days of presence, if poses of this paragraph (c)(3), the term all the days that occur during that pe- thirty-one day period means any period riod cannot be excluded. An individual of 31 consecutive days during which an must include days of presence for pur- individual is physically present in the poses of determining whether the indi- United States during each day of the vidual meets the substantial presence period. test even though the days may be dis- (iv) Period of continuous presence. For regarded for purposes of determining purposes of this paragraph (c)(3), the the individual’s residency starting date term continuous presence means a pe- or residency termination date. riod of presence in the United States (2) Proration. If an individual’s resi- that includes 75 percent of the days in dency starting date does not fall on the the current year beginning with (and first day of the tax year, or the individ- including) the first day of the individ- ual’s residency termination date does ual’s thirty-one day period of presence. not fall on the last day of the tax year, Only for purposes of the continuous the individual’s income tax liability presence requirement, an individual should be calculated in accordance will be deemed to be present in the with § 1.871–13 of this chapter dealing United States for up to 5 days on which with the taxation of individuals who the individual is absent from the change residence status during the tax- United States. These days will not be deemed to be days of presence for pur- able year. poses of the thirty-one day period of (3) Residency starting date for certain presence requirement. If an individual —(i) If an alien individuals In general. is present for more than one thirty-one individual (who otherwise does not day period of presence and satisfies the meet the substantial presence test or continuous presence requirement with the green card test for the current regard to each period, the individual’s year) is physically present in the residency starting date shall be the United States for at least 31 consecu- first day of the first thirty-one day pe- tive days during the current year, and riod of presence. If an individual is also for a period of continuous presence present for more than one thirty-one beginning with the first day of that day period of presence but satisfies the thirty-one day period (see paragraph continuous presence requirement only (c)(3)(iii) of this section), then the indi- for a later thirty-one day period, the vidual may elect to be treated as a individual’s residency starting date resident during the current year. The shall be the first day of the later thir- individual’s residency starting date ty-one day period of presence. For pur- shall be the first day of that thirty-one poses of this paragraph (c)(3), days of day period, if— presence that are otherwise excluded (A) The individual was not a resident under section 7701(b)(3)(D)(i) and of the United States under the substan- § 301.7701(b)–3(a)(1) (exempt individual), tial presence test or the green card test (a)(2) (medical condition), (a)(3) (in in the year preceding the current year; transit between two foreign points), and and (a)(4) (regular commuter) shall not (B) The individual is a resident of the be counted as days of presence for pur- United States in the subsequent year poses of either the thirty-one day pe- under the substantial presence test riod or continuous presence require- (whether or not the individual is also a ment. resident of the United States under the (v) Election procedure—(A) Filing re- green card test). quirements. An alien individual shall
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make an election to be treated as a test in the year following the election resident under paragraph (c)(3) of this year; section by attaching a statement (de- (3) The individual’s number of days of scribed in paragraph (c)(3)(v)(C) of this presence in the United States during section) to the individual’s income tax the year following the election year; return (Form 1040) for the taxable year (4) The date or dates of the alien indi- for which the election is to be in effect vidual’s thirty-one day period of pres- (the election year). The alien indi- ence and period of continuous presence vidual may not make this election in the United States during the elec- until such time as he has satisfied the tion year; and substantial presence test for the year (5) The date or dates of absence from following the election year. If an alien the United States during the election individual has not satisfied the sub- year that are deemed to be days of stantial presence test for the year fol- presence. lowing the election year as of the due (vi) Penalty for failure to comply with date (not including extensions) of the filing requirements—(A) General rule. If tax return for the election year, the an individual fails to comply with the alien individual may request an exten- election procedure of paragraph sion of time for filing the return until (c)(3)(v) of this section, the individual a reasonable period after he or she has must file his or her income tax return satisfied such test, provided that the for the current year as a nonresident individual pays with his or her exten- alien. sion application the amount of tax he (B) Exception. The penalty described or she expects to owe for the election in paragraph (c)(3)(vi)(A) of this sec- year computed as if he or she were a tion shall not apply if the individual nonresident alien throughout the elec- can show by clear and convincing evi- tion year. An election made under dence that he or she took reasonable paragraph (c)(3) of this section may not actions to become aware of the filing be revoked without the approval of the requirements and significant affirma- Commissioner or his delegate. tive steps to comply with the require- (B) Election on behalf of a dependent ments. An individual who requests an child. An individual may make an elec- extension of time to file his or her in- tion on behalf of a dependent child (as come tax return pursuant to paragraph defined in paragraphs (1) and (2) of sec- (c)(3)(v) of this section will be consid- tion 152(a), without regard to section ered to have taken significant affirma- 152(b)(3)) if the individual is qualified tive steps to comply with the require- to make an election on his or her own ment that the individual pay his or her behalf, the child qualifies to make an tax determined as if the individual election under this paragraph (c)(3), were a nonresident alien if the indi- and the child is not required by section vidual paid with his or her extension 6012 to file a United States income tax application at least 90 percent of the return for the year for which the elec- amount of the tax the individual actu- tion is to be effective. ally owed for the election year com- (C) Statement. The statement required puted as if he or she were a nonresident by paragraph (c)(3)(v)(A) of this section alien throughout the election year. shall include the name and address of (d) Examples. The following examples the alien individual and contain a illustrate the operation of this section: signed declaration that the election is Example 1. B, a citizen of foreign country being made. If the individual is also X, is an alien who has never before been a making an election on behalf of any de- United States resident for tax purposes. B pendent children, then the statement comes to the United States on January 6, must include the required information 1985, to attend a business meeting and re- with respect to those children. The turns to country X on January 10, 1985. B is statement must specify— able to establish a closer connection to coun- (1) That the alien individual was not try X for the period January 6–10. On March 1, 1985, B moves to the United States and re- a resident in the year immediately pre- sides here until August 20, 1985, when he re- ceding the election year; turns to country X. On December 12, 1985, B (2) That the alien individual is a resi- comes to the United States for pleasure and dent under the substantial presence stays here until December 16, 1985 when he
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returns to country X. B is able to establish from a continuous period of presence only if a closer connection to country X for the pe- she can exclude all the days that occur dur- riod December 12–16. B is not a United States ing that period. Thus, C may choose either of resident for tax purposes during the fol- the following periods of residency: residency lowing year and can establish a closer con- starting date February 5, 1985, and residency nection to country X for the remainder of termination date November 20, 1985, or resi- calendar year 1985. B is a resident of the dency starting date April 20, 1985, and resi- United States under the substantial presence dency termination date December 17, 1985. test because B is present in the United Example 5. D, a citizen of foreign country States for 183 days (5 days in January plus Z, is an alien who has never before been a 173 days for the period March 1–August 20 United States resident for tax purposes. D plus 5 days in December). B’s residency comes to the United States on November 1, starting date is March 1, 1985, and his resi- 1985 and is present in the United States on 31 dency termination date is August 20, 1985. consecutive days (from November 1 through Example 2. The facts are the same as in Ex- December 1, 1985). D returns to country Z on ample 1, except that B remains in the United December 1 and does not come back to the States until December 17, 1985, and is able to United States until December 17, 1985. He re- establish a closer connection to country X mains in the United States for the rest of the for the period December 18 through 31. B’s year. During 1986, D is a resident of the residency termination date is December 17, United States under the substantial presence 1985. test. D may elect to be treated as a resident Example 3. C, a citizen of foreign country of the United States for 1985 because he was Y, is an alien who has never before been a present in the United States in 1985 for a 31 United States resident for tax purposes. C consecutive day period of presence (Novem- comes to the United States for the first time ber 1 through December 1, 1985) and for at on February 10, 1985, and attends a business least 75 percent of the days following (and in- conference until February 24, 1985, when she cluding) the first day of D’s 31 consecutive returns to country Y. On April 20, 1985, C en- day period of presence (46 total days of pres- ters the United States as a lawful permanent ence in the United States/61 days in the pe- resident. On November 10, 1985, C ceases to riod from November 1 through December be a lawful permanent resident but stays on 31=75.4%). If D makes the election to be in the United States until November 20, 1985 treated as a resident, his residency starting when she returns to country Y. On December date will be November 1, 1985. 8, 1985, C comes to the United States and Example 6. The facts are the same as in Ex- stays here until December 17, 1985 when she ample 5, except that D is absent from the returns to country Y. She can establish a United States on December 24, 25, 29, 30 and closer connection to country Y for that pe- 31. D may make the election to be treated as riod. C is not a resident of the United States a resident for 1985 because up to five days of during the following calendar year and can absence will be deemed to be days of pres- establish a closer connection to country Y ence for purposes of the continuous presence for the remainder of calendar year 1985. C requirement. qualifies as a United States resident under Example 7. F, a citizen of foreign country both the green card test and the substantial M, is an alien individual who has never be- presence test. C’s residency starting date fore been a United States resident for tax under the green card test is April 20, 1985. purposes. F comes to the United States on Under the substantial presence test, C’s resi- January 1, 1985 and remains in the United dency starting date is February 10, 1985, be- States through January 31, 1985, when she re- cause she is present for more than ten days turns to country M. F comes back to the in February and cannot take advantage of United States on October 1, 1985 and is the de minimis presence rule. Therefore, C’s present in the United States through Novem- residency starting date is February 10, 1985. ber 1, 1985. From November 1, 1985 through C’s residency termination date under the December 31, 1985, F is present in the United green card test is November 10, 1985. Her States for 38 days. Although F satisfies two residency termination date under the sub- 31 consecutive day periods of presence, (Jan- stantial presence test is November 20, be- uary 1 through January 31 and October 1 cause B can disregard ten days of presence in through November 1), she satisfies the con- December. Thus, her residency termination tinuous presence requirement only with re- date is November 20, 1985, the later of her gard to the later period of presence (69 total residency termination date under the sub- days of presence/92 days in the period from stantial presence test or the green card test. October 1 through December 31=75%). Thus, Example 4. The facts are the same as in Ex- if F makes the election to be treated as a ample 3, except that C is initially present in resident, his residency starting date is Octo- the United States on business from February ber 1, 1985. 5 to February 9, 1985. C is able to establish a closer connection to country Y for that pe- (e) No lapse—(1) Residency in prior riod. C may take advantage of only ten days year. An alien individual who was a of de minimis presence and may exclude days United States resident during any part
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of the preceding calendar year and who § 301.7701(b)–5 Coordination with sec- is a United States resident for any part tion 877. of the current year will be considered (a) General rule. An alien individual to be taxable as a resident at the begin- will be subject to United States income ning of the current year. For purposes tax in the manner provided by section of this paragraph (e)(1), it is immate- 877, regardless of whether the indi- rial whether an individual is considered vidual has a tax avoidance motive, if— to be a resident under the substantial (1) The alien individual is a resident presence test or the green card test. alien of the United States for at least (2) Residency in following year. An three consecutive calendar years (the alien individual who is a United States initial residency period) beginning resident for any part of the current after December 31, 1984; year and who is also a United States (2) The period of residence for each of resident for any part of the following the three consecutive calendar years year (regardless of whether the indi- includes at least 183 days; vidual has a closer connection to a for- (3) The alien is once again taxed as a nonresident (including an individual eign country than the United States taxed as a nonresident) under during the current year) will be taxable § 301.7701(b)–7(a)(1); and as a resident through the end of the (4) The alien then becomes a resident current year. For purposes of this para- of the United States before the close of graph (e)(2), it is immaterial whether the third calendar year beginning after an individual is considered to be a resi- the individual’s residency termination dent under the substantial presence date in the initial residency period. test or the green card test. (b) Tax imposed. The tax provided for (3) Special rule. If an individual meets under paragraph (a) of this section will the green card test for the current year be imposed for the intervening period but is not physically present in the of nonresidency only if the amount of United States during the current year, tax would exceed the amount of tax then the individual’s residency starting that would be imposed under section date shall be the first day of the fol- 871, relating to the taxation of non- lowing year. resident aliens. (4) Example. The following example il- (c) Example. The following example lustrates the application of this para- illustrates the application of this sec- graph (e). tion. Example. B, a citizen of foreign country F, Example. B, an alien individual who is a enters the United States on April 1, 1985, as citizen of foreign country M, comes to the a lawful permanent resident. On August 1, United States for the first time on May 1, 1987, B ceases to be a lawful permanent resi- 1985, and remains in the United States until dent and returns to country F. B meets the November 5, 1985, when he returns to country initial residency period requirement because M. B comes back to the United States on he is a resident of the United States for at March 5, 1986 as a lawful permanent resident least 183 days in each of three consecutive and remains in the United States until Sep- years (1985, 1986 and 1987). B returns to the tember 10, 1986, when he ceases to be a lawful United States on October 5, 1990, as a lawful permanent resident and returns to country permanent resident. Because B became a M. B is not a resident in calendar year 1987. resident of the United States before the close B’s United States residency in calendar year of the third calendar year (1990) beginning 1985 continues through December 31, 1985, be- after the close of the initial residency period cause he is a United States resident in the (August 1, 1987), he is subject to tax under following calendar year. In calendar year section 877(b) for the intervening period of 1986, B’s United States residency is deemed nonresidency, August 2, 1987 through October to begin on January 1, 1986 because B quali- 4, 1990, if the amount of the tax imposed fied as a resident in the preceding calendar under section 877 is more than the tax im- year. Thus, B’s residency period in the posed under section 871. United States begins on May 1, 1985, and ends [T.D. 8411, 57 FR 15250, Apr. 27, 1992] on September 10, 1986. § 301.7701(b)–6 Taxable year. [T.D. 8411, 57 FR 15247, Apr. 27, 1992; 57 FR 28612, June 26, 1992] (a) In general. An alien individual who has not established a fiscal year as
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his or her taxable year prior to the pe- tember 30, 1985. For his fiscal year that ends riod that the individual is subject to on September 30, 1986, B will only be taxed as United States income tax as a resident a United States resident for the period that or a nonresident shall adopt the cal- begins on October 1, 1985 and ends on October 10, 1985. endar year as his or her taxable year. Example 2. The facts are the same as in Ex- An alien who has established a fiscal ample 1, except that B’s 1982 business was a year in a foreign country prior to the country F business established on a fiscal period that the individual is subject to year basis and at no time prior to 1985 was B United States income tax may adopt subject to United States income tax. B may the calendar year as his or her taxable adopt a calendar year as his taxable year for year for United States income tax pur- United States income tax purposes without poses without requesting a change in requesting a change of accounting period. B continues to use a fiscal year as his taxable accounting period. An individual will year. For his fiscal year that ends on Sep- be considered to have established a fis- tember 30, 1985, B will be taxed as a United cal year (whether in the United States States resident for the period that begins on or a foreign country) if the annual ac- March 8, 1985 and ends September 30, 1985. counting period on which the indi- For his fiscal year that ends on September vidual computes his or her income is a 30, 1986, B will be taxed as a United States fiscal year, the individual keeps his or resident for the period that begins on Octo- her books in accordance with that fis- ber 1, 1985 and ends on October 10, 1985. Example 3. The facts are the same as in Ex- cal year, and the requirements of sec- ample 1, except that B’s 1982 business was a tion 441 and § 1.441–1(e) of this chapter country F business established on a fiscal are otherwise satisfied. An alien who year basis and at no time prior to 1985 was B has established a fiscal year and is a subject to United States income tax. B may resident alien during the calendar year adopt a calendar year as his taxable year for will be treated as a resident alien with United States income tax purposes without respect to any portion of his or her tax- requesting a change of accounting period. B able year (beginning with the individ- adopts a calendar year as his taxable year ual’s residency starting date and end- for 1985. For his calendar year taxable year ending on December 31, 1985, B will be taxed ing with the individual’s residency ter- as a United States resident for the period mination date) that falls within such that begins on March 8, 1985, and ends on Oc- calendar year. Once the individual has tober 10, 1985. established either a fiscal or calendar [T.D. 8411, 57 FR 15250, Apr. 27, 1992; 57 FR year taxable year for any period for 28612, June 26, 1992] which the individual is subject to United States income tax, the indi- § 301.7701(b)–7 Coordination with in- vidual may not change that taxable come tax treaties. year without the approval of the Sec- (a) Consistency requirement—(1) Appli- retary. See section 442. cation. The application of this section (b) Examples. The following examples shall be limited to an alien individual illustrate the operation of this section: who is a dual resident taxpayer pursu- Example 1. B, a citizen and resident of for- ant to a provision of a treaty that pro- eign country F, was engaged in a United vides for resolution of conflicting States business during 1982 and filed a return claims of residence by the United on a fiscal year basis. B’s fiscal year runs States and its treaty partner. A ‘‘dual from October 1 to September 30. B comes to resident taxpayer’’ is an individual who the United States on March 8, 1985 and re- is considered a resident of the United mains in the United States until October 10, 1985, when he returns to country F. B main- States pursuant to the internal laws of tains a closer connection to and his tax the United States and also a resident of home in Country F for the remainder of cal- a treaty country pursuant to the trea- endar year 1985. B, who is not a United ty partner’s internal laws. If the alien States resident at any time in 1986, is a individual determines that he or she is United States resident for the period that be- a resident of the foreign country for gins on March 8, 1985, and ends on October 10, treaty purposes, and the alien indi- 1985. B has adopted a fiscal year taxable year vidual claims a treaty benefit (as a for purposes of computing his United States income tax liability. For his fiscal year that nonresident of the United States) so as ends on September 30, 1985, B will be taxed as to reduce the individual’s United a United States resident for the period that States income tax liability with re- begins on March 8, 1985 and ends on Sep- spect to any item of income covered by
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an applicable tax convention during a 1040NR. The Form 1040NR and the at- taxable year in which the individual tached statement, shall be filed with was considered a dual resident tax- the Internal Revenue Service Center, payer, then that individual shall be Philadelphia, PA 19255. The filing of a treated as a nonresident alien of the Form 1040NR by an individual de- United States for purposes of com- scribed in paragraph (a) of this section puting that individual’s United States may affect the determination by the income tax liability under the provi- Immigration and Naturalization Serv- sions of the Internal Revenue Code and ice as to whether the individual quali- the regulations thereunder (including fies to maintain a residency permit. the withholding provisions of section (c) Contents of statement—(1) In gen- 1441 and the regulations under that sec- eral—(i) Returns due after December 15, tion in cases in which the dual resident 1997. The statement filed by an indi- taxpayer is the recipient of income vidual described in paragraph (a)(1) of subject to withholding) with respect to this section, for a return relating to a that portion of the taxable year the in- taxable year for which the due date dividual was considered a dual resident (without extensions) is after December taxpayer. 15, 1997, must be in the form of a fully (2) Computation of tax liability. If an completed Form 8833 (Treaty-Based Re- alien individual is a dual resident tax- turn Position Disclosure Under Section payer, then the rules on residency pro- 6114 or 7701(b)) or appropriate successor vided in the convention shall apply for form. See section 6114 and § 301.6114–1 purposes of determining the individ- for rules relating to other treaty-based ual’s residence for all purposes of that return positions taken by the same treaty. taxpayer. (3) Other Code purposes. Generally, for (ii) Earlier returns. For returns relat- purposes of the Internal Revenue Code ing to taxable years for which the due other than the computation of the indi- date for filing returns (without exten- vidual’s United States income tax li- sions) is on or before December 15, 1997, ability, the individual shall be treated the statement filed by the individual as a United States resident. Therefore, described in paragraph (a)(1) of this for example, the individual shall be section must contain the information treated as a United States resident for in accordance with paragraph (c)(1) of purposes of determining whether a for- this section in effect prior to December eign corporation is a controlled foreign 15, 1997 (see § 301.7701(b)–7(c)(1) as con- corporation under section 957 or wheth- tained in 26 CFR part 301, revised April er a foreign corporation is a foreign 1, 1997). personal holding company under sec- (2) Controlled foreign corporation tion 552. In addition, the application of shareholders. If the taxpayer who paragraph (a)(2) of this section does not claims a treaty benefit as a non- affect the determination of the individ- resident of the United States is a ual’s residency time periods under United States shareholder in a con- § 301.7701(b)–4. trolled foreign corporation (CFC), as (4) Special rules for S corporations. [Re- defined in section 957 or section 953(c), served] and there are no other United States (b) Filing requirements. An alien indi- shareholders in that CFC, then for pur- vidual described in paragraph (a) of poses of paragraph (c)(1) of this section, this section who determines his or her the approximate amount of subpart F U.S. tax liability as if he or she were a income (as defined in section 952) that nonresident alien shall make a return would have been included in the tax- on Form 1040NR on or before the date payer’s income may be determined prescribed by law (including exten- based on the audited foreign financial sions) for making an income tax return statements of the CFC. as a nonresident. The individual shall (3) S corporation shareholders. [Re- prepare a return and compute his or served] her tax liability as a nonresident alien. (d) Relationship to section 6114(a) trea- The individual shall attach a state- ty-based return positions. The statement ment (in the form required in para- required by paragraph (b) of this sec- graph (c) of this section) to the Form tion will be considered disclosure for
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purposes of section 6114 and § 301.6114– (i.e., after the allowance of deductions) than 1(a), but only if the statement is in the if he were treated as a nonresident alien. If, form required by paragraph (c) of this however, B chooses to file as a nonresident section. If the taxpayer fails to file the in order to claim treaty benefits with respect to his share of R’s subpart F income, his statement required by paragraph (b) of overall United States tax liability, including this section on or before the date pre- the portion attributable to the dividends, scribed in paragraph (b) of this section, must be determined as if he were a non- the taxpayer will be subject to the pen- resident alien. alties imposed by section 6712. See sec- Example 3. C, a married alien individual tion 6712 and § 301.6712–1. with three children, is a resident of foreign (e) Examples. The following examples country Y, under Y’s internal law. Country Y illustrate the application of this sec- is a party to an income tax convention with tion: the United States. C is also a resident of the United States under the Internal Revenue Example 1. B, an alien individual, is a resi- Code. C is considered to be a resident of dent of foreign country X, under X’s internal country Y under the convention. The con- law. Country X is a party to an income tax vention specifically covers, among other convention with the United States. B is also items of income, personal services income, a resident of the United States under the In- dividends and interest. C is sent by her coun- ternal Revenue Code. B is considered to be a try Y employer to work in the United States resident of country X under the convention. from January 1, 1985 until December 31, 1985. The convention does not specifically deal During 1985, C also earns United States with characterization of foreign corporations source dividends and interest and incurs as controlled foreign corporations or the tax- mortgage interest expenses on her personal ability of United States shareholders on in- residence. The United States-Y treaty pro- clusions of subpart F income, but it provides, vides that remuneration for personal serv- in an ‘‘Other Income’’ article similar to Arti- ices performed in the United States by a cle 21 of the 1981 draft of the United States country Y resident is exempt from United Model Income Tax Convention (U.S. Model), States tax if, among other things, the indi- that items of income of a resident of country vidual performing such services is present in X that are not specifically dealt with in the the United States for a period that is not in convention shall be taxable only in country excess of 183 days. The treaty provides that X. B owns 80% of the one class of stock of the rate of United States tax on United foreign corporation R. The remaining 20% is States source dividends paid to residents of owned by C, a United States citizen who is Y shall not exceed 15 percent of the gross unrelated to B. In 1985, corporation R’s only amount of the dividends and it exempts resi- income is interest that is foreign personal dents of Y from United States tax on United holding company income under § 1.954A–2 of States source interest. In filing her 1985 tax this chapter. Because the United States-X return, C may choose to file either as a resi- income tax convention does not deal with dent alien without claiming any treaty bene- characterization of foreign corporations as fits or as a nonresident alien if she desires to controlled foreign corporations, United claim any treaty benefit. C files as a non- States internal income tax law applies. resident (i.e. by following the procedure de- Therefore, B and C are United States share- scribed in § 301.7701(b)–7(b)). Because C does holders within the meaning of § 1.951–1(g) of not satisfy the requirements of the United this chapter, corporation R is a controlled States-Y treaty with regard to exempting foreign corporation within the meaning of personal services income from United States § 1.957–1 of this chapter, and corporation R’s tax, C will be taxed on her personal services income is included in C’s income as subpart income at graduated rates under section 1 of F income under § 1.951–1 of this chapter. B the Code pursuant to section 871(b) of the may avoid current taxation on his share of Code. She will not be entitled to deduct her the subpart F inclusion by filing as a non- mortgage interest expenses or to claim more resident (i.e., by following the procedure in than one personal exemption because she is § 301.7701(b)–7(b)). taxed as a nonresident alien under the Code Example 2. The facts are the same as in Ex- by virtue of her decision to claim treaty ben- ample 1, except that B also earns United efits, and section 873 of the Code denies non- States source dividend income. The United residents the deduction for personal resi- States-X income tax convention provides dence mortgage interest expense and gen- that the rate of United States tax on United erally limits them to only one personal ex- States source dividends paid to residents of emption. C will be subject to a tax of 15 per- country X shall not exceed 15 percent of the cent of the gross amount of her dividend in- gross amount of the dividends. B’s United come under section 871(a) of the Code as States tax liability with respect to the divi- modified by the treaty, and she will be ex- dends would be smaller if he were treated as empt from tax on her interest income. C is a resident alien, subject to tax on a net basis not entitled to file a joint return with her
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spouse even if he is a resident alien under return relating to a taxable year for the Code for 1985. which the due date (without exten- Example 4. The facts are the same as in Ex- sions) is after December 15, 1997, must ample 3, except that C does not choose to claim treaty benefits with respect to any be in the form of a fully completed items of income covered by the treaty (i.e., Form 8840 (Closer Connection Excep- she files as a resident). Therefore, she is tion Statement) or appropriate suc- taxed as a resident under the Code and pays cessor form. tax at graduated rates on her personal serv- (ii) Earlier returns. For returns relat- ices income, dividends, and interest. In addi- ing to taxable years for which the due tion, she is entitled to deduct her mortgage date for filing returns (without exten- interest expenses and to take personal ex- emptions for her spouse and three children. C sions) is on or before December 15, 1997, will be entitled to file a joint return with her the statement filed by the individual spouse if he is a resident alien for 1985 or, if described in paragraph (a)(1) of this he is a nonresident alien, C and her spouse section must contain the information may elect to file a joint return pursuant to in accordance with paragraph (b)(1) of section 6013. this section in effect prior to December [T.D. 8411, 57 FR 15251, Apr. 27, 1992; 57 FR 15, 1997 (see § 301.7701(b)–8(b)(1) as con- 28612, June 26, 1992, as amended by T.D. 8733, tained in 26 CFR part 301, revised April 62 FR 53387, Oct. 14, 1997] 1, 1997). (2) Exempt individuals and individuals § 301.7701(b)–8 Procedural rules. with a medical condition—(i) Returns due (a) Who must file—(1) Closer connection after December 15, 1997. The statement exception. An alien individual who oth- filed by an individual described in erwise meets the substantial presence paragraph (a)(2) of this section, for a test must file a statement to explain return relating to a taxable year for the basis of the individual’s claim that which the due date (without exten- he or she is able to satisfy the closer sions) is after December 15, 1997, must connection exception described in be in the form of a fully completed § 301.7701(b)–2. Form 8843 (Statement for Exempt Indi- (2) Exempt individuals and individuals viduals and Individuals with a Medical with a medical condition. An alien indi- Condition) or appropriate successor vidual must file a statement to explain form. the basis of the individual’s claim that (ii) Earlier returns. For returns relat- he or she is able to exclude days of ing to taxable years for which the due presence in the United States because the individual— date for filing returns (without exten- (i) Is an exempt individual as de- sions) is on or before December 15, 1997, scribed in § 301.7701(b)–3(b)(3) (teacher/ the statement filed by the individual trainee) or (b)(4) (student); described in paragraph (a)(2) of this (ii) Is an exempt individual described section must contain the information in § 301.7701 (b)–3(b)(5) (professional ath- in accordance with paragraph (b)(2) of lete); or this section in effect prior to December (iii) Has a medical condition or prob- 15, 1997 (see § 301.7701(b)–8(b)(2) as con- lem as described in § 301.7701(b)–3(c). tained in 26 CFR part 301, revised April (3) De minimis presence and residency 1, 1997). starting and termination dates. A state- (3) De minimis presence and residency ment must be filed by an individual starting and termination dates. The who is seeking to establish— statement filed by an individual de- (i) That a period of de minimis pres- scribed in paragraph (a)(3) of this sec- ence of ten or fewer days should be dis- tion shall be dated, signed by the indi- regarded for purposes of the individ- vidual seeking to exclude de minimis ual’s residency starting or termination presence for purposes of the individ- date; or ual’s residency starting or termination (ii) A residency termination date. date or to establish a residency termi- (b) Contents of statement—(1) Closer nation date, and verified by a declara- connection exception—(i) Returns due tion that the statement is made under after December 15, 1997. The statement the penalty of perjury. The statement filed by an individual described in shall contain the information described paragraph (a)(1) of this section, for a in paragraphs (b)(1) (i), (ii) and (iii) of
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this section and the following informa- to paragraph (a)(1), (a)(2)(ii), (a)(2)(iii) tion (as applicable)— or (a)(3) of this section and fails to file (i) The first day that the individual such statement on or before the date was present in the United States dur- prescribed by paragraph (c) of this sec- ing the current year; tion, the individual will not be eligible (ii) The last day that the individual for the closer connection exception de- was present in the United States dur- scribed in § 301.7701(b)–2 and will be re- ing the current year; quired to include all days of presence (iii) Dates of de minimis presence in the United States (calculated with- that the individual is seeking to ex- out the benefit of §§ 301.7701(b)–3(b)(5), clude from his or her residency start- 301.7701(b)–3(c), and 301.7701(b)–4(c)(1)) ing or termination dates; for purposes of the substantial presence (iv) Sufficient facts to establish that test and for determining the individ- the individual has maintained his or ual’s residency starting and termi- her tax home in and a closer connec- nation dates. If an individual is consid- tion to a foreign country during a pe- ered to be a resident because of this riod of de minimis presence; paragraph and the individual is also a (v) Sufficient facts to establish that resident of a country with which the the individual has maintained his or United States has an income tax con- her tax home in and a closer connec- vention pursuant to that convention, tion to a foreign country following the the individual shall be treated in the individual’s last day of presence in the manner provided in § 301.7701(b)–7 (a) United States during the current year (relating to the treatment of individ- or following the abandonment or re- uals who are dual residents). scission of the individual’s status as a (2) Exception. The penalty described lawful permanent resident during the in paragraph (d)(1) of this section shall current year; not apply if the individual can show by (vi) Date that the individual’s status clear and convincing evidence that he as a lawful permanent resident was or she took reasonable actions to be- abandoned or rescinded; and come aware of the filing requirements (vii) Sufficient facts (including copies and significant affirmative steps to of relevant documents) to establish comply with those requirements. that the individual’s status as lawful (e) Filing requirement disregarded. Not- permanent resident has been aban- withstanding paragraph (d) of this sec- doned or rescinded. tion, the Secretary or his or her dele- (c) How to file. Individuals described gate may in their sole discretion, when in paragraph (a) of this section who are required to make a return on Form 1040 it is in the best interest of the govern- or 1040NR pursuant to paragraph (a) or ment to do so and based on all of the (b) of § 1.6012–1 of this chapter must at- facts and circumstances, disregard the tach the statement described in para- individual’s failure to file timely the graph (b) of this section to their return statement described in paragraph (a) of for the taxable year for which the this section in determining the individ- statement is relevant. An individual ual’s days of presence in the United who is not required to file either Form States. 1040 or l040NR must file the statement [T.D. 8411, 57 FR 15252, Apr. 27, 1992; 57 FR with the Internal Revenue Service Cen- 28612, June 26, 1992; 57 FR 37190, Aug. 18, 1992; ter, Philadelphia, PA 19255 on or before as amended by T.D. 8733, 62 FR 53387, Oct. 14, the date prescribed by law (including 1997] extensions) for making an income tax return as a nonresident for the cal- § 301.7701(b)–9 Effective dates of endar year for which the statement ap- §§ 301.7701(b)–1 through plies. The statement may be signed and 301.7701(b)–7. filed for the taxpayer by the taxpayer’s (a) In general. Except as indicated in agent in accordance with § 1.6061–1 of paragraph (b) of this section, this chapter. §§ 301.7701(b)–1 through 301.7701(b)–7 (d) Penalty for failure to file state- apply to taxable years beginning after ment—(1) General rule. If an individual December 31, 1984. For the rules appli- is required to file a statement pursuant cable to earlier taxable years, see
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§§ 1.871–2 through 1.871–5 of this chap- (c) Asset composition tests. ter. (1) Determination of amount of assets. (b) Special rules—(1) Green card test- (2) Substantially all. residency starting date. If an alien was a (i) In general. lawful permanent resident throughout (ii) Safe harbor. (3) Equity interests in pass-through ar- 1984 (regardless of whether the indi- rangements. vidual was physically present in the (4) Treatment of certain credit enhance- United States), or was physically ment contracts. present in the United States at any (i) In general. time during 1984 while a lawful perma- (ii) Credit enhancement contract defined. nent resident, the individual will be (5) Certain assets not treated as debt obli- considered to have been a resident of gations. the United States during 1984 for pur- (i) In general. poses of applying the provisions of sec- (ii) Safe harbor. (A) In general. tion 7701(b)(2)(A) and § 301.7701(b)–4 such (B) Payments with respect to a mortgage that the individual will, if he meets the defined. substantial presence or green card test (C) Entity treated as not anticipating pay- in 1985, be considered a resident of the ments. United States as of January 1, 1985, re- (d) Real estate mortgages or interests gardless of when the individual was therein defined. first present in the United States in (1) In general. 1985. (2) Interests in real property and real prop- (2) Substantial presence test-years in- erty defined. cluded. For purposes of applying the (i) In general. (ii) Manufactured housing. substantial presence test for calendar (3) Principally secured by an interest in years 1985 and 1986, days of presence in real property. 1984 will only be counted for aliens who (i) Tests for determining whether an obli- had been residents under prior law gation is principally secured. (§§ 1.871–2 through 1.871–5 of this chap- (A) The 80 percent test. ter) at the end of calendar year 1984. (B) Alternative test. Days of presence in 1983 will only be (ii) Obligations secured by real estate counted for aliens who had been resi- mortgages (or interests therein), or by com- dents under prior law at the end of binations of real estate mortgages (or inter- ests therein) and other assets. both calendar year 1983 and 1984. (A) In general. (3) Professional athletes. For purposes (B) Example. of applying the substantial presence (e) Two or more maturities. test, only days of presence in the (1) In general. United States after October 22, 1986, (2) Obligations that are allocated credit shall be excluded for individuals de- risk unequally. scribed in § 301.7701(b)–3(b)(5) (profes- (3) Examples. sional athletes). (f) Relationship test. (4) Procedural rules and filing require- (1) In general. ments. The procedural rules and filing (2) Payments on asset obligations defined. (3) Safe harbor for entities formed to liq- requirements described in §§ 301.7701(b)– uidate assets. 7(b) and 301.7701(b)–8 shall apply to tax- (g) Anti-avoidance rules. able years beginning after December 31, (1) In general. 1991. (2) Certain investment trusts. (3) Examples. [T.D. 8411, 57 FR 15253, Apr. 27, 1992] § 301.7701(i)–2 Special rules for portions of § 301.7701(i)–0 Outline of taxable mort- entities. gage pool provisions. (a) Portion defined. This section lists the major para- (b) Certain assets and rights to assets dis- graphs contained in §§ 301.7701(i)–1 regarded. through 301.7701(i)–4. (1) Credit enhancement assets. (2) Assets unlikely to service obligations. § 301.7701(i)–1 Definition of a taxable mortgage (3) Recourse. pool. (c) Portion as obligor. (a) Purpose. (1) In general. (b) In general. (2) Example.
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§ 301.7701(i)–3 Effective dates and duration of turities, and payments on the debt ob- taxable mortgage pool classification. ligations under which the entity is ob- (a) Effective dates. ligor bear a relationship to payments (b) Entities in existence on December 31, on the debt obligations that the entity 1991. holds as assets. (1) In general. (2) Special rule for certain transfers. (2) Paragraph (c) of this section pro- (3) Related debt obligation. vides the tests for determining whether (4) Example. substantially all of an entity’s assets (c) Duration of taxable mortgage pool clas- are debt obligations and for deter- sification. mining whether more than 50 percent (1) Commencement and duration. of its debt obligations are real estate (2) Testing day defined. mortgages. Paragraph (d) of this sec- § 301.7701(i)–4 Special rules for certain entities. tion defines real estate mortgages for (a) States and municipalities. purposes of the 50 percent test. Para- (1) In general. graph (e) of this section defines two or (2) Governmental purpose. more maturities and paragraph (f) of (3) Determinations by the Commissioner. this section provides rules for deter- (b) REITs. [Reserved] mining whether debt obligations bear a (c) Subchapter S corporations. relationship to the assets held by an (1) In general. entity. Paragraph (g) of this section (2) Portion of an S corporation treated as a separate corporation. provides anti-avoidance rules. Section 301.7701(i)–2 provides rules for applying [T.D. 8610, 60 FR 40088, Aug. 7, 1995] section 7701(i) to portions of entities and § 301.7701(i)–3 provides effective § 301.7701(i)–1 Definition of a taxable mortgage pool. dates. Section 301.7701(i)–4 provides spe- cial rules for certain entities. For pur- (a) Purpose. This section provides poses of the regulations under section rules for applying section 7701(i), which 7701(i), the term entity includes a por- defines taxable mortgage pools. The tion of an entity (within the meaning purpose of section 7701(i) is to prevent of section 7701(i)(2)(B)), unless the con- income generated by a pool of real es- text clearly indicates otherwise. tate mortgages from escaping Federal (c) Asset composition tests—(1) Deter- income taxation when the pool is used to issue multiple class mortgage- mination of amount of assets. An entity backed securities. The regulations in must use the Federal income tax basis this section and in §§ 301.7701(i)–2 of an asset for purposes of determining through 301.7701(i)–4 are to be applied whether substantially all of its assets in accordance with this purpose. The consist of debt obligations (or interests taxable mortgage pool provisions apply therein) and whether more than 50 per- to entities or portions of entities that cent of those debt obligations (or inter- qualify for REMIC status but do not ests) consist of real estate mortgages elect to be taxed as REMICs as well as (or interests therein). For purposes of to certain entities or portions of enti- this paragraph, an entity determines ties that do not qualify for REMIC sta- the basis of an asset with the assump- tus. tion that the entity is not a taxable (b) In general. (1) A taxable mortgage mortgage pool. pool is any entity or portion of an enti- (2) Substantially all—(i) In general. ty (as defined in § 301.7701(i)–2) that sat- Whether substantially all of the assets isfies the requirements of section of an entity consist of debt obligations 7701(i)(2)(A) and this section as of any (or interests therein) is based on all the testing day (as defined in § 301.7701(i)– facts and circumstances. 3(c)(2)). An entity or portion of an enti- (ii) Safe harbor. Notwithstanding ty satisfies the requirements of section paragraph (c)(2)(i) of this section, if 7701(i)(2)(A) and this section if substan- less than 80 percent of the assets of an tially all of its assets are debt obliga- entity consist of debt obligations (or tions, more than 50 percent of those interests therein), then less than sub- debt obligations are real estate mort- stantially all of the assets of the entity gages, the entity is the obligor under consist of debt obligations (or interests debt obligations with two or more ma- therein).
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(3) Equity interests in pass-through ar- it enhancement contract. An agree- rangements. The equity interest of an ment by a debt servicer to pay taxes entity in a partnership, S corporation, and hazard insurance premiums on trust, REIT, or other pass-through ar- property securing a debt obligation, or rangement is deemed to have the same other expenses incurred to protect an composition as the entity’s share of entity’s security interests in the col- the assets of the pass-through arrange- lateral in the event that the debtor ment. For example, if an entity’s stock fails to pay such taxes, insurance pre- interest in a REIT has an adjusted miums, or other expenses, is a credit basis of $20,000, and the assets of the enhancement contract. REIT consist of equal portions of real (5) Certain assets not treated as debt ob- estate mortgages and other real estate ligations—(i) In general. For purposes of assets, then the entity is treated as section 7701(i)(2)(A), real estate mort- holding $10,000 of real estate mortgages gages that are seriously impaired are and $10,000 of other real estate assets. not treated as debt obligations. Wheth- (4) Treatment of certain credit enhance- er a mortgage is seriously impaired is ment contracts—(i) In general. A credit based on all the facts and cir- enhancement contract (as defined in cumstances including, but not limited paragraph (c)(4)(ii) of this section) is to: the number of days delinquent, the not treated as a separate asset of an loan-to-value ratio, the debt service entity for purposes of the asset com- coverage (based upon the operating in- position tests set forth in section come from the property), and the debt- 7701(i)(2)(A)(i), but instead is treated as or’s financial position and stake in the part of the asset to which it relates. property. However, except as provided Furthermore, any collateral supporting in paragraph (c)(5)(ii) of this section, a credit enhancement contract is not no single factor in and of itself is deter- treated as an asset of an entity solely minative of whether a loan is seriously because it supports the guarantee rep- impaired. resented by that contract. (ii) Safe harbor—(A) In general. Unless (ii) Credit enhancement contract de- an entity is receiving or anticipates re- fined. For purposes of this section, a ceiving payments with respect to a credit enhancement contract is any ar- mortgage, a single family residential rangement whereby a person agrees to real estate mortgage is seriously im- guarantee full or partial payment of paired if payments on the mortgage are the principal or interest payable on a more than 89 days delinquent, and a debt obligation (or interest therein) or multi-family residential or commercial on a pool of such obligations (or inter- real estate mortgage is seriously im- ests), or full or partial payment on one paired if payments on the mortgage are or more classes of debt obligations more than 59 days delinquent. Whether under which an entity is the obligor, in an entity anticipates receiving pay- the event of defaults or delinquencies ments with respect to a mortgage is on debt obligations, unanticipated based on all the facts and cir- losses or expenses incurred by the enti- cumstances. ty, or lower than expected returns on (B) Payments with respect to a mort- investments. Types of credit enhance- gage defined. For purposes of paragraph ment contracts may include, but are (c)(5)(ii)(A) of this section, payments not limited to, pool insurance con- with respect to a mortgage mean any tracts, certificate guarantee insurance payments on the mortgage as defined contracts, letters of credit, guarantees, in paragraph (f)(2)(i) of this section if or agreements whereby an entity, a those payments are substantial and mortgage servicer, or other third party relatively certain as to amount and agrees to make advances (regardless of any payments on the mortgage as de- whether, under the terms of the agree- fined in paragraph (f)(2) (ii) or (iii) of ment, the payor is obligated, or merely this section. permitted, to make those advances). (C) Entity treated as not anticipating An agreement by a debt servicer to ad- payments. With respect to any testing vance to an entity out of its own funds day (as defined in § 301.7701(i)–3(c)(2)), an amount to make up for delinquent an entity is treated as not having an- payments on debt obligations is a cred- ticipated receiving payments on the
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mortgage as defined in paragraph least equal to 80 percent of the ad- (f)(2)(i) of this section if 180 days after justed issue price of the obligation at the testing day, and despite making the time the obligation was originated reasonable efforts to resolve the mort- (that is, the issue date). For purposes gage, the entity is not receiving such of this test, the fair market value of payments and has not entered into any the real property interest is first re- agreement to receive such payments. duced by the amount of any lien on the (d) Real estate mortgages or interests real property interest that is senior to therein defined—(1) In general. For pur- the obligation being tested, and is re- poses of section 7701(i)(2)(A)(i), the duced further by a proportionate term real estate mortgages (or inter- amount of any lien that is in parity ests therein) includes all— with the obligation being tested. (i) Obligations (including participa- (B) Alternative test. An obligation is tions or certificates of beneficial own- principally secured by an interest in ership therein) that are principally se- real property if substantially all of the cured by an interest in real property proceeds of the obligation were used to (as defined in paragraph (d)(3) of this acquire, improve, or protect an interest section); in real property that, at the origina- (ii) Regular and residual interests in tion date, is the only security for the a REMIC; and obligation. For purposes of this test, (iii) Stripped bonds and stripped cou- loan guarantees made by Federal, pons (as defined in section 1286(e) (2) state, local governments or agencies, and (3)) if the bonds (as defined in sec- or other third party credit enhance- tion 1286(e)(1)) from which such ment, are not viewed as additional se- stripped bonds or stripped coupons curity for a loan. An obligation is not arose would have qualified as real es- considered to be secured by property tate mortgages or interests therein. other than real property solely because (2) Interests in real property and real the obligor is personally liable on the property defined—(i) In general. The def- obligation. inition of interests in real property set forth in § 1.856–3(c) of this chapter and (ii) Obligations secured by real estate the definition of real property set forth mortgages (or interests therein), or by in § 1.856–3(d) of this chapter apply to combinations of real estate mortgages (or define those terms for purposes of para- interests therein) and other assets—(A) In graph (d) of this section. general. An obligation secured only by (ii) Manufactured housing. For pur- real estate mortgages (or interests poses of this section, the definition of therein), as defined in paragraph (d)(1) real property includes manufactured of this section, is treated as an obliga- housing, provided the properties qual- tion secured by an interest in real ify as single family residences under property to the extent of the value of section 25(e)(10) and without regard to the real estate mortgages (or interests the treatment of the properties under therein). An obligation secured by both state law. real estate mortgages (or interests (3) Principally secured by an interest in therein) and other assets is treated as real property—(i) Tests for determining an obligation secured by an interest in whether an obligation is principally se- real property to the extent of both the cured. For purposes of paragraph (d)(1) value of the real estate mortgages (or of this section, an obligation is prin- interests therein) and the value of so cipally secured by an interest in real much of the other assets that con- property only if it satisfies either the stitute real property. Thus, under this test set out in paragraph (d)(3)(i)(A) of paragraph, a collateralized mortgage this section or the test set out in para- obligation may be an obligation prin- graph (d)(3)(i)(B) of this section. cipally secured by an interest in real (A) The 80 percent test. An obligation property. This section is applicable is principally secured by an interest in only to obligations issued after Decem- real property if the fair market value ber 31, 1991. of the interest in real property (as de- (B) Example. The following example fined in paragraph (d)(2) of this sec- illustrates the principles of this para- tion) securing the obligation was at graph (d)(3)(ii):
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Example. At the time it is originated, an (ii) The Class C bonds and the Class D obligation has an adjusted issue price of bonds share credit risk unequally because of $300,000 and is secured by a $70,000 loan prin- the subordination feature. However, neither cipally secured by an interest in a single this difference, nor the difference in interest family home, a fifty percent co-ownership in- rates, causes the bonds to have different ma- terest in a $400,000 parcel of land, and $80,000 turities. The result is the same if, in addi- of stock. Under paragraph (d)(3)(ii)(A) of this tion to the other terms described in para- section, the obligation is treated as secured graph (i) of this Example 2, the Class C bonds by interests in real property and under para- are accelerated as a result of the issuer be- graph (d)(3)(i)(A) of this section, the obliga- coming unable to make payments on the tion is treated as principally secured by in- Class C bonds as they become due. terests in real property. (f) Relationship test—(1) In general. (e) Two or more maturities—(1) In gen- For purposes of section eral. For purposes of section 7701(i)(2)(A)(iii), payments on debt obli- 7701(i)(2)(A)(ii), debt obligations have gations under which an entity is the two or more maturities if they have obligor (liability obligations) bear a re- different stated maturities or if the lationship to payments (as defined in holders of the obligations possess dif- paragraph (f)(2) of this section) on debt ferent rights concerning the accelera- obligations an entity holds as assets tion of or delay in the maturities of the (asset obligations) if under the terms of obligations. the liability obligations (or underlying (2) Obligations that are allocated credit arrangement) the timing and amount risk unequally. Debt obligations that of payments on the liability obliga- are allocated credit risk unequally do tions are in large part determined by not have, by that reason alone, two or the timing and amount of payments or more maturities. Credit risk is the risk projected payments on the asset obli- that payments of principal or interest gations. For purposes of the relation- will be reduced or delayed because of a ship test, any payment arrangement, default on an asset that supports the including a swap or other hedge, that debt obligations. achieves a substantially similar result (3) Examples. The following examples is treated as satisfying the test. For illustrate the principles of this para- example, any arrangement where the graph (e): timing and amount of payments on li- Example 1. (i) Corporation M transfers a ability obligations are determined by pool of real estate mortgages to a trustee in reference to a group of assets (or an exchange for Class A bonds and a certificate index or other type of model) that has representing the residual beneficial owner- an expected payment experience simi- ship of the pool. All Class A bonds have a lar to that of the asset obligations is stated maturity of March 1, 2002, but if cash treated as satisfying the relationship flows from the real estate mortgages and in- vestments are sufficient, the trustee may se- test. lect one or more bonds at random and re- (2) Payments on asset obligations de- deem them earlier. fined. For purposes of section (ii) The Class A bonds do not have different 7701(i)(2)(A)(iii) and this section, pay- maturities. Each outstanding Class A bond ments on asset obligations include— has an equal chance of being redeemed be- (i) A payment of principal or interest cause the selection process is random. The on an asset obligation, including a pre- holders of the Class A bonds, therefore, have payment of principal, a payment under identical rights concerning the maturities of a credit enhancement contract (as de- their obligations. Example 2. (i) Corporation N transfers a fined in paragraph (c)(4)(ii) of this sec- pool of real estate mortgages to a trustee in tion) and a payment from a settlement exchange for Class C bonds, Class D bonds, at a discount (other than a substantial and a certificate representing the residual discount); beneficial ownership of the pool. The Class D (ii) A payment from a settlement at bonds are subordinate to the Class C bonds a substantial discount, but only if the so that cash flow shortfalls due to defaults settlement is arranged, whether in or delinquencies on the real estate mort- writing or otherwise, prior to the gages are borne first by the Class D bond holders. The terms of the bonds are other- issuance of the liability obligations; wise identical in all relevant aspects except and that the Class D bonds carry a higher coupon (iii) A payment from the foreclosure rate because of the subordination feature. on or sale of an asset obligation, but
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only if the foreclosure or sale is ar- § 301.7701–4(c) will not be treated as a ranged, whether in writing or other- debt obligation of the trust. wise, prior to the issuance of the liabil- (3) Examples. The following examples ity obligations. illustrate the principles of this para- (3) Safe harbor for entities formed to liq- graph (g): uidate assets. Payments on liability ob- Example 1. (i) Partnership P, in addition to ligations of an entity do not bear a re- its other investments, owns $10,000,000 of lationship to payments on asset obliga- mortgage pass-through certificates guaran- tions of the entity if— teed by FNMA (FNMA Certificates). On May (i) The entity’s organizational docu- 15, 1997, Partnership P transfers the FNMA ments manifest clearly that the entity Certificates to Trust 1 in exchange for 100 is formed for the primary purpose of Class A bonds and Certificate 1. The Class A bonds, under which Trust 1 is the obligor, liquidating its assets and distributing have a stated principal amount of $5,000,000 proceeds of liquidation; and bear a relationship to the FNMA Certifi- (ii) The entity’s activities are all rea- cates (within the meaning of § 301.7701(i)– sonably necessary to and consistent 1(f)). Certificate 1 represents the residual with the accomplishment of liqui- beneficial ownership of the FNMA Certifi- dating assets; cates. (iii) The entity plans to satisfy at (ii) On July 5, 1997, with a view to avoiding the application of section 7701(i), Partnership least 50 percent of the total issue price P transfers Certificate 1 to Trust 2 in ex- of each of its liability obligations hav- change for 100 Class B bonds and Certificate ing a different maturity with proceeds 2. The Class B bonds, under which Trust 2 is from liquidation and not with sched- the obligor, have a stated principal amount uled payments on its asset obligations; of $5,000,000, bear a relationship to the FNMA and Certificates (within the meaning of (iv) The terms of the entity’s liabil- § 301.7701(i)-1(f)), and have a different matu- ity obligations (or underlying arrange- rity than the Class A bonds (within the meaning of § 301.7701(i)-1(e)). Certificate 2 ment) provide that within three years represents the residual beneficial ownership of the time it first acquires assets to be of Certificate 1. liquidated the entity either— (iii) For purposes of determining whether (A) Liquidates; or Trust 1 is classified as a taxable mortgage (B) Begins to pass through without pool, the Commissioner can disregard the delay all payments it receives on its separate existence of Trust 2 and treat Trust asset obligations (less reasonable al- 1 and Trust 2 as a single trust. Example 2. (i) Corporation Q files a consoli- lowances for expenses) as principal dated return with its two wholly-owned sub- payments on its liability obligations in sidiaries, Corporation R and Corporation S. proportion to the adjusted issue prices Corporation R is in the business of building of the liability obligations. and selling single family homes. Corporation (g) Anti-avoidance rules—(1) In gen- S is in the business of financing sales of eral. For purposes of determining those homes. whether an entity meets the definition (ii) On August 10, 1998, Corporation S transfers a pool of its real estate mortgages of a taxable mortgage pool, the Com- to Trust 3, taking back Certificate 3 which missioner can disregard or make other represents beneficial ownership of the pool. adjustments to a transaction (or series On September 25, 1998, with a view to avoid- of transactions) if the transaction (or ing the application of section 7701(i), Cor- series) is entered into with a view to poration R issues bonds that have different achieving the same economic effect as maturities (within the meaning of that of an arrangement subject to sec- § 301.7701(i)–1(e)) and that bear a relationship (within the meaning of § 301.7701(i)-1(f)) to tion 7701(i) while avoiding the applica- the real estate mortgages in Trust 3. The tion of that section. The Commis- holders of the bonds have an interest in a sioner’s authority includes treating eq- credit enhancement contract that is written uity interests issued by a non-REMIC by Corporation S and collateralized with as debt if the entity issues equity in- Certificate 3. terests that correspond to maturity (iii) For purposes of determining whether classes of debt. Trust 3 is classified as a taxable mortgage pool, the Commissioner can treat Trust 3 as (2) Certain investment trusts. Notwith- the obligor of the bonds issued by Corpora- standing paragraph (g)(1) of this sec- tion R. tion, an ownership interest in an entity Example 3. (i) Corporation X, in addition to that is classified as a trust under its other assets, owns $110,000,000 in Treasury
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securities. From time to time, Corporation X Partnership L, in addition to its other as- acquires pools of real estate mortgages, sets, owns $20,000,000 in notes that are prin- which it immediately uses to issue multiple- cipally secured by interests in single family class debt obligations. homes and $3,500,000 in notes that are prin- (ii) On October 1, 1996, Corporation X trans- cipally secured by interests in personal prop- fers $20,000,000 in Treasury securities to erty. Trust 4 in exchange for Class C bonds, Class (ii) On December 1, 1995, Partnership L D bonds, Class E bonds, and Certificate 4. asks Corporation Z for two separate loans, Trust 4 is the obligor of the bonds. The dif- one in the amount of $9,375,000 and another ferent classes of bonds have the same stated in the amount of $625,000. Partnership L of- maturity date, but if cash flows from the fers to collateralize the $9,375,000 loan with Trust 4 assets exceed the amounts needed to $10,312,500 of notes secured by interests in make interest payments, the trustee uses single family homes and the $625,000 loan the excess to retire the classes of bonds in al- with $750,000 of notes secured by interests in phabetical order. Certificate 4 represents the personal property. Corporation Z has made residual beneficial ownership of the Treasury securities. similar loans to Partnership L in the past. (iii) With a view to avoiding the applica- (iii) With a view to avoiding the applica- tion of section 7701(i), Corporation X reserves tion of section 7701(i), Corporation Z induces the right to replace any Trust 4 asset with Partnership L to accept a single $10,000,000 real estate mortgages or guaranteed mort- loan and to post as collateral $7,500,000 of the gage pass-through certificates. In the event notes secured by interests in single family the right is exercised, cash flows on the real homes and all $3,500,000 of the notes secured estate mortgages and guaranteed pass- by interests in personal property. Ordinarily, through certificates will be used in the same Corporation Z would not make a loan on manner as cash flows on the Treasury securi- these terms. Thereafter, the loan to Partner- ties. Corporation X exercises this right of re- ship L, together with the $3,000,000 in notes placement on February 1, 1997. secured by interests in retail shopping cen- (iv) For purposes of determining whether ters, are transferred to Trust 6 and used to Trust 4 is classified as a taxable mortgage issue bonds that have different maturities pool, the Commissioner can treat February (within the meaning of § 301.7701(i)–1(e)) and 1, 1997, as a testing day (within the meaning that bear a relationship (within the meaning of § 301.7701(i)-3(c)(2)). The result is the same of § 301.7701(i)–1(f)) to the loans secured by in- if Corporation X has an obligation, rather terests in retail shopping centers and the than a right, to replace the Trust 4 assets loan to Partnership L. with real estate mortgages and guaranteed (iv) For purposes of determining whether pass-through certificates. Trust 6 is a taxable mortgage pool, the Com- Example 4. (i) Corporation Y, in addition to missioner can treat the $10,000,000 loan to its other assets, owns $1,900,000 in obligations Partnership L as consisting of a $9,375,000 ob- secured by personal property. On November ligation secured by interests in real property 1, 1995, Corporation Y begins negotiating a and a $625,000 obligation secured by interests $2,000,000 loan to individual A. As security in personal property. Under § 301.7701(i)– for the loan, A offers a first deed of trust on 1(d)(3)(ii)(A), the notes secured by single land worth $1,700,000. family homes are treated as $7,500,000 of in- (ii) With a view to avoiding the application terests in real property. Under § 301.7701(i)– of section 7701(i), Corporation Y induces A to 1(d)(3)(i)(A), $7,500,000 of interests in real place the land in a partnership in which A property are sufficient to treat a $9,375,000 will have a 95 percent interest and agrees to obligation as principally secured by an inter- accept the partnership interest as security est in real property ($7,500,000 equals 80 per- for the $2,000,000 loan. Thereafter, the loan to cent of $9,375,000). A, together with the $1,900,000 in obligations secured by personal property, are transferred [T.D. 8610, 60 FR 40088, Aug. 7, 1995; 60 FR to Trust 5 and used to issue bonds that have 49754, Sept. 27, 1995] different maturities (within the meaning of § 301.7701(i)-1(e)) and that bear a relationship § 301.7701(i)–2 Special rules for por- (within the meaning of § 301.7701(i)-1(f)) to tions of entities. the $1,900,000 in obligations secured by per- sonal property and the loan to A. (a) Portion defined. Except as provided (iii) For purposes of determining whether in paragraph (b) of this section and Trust 5 is a taxable mortgage pool, the Com- § 301.7701(i)–1, a portion of an entity in- missioner can treat the loan to A as an obli- cludes all assets that support one or gation secured by an interest in real prop- more of the same issues of debt obliga- erty rather than as an obligation secured by an interest in a partnership. tions. For this purpose, an asset sup- Example 5. (i) Corporation Z, in addition to ports a debt obligation if, under the its other assets, owns $3,000,000 in notes se- terms of the debt obligation (or under- cured by interests in retail shopping centers. lying arrangement), the timing and
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amount of payments on the debt obli- complex and $90,000,000 of real estate mort- gation are in large part determined, ei- gages. ther directly or indirectly, by the tim- (ii) On November 30, 1998, Corporation Z ing and amount of payments or pro- issues eight classes of bonds, Class A through Class H. Each class is secured by a separate jected payments on the asset or a letter of credit and by a lien on the office group of assets that includes the asset. complex. One group of the real estate mort- Indirect payment arrangements in- gages supports Class A through Class D, an- clude, for example, a swap or other other group supports Class E through Class hedge, or arrangements where the tim- G, and a third group supports Class H. It is ing and amount of payments on the anticipated that the cash flows from each debt obligations are determined by ref- group of mortgages will service its related bonds. erence to a group of assets (or an index (iii) Each of the following constitutes a or other type of model) that has an ex- separate portion of Corporation Z: the group pected payment experience similar to of mortgages supporting Class A through that of the assets. For purposes of this Class D; the group of mortgages supporting paragraph, the term payments includes Class E through Class G; and the group of all proceeds and receipts from an asset. mortgages supporting Class H. No other (b) Certain assets and rights to assets asset is included in any of the three portions notwithstanding the lien of the bonds on the disregarded—(1) Credit enhancement as- office complex and the fact that Corporation sets. An asset that qualifies as a credit Z is the issuer of the bonds. The letters of enhancement contract (as defined in credit are treated as incidents of the mort- § 301.7701(i)–1(c)(4)(ii)) is not included in gages to which they relate. a portion as a separate asset, but is (iv) For purposes of section 7701(i)(2)(A)(ii), treated as part of the assets in the por- each portion described above is treated as tion to which it relates under the obligor of the bonds of that portion, not- § 301.7701(i)–1(c)(4)(i). An asset that does withstanding the fact that Corporation Z is the legal obligor with respect to the bonds. not qualify as a credit enhancement contract (as defined in § 301.7701(i)– [T.D. 8610, 60 FR 40091, Aug. 7, 1995] 1(c)(4)(ii)), but that nevertheless serves the same function as a credit enhance- § 301.7701(i)–3 Effective dates and du- ration of taxable mortgage pool ment contract, is not included in a por- classification. tion as a separate asset or otherwise. (2) Assets unlikely to service obligations. (a) Effective dates. Except as other- A portion does not include assets that wise provided, the regulations under are unlikely to produce any significant section 7701(i) are effective and applica- cash flows for the holders of the debt ble September 6, 1995. obligations. This paragraph applies (b) Entities in existence on December 31, even if the holders of the debt obliga- 1991—(1) In general. For transitional tions are legally entitled to cash flows rules concerning the application of sec- from the assets. Thus, for example, tion 7701(i) to entities in existence on even if the sale of a building would December 31, 1991, see section 675(c) of cause a series of debt obligations to be the Tax Reform Act of 1986. redeemed, the building is not included (2) Special rule for certain transfers. A in a portion if it is not likely to be transfer made to an entity on or after sold. September 6, 1995, is a substantial (3) Recourse. An asset is not included transfer for purposes of section 675(c)(2) in a portion solely because the holders of the Tax Reform Act of 1986 only if— of the debt obligations have recourse to (i) The transfer is significant in the holder of that asset. amount; and (ii) The transfer is connected to the (c) Portion as obligor—(1) In general. entity’s issuance of related debt obliga- For purposes of section 7701(i)(2)(A)(ii), tions (as defined in paragraph (b)(3) of a portion of an entity is treated as the this section) that have different matu- obligor of all debt obligations sup- rities (within the meaning of § 301.7701– ported by the assets in that portion. 1(e)). (2) Example. The following example il- (3) Related debt obligation. A related lustrates the principles of this section: debt obligation is a debt obligation Example. (i) Corporation Z owns whose payments bear a relationship $1,000,000,000 in assets including an office (within the meaning of § 301.7701–1(f)) to
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payments on debt obligations that the meaning of section 115. A governmental entity holds as assets. purpose does not include the mere (4) Example. The following example il- packaging of debt obligations for re- lustrates the principles of this para- sale on the secondary market even if graph (b): any profits from the sale are used in Example. On December 31, 1991, Partnership the performance of an essential govern- Q holds a pool of real estate mortgages that mental function. it acquired through retail sales of single (3) Determinations by the Commissioner. family homes. Partnership Q raises If an entity is not described in para- $10,000,000 on October 25, 1996, by using this pool to issue related debt obligations with graph (a)(1) of this section, but has a multiple maturities. The transfer of the similar purpose, then the Commis- $10,000,000 to Partnership Q is a substantial sioner may determine that the entity transfer (within the meaning of § 301.7701(i)– is not classified as a taxable mortgage 3(b)(2)). pool. (c) Duration of taxable mortgage pool (b) REITs. [Reserved] classification—(1) Commencement and (c) Subchapter S corporations—(1) In duration. An entity is classified as a general. An entity that is classified as a taxable mortgage pool on the first test- taxable mortgage pool may not elect to ing day that it meets the definition of be an S corporation under section a taxable mortgage pool. Once an enti- 1362(a) or maintain S corporation sta- ty is classified as a taxable mortgage tus. pool, that classification continues (2) Portion of an S corporation treated through the day the entity retires its as a separate corporation. An S corpora- last related debt obligation. tion is not treated as a member of an (2) Testing day defined. A testing day affiliated group under section is any day on or after September 6, 1995, on which an entity issues a re- 1361(b)(2)(A) solely because a portion of lated debt obligation (as defined in the S corporation is treated as a sepa- paragraph (b)(3) of this section) that is rate corporation under section 7701(i). significant in amount. [T.D. 8610, 60 FR 40092, Aug. 7, 1995] [T.D. 8610, 60 FR 40092, Aug. 7, 1995] § 301.7704–2 Transition provisions. § 301.7701(i)–4 Special rules for certain See the regulations under section entities. 7704 contained in part 1 of this chapter (a) States and municipalities—(1) In for a definition of the ‘‘substantial new general. Regardless of whether an enti- line of business’’ that an ‘‘existing’’ ty satisfies any of the requirements of publicly traded partnership cannot section 7701(i)(2)(A), an entity is not enter without forfeiting its partnership classified as a taxable mortgage pool status under the transition provisions if— applicable to section 7704. (i) The entity is a State, territory, a possession of the United States, the [T.D. 8450, 57 FR 58710, Dec. 11, 1992] District of Columbia, or any political subdivision thereof (within the mean- General Rules ing of § 1.103–1(b) of this chapter), or is empowered to issue obligations on be- APPLICATION OF INTERNAL REVENUE half of one of the foregoing; LAWS (ii) The entity issues the debt obliga- tions in the performance of a govern- § 301.7803–1 Security bonds covering mental purpose; and personnel of the Internal Revenue (iii) The entity holds the remaining Service. interests in all assets that support those debt obligations until the debt For regulations relating to the pro- obligations issued by the entity are re- curement of security bonds covering tired. designated personnel of the Internal (2) Governmental purpose. The term Revenue Service between January 1, governmental purpose means an essen- tial governmental function within the
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